By accurately forecasting product demand, you will require less inventory on hand, receive more sales from fewer stock-out items, and benefit from a more efficient replenishment cycle. The key is to have just enough stock to cover supply & demand fluctuations, but not so much that you’re tying up cash needlessly and taking up valuable warehouse space.
Once your forecasts are in place, it is time to start buying into it. The below steps will give you a walk-through of how replenishment works in a time-phased inventory system for items with a forecast.
- Calculate your reorder point. The reorder point is the quantity at which you place a new order or the lowest acceptable amount of inventory.
Reorder point = lead time demand + safety stock
- Calculate your lead time. Lead time is the time it takes from placing an order to having the inventory arrive at your warehouse. Many suppliers provide an estimated lead time, but it’s a good idea to use your own historical data based on actual performance.
Lead Time Demand = lead time x average daily sales
- Calculate your review cycle, which is simply the number of days you are looking ahead to buy for. If you buy weekly, the review cycle is seven days. This number is typically driven by the number of days it takes to get an order that qualifies for free freight from the supplier.
Review Cycle Usage = review cycle x average daily sales
- Calculate your safety stock. This is the extra stock you have on hand to minimize stockouts or fluctuations in demand.
Safety stock days = usage per day X number of days needed to meet service level goal
- Calculate a line point or the “quantity to buy back to.” A line point works similar to the Max in a Min/Max, with a little more sophistication.
Line Point = lead time demand + review cycle usage + safety stock
The above is a comprehensive approach to replenishing inventory, but a practical example is Bob’s Motors. Bob runs an automotive shop and specializes in truck motors. He sells an average of 3 motors per day and buys from the supplier every two weeks. It takes him 30 days to receive a new order from the manufacturer.
Bob’s lead time demand is 30 x 3 = 90 and the review cycle usage is 14 x 3 = 42
Bob wants to have a customer service level of about 95%. Using some statistical analysis, we convert the 95% service level to a multiple of 1.37. We will add .37 x the review cycle usage as the safety stock.
42 x .37 = 16.
Another, more conservative approach would be to use monthly demand instead of review cycle usage. This method will cause you to carry more inventory, but it may make more sense in your case. The reorder point is 90 + 16 = 106
The line point or the quantity you need to get back up to is: 90 + 16 + 42 = 148
The quantity to buy is simply the difference between the net inventory and line point: 148 – 106 = 42. If net inventory has dropped to 91, the buy quantity would be 148 – 91 = 57
When Bob has 106 or fewer motors available and/or on existing open purchase orders, he needs to reorder.
That calculation might look like the below:
119 on hand – 56 committed to sales orders + 20 on existing purchase orders = 83 net available….time to order.
Quantity to Order = Line Point (148) – Net Available (83) = 65
There is no crystal ball to predict demand. Even with all the data at your fingertips, things can change. But, if you’re prepared for likely scenarios and ready to pivot quickly due to unforeseen circumstances, you’ll be in an excellent position to maintain proper inventory levels and positive cash flow.