A young man in a button-up shirt stands in a cavernous warehouse, looking up at one of many industrial shelves holding wrapped boxes on wooden pallets. He holds an electronic tablet in one hand and uses the other hand to point a pen at the boxes, as if counting them.
Inventory should exist in the Goldilocks Zone—not too much and not too little. — Getty Images/Zephyr18

Managing inventory is a bit of a balancing act. On one hand, you never want to sell out of your most popular items. On the other hand, you never want old inventory to pile up, and if you run a restaurant or cafe, using inventory before its sell-by date is critical.

Costs related to poor inventory management pile up quickly. Overstocking and understocking are equally problematic. In the retail industry, bad decisions around inventory planning led to $300 billion in lost revenues due to markdowns, one report found. Another report found that out-of-stock orders cause $634.1 billion in annual losses for retailers.

Here’s how to overcome challenges in inventory management to estimate how much inventory you need, optimize your planning and avoid inventory-related losses.

[Read more: 5 Ways to Simplify Your Inventory Management]

Use technology

The simplest way to estimate how much inventory you need is to use inventory management software. Technology can help keep tabs on current stock levels, reduce storage costs for excess inventory and improve relationships with suppliers and vendors. The right software will let you know when you’re running short on a product and will make it easy to automatically reorder items. It can also help you organize your customer and vendor information.

[Read more: What Is Inventory Management Software and Do You Need It?]

Inventory software comes in many shapes and sizes. Some solutions can be integrated into your POS system; some come with a mobile app that can scan barcodes, manage stock and interface with suppliers while on the go. Many products are cloud-based, which can cut down on your hardware costs and make the tool more accessible.

Practice demand planning

Estimating how much inventory you need starts with customer demand planning. This is the practice of forecasting how much your customers will buy from you over a certain period of time. It’s tricky to get right since customer trends can be unpredictable, but there are a few data points that can make it easier to forecast demand.

  • Historic trends: How closely do your recent sales represent sales from the same time last year?
  • Seasonality: Do you anticipate a holiday rush?
  • Competitive landscape: Has the competition launched similar products that will impact your target customer?
  • Marketing and promotions: Are you running any discounts or bundles that may increase demand?

Again, there are plenty of events that can throw off your demand planning. But starting with a basic understanding of how regularly you sell out of a product can help establish a baseline of how much stock you need to keep on hand.

Turnover varies for different products—for example, ice cream has a lower days inventory than freezers.

Margaret Spencer, Fundera

Estimate restock lead times

There are two lead times you need to know to keep your inventory levels in balance. These are internal lead time and supplier lead time.

Internal lead time is how long it takes your business to receive a delivery and get the products ready for the customer to buy. There are several factors that play into the amount of lead time you need internally, including:

  • Receiving time: E.g., how long does it take to unload products from the delivery truck?
  • Put away time: How long does it take to add and organize items in the stock room?
  • Inspection time: How long does it take to check if all items are delivered and undamaged?
  • Display time: If you run a brick-and-mortar store, how long does it take to restock the shelves for customers?

Supplier lead time refers to the time between when you place an order with a supplier and when they deliver the order to your store or warehouse. It’s helpful to keep track of your supplier’s lead time. If they tell you they can deliver your inventory in two weeks but consistently take four weeks to complete the delivery, you need to build a two-week cushion into your ordering cycle.

Ultimately, these lead times can help you understand how soon you need to reorder inventory and expect to have it ready for customers.

Do some calculations

If you don’t use inventory management software, there are three key calculations that can help you estimate when to reorder your inventory.

The first is the inventory turnover ratio, which tells you how quickly you sell out of stock. This calculation is your sales (or cost of goods sold) divided by average inventory. If your inventory turnover ratio is low, you may have excess inventory.

The next calculation is days sales of inventory (DSI). This is the number of days it takes your inventory to sell. To get your DSI, divide inventory by cost of sales and multiply by 365. “This calculation is particularly relevant in the context of your industry, because turnover varies for different products—for example, ice cream has a lower days inventory than freezers,” said the experts at Fundera.

Finally, estimate your safety stock, or how much stock you should have in case there’s a run on a specific product (for instance, umbrellas during a thunderstorm). To find this metric, take an average of your top three days’ sales volume over the previous month/quarter/year and subtract the average daily sales volume for the same period.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published August 24, 2021