In today’s market, there is increased competition among businesses largely owing to the proliferation of the internet. Businesses cannot afford to rely on their intuition. They need accurate data they can trust.
Proper inventory planning can help businesses develop strategies to manage their inventory to keep up with customer demands and stay ahead of the competition. To fulfill orders, it’s important to understand acquisition, distribution, and replenishment of stock on hand. Inventory planning becomes essential as your business scales. Learn more with this inventory planning guide.
In this article we will cover the advantages of inventory planning and how managing your inventory keeps you one step ahead of your competitors.
What is inventory planning?
Inventory is the stock on hand to meet impending orders whether that is the finished product or the raw materials used to make that product. Inventory planning is the process of determining the optimal quantity and timing of what you have on stock to meet customer needs in terms of sales and production capacity.
Effectively managing inventory improves company cash flow and profits as well as contributes to an efficient supply chain. It can also decrease inventory costs by minimizing deficiencies and overruns.
Inventory lifecycle
The inventory lifecycle is similar for all business sectors, whether that’s manufacturing or retail. The lifecycle can be delineated into six distinctive phases.
1. Purchase
Raw material and finished products are purchased for manufacturing or sales depending on the target customer. Businesses use past data or their best judgment when making purchases to ensure the optimal amount of stock is on hand to meet customer demand. Having too much inventory can decrease cash flow.
2. Storage
Warehouses and other facilities are used to store inventory. Depending on the type of inventory, storage facilities may be heated or refrigerated. They must be secure and clean. Storage facilities incur holding costs which must be included in the cost of goods sold (COGS).
3. Use
This phase utilizes inventory for its intended purpose. This includes sales items or raw material for production or repairs. This is the only cash-generating phase of the inventory cycle.
4. Tracking
Tracking involves monitoring how much inventory is available for purchase by the intended customer. It is essential for maintaining production and cash flow.
5. Reordering
A big part of inventory management is knowing when to reorder to meet inventory needs. This process can be manual or automated and should consider supply chain delays for rare or hard to find items or item shortages.
6. Forecasting
Forecasting is the process of looking at past data to predict future needs. It helps businesses anticipate future inventory needs to maintain optimal inventory throughout the year. Thus, improving the bottom line while conserving cash flow.
What are the benefits of inventory planning?
Robust inventory planning ensures that materials are available when required to meet demand. Here are some more benefits of planning your inventory.
1. Improves cash flow
The money spent on purchasing and storing inventory is a huge expense for businesses. This expense is known as carrying costs, and generally constitutes 20%-30% of the total inventory expense.
Using inventory planning tools, businesses can minimize carrying costs through product forecasting – knowing when and how much to order to meet customer needs. This prevents under – or overstocking inventory. When too much inventory is on hand, the carrying costs are higher, as well, cash is tied up in inventory that’s not selling. On the opposite extreme, not having enough inventory leads to missed sales which also diminishes cash flow.
Inventory planning helps businesses find the sweet spot between these two extremes. Additionally, inventory planning can help with inventory financing and minimizing inventory acquisition costs.
2. Enhances demand forecasting
Demand forecasting refers to the process of using historical data (like past sales) to predict upcoming trends and demand for your products.
Using forecasting tools, as mentioned earlier, can help you make informed decisions about future inventory needs. Forecasting helps cater to customers’ demand and fosters better financial decisions pertaining to inventory allocation, warehousing, and distribution.
3. Revamps storage needs
Storage accounts for a large amount of any businesses carrying costs. Poor storage can be anything from inefficient layout, improper use of cold or hot storage, or too little or too much space. Just as having too much or not enough inventory hurts your business, so does improper storage.
Using appropriate inventory planning tools, helps you analyze the requirements of your business in terms of storage needs. In turn, you can quickly analyze whether you need more or less storage or if changes can be made to your existing facility to accommodate new products.
Product storage is an ever-changing variable with any business and depends largely on customer demand and seasonal fluctuations. Inventory planning helps you choose a storage system that best fits your business.
4. Reduces backorders
Backorder problems arise due to stock delays or improper inventory planning. Unfortunately, when an item is on backorder, customers are quick to search for companies that have the item in stock. This can affect long-term profitability.
However, with meticulous inventory scoping, you can maintain adequate inventory to meet customer demands.
5. Facilitates quality control
Faulty products can negatively impact the perception of your product’s quality. Establishing quality benchmarks for inventory should be part of your overall plan. By closely monitoring the products in stock, you can evaluate their quality.
Inventory planning is often done in tandem with regular quality control checks. This ensures the best quality products are shipped to your customers.
6. Enhances customer satisfaction and retention
Technological advancements have empowered customers and forced businesses to deliver superior customer service. According to a report from ReviewTrackers, 94% of customers have avoided purchasing a product due to a negative review.
Businesses need to minimize negative reviews on social media. To do this, they need to focus on over-delivering. Strategizing inventory requirements can improve the customer experience by fulfilling orders quickly and efficiently. Positive reviews lead to improved business opportunities.
