Making sure inventory levels are managed properly is crucial to scale your business effectively. Reducing stock-outs and overstocks can reduce your total inventory costs by 10 percent. So, you need to monitor your inventory levels closely to save money rather than lose it. Retaining the right inventory levels is a critical management tool, whatever your business type.
Inventory is the backbone of any business and is essential if you want yours to run cost-effectively. You need to be able to rely on accurate inventory levels to operate and fulfill customer orders and ensure you aren’t overstocking. Equally, if you don’t have enough stock, you may face stockouts, which leads to delays in your company’s order fulfillment.
Scaling your ecommerce store? At Upscribe, we want to help prevent everyday inventory management problems while you do so. In this article, we’ll explore what inventory levels are and why maintaining adequate levels of inventory is imperative to your business. Let’s get started
What Are Inventory Levels?
The term ‘inventory levels’ means how much stock you have across your distribution center, on any occasion, to fulfill frequent demand for your products. If you keep tabs on what’s available in stock, you’ll always meet demand rather than accumulating needless holding costs that reduce gross profits.
If your inventory levels are short, you won’t have sufficient inventory to fulfill all the demand that comes your way. The result? You’ll experience a stockout. When you’re out of stock, you won’t see any income and sales – you’ll need to sell your products on backorder.
On the other hand, having an excessive amount of stock entails a substantial up-front capital investment. The more time your products spend in your warehouse, the more carrying costs you’ll accumulate. And the more chance they’ll become dead stock. By the time you sell these products, their margins will have declined, meaning you won’t make much profit.
Why Is Maintaining Adequate Inventory Levels Imperative?
Ideally, you want a happy medium between too much and too little inventory. And so, you achieve optimum inventory levels and only carry units guaranteed to sell. Optimal inventory levels indicate profitability and efficiency across your ecommerce logistics network.
Maintaining adequate levels of inventory is paramount because:
You’ll Experience Fewer Missed Sales
Stockouts can cost businesses roughly $1 trillion annually. If you don’t maintain your inventory, you may run out of products – thus, missing out on sales. Rather than make a trip to your warehouse or rely on your memory to select what to order, use an efficient stock report to see what products you’re running short of instantly.
You’ll Invest Your Cash Wisely
Maintaining sufficient levels of inventory means better-invested cash, as you’re purchasing the right amount of each product. That means you’ll only be keeping the optimum quantity that keeps your sales going and prevents stock-outs. But not so much that your products just sit forlornly on the shelf.
You’ll Detect Issues Early
If you monitor your inventory levels closely, you’ll identify issues quickly. This is much better than discovering a problem later down the line in the midst of a yearly stock outtake, when they may have already cost you a considerable amount of money.
How to Ascertain the Optimum Levels of Inventory
Want to ascertain the optimum inventory level? Make sure you carry out a few thorough calculations – look back over what you ordered in the past. What products sold well? Which ones didn’t? Also, you may need to consider when your inventory needs reordering, so your items arrive promptly for your supplier. This will also help you meet clients’ orders on time..
Check out our Upscribe reorder feature. It offers a built-in button that enables existing customers to buy again in as little as a single click – they won’t feel as if they’re tied into something they don’t want or need. Small things like this help to streamline a customer’s shopping experience, which is crucial for customer retention.
Let’s go through some different methods for maintaining an optimum inventory level:
Safety stock means any further inventory your company has saved for exceptional circumstances. For example, there may be a time when there’s a delay in the production of products. Or an abrupt increase in orders. Be sure to consider the following points when figuring out the safety stock:
- Greatest lead time
- Greatest daily usage
- Typical lead time
- Typical daily usage
Order Placement and Manufacture Completion
Determining the optimum levels of inventory also depends on the time frame between when you place a purchase order and the supplier completing the order (production lead times). If you have a particularly good understanding of inventory production lead times, you’ll be able to make educated choices on behalf of your company.
For instance, you’ll know how to keep the right level of inventory and how much inventory needs reordering. How many goods you stock at a certain time is also affected by the length of time it takes your manufacturer or supplier to convert unprocessed material into the completed product following the order placement.
How To Determine Minimum And Maximum Inventory Level
Want to work out your maximum inventory levels? Establish where your minimum and maximum stock levels are. This isn’t too tricky to do – you just need to determine:
- The point at which you need to restock your inventory to avoid shortage (reorder point).
- The most profitable quantity of inventory you need to buy at a given time (optimal order quantity/economic order quantity).
- The smallest amount of demand you can foresee during a specific length of time (minimum consumption).
