Managing inventory well is critical for businesses wanting to balance supply and demand. Optimizing inventory levels means you can ensure you have the right products for your customers and avoid the headaches of having too much stock.

In this article, we will explore some practical strategies for maintaining optimal inventory levels, avoiding common inventory mistakes, and boosting your business’s overall efficiency.

Understanding Inventory Management

Efficient inventory management is all about finding the right balance.

One popular strategy is "just-in-time management," where stock levels are kept low to cut down on warehousing costs while still meeting customer needs. However, this approach hit some bumps during the COVID-19 pandemic when supply chains were disrupted.

The main challenge is balancing the levels of inventory. If you hold too much, it can eat into your profits with all those storage costs. But, if you run out, you might miss out on sales. So, by figuring out the right strategies, you can keep your cash flow smooth, make customers happy, and boost your profits overall.

Consequences of Excessive Inventory

Another common practice is finding a warehouse and storing as much inventory as possible. This became much more popular after the pandemic when the supply lines shut down. However, this mentality can have some drawbacks. Here are a few to know.

Increased Holding Costs

Too much inventory can increase hefty holding costs, such as storage, insurance, and management expenses. These can eat into profits and divert resources from other vital parts of your business.

The rising costs of renting warehousing space are making it increasingly expensive to store excess inventory.

Plus, there are hidden costs like inflation and inventory taxes to consider. And if you’re not careful, overstocking could wipe out a year’s worth of profits.

Risk of Obsolescence and Spoilage

Inventory can expire and become unusable as time goes by. Take grocery stores — they deal with produce going bad by including a percentage of waste in their pricing. When they hit max inventory, they often donate the extra to charity and write it off as a loss.

Don’t forget about environmental factors like humidity, mold, and termites — they can really mess up your stock and could even lead to a total inventory loss.

Tied-Up Capital

Excess inventory ties up capital that could be invested in other areas of your business, such as marketing, product development, or expansion efforts. Keeping the right amount of inventory frees up money for things like payroll or other expenses.

Importance of Maintaining Optimal Inventory Levels

Let’s talk about why inventory optimization makes sense for businesses.

Enhances Cash Flow and Reduces Holding Costs

Optimizing inventory levels is a smart way to boost cash flow by making sure your capital isn’t tied up in excess stock. Plus, lower holding costs can further improve your financial health, giving you more flexibility in resource allocation.

Prevents Stockouts and Overstocking

Optimizing inventory levels prevents stockouts, leading to lost sales and unhappy customers. It also helps avoid having too much stock sitting around, which can add unnecessary costs and risks.

Improves Customer Satisfaction and Loyalty

Having the right products available at the right time enhances customer satisfaction and builds loyalty. Customers are more likely to return to a business that consistently meets their needs and avoids the frustration of out-of-stock items.

How to Calculate Minimum and Maximum Inventory Levels

Minimum and maximum levels of inventory are critical components of inventory management.

The minimum level represents the lowest amount of inventory you should hold to avoid stock shortages. In contrast, the maximum level is the highest amount you should keep to prevent excess stock.

Determine Average Daily Demand

Based on historical sales data, average daily demand is the average number of units sold per day. To calculate this, divide the total number of units sold in a given time period (e.g., one month) by the number of days in that period.

As you track the items, you will find some have seasonal highs and lows that shift throughout the year. For example, you may sell more snow shovels in January than in August. So, keep note of those ups and downs for next year.

By the way, your ecommerce platform can help you manage your inventory better. For instance, Ecwid by Lightspeed not only gives business owners a robust online store but also comes with handy sales reports.

The Orders report, for example, shows you how many items customers usually buy, how many you’ve sold over a certain period, and other insights.

Ecwid also provides a Product Sales and Stock Overview report, which gives you a quick summary of your sales over a certain period and your stock levels. You can easily compare these stats to the previous period to see if sales for specific items have increased or decreased.

Determine Lead Time

Lead time is the time it takes for an order to be fulfilled and delivered from the supplier to your warehouse. Incorporating lead time into your inventory management helps ensure you always have enough stock on hand.

For example, if it takes two weeks for a supplier to deliver an item to your warehouse, you should maintain at least two weeks’ worth of stock in case there are any delays or unexpected changes in demand.

