How To Optimise Stock Levels In Your Business

How To Optimise Inventory Levels

Optimising Inventory Levels Saves Cash

Optimising your stock (inventory) levels is an often overlooked way to free up cash. By optimising stock levels, you can reduce the size of your next order, resulting in cash savings

How To Optimise Inventory Levels

Your objective for optimising the stock level of a particular product, is to ensure that you have enough stock to meet customer demand while avoiding excess stock that ties up your cash.

Calculating Optimum Inventory Levels

In order to calculate your optimum stock level, one key strategy is to use historical Sales data to predict future demand. You can then use this future demand to calculate your stock levels accordingly (remembering to also adjust your stock level based on factors like seasonality, demand trends and product availability).

Strategies To Optimise Inventory levels

Other key strategies to ensure optimum stock levels include maintaining good
relationships with your suppliers, monitoring their lead times (the time from order to delivery) and establishing adequate safety stock levels to account for any unforeseen demand spikes or supply chain disruptions. 

Safety Stock Buffers

These safety stock buffers can be held either by yourselves or your supplier, it’s worth noting that it’s much cheaper if your supplier pays to hold some of your safety stock.

Just-In-Time Inventory Management

Another option worth exploring is Just-in-time inventory management. This was first adopted and perfected in Japan in the early 1970’s. The idea of Just-in-time inventory management marked a radical new approach to the manufacturing process, cutting waste and increasing cash flow by supplying parts only as and when they were required.

The old system became known as the just-in-case management system, where
inventory was held for every possible eventuality, just in case it arose.

Toyota pioneered the Just-in-time inventory management method. The introduction of this method helped the automotive manufacturer to reduce waste, improve efficiency, increase productivity and boost cash flow.

Although Just-in-time inventory management was first developed in Japan, the concept of producing only what is needed, when it is needed, can be traced back to Henry Ford's production line.

So essentially Just-in-time inventory management involves ordering your stock such that it arrives just in time to meet demand, reducing the amount of inventory your company holds and freeing up cash that would otherwise be tied up in inventory.

The Just-in-time inventory management method involves working very closely with your suppliers, to ensure impeccable service levels are retained for your customers.

Inventory Management Systems

Keeping track of your stock levels can be tough, depending on the volume of your stock.

Utilizing inventory management software resellers can help you keep track of your stock levels in real-time, thereby helping you to identify slow-moving or obsolete items and to set up automated reorder points to prevent stock-outs.

If you don't have inventory management software, you can still calculate optimum stock levels manually. Let’s work through an example together so you can see for yourself, how optimising your stock (or raw material) levels can help make cash remain in your bank account instead of your supplier’s.

How To Calculate Optimum Stock Levels

Here you'll learn when it’s the right time to reorder more stock.

To achieve this, calculate the optimum amount of stock to hold at your reorder point. The reorder point is the stock level at which you need to place an order, to replenish your stock. It’s calculated as the lead time demand plus safety stock:

OPTIMUM STOCK LEVEL AT REORDER POINT = LEAD TIME DEMAND + SAFETY STOCK

Lead Time

Lead time is the time it takes from you placing an order to you receiving the goods or services.

Lead Time Demand

Lead time demand is the average number of units sold during the lead time.

Safety Stock

Safety stock is the extra stock you hold on hand, to ensure you don’t run out of stock and lose out on sales, due to unforeseen demand spikes or delays in replenishment.

Sales History

For us to start calculating optimum stock levels, we should first calculate how many units of a particular stock item are being sold per day.

To do this, we look at your sales history. We take the total units sold of that particular item over the previous 3 months and divide that by the total number of days in that 3 month period. This gives us your average units sold per day.

UNITS SOLD PER DAY = UNITS SOLD OVER THE LAST 3 MONTHS / 90 DAYS

(Note, to calculate the Units Sold Over The Last 3 Months, if this is not easily available,you can calculate it as follows: Sales Value over the last 3 months / Selling Price per Unit)

Lead Time Demand

We can now use these Units Sold Per Day to calculate our Lead Time Demand by
multiplying the Units Sold Per Day by the Lead Time (the number of days from placing an order to receiving the goods).

UNITS SOLD PER DAY x LEAD TIME = LEAD TIME DEMAND

Calculating Optimum Stock Level At Reorder Point

We then add our safety stock in units (to account for any delivery delays or demand spikes), which gives us our Optimum Stock Level at Reorder Point.

OPTIMUM STOCK LEVEL AT REORDER POINT = LEAD TIME DEMAND + SAFETY STOCK

How To Calculate Optimum Stock Level - Example

Let’s go through an example together to see how it works:

Example Showing How To Optimise Stock Levels in Your Business

In this example, the company has chosen to calculate the optimum stock level for a product that has a Cost Price per Item of 1000. They have 250 units of this product in stock. So their Stock on Hand (Inventory Value) amounts to 250 units x 1000 = 250K.

They calculated their Units Sold per Day by looking at their sales history over the last 90 days.

Over the last 90 days, they sold 900 units at a selling price of 2000 per unit, so total Sales Value is 900 * 2000 = 1,800,000.

To calculate the Average Number of Units Sold per day we divide the Total Units Sold (900 units) by the total days (90 days) which amounts to 10 units sold per day (900 units / 90 = 10).

Next we determine the lead time for orders with our suppliers, which is the number of days from placing your order to receiving it. We can use past experience to obtain this information or for a more detailed calculation, I would suggest looking at the dates of your orders and the dates on your goods received notes, for at least your last 5 orders and calculate the time it takes from order to receipt. In our example it’s 10 days.

Now we can move on to determining our safety stock.

We must also remember to adjust our safety stock level based on factors like
seasonality, demand trends and product availability.

In our example, our Safety Stock buffer is 5 days.

To find the total number of days of stock required for the optimum stock level, we add the lead time in days, to the safety stock in days.

LEAD TIME IN DAYS + SAFETY STOCK IN DAYS = TOTAL DAYS OF STOCK REQUIRED

In our example, it is 10 days lead time + 5 days of safety stock, amounting to 15 days.

Now we must convert these 15 days of stock, to the total number of units required. To do that we multiply this number by the Average Number of Units Sold per Day to determine the total units to hold in stock.

AVERAGE NUMBER OF UNITS SOLD PER DAY X TOTAL DAYS OF STOCK REQUIRED = TOTAL UNITS REQUIRED FOR OPTIMUM STOCK

In our example, this is 10 units sold per day multiplied by the Total Days of Stock
Required, which is 15 days, amounting to 150 units.

10 Units Sold per Day x 15 Days of Stock Required = 150 UNITS

Next, we calculate the value of our optimum stock, by multiplying the Total Units
Required, by their Cost Price per unit.

TOTAL UNITS REQUIRED FOR OPTIMUM STOCK X COST PRICE PER UNIT = OPTIMAL STOCK VALUE

150 units x 1000 Cost Price per unit = 150 000.

If we now look at how much stock we hold on hand, which is 250 000, this shows that we no longer have to order any more stock, until the value on hand drops to 150 000.

By letting our stock level fall closer to the optimum level, we can effectively save on spending 100 000 on extra stock we don’t really need to hold.

Optimising Stock Levels Uncovers Hidden Cash

By following these steps, you can calculate your optimum stock levels for each product or item of raw material your business requires and thereby free up cash.

By regularly calculating and optimising your stock levels, you can maintain a healthy cash flow, minimize waste and ensure that you have the right number of products on hand to meet customer demand, without tying up too much capital (cash) in excess inventory.

Want to learn cash flow management strategies used by elite cfo's to increase cash and grow profits? VIEW THE CASH MANAGEMENT SOLUTIONS

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