Challenges related inventory planning
Anticipating future needs can be incredibly challenging in and of itself. In addition, several other challenges present themselves as businesses negotiate current trends and marketing forecasts. Nonetheless, businesses can utilize tools to mitigate some of the challenges of maintaining inventory.
Here are some pitfalls to watch for that complicate the planning process:
1. Unorganized data
Many organizations still rely on manual methods to track data. This leads to data dispersion, making it challenging to connect all the pieces to get a clear picture of inventory.
To eliminate the problem of scattered data, it is advisable to implement a cloud-based real-time inventory management system.
The inventory management system acts as a centralized repository to store all inventory-related data, with convenient access from anywhere. It can also generate reports about sales and other important key performance indicators (KPIs) to help make data-driven decisions to simplify your work.
2. Lack of automation
Businesses can leverage software to automate inventory management tasks to keep up with rising customer demands. Automation not only saves time but also reduces the chances of human error.
Another advantage of automation is streamlining your inventory management process to improve accuracy and simply the reordering process.
3. Over-reliance on technology
At first glance, this point may seem counterintuitive to the previous point, which is not entirely incorrect.
We have discussed how automation can help reduce human errors and improve the inventory process. But technology should not be treated as a substitute for human judgment. Instead, it should be treated as a supplement.
Technology acts as the library for your business – it stores information about past sales and other historical information about your customers and their buying behaviors. However, inventory planning requires careful analysis of the data along with trends to determine future needs.
The role of human judgment is critical to this process.
4. Inadequate training
Technology is not a substitute for employee training. Untrained staff can cost your business through inefficiencies and errors. Employees should be equipped with the proper knowledge of your business processes, data analytics, and supply chains. These are necessary components of inventory planning and execution.
While training can be time-consuming and expensive, the benefits outweigh the costs.
“Give me six hours to chop down a tree, and I will spend the first four sharpening the ax.”
– Abraham Lincoln
5. Inefficient picking process
How inventory is stored makes a difference. When an order is received, staff should be able to quickly and efficiently pick the items from the shelf for packaging and shipping. An inventory management plan should focus on stock placement in terms of product demand.
Ideally, the most in demand products should be most accessible to enable quick retrieval.
6. Limited cycle counts
Cycle counting is a method used to reconcile physical inventory with inventory records. Annual cycle counts reduce the effectiveness of operations as they are often labor-intensive and require that you close for at least a day.
A better approach includes frequent inventory reconciliation on select inventory segments; thus, preventing business disruptions.
7. Multichannel warehousing
Often inventory is stored in more than one location. For example, a retailer might have a brick and mortar store and a warehouse. Tracking inventory located in multiple distribution centers adds a layer of complexity to inventory and order management.
Inventory management software can streamline the coordination process afflicted by multiple locations.
8. Lack of cross-functional team communication
Cross-functional team communication is a must so everyone is aware of production and procurement needs to circumvent supply deficiencies.
Inventory tracking software helps eliminate communication breakdown by maintaining inventory in one spot – cloud-based storage.
9. Employee attrition
The employee “turnover tsunami” is real, and has been catalyzed by the pandemic. According to the 2021 employee engagement and retention report by the Achievers Workforce Institute, 52% of employees (North America) indicated they will look for a new job in the near future.
Replacing and bringing new inventory planners up to speed can be a struggle for your organization. Moreover, new employees may have a difficult learning curve to understand your business systems, especially if you do not have a reliable method to extract historical data.
A robust benefits package centered on employee wellbeing may improve employee retention.
How to develop an inventory plan
Once you understand the advantages and challenges associated with inventory planning, it’s time to begin developing an inventory plan.
An inventory plan is an outline to follow that helps your business order, track, and process inventory. Here are four considerations of an inventory management plan.
1. Estimating demand
Inventory planning requires a thorough understanding of product demand. Historical sales data is a great place to start. For example, if sales data suggests that you sell 100 boxes of chocolates every day, your inventory plan needs to account for this demand. This ensures you do not end up under – or overstocking inventory.
Two other factors to consider when estimating demand are scarcity and competition. If a product is hard to find or source, it might be important to have extra stock to keep up with demand fluctuations. Additionally, if running out of a product will cause your customers to switch to your competitors, the extra storage cost may be better than losing customers.
2. Creating a replenishment plan
A replenishment plan is necessary to keep production running smoothly. The reorder point (ROP) is a threshold that determines the time to place an order with your vendor. The reorder point is determined by the time needed for your vendors to package and deliver products and circumvent any potential supply issues.
A just-in-time inventory system works in some instances when the supply chain is steady.
A replenishment strategy should consider items that are required on a regular schedule as well as those needed less frequently. Technology aids the replenshipment process as well as calculated cost impacts.
