Hint: Striking the balance between overstocking and understocking should not always be a guessing game.
Inventory planning inherently comes with a lot of uncertainty. A change in market conditions could tip the scale – and you could find yourself with an excess of inventory or struggling to keep up with demand. While it is very unlikely that you’ll be able to predict demand perfectly, the key to winning the demand forecasting and inventory planning game lies with creating a repeatable, data-driven process.
Effective inventory management or control is arguably at the heartbeat of any supply chain. Physical inventory can be in the form of Raw Material, Work in Progress (WIP), Sub-assemblies, Packaging Material, and Finished Goods. Inventory management if left unchecked, can lead to financial losses due to inefficiencies. This eventually leads to mammoth clean-up challenges for any organization. For typical businesses, Inventories can easily represent 65 to 70 percent of total working capital and current assets.
In my upcoming webinar on “Striking the Balance Between Overstocking and Understocking,” I will discuss how to use the Arkieva Inventory planning solution to create an effective inventory control process by calculating target stock levels, creating the right inventory policies, using demand segmentation to prioritize your important products.
In this blog post, I will cover some of the fundamental elements of creating a multi-faceted inventory management process.
What is Inventory Planning?
Inventory Planning can be defined as the supply chain process which deals with determining the optimum level of inventory, timing, and location of inventory, with the purpose of aligning all inventories with the sales plan and production capacity. Inventory Planning has a direct impact on the cash flow, working capital, profit margin, resource capacity utilization and customer service levels of any organization.
Basic Models of Inventory Planning
The fundamental Inventory Planning process consists of three traditional approaches as outlined below:
- EOQ – Economic Order Quantity:
The concept of Economic Ordering Quantity was first developed by F. Harris in 1916 and outlines that Management is confronted with a set of opposing costs depending on the lot size. For increasing lot size, the carrying charges will increase while the ordering cost will decrease, and vice versa. The EOQ is that size of order which minimizes the total cost of carrying inventory and the cost of ordering under the condition of known demand.
- Continuous Order Model:
The Continuous Order Model works on the basic functioning of safety stock level, re-ordering level and re-order quantity. This model triggers a fixed quantity replenishment order, whenever the inventory level reaches the defined safety stock level or re-order level.
- Periodic Review System Model:
The Periodic Review System Model works on the agreed practice of reviewing the inventory levels at fixed time intervals and placing orders thereafter. This model can be applied to stable businesses with limited SKUs and known steady demand.
Objectives of Inventory Planning
Following are the key objectives of Inventory Planning process:
- Increasing customer service levels
- Improving cash flow cycle
- Reduction in working capital requirements
- Increasing Supply Chain efficiency and responsiveness
- Avoiding inventory loss due to obsolescence
- Increasing resource capacity utilization
What is Inventory Control?
Inventory Control is defined as the supervision of supply, storage, and accessibility of inventories on order. Inventory Control ensures the timely supply of items required with minimal risk of stock-out and excessive supplies.
Objectives of Inventory Control
The following are the key objectives of an Inventory Control process:
- Safeguard against fluctuations in customer demand
- Optimized and balanced utilization of available resources
- Protection against fluctuations in supplier deliveries and manufacturing output
- Control and maintenance of inventory levels across the Supply Chain
Following are the vital signs that indicate the absence or lack of proper Inventory Planning and Control in your organization:
- Overstocking of raw material, packaging material, and finished goods
- Frequent shortage of required inventories and stock out situations
- Increasing open orders and backorders of customers
- Reduction in customer service levels
- Increase in the obsolescence of inventories due to expiry or seasonality
- Increase in inventory pilferage and mismatches during cycle counting
- Increase in working capital requirement and reduced cash flow
- Increase in non-utilization of available resources
Identifying Risky Inventory
A key cost reduction technique in inventory management is to identify and remove dead or obsolete inventory. Having more inventory than needed can slowly reduce your cash on hand. To prevent this, it’s essential to create a process for identifying issues before they start affecting bottom-line results. In our blog post on “Three Simple Analyses for Identifying Risky Inventory,” we discuss some of these inventory management techniques in great detail namely:
Match ABC classification on your demand items to your inventory positions
Using this method, you create a classic Pareto or ABC analysis on your item demand over the last 12 months. The classic percent split is 80-15-5 but feel free to tweak it. Now, add up all the inventory on items that fall in the A category. Repeat for B and C categories.
Analyze Order Count
Suppose you have items that you sell every day of the month, multiple times a day. You likely have these items’ inventory profile in your memory and very likely do a good job of managing these ‘top-of-the-mind’ inventory items. In any case, this inventory is less risky because there is a good chance that you will get ample opportunities to work it out of the system. The one risk it does have is the following: because it is such a popular seller, your procurement strategy might be to acquire large quantities in one go. Find out what percentage of your items have low order counts per period. How much inventory do you have on those items?
Analyze Your Customer Count
Similarly, how many distinct customers buy your items across time periods? If there are many that do, you will likely have a significant number of orders. So, the risk involved with the inventory is low and is just like the risk involved with the case above with a lot of orders. Find out what percentage of your items have low customer counts. How much inventory do you have on those items?
In the end, inventory management is a delicate balancing act. One that requires a careful data-driven execution process that creates a balance between your service level goals and excess reduction. During my webinar, I’ll share techniques that we’ve learned along the way that have helped many of our customers create a better balance. At last, it’s not about having the perfect inventory count. The balance is more about creating a continuous improvement culture and commitment throughout your organization.