Benefits of Efficient Inventory Planning & 3 Models to Implement
What is Inventory Planning?
Inventory planning is essentially a company's effective management of goods. This process oversees several supply chain components such as the acquisition of products (raw materials, finished goods), determining optimal order quantities, and demand planning.
Effective planning will enhance customer service, increase the efficiency of the supply chain, and control inventory-related expenditures.
Advantages of Inventory Planning
Costs associated with poor inventory planning can heavily contribute to a business' bottom line. In fact, a Business Wire study showed that retailers worldwide lose $1.75 Trillion in Revenue due to overstocking, shortages, and product returns, with the average retailer overstocking by 50%.
For retail shops and other product-based businesses, simply addressing this costly issue can lead to significant cost savings. Other benefits of efficient inventory planning include-
- Increased transparency - A business will have far more control and clarity around what is stored and sold, limiting the risk of employee theft and other avenues for inventory shrinkage. With accurate inventory planning and tracking procedures in place, warehouse visibility will increase as well as the accountability of staff members.
- Smooth cash flow - Organizing inventory levels and management in line with data-driven information allows businesses to reduce costs on over-ordering, as well as losing customer rapport through under-stocking. When a business meets demand, the cash flow from sales becomes more consistent.
- Increased profit - Through effective inventory planning, a company will waste less capital on ordering, storing, and managing excess stock. This will also lower associated expenses, such as labor wages, warehouse rent, and security costs, creating a higher profit margin with consistent revenue.
- Enhanced customer satisfaction - Unforeseen product shortages can greatly affect a business's reputation and consumer retention rates. For both brick-and-mortar shops and eCommerce businesses, running out of popular items will lead to losses in sales due to missed opportunities and disappointed consumers who will likely turn to competitor brands.
Inventory Planning Models
Generally speaking, there are three main models used to assist with inventory planning-
1. EOQ (Economic Order Quantity) Model
This model focuses on the most economical amount of items a business needs to order to reduce costs and maximize value in the restocking and ordering process.
A company produces beauty products to sell to wholesalers in the industry. One of the raw materials the company acquires is Cedarwood oil, purchased at $20.50 per ton. The company's forecasts reveal that an estimated required amount of Cedarwood oil for the coming year is 680,000 tons. The total carrying cost for the material is 35% for the acquisition cost, and the cost of ordering is $675. With these numbers in mind, the most Economical Order Quantity would be-
EOQ = square root of 2 X D X S divided by the carrying cost
D = annual demand = 680,000 tons
C = carrying cost = 0.35(20.50) = $7.175 per ton per year
S = ordering costs = $675 per order
EOQ = 2 X 680,000 X 675 divided by 7.175
= square root of 127,944,251
Therefore, the EOQ in this situation would be 11311.25 tons per order.
Pros of EOQ-
- Businesses can take advantage of vendor deals when they are clear about how much inventory they will need for the year - ordering in bulk can save purchasing costs.
- It lowers the cost of carrying inventory with a specific recommendation for the annual order level.
- Balances stock levels and gives more clarity on how to manage and when to order inventory.
- It assumes a steady demand for a product, not taking into account economic and seasonal fluctuations.
- Requires consistent monitoring of inventory levels.
- The main assumption is that it is a one-product business, as no interactions between products are accounted for in the formula.
2. Perpetual Inventory System
This method involves keeping constant track of inventory quantities. Businesses should monitor inventory counts and when certain products reach their reorder points, it is then time to place an order for a predetermined quantity.
When a product is received or sold, as well as in the case of products being returned, the inventory level should automatically be updated. As this requires constant monitoring of stock fluctuations, businesses need to utilize inventory management software with barcoding capabilities to successfully implement this method.
Pros of Perpetual Inventory-
- Clarity on real-time stock levels.
- More direct control of inventory for management.
- Ease of tracking stock across many different locations.
- Unable to be manually maintained - specific software needs to be used.
- Complex model which requires staff to be trained in the software use.
- If the recorded inventory does not reflect actual inventory levels, the whole system is affected.
3. Periodic Inventory System
This physical count method measures inventory levels and the cost of goods sold (COGS). Levels of inventory along with the COGS are updated at the end of a specific period (such as monthly, or yearly). The amount of inventory determined to order is based on what is on hand along with the expected demand.
The calculation for COGS under a Periodic Inventory System-
Start balance of inventory + cost of purchased inventory ending cost of inventory = COGS.
Pros of Periodic Inventory-
- Suited to small business models.
- It can be done without complex preparation.
- A business can set the time frame based on their needs.
- Not as accurate as the perpetual system, since the period of counting the levels are longer, rather than in real-time.
- When several accounts track sales, orders, holding, etc, it can be complex to periodically count.
The Bottom Line
To effectively plan for inventory, a business will need to choose the most effective method that can efficiently track and manage inventory accurately. For most businesses, it may be beneficial to implement all 3 methods and use them together to increase the accuracy of their inventory control procedures.
With the right kind of inventory planning system, businesses can create optimal inventory strategies without spending too much time working out the complexities. This is where inventory management software offers businesses the value of efficient planning systems.