Minimizing the Negative Effects of Forced Inventory Reduction – Part #2
By Jon and Matt Schreibfeder
The time to issue a replenishment order when you have enough inventory left in stock to satisfy customer demand during the lead time. If you forecast that you will sell two pieces of a product per day, and it takes seven days to replenish your stock, you should reorder the product when you have no less than 14 pieces in stock.
However, you might sell more than two pieces per day, or there may be a delay in receiving your replenishment shipment. This is why you maintain additional inventory as safety stock, also known as safety allowance, to protect against stockouts and disappointing customers.
But if safety stock quantities are too high, part of your inventory investment will be tied up in non-productive stock. This excess inventory will not contribute to your efforts in achieving the goal of effective inventory management.
There is a simple, best practice analysis that will help ensure that the safety stock quantity you maintain for each item is “just right”. To perform this analysis, for each item record the forecast quantity, actual usage and the safety stock quantity for each of the previous three months. For each item in each month add the safety stock quantity to the forecast:
Forecast + Safety Stock = Planned Total Available Stock for the Month
The result is the planned total available stock for each of the past 3 months. This is the quantity you are intending to sell or use plus your insurance stock to cover unanticipated demand or delays in receiving replenishment shipments. Subtract the actual usage quantity for the month from the Planned Total Available Stock for the Month. The result is called “residual inventory.”
Planned Total Available Stock for the Month – Actual Usage = Residual Inventory.
To convert the residual inventory quantity into a number of day’s supply, divide this quantity by daily demand (e.g., your monthly forecast divided by 30):
Residual Inventory ÷ (Forecast ÷ 30) = Residual Inventory Day’s Supply
If residual inventory analysis shows that a product consistently has a residual inventory quantity representing more than an “x” days’ supply (typical value is 21 days), you are probably maintaining too much safety stock. You can lower the amount of insurance inventory you are maintaining for this item without adversely affecting customer service.
In today’s competitive environment it is critical to make sure that every dollar invested in inventory is contributing to achieving the goal of effective inventory management. Free up dollars that are not actively contributing to this effort.
Next month we will continue our discussion of fine-tuning your replenishment parameters. In the meantime, if you have any questions, please let us know.