Again, each item might have its seasonal highs and lows. For example, snow shovels will take longer to stock in January than in August.

How to Calculate the Minimum Inventory Level

Multiply average daily usage by the daily lead time to determine the minimum inventory level.

Minimum inventory level = Average daily demand x Lead time

This calculation helps you monitor your inventory levels effectively. If an item nears its minimum inventory level, you can adjust your next order with the supplier accordingly.

For example, if you sell coffee mugs and your store sells one mug per day, and it takes 7 days for new mugs to arrive after ordering, you should always have at least 7 mugs in stock to avoid running out.

How to Calculate the Maximum Inventory Level

While tracking your inventory data, you’ll likely tweak your maximum inventory level. A simple place to start is by multiplying your minimum inventory level by 2.5, which allows you to cover a missed cycle with your supplier.

The maximum inventory you want in the coffee mug example above is 17-18 mugs. It is unlikely that you will go through that many mugs in one week, and it becomes unnecessary to have more.

You can use this number to decide if it’s time for a sale. Since the average daily usage of snow shovels tends to drop in spring, why not consider a sale to help reduce your inventory below the maximum level?

How to Calculate the Average Inventory Level

The average inventory level represents the amount of a product you expect to sell during the next period. This level can vary depending on seasonal fluctuations, lead time, and anticipated sales.

The goal here is to look ahead and determine what you should have in your inventory.

To determine a good starting point, calculate your average daily sales, multiply that by the lead time, and then add a safety buffer.

A safety buffer is typically a percentage that accounts for unexpected changes or delays. Depending on your industry and business, it could be anywhere from 10% to 20%.

Given that, the formula for the average inventory level is:

Average inventory level = (Average daily sales x lead time) + Safety buffer

Adjust this based on your warehouse capacity, available cash, and the product’s sales velocity.

This approach can be used as your optimal inventory level formula. The key is setting an initial safety buffer and monitoring your inventory. Continuously adjust and reassess this buffer to ensure it remains effective.

More Tips for Inventory Optimization

Let’s talk about other inventory optimization techniques that can improve your overall efficiency.

Real-Time Inventory Tracking

Tracking inventory in real-time is much more valuable than doing it on a month-to-month basis. Implement real-time tracking systems to monitor stock levels. This enables you to respond quickly to fluctuations and complete orders more efficiently.

Your ecommerce platform can also help with inventory tracking. For instance, if you’re using Ecwid by Lightspeed, you can easily set the stock quantity for your products. When customers make purchases, our system automatically updates your stock levels.

Automated Reorder Alerts

Many inventory software systems help you manage your current stock by alerting you when you’re nearing minimum inventory levels. This prevents stockouts and helps maintain optimal inventory levels.

For instance, if you’re using Ecwid by Lightspeed for your online store, you can set up low-stock alerts. You’ll receive a heads-up when your inventory is running low so you won’t run out unexpectedly and have time to restock.

Demand Forecasting

Along with managing current stock levels, demand forecasting is another important aspect of inventory management. This involves predicting how much inventory will need to be stocked in the future based on past trends and customer habits.

Your most valuable tool for demand forecasting is your own inventory data, which reflects your seasonal trends and customer habits. You can do this manually using spreadsheets or software to analyze your data and generate accurate forecasts.

If you’re using Ecwid by Lightspeed for your online store, you can check out the Orders report to see how many items people typically buy, how many you’ve sold during a specific period, and more. This can help with demand forecasting.

Multi-Echelon Inventory Optimization

Multi-echelon inventory optimization involves managing inventory across stages of the supply chain, from suppliers to warehouses to retail locations. This approach ensures that inventory levels are optimized at each level, reducing costs and improving service levels.

This approach could be pricey, effortful, and time-consuming since it involves integrating systems for coordination across the supply chain. It might be more practical for large enterprises than for small businesses.

Wrap Up

Keeping an optimal level of inventory is critical to maintaining consistent sales. Finding this optimal level requires balancing demand forecasting, supply chain management, and inventory optimization strategies.

When picking an ecommerce platform for your business, go for one with inventory management tools and order reports to track your stock levels easily. For example, Ecwid by Lightspeed. It helps you streamline your inventory, prep for seasonal spikes, and manage your online store more efficiently.

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