Inventory management is a fundamental practice for any successful business. When a business does this well, we would usually expect to say that the business has ‘healthy inventory’. This notion of inventory health is a difficult one to define, but in general it is concerned with whether a company holds optimal inventory levels (not too much, or too little), the right combinations of each product given current and predicted demand, and whether the inventory on hand is of an acceptable quality (not out-of-date or expired). This sounds simple, but there is no golden compound metric that includes all of the above considerations, which makes evaluating inventory health difficult in practice. The following questions will aid you in making this evaluation.
Can you break your inventory levels down into safety, replenishment, and excess/obsolete stock?
The three categories: safety stock, replenishment stock, and excess/obsolete inventory, are the main categories of inventory for reporting purposes. In brief, safety stock is the minimum levels held to avoid a shortage; replenishment is the stock brought in to replace items that have been sold; and excess/obsolete inventory is inventory that is held in excess of what is needed, or has become out-of-date. It is critical that you recognize each category in order to make decisions about what they should be, and when you need to make changes. For example, you may find low levels of excess inventory acceptable, but too much may mean your requirements for safety stock are too high.
Who is making the key decisions?
Many inventory-related decisions are strategic, so it is important that top-level management has a say in important decisions. One example is deciding what the right balance is between holding sufficient stock levels to ensure that products are consistently available for customers, and holding levels that are cost-effective for the business. This balance between customer satisfaction and cost savings is one that higher management should be determining. Another example is deciding whether the right mixes of products is offered by your business, and whether a sufficient depth of products is offered, which involves a similar trade-off.
How do you calculate safety stock?
Safety stock is necessary because in most industries it is impossible to predict with 100% certainty the amount of stock that will be needed, and the amount of stock available, to supply customers over a given period of time. Holding this stock can be very costly however. Ask yourself whether you are using the best method for calculating the appropriate safety stock levels. Do you use statistical methods that incorporate factors such as accuracy of sales forecasts, required production lead times, and manufacturing schedule adherence; or do you use mainly ‘rules of thumb’ or guesswork? Most of the time, using widely accepted statistical formulas give the best results. Modern inventory management software can help with this (e.g. via an add-on such as Lokad). It will also make it easier to re-calculate optimal levels frequently, which is important as this ensures that these optimum levels are based on accurate information.
Do you have regular visibility into excess and obsolete stock, and is it linked to targeted action plans to sell off or reduce this inventory?
Excess and obsolete stock usually results from inaccuracies in sales forecasting and planning. It is difficult to completely eliminate this entirely, because no prediction of future events can be entirely accurate. What is important is that levels of excess and obsolete stock are monitored closely, and your business has strategies in place to minimize these levels as much as possible. Once again, modern inventory management software greatly assists in this process, as it gives information on all inventory levels in real-time, which allows strategies to be formulated and implemented quickly.
Answering the above questions should give you a good idea about the health of your inventory. If you believe your inventory is not as healthy as it could be, take action! Inventory management is not difficult to do well, especially with modern software at your disposal, but be aware that inventory health is an often-underrated component of the health of your overall business.