- The typical predicted demand (based on previous sales) you foresee during that same length of time (normal consumption)
- The least amount of time it’ll involve to obtain your replenishment at your warehouse following PO placement (minimum order lead time).
- The typical length of time involved in obtaining your replenishment at your warehouse (normal delivery time)
As soon as you have these figures to hand, it’s time to work out your inventory levels.
Working Out Your Minimum Inventory Levels
To figure out your minimum inventory levels, you’ll need to use the below formula:
- Minimum inventory level = reorder point – [normal consumption × normal delivery time]
Let’s say you’re a sneaker retailer, and your reorder point is 5,000 sneakers. Your delivery time is four weeks, and the normal consumption of these sneakers is 1,200 units every calendar week.
- Minimum inventory level = 5,000 sneakers – (800 sneakers per week × 4 weeks) = 1,800
So, in this case, your minimum inventory level is 1,800 sneakers.
Working Out Your Maximum Inventory Levels
Work out your maximum inventory levels using the below maximum inventory level formula:
- Maximum inventory levels = reorder point + reorder quantity – [minimum consumption × minimum lead time].
Refer back to the sneaker example above. Your reorder point is still 5,000 sneakers, while your reorder quantity is normally 10,000 sneakers. Your minimum consumption is 500 sneakers a week, whereas your maximum lead time sticks at around four weeks.
- Maximum inventory levels = 5,000 sneakers + 10,000 sneakers – (500 shirts × 4 weeks) = 13,000
So, your maximum inventory level would be 13,000 sneakers.
Figuring Out Optimum Levels of Inventory
Somewhere in between your minimum and maximum inventory levels sit your optimal levels. It’s crucial to work out this number to maintain optimal inventory levels. That said, working out what your optimal levels are is a little more complicated – it doesn’t just involve typing numbers into a formula. Really, it hinges on the real-time inventory statistics and growth assumptions your demand predictions depend on.
Given that these factors are continuously changing, figuring out the precise optimal stock levels is complex. It can be laborious and untrustworthy to work out this number using spreadsheets. The most accurate way to calculate this is by using an inventory management application.
Optimal Inventory Level Formula
Whilst it is true that figuring out optimum levels of inventory takes more than adding numbers into a formula, there are a number of formulas that you can use to identify optimal inventory levels.
Economic Order Quantity (EOQ) formula
Calculates the optimal order quantity that minimizes total inventory costs, including ordering costs and holding costs.
EOQ = √(2DS/H)
D = Annual demand for the product
S = Ordering cost per order
H = Holding cost per unit per year
So, let’s say you sell a total of 500 sneakers per year. It costs your company $5 to hold a pair of sneakers per year, with a $1.50 ordering charge. That means your equation will look something like this:
√(2x500x1.50/5) = 17.3 (Be sure to round up or down)
So, that means the optimum amount of stock to keep up with customer demand, but keep prices down is just over 17 pairs of sneakers.
Reorder Point (ROP) formula
This formula calculates the minimum inventory level at which a reorder should be triggered to avoid stockouts.
ROP = Lead time demand + Safety stock
Lead time demand = Average daily demand x Lead time
Safety stock = Z-score x Standard deviation of lead time demand x √Lead time
Calculating ROP would require a whole article by itself, as it requires you to formulate each of the independent variables by themselves. Instead, check out this guide on reorder point formula.
Service Level formula
The service level formula calculates the probability of not running out of stock during a given lead time, also known as the service level.
Service level = 1 – (Probability of stockout)
Probability of stockout = Z-score x Standard deviation of lead time demand / Mean lead time demand
Z-score is the number of standard deviations from the mean, and its value depends on the desired service level and the normal distribution of demand.
Again, calculating service level formula can be complex, and it’s a subject we won’t go into too much detail here. However you can check out this guide on optimal service levels to see you through!
6 Tips for Maintaining Optimal Inventory Levels
Each ecommerce business needs a distinctive inventory management scheme to record inventory effectively. That said, we’ve pulled together some top tips for maintaining optimal inventory levels:
1. Use a Subscription Service
Subscriptions are a predictable form of revenue and a great way to maintain optimal inventory levels. Numerous ecommerce stores can be somewhat inconsistent each month due to fluctuating conversions and traffic. But when you implement subscriptions for your ecommerce business, you’ll be able to predict accurately, as you’ll have more of an idea of how much revenue you’ll generate each month.
When you can predict your revenue, planning your inventory levels is more effortless. You know what items will sell in a certain month or quarter, making it simpler to plan your inventory.
2. Talk Clearly to Manufacturers
Tell your suppliers explicitly about your new goods plan and what you expect – this is the secret to maintaining optimal inventory. Also, you need to know about any shutdowns your supplier has planned, like factory closures and vacations.
