How much inventory should you start with? This is one of the most common questions businesses ask. It’s an important consideration and a great opportunity to assess your inventory performance and fine-tune your strategy.
The following insights and tips will help you take a closer look at your company’s inventory policy and make data-driven decisions.
Let’s Start with Safety Stock
Safety stock levels are a key consideration, especially in an era where just-in-time shipping and inventory minimization play a crucial role in maintaining smooth operations.
There’s no universal formula for determining safety stock, but here are a few critical factors to keep in mind:
Lead Time Variability – How reliable are your suppliers? If delivery times fluctuate between two days and two weeks, you’ll need more safety stock than if your suppliers consistently deliver on time.
Demand Patterns – The demand for some products remains steady, while others experience unpredictable spikes. For items with consistent demand, two to three weeks of safety stock may suffice, but for those with erratic demand, you might need four to six weeks or more.
Service Level Targets – What happens if you run out of stock? If an item is crucial to production, you’ll want higher safety stock levels. If stockouts are only a minor inconvenience, you can afford to carry less.
Many businesses set safety stock targets based on product categories, such as:
A-items: 15–30 days
B-items: 30–60 days
C-items: 60–90 days
It’s wise to closely monitor stock levels and stockout incidents in the first few months and make adjustments as needed.
Know Your Turnover Ratios
Another key factor in inventory management is your inventory turnover ratio. To calculate this, divide your annual cost of goods sold (COGS) by the average inventory value on hand.
For example, if your COGS for 2020 was $250,000 and your average inventory value was $25,000, your turnover ratio would be:
$250,000 / $25,000 = 10
This means your inventory turns over ten times per year.
Turnover Days: A Deeper Look
Your turnover ratio is useful, but it doesn’t account for seasonality or fluctuations in demand. A more refined approach is to calculate inventory turnover days by dividing 365 (days in a year) by your turnover ratio.
Using our previous example:
365 / 10 = 36.5 turnover days
With this information, you can fine-tune your inventory levels for peak and slow sales periods.
Determining Safety Stock Levels
A simple way to estimate safety stock is to factor in the difference between average and maximum daily sales and the variability of lead times. The formula is:
(Maximum lead time × Maximum daily sales) – (Average lead time × Average daily sales)
This formula provides a baseline recommendation. To determine your reorder point, add the typical demand during lead time to your safety stock.
Of course, these calculations are only a starting point. Your specific supply chain conditions will influence the optimal approach. Regularly reassessing your strategy ensures that you adapt to changes in demand and supply.
Can You Trust Your Inventory Data?
Before refining your inventory strategy, you need an accurate count of what you currently have. Surprisingly, many businesses struggle with incomplete or inaccurate inventory data—even in the age of digital inventory management.
Even the most advanced inventory software relies on accurate physical counts. To ensure accuracy, follow these best practices:
Maintain Up-to-Date Data – Are all inbound shipments promptly recorded? If you rely on barcode scanning or manual entry, ensure your receiving team follows strict data entry protocols.
Conduct a Full Physical Inventory Count – Before making strategic changes, perform a complete inventory count to establish a reliable starting point.
Implement Regular Cycle Counts – Quarterly cycle counts are a minimum best practice, but prioritizing “A” items and high-risk SKUs can help maintain accuracy. If possible, aim for weekly cycle counts to stay ahead of discrepancies.
A Data-Driven Approach to Inventory Optimization
So, how much inventory should your company hold? There’s no universal answer—it depends on your unique business dynamics and supply chain.
Many business leaders seek expert guidance on inventory optimization. At Best Global LogisticsL, we specialize in providing data-driven insights to answer questions such as:
- How much inventory should we carry?
- How can we optimize stock levels without becoming too lean
- What adjustments should we make for the modern supply chain?
If you’re looking for expert advice, contact BGL today.