For businesses looking to reduce cash burn while continuing to satisfy customer demand, optimizing inventory levels is a perfect place to get started. In this article, we’ll define inventory optimization, reveal how to calculate optimal inventory levels, and show you how to optimize inventory levels with an inventory management system.
Inventory Optimization Definition
Inventory optimization occurs when a business maintains a “just right” amount of inventory to satisfy customer demand. By optimizing inventory, a business reduces costs while avoiding the most common inventory-related frustrations, including stockouts, excess inventory, and inventory obsolescence.
Seen as a precursor to inventory control, inventory optimization is a robust, organizational commitment to thorough, thoughtful, and profitable inventory management.
How to optimize inventory levels
Inventory optimization is about so much more than adequately forecasting demand. To truly optimize your business’s inventory, your team must reconsider how it stores, orders, and organizes inventory, recalculate key formulas, predict seasonal trends, and improve its overall inventory management strategy.
Here’s a step-by-step process for optimizing your company’s inventory levels:
1. Learn to forecast demand
There’s no skirting around this first—and crucial—step to inventory optimization. To optimize inventory levels, your business must know exactly what it needs.
Choose a demand forecasting model that works for your industry and incorporates past inventory trends and predictions about future demand fluctuations. Consider working with a consultant or another expert to help your business predict inventory needs. If you use inventory management software, you can lean on past inventory records to help predict future usage.
2. Standardize your inventory management strategy
If your business lacks a cohesive, consistent inventory management strategy, attempts to optimize inventory levels will be moot.
Take some time to select an inventory management system that works for your team: a manual inventory list, an inventory spreadsheet, or an inventory app. Keep in mind that inventory apps tend to work better for teams, are easier to use across multiple locations, and feature automation tools that can speed up time-consuming inventory processes.
Once you settle on a strategy, create a standard operating procedure (SOP) that puts your everyday inventory processes into writing. This document can serve as a training manual and everyday resource for your employees.
This guide should outline all aspects of inventory management, including:
- How inventory is ordered
- How inventory is checked in
- How inventory is stored
- How inventory is counted
- How inventory is moved around the business
- How inventory is “checked out,” consumed, or sold
- How inventory is audited or accounted for
Remember that to truly optimize inventory levels, your business must focus on all the above aspects of inventory management—not just having the “right” amount of inventory on hand.
3. Manage inventory from receiving to consumption
Once you have a solid inventory system in place, you’ll need to put that inventory tracking strategy into practice. Ensure that your team has eyes on every item in your inventory, from when it arrives at your loading dock or office door to when it’s moved or transferred to when it’s finally sold, consumed, or used to create another product.
If tracking inventory seems overwhelming, consider upgrading to an inventory app that offers in-app barcode and QR code scanning. By using a phone or tablet’s camera to check products in and out—or update key details about that inventory—your team can speed through inventory tracking, all while minimizing human error.
4. Continue to refine your forecasts
There’s a reason why forecasting demand is the first and foremost step in optimizing inventory levels: it’s the backbone of inventory optimization. But that’s also why your business will need to continue optimizing inventory over time, not just on January 1st.
Continue to refine your forecasts based on changes in consumer behavior, supply chain challenges, economic fluctuations, and any other variables that might affect how much inventory your business needs.
5. Keep an eye on supplier performance
While you keep a close watch on changes to demand, you’ll also want to take note of supplier performance. Now more than ever, suppliers are plagued by a tumultuous supply chain. Everything from weather events to a viral trend to a holdup at a shipping port can affect your business’s ability to procure the products it needs when it needs them most.
While even reliable suppliers can run into problems now and then, your business should focus on identifying vendors that fail to meet delivery deadlines or consistently ship inventory that arrives damaged, expired, or not in tip-top shape. If you can’t remedy these issues, or if they begin to hamper your ability to optimize inventory levels, then it may be time to look for new suppliers you can trust.
6. Stay organized all year round
New fiscal years and annual inventory audits present great opportunities to get organized, make sense of stock, and dive into predictions about the future. But to truly optimize inventory, your business will need to keep tabs on all these factors all year round.
Adhere to your business’s standard operating procedure, implement an inventory management system that your team will actually use, and don’t be afraid to part ways with a supplier that’s not meeting your business’s inventory needs. Continue to refine your inventory control and inventory management strategies, and continue to train and retrain employees before problems arise.
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How to calculate optimal inventory levels
To calculate how much inventory you need to have on hand, your business should familiarize itself with the following three formulas:
1. Safety stock
Safety stock is buffer stock—the extra inventory your business should keep on hand, just in case.
Safety stock = (Maximum Daily Usage x Maximum Lead Time in Days) – (Average Daily Usage x Average Lead Time in Days)
Related: How to Calculate Safety Stock
2. Reorder point
Reorder point identifies the “trigger point” when your business should order more inventory. By calculating reorder point, you’ll figure out the inventory minimum for a product. Then, when you hit that minimum, you’ll know it’s time to reorder.
Reorder Point = (Average Daily Sales in Units x Lead Time) + Safety Stock
If you’re using an inventory app like Sortly, you can set an inventory minimum for every item in your database. Sortly will alert you when an item is approaching its reorder point.
Want to understand reorder point even better? This in-depth guide to reorder point details how to calculate the formula and how to apply the results to help your business run even better.
3. Economic order quantity (EOQ)
Economic order quantity is an excellent formula for any business looking to optimize inventory levels. That’s because it zeroes in on exactly how much inventory a business needs to meet customer demand while minimizing holding and inventory costs.
EOQ = √(2 x Demand x Setup Costs / Holding Costs)
The formula requires a bit of setup, so visit our guide on calculating economic order quantity to learn more.
Optimize your inventory levels easily with Sortly
Sortly is an end-to-end inventory solution that lets you organize, track, and manage your inventory from any device, in any location. Our easy-to-use mobile app lets you and your team update inventory on the job, scan barcodes from your smartphone, set low stock alerts to remind you to re-order, and more. That means you can work more efficiently, plan for jobs better, and serve your customers to their highest satisfaction.
If your company would benefit from improved inventory management, try Sortly free for 14 days.