The secret to a successful inventory management strategy is being aware of your manufacturer’s processes. Manufacturers are a pivotal part of your logistics network, so you must track their performance.
3. Introduce an Inventory Tracking System
If you know the number of stock-keeping units (SKUs) are situated at each geographical site, you’ll no doubt boost stock control throughout your distribution channels. Inventory tracking systems provide real-time access to stock levels across sales networks and logistics centers, enabling you to maintain your optimal inventory levels.
4. Introduce a Just-In-Time Inventory System
As the name suggests, JIT is a system where inventory is ordered so as to be received just in time to execute the sale of the product.
JIT helps to reduce the costs associated with holding excess inventory and goes a long way to optimizing inventory levels.
5. Consider Dropshipping
Dropshipping is a method of retail fulfilment in which a company doesn’t hold the products it sells in stock as inventory.
Instead, when a store sells a product, it purchases the item from a third party and has it shipped directly to the customer.
Adding dropshipping to your business enables you to reduce the cost of holding inventory whilst still fulfilling your customer orders promptly.
6. Optimize Your Warehouse/Storage Space
Quite simply, many businesses operate with a storage facility that is larger than they actually need. Consequently, they end up paying fees like rent and insurance far beyond what is actually required for the business to operate.
7. Be Proactive
Being proactive, rather than reactive, is a large part of ensuring your business can meet future demands and challenges without suffering from losses that could have been foreseen.
Monitoring market trends, such as industry developments like supply-chain issues, for instance, will allow businesses to forecast future demand and make informed, appropriate decisions around inventory accordingly.
By pre-empting the issue a business gives itself a much high probability of coming out unscathed on the other side.
Inventory Levels FAQs
In this section, we give the answers to the most frequently searched questions relating to inventory levels and inventory management.
What Factors May Have Determined the Size of the Maximum Inventory Level?
- Demand variability: The more the demand for a product varies, the higher the maximum inventory level is needed to ensure there’s sufficient inventory to meet demand, especially during peak periods.
- Lead time: The longer the lead time for a product (the time between ordering new stock and receiving it), the higher the maximum inventory level needs to be to account for the time it takes to receive new inventory.
- Safety stock: The amount of safety stock a business keeps on hand impacts the size of the maximum inventory level.
- Holding costs: Holding costs refer to the cost of storage, insurance, and other expenses incurred when holding stock. The higher the holding costs, the lower the maximum inventory level should be to minimize the cost of holding excess inventory.
- Order costs: Order costs refer to the cost of placing and receiving orders. The lower the order costs, the smaller the maximum inventory level can be because it is more cost-effective to place smaller orders more frequently.
- Capital constraints: Businesses with limited capital may need to keep lower inventory levels to avoid tying up too much capital in inventory.
- Seasonal demand: If a product has seasonal demand patterns, the maximum inventory level may need to be adjusted from time to time to ensure that there is enough inventory to meet demand during peak seasons.
In What Circumstances Would You Have to Check Inventory Levels?
There are various drivers that make it necessary to check inventory levels to ensure the health of your business. Some of these include
- Reorder point: When the inventory level of a product falls below the reorder point, it is time to restock. Regular inventory checks can help businesses ensure that they are not caught off guard by stockouts and can reorder stock in a timely manner.
- Sales forecasting: Checking inventory levels regularly is essential in enabling businesses to forecast future sales. By tracking inventory levels over time, businesses can identify trends in demand and adjust their inventory levels to meet that demand.
- Seasonal demand: Much the same as with the determination of maximum inventory levels (above), businesses whose inventory trades seasonally may need to check inventory levels more frequently to ensure that they have enough inventory to meet demand during peak seasons.
- Supply chain disruptions: When there are disruptions in the supply chain, such as delays or shortages, businesses may need to check inventory levels more frequently to ensure that they have enough inventory to meet demand. Supply chain disruption was one of the significant causes of business failure during the recent global pandemic and should serve as a clear lesson for inventory management practices.
Tracking your inventory levels and knowing what you have available prevents under and overstocking. This means you have more time to concentrate on keeping your customers happy and expanding your business. You’ll also be able to maintain optimum stock levels and prevent out of stocks entirely.
Are you a high-growth brand in need of a comprehensive subscription solution? We at Upscribe don’t merely manage your subscriptions – we go beyond the basics to empower you to grow your ecommerce business. We help you rebuild a subscription platform from your subscriber’s point of view and equip you with the data and tools to make high ROI choices. Why not schedule a demo today?