The intention of inventory management is to be able to correlate the ordering quantities and frequency of products with demand so that there are always just enough products on hand, never too many and never too few. In the real world, it can be extremely difficult to predict these ordering parameters when there are uncertainties at play, it can include economic and geographical parameters. There are however some developed models of inventory control which can make the whole management process a lot clearer. In this article, we take a look at the deterministic model of inventory control and review the different analyses that are incorporated under this broad term.
Deterministic vs probabilistic models
The deterministic model is where it is assumed that there is no fluctuation in parameters affecting inventory such as demand, lead times and shipping times (which influence supply). On the contrary, the probabilistic model assumes that there is always some level of uncertainty associated with these parameters which must be considered. In reality, the probabilistic model can often be more useful as uncertainties are inevitable and must always be considered.
Read more about the probabilistic inventory model
The deterministic model broken down
The deterministic model of inventory control is utilised in trying to predict a best-fit inventory order when the demand is completely unpredictable. The accepted or perceived demand is then met over a period of equal incremental orders, essentially building up inventory at a constant rate. The deterministic inventory model is expressed through three primary methods. These are the Economic Ordering Quantity method (EOQ), ABC analysis and the inventory turnover ratio.
Economic Ordering Quantity
The EOQ method is used to determine a company’s optimal ordering quantity that achieves minimal ordering, receiving and holding inventory costs. Therefore, this method is best used in situations where the ordering, receiving and holding costs of inventory remain relatively stagnant.
This is based on the pareto principle where items are segregated into three main categories namely, A, B and C. Items in the A category are those with a higher annual consumption value (demand x cost per unit) and typically comprise 10-20% of your total inventory. Items in the B category are intermediary where they account for approximately 15-20% of the annual consumption value and approximately 30% of the total inventory. The items in category C, although contributing to only 5% of the annual consumption value, comprise 50% of the stocked inventory.
Learn more about categorising and managing your inventory using the ABC method
Inventory Turnover Ratio
Inventory turnover ratio refers to the amount of times inventory is completely turned over in a year. This gives an idea of the relationship between demand and sales and whether the one is meeting the other. If the ratio is very low, this indicates demand is slow and inventory could be in excess of demand. If the ratio is high, this could indicate sales are healthy and the inventory is being turned over appropriately. If the ratio is very high, though you may think sales could be exceptional, it can also be a sign of insufficient supply for the demand and therefore there is a risk of lost sales due to stock-outs.
Learn more about improving your inventory turnover ratio
Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.