Today, we’ll discuss how to calculate an adequate inventory and appropriate order quantity.
[Intro Video]
Hi, this is Mike Negami, Lean Sigma, Black Belt.
The previous video was about ‘First In, First Out’.
In that video, I said that “It’s important to maintain an adequate inventory amount.”
I’ve talked about inventory in many of my videos before, but here I’ll summarize the
cons of excessive inventory.
1, It’s a useless expense.
You cannot make any profit if you’re just holding onto the inventory.
2, It increases additional inventory management expenses such as labor, electricity and storage
fees, etc. 3, It increases the risk of inventory loss due to obsolescence and quality deterioration.
4, It obstructs your visual management and prevents early problem detection.
5, It interferes with organizing storage and may cause mis-ordering.
There is almost no good thing about excess inventory, except it does help to decrease
the risk of sales loss from out-of-stock items.
Taking all these points into consideration, the proper inventory quantity is the minimum
amount that avoids being out-of-stock.
This is the basic concept.
Next, I’ll show you how to calculate an adequate inventory quantity.
Do you know that it depends on your ordering method?
The ordering method roughly depends on whether the time to place an order is regular or irregular,
and whether the quantity to order is fixed or unfixed.
No company always has the same amount of sales, so they never use regular timing & fixed-quantity
ordering.
On the contrary, some companies use irregular timing & unfixed-quantity ordering.
In many cases with this method, they may end up that way due to a lack of planning.
This method is not efficient when considering company optimization.
I recommend that you move to one of the other two ordering methods.
Irregular timing & fixed-quantity ordering places fixed-quantity orders when the current
inventory quantity reaches a certain level.
Since it’s very simple, many companies are using this method.
However, it’s difficult to accommodate sudden sales and usage changes, and it’s necessary
to regularly check the proper fixed-order quantity.
This method is good for products with inexpensive prices and little degradation of quality and
value.
If that’s not the case, I recommend moving to the regular timing & unfixed-quantity ordering.
Since you’ll be regularly placing orders like on a weekly or monthly basis, they will
arrive regularly, so it becomes easy for both you and other departments to make work schedules.
Please select the most advantageous order frequency for all related departments.
Deciding the order quantity requires you to record inventories and received amounts and
do calculations.
Next, I’ll talk about how to calculate proper inventory for the regular timing & unfixed-quantity
ordering method.
For that, we need the following four factors.
They are Order Frequency, Lead Time, Safety Inventory and Estimated Inventory Usage per
period.
The more frequent your Order Frequency is, the lower the required inventory quantity
can be, but the more your labor and cost requirement are.
It’s also influenced by your supplier’s schedule.
Consider all these factors and decide the best Order Frequency.
Lead Time is the number of days for your order to arrive when ordering today.
Safety Inventory is extra days of inventory.
Nobody can predict the future.
There are times that you’ll sell more than expected or your order arrival has been delayed.
This inventory quantity can prevent becoming out of stock.
The longer the Order Frequency and the Lead Time, the more Safety Stock is needed.
You could calculate Safety Inventory statistically, but you should decide it by having plenty
of safety inventory at the beginning, then gradually reducing it.
The unit measures of Order Frequency, Lead Time and Safety Inventory are all period.
In this chart, the vertical axis represents the inventory quantity by day and the horizontal
axis represents time.
For example, let's say that Order Frequency is 14 days, Lead Time is 7 days, and Safety
Inventory is 14 days.
Then, the total days, which is 35 days in this example, is the proper inventory.
If you want to convert it to quantity or currency amount, just multiple it by the daily usage
quantity or that price.
Now, why does the total of this Order Frequency, Lead Time and Safety Inventory become the
proper inventory quantity?
You may have thought it’s low.
Let’s do a simulation.
For example, today is the ordering day, which is Day 0.
If the current inventory is over 35 days, which is more than the proper inventory, you
do not need to place an order at this time.
The inventory will be decreasing until the next ordering day, which is Day 14.
The proper order quantity is also easily calculated by subtracting the current inventory quantity
from the proper inventory quantity.
You may have thought it’s too low.
Let’s continue.
Suppose we sold more than usual in the following week.
Because of the safety inventory, we could avoid running out of stock.
Then, the order quantity arrived and inventory was increased.
A week later, we’ll place another order for the quantity of the proper inventory minus
the current inventory.
As we continue this, every product will fall within its proper inventory quantities.
I made a sample file so that you can check how the calculation is formulated.
Here are explanations for that.
You can download this sample file.
Please check how it formulates the calculations.
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