Managing Inventory Levels

Management strategies and tools vary with the type of inventory and the marketing model. The objective of a modern inventory management system is to have just enough stock on hand to fulfill every sale, without running out of goods. The moment the last item is sold, replacement stock is being placed on the shelves. This principle achieves the maximum turnover rate which in turn results in optimum merchandising profit.

Let’s imagine a mom and pop store selling pet food, toys and accessories such as kennels, carriers, leashes, baskets, bowls and blankets. The store has established a computer-based perpetual inventory record for every item. Each inventory record accumulates data on daily sales, supplier orders and stock on hand. Every time an order for merchandise is placed, the date of the order, number of units and price are entered. Every sale is recorded with the date, price and number of units sold. Every transaction becomes part of an historical data base that reflects the stores “experience” with that item. The historical data is used to map the sales and profit contribution of the item and calculate when and how much to reorder.

Here’s how part of the data base might look:

Pet Food Store inventory Model

Category/Description

Size

Unit Cost

Selling Price

Avg. Lead Days 1

Avg. Daily Usage2

Working Stock

Safety Stock

Reorder Point

Large Bags Dog Food

10 Kg

25.00

40.00

7

6

42

4.2

46

Small Bags Dog Food

5 Kg

15.00

29.95

7

12

84

8.4

92

Cat Food: Bags

5Kg

16.50

29.95

7

10

70

7.0

77

Dog Food: Tins

12 Oz.

0.85

1.95

9

16

144

14.4

158

Cat Food: Tins

3 Oz

0.55

1.25

9

12

108

10.8

119

Dog Leashes

12.50

24.95

12

2

24

2.4

26

Dog Beds

24.00

49.95

15

0.5

7.5

0.8

8

Kitty Baskets

15.00

29.95

15

0.3

4.5

0.5

5

Dog & Cat Bowls

8.00

14.95

7

2

14

1.4

15

Dog Toy

5.00

9.95

5

3

15

1.5

17

Cat Toy

4.50

9.95

5

2

10

1.0

11

1 Average number of calendar days from placement of order to receipt

2 Average number of units sold per day

Every item sold in the store has its own inventory record. If the same item comes in different sizes and colours, each has its own record. This enables the manager to determine whether one size or colour is selling better than another and to identify what and how much to reorder.

Category/Description:
The description, with size, colour or other attributes that make the item unique

Unit Cost:
The unit cost will appear in two forms in the inventory record. The first cost will be the current vendor’s price that will be used in placing orders. This is the unit price we expect to see on the Vendor’s invoice for goods we have received. The second cost is one that the inventory management system generates. It can be an average cost, based on previous orders or, more likely, a system that attaches a specific cost to each item as it is received in inventory. This method is known as “First-in/First out” or FIFO.

Let’s track an inventory item that is initially sold at $39.95 and bears a unit cost of $25.00. to see how FIFO works:

First In/First Out (FIFO) Inventory Costing

Retail Price

Selling

Cost

January 5, 201X

39.95

25.00

January 8, 201X

43.25

26.50

Transaction Date

Receipts

Sales

Balances

Quantity

Unit Cost

Quantity

Price

Stock on Hand

Inventory Value

January 5, 201X

12

25.00

12

300.00

January 6, 201X

4

25.00

8

200.00

January 7, 201X

5

25.00

3

75.00

January 8, 201X

12

26.50

15

393.00

January 9, 201X

3

25.00

January 9, 201X

2

26.50

10

265.00

In this example we can see that the initial vendor cost of $25.00 applied to the 12 units received on January 5th. On January 6th and 7th, we sold a total of 9 units at the $25. cost, leaving a remainder of 3 units at the $25. cost. On January 8th, we received a replenishment order of 12 units but the vendor price had changed to $26.50. When we sold a total of 5 units on January 9th, the 3 remaining units from the first order will bear a cost of $25. and the two units from the second order bear a cost of $26.50.  (See "Managing Price Changes")

Selling Price:
The selling price is established, based on a profit margin required to support operating costs, competition in the market and marketability of the product.

Average Lead Days:
The system tracks the time, in calendar days, from placement to receipt of each order. With some products and suppliers the lead days may be relatively consistent. In other cases, lead times may vary according to manufacturing cycles, shipping schedules or seasonal variables. Sophisticated inventory systems will use a form of mathematical “smoothing” to rationalize large fluctuations in delivery times, which in turn, affect working stock.

Average Daily Usage:
Tracking usage or sales on a daily basis enables us to estimate how much inventory we must keep on hand to meet demand. By multiplying Average Daily Usage by Average Lead Days, we can determine our Working Stock level. If our average sales per day and our lead days numbers are reasonably accurate, when we sell the last of our shelf stock, the replacement order is arriving and we never run out of stock. Because the ideal rarely happens, we add a margin for error.

Safety Stock:
In our inventory model, we add a factor of 10% or our working stock for safety, to cover spikes in average daily sales or, delays in delivery. There is no hard and fast rule about safety stock. The inventory manager makes an educated guess.

Floating Reorder Point:
Before computers were in widespread use in tracking inventory and records were maintained in ledgers or index cards, minimum and maximum levels were established by the inventory manager who typically carried everything around in his head. When the stock on hand equalled the established minimum, an order was placed for the quantity required to bring the stock up to the maximum level. These minimums and maximums were fixed, changed only when the inventory manager sat sown to review each record, if he got around to it.

The floating reorder point is recalculated with every sale or receipt transaction, automatically initiating a request for replenishment. In this way, the system is constantly responding to variables.

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