Thresholds and Ceilings
By Matt and Jon Schreibfeder
Most ERP and forecasting/replenishment systems calculate replenishment parameters for every stocked item in each warehouse, store or other stocking location. That is, they suggest when to reorder products and how much of each item to order. The “minimum quantity” or reorder point is typically calculated with the formula:
Safety Stock + Anticipated Lead Time Usage + Anticipated Order/Review Cycle Usage
The reorder quantity is often an economic order quantity or EOQ (i.e., the quantity that minimizes your total cost of inventory), or a specific number of day’s or month’s supply.
But often these calculated amounts are not realistic. They must be overridden to meet your business needs and situations. We refer to these manually specified stock levels as “thresholds” and “ceilings”.
A threshold is a manually specified minimum amount of inventory you want to have in stock and available for sale or use at any time. Reasons for specifying a threshold include:
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- An agreement with a preferred customer that a certain quantity of the product will be available for immediate delivery, regardless of previous usage.
- It is necessary to maintain a certain quantity of an item to provide a pleasing display in a retail area.
- It is a critical item that must be available in case of emergency.
Safety stock is the amount of a product you maintain in stock to protect against stockouts due to unusual usage or delays in receiving a replenishment shipment. If a calculated safety stock quantity is less than the specified threshold, it should be increased to equal the threshold quantity. That is, your desired level of reserve inventory is greater than the system-calculated quantity. If the calculated safety stock quantity is greater than the specified threshold quantity, the calculated safety stock quantity should be used in determining when to reorder the product.
A “ceiling quantity” is a practical maximum amount of an item you want to have in inventory. Reasons for specifying a ceiling quantity for a product include:
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- There is not sufficient space in your facility to store the EOQ or specified number of day’s or month’s supply of a product.
- The EOQ or specified number of day’s or month’s supply exceeds the quantity that can be sold or used during the practical shelf life of the item.
Add the safety stock or threshold quantity (whichever is greater) to the normal reorder quantity for an item and compare it to the specified ceiling quantity. If the sum of these two components is greater than the ceiling quantity, lower the reorder order quantity so that added to the safety stock quantity, it equals the ceiling quantity.
Why do we consider the safety stock quantity in this analysis? Because the safety stock quantity is reserve or insurance inventory. It should be on the shelf when the replenishment shipment arrives. And, if it is on the shelf, it takes up space. Of course, if the sum of the safety stock (or threshold quantity) plus the normal reorder quantity is less than the specified ceiling amount, replenish stock with the normal replenishment quantity.
Good systems will calculate optimal replenishment parameters. But these parameters must be modified, if necessary, to comply with your business requirements and situations.
Have questions or want to discuss your specific inventory-related challenges? Please send us an email and we will schedule a time to talk.