3. Tracking inventory
The efficiency of any inventory management system is as good as its tracking mechanisms. A point of sale (POS) system catalogs inventory and records changes in real-time. Using barcode scanners reduces errors in tracking and increases efficiency.
Inventory planning should ensure that the warehouse area is large enough to accommodate any extra inventory required during peak times.
4. Monitoring and adapting stock
Any inventory system needs to be monitored and adapted to meet present demand for products. Appropriate monitoring will help forecast when sales are needed to move stagnant inventory or when it is time to stock up on certain items to meet growing demand.
Inventory models
Inventory planning techniques can help forecast product demand and reordering points to ensure optimum amount of inventory.
1. Economic order quantity
The economic order quantity (EOQ) is used to calculate the optimum ordering quantity that minimizes inventory cost and optimizes storage space.
The computation of EOQ requires three variables:
- Holding cost – The cost of keeping (storing) inventory.
- Annual demand – The annual demand for your product.
- Ordering cost – The cost of purchasing inventory.
The formula for calculating EOQ is:
To understand EOQ, let’s look at an example. Suppose the annual demand for dark chocolate is 1000 units. Your purchase cost for each unit is $5, and the cost to store each unit (holding cost) is $1.
By inputting the values into the formula, the EOQ is 100 units. Therefore, each time an order is placed, it should be for 100 units (provided these variables remain the same).
If you order in bulk, the ordering cost may decrease. The discount may act as an incentive to purchase more units at a time; however, the benefit is offset by the increase in cost of storing the extra inventory.
EOQ helps strike a balance between both of these costs. The image below shows the graphical representation of EOQ and how it minimizes the overall ordering and holding costs.
On the flip side, EOQ has some disadvantages. It works under the assumption that the demand and the costs remain constant and doesn’t factor in seasonal fluctuations.
2. Reorder point (ROP)
The EOQ calculates the amount that should be ordered. The ROP determines when the order should be placed.
The ROP is the minimum inventory level that a specific product can reach before it’s time to place an order. The following three variables are needed to compute the ROP:
- Average daily unit sales – This average number of units sold each day.
- Delivery lead time – The average time between placing the order and receiving the product. Lead time can be affected by quantity and seasonal demand.
- Safety stock – Safety stock is the surplus stock on hand in case of supply issues.safety stock = (maximum lead time x maximum daily usage) – (average lead time x average daily usage)
Once you know these variables, calculating reorder points becomes easy.
reorder point = (average daily unit sales x delivery lead time) + safety stock
Continuing with the chocolate illustration, let’s suppose you sell ten units daily with a delivery lead time of five days and safety stock of 150 units.
The reorder point is 200 units, calculated as follows: 200 = (10 x 5) + 150
Therefore, a new order needs to be placed when inventory reaches 200 units. This formula includes a safety net for production or shipping delays.
Once the ROP is known, the reordering process can be automated using modern inventory management tools.
3. Perpetual ordering
Perpetual ordering requires constant monitoring of inventory quantities to determine when the reordering point is triggered.
This method is dependent upon the inventory on hand. Stock levels need to be continuously adjusted for sales and returns. Barcode scanning is a necessity when using a perpetual ordering system to actively and accurately monitor inventory.
Perpetual ordering accesses information in real-time and eases tracking processes across different locations. However, because this system relies on technology, companies that use manual inventory systems cannot utilize perpetual ordering. Any miscalculations affect the entire system.
4. Periodic ordering
Periodic ordering system measures inventory levels and COGS. Both of these variables are updated at specific time intervals, either monthly, quarterly, or annually.
Ordering is determined based on current stock and the expected demand. The cost of goods sold through this method is calculated as follows:
COGS = (opening inventory balance + cost of inventory) – closing inventory
To illustrate, let’s say you have a starting inventory worth $10,000. At some point during the accounting period, you acquire additional inventory worth $60,000. At the end of the period, you find that your closing inventory is worth $20,000.
COGS is $50,000 calculated as follows: $50,000 = ($10,000 + $60,000) – $20,000.
This method is feasible for small businesses that do not keep a lot of inventory in stock (making it easier to count). Unlike the perpetual inventory system, this method does not require the business to monitor every transaction.
However, if there is high stock turnover, in other words a large SKU count, this method is not efficient. Inventory information lags leading to forecasting issues. Periodic tracking is also more prone to human error than any of the other methods.
Final words
Successful inventory planning is the key to maintaining optimal inventory levels. This boosts your bottom line, increasing profits. The success of inventory planning can be gauged by implementing KPIs including:
- Stock turnover
- Customer satisfaction level
- Forecasting accuracy
- Utilization of storage capacity
- Order delays due to stockouts
- Inventory carrying cost
Apart from these KPIs, robust inventory management software can help with successfully executing your inventory plan. DEAR Systems is an easy-to-use tool for inventory management. It is a cloud-based solution that can help track inventory in real-time and generate reports that provide insights for inventory planning.
Get in touch with the experts at DEAR Systems to learn more about how we can help with your inventory needs.