How to Keep Inventory
Know the four categories of inventory., Understand the advantages and disadvantages of holding on to inventory., Understand the costs of holding inventory., Learn how the type of stock influences how much you need to store., Set a minimum level...
Step-by-Step Guide
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Step 1: Know the four categories of inventory.
Your inventory consists of everything you use to run your business and to provide your service or produce your products.
Inventory can be broken down into four categories.
The type of inventory determines how much of it you should keep on hand.Raw materials and components are items that you use to produce products.
Work in progress is your stock of goods that are in the midst of production.
They are unfinished.
Finished goods are your finished products that are ready to be sold.
Consumables are materials you use to run your business, such as office supplies or fuel. -
Step 2: Understand the advantages and disadvantages of holding on to inventory.
You can choose to keep small amounts of stock on hand and have it delivered as you need it.
Alternatively, you can choose to keep a lot of stock on hand and store what you are not using currently.
Each method has advantages and disadvantages.Keeping little or no stock on hand saves you money in storage costs and allows you to always use the most up-to-date components.
However, you must have reliable suppliers, and you also run the risk of running out of materials in the midst of production.
This also means your costs are related to the latest prices, since every purchase reflects the current price and the purchased inventory is quickly used up.
Keeping a lot of stock on hand means you may be able to save money by buying materials in bulk, and you never have to worry about running out of materials.
However, you may have to pay for storage, and items may expire or become outdated before you can use them.
You also assume a price risk if purchases go down in price versus the price of your inventory (but make gain if prices rise). , Determining the optimum stock level involves balancing the different costs associated with storing and purchasing stock.
The costs of inventory involve purchasing costs, carrying costs and stock out costs.Ordering costs include paying for transportation, paying for staff to receive, store and control quality of materials and paying clerical staff to prepare requisitions, place orders and manage the ordering process.
Carrying costs include the cost of storage in outside facilities, insurance, taxes, capital costs and the cost of staff to handle the materials.
Stock out costs refer to the interruption in production if you run out of materials. , The levels of stock you keep may vary depending on the type of stock.
For each category, consider the reliability of your suppliers.
The price is also a consideration.
The price of some materials fluctuates, and you may get discounts for buying certain materials in bulk.With raw materials, the schedule and reliability of your suppliers drives how much you keep on hand.
It’s a good idea to have alternative sources of materials in case of a problem with your supplier.
Also, if the price of materials fluctuates, you may have to time purchases to take advantage of the best prices.
Keeping a stock of works in progress can come in handy if there is a problem with delivery of raw materials that interrupts production.
Only keep a supply of finished products on hand if you are producing items in batches or you are in the midst of producing a large order.
The level of stock for consumable supplies depends on how you use them, discounts for purchasing in bulk and the reliability of your suppliers. , This is the level below which stock on hand should never fall.
Lead time affects this level.
This means how much time it takes to replace stock you have used.
Also, the rate of consumption determines the minimum level.
Know how quickly you use materials and how much you will use during lead time.Lead time is the amount of time you need to replenish the inventory.
It is the number of days between when you place an order and when you receive it.
The rate of consumption is refers to how much of an item you use in a specified time frame.
Suppose, for example, that you run an office and you need to determine the minimum number of reams of printing paper to keep on hand.
You know that your supplier can get an order of paper to you within five business days.
This is your lead time.
Also, you know that the office uses an average of three reams of paper per day.
This is your consumption rate.
Since you know your lead time is five days, you must never allow your inventory of paper to fall below five days’ worth of paper.
If your office uses three reams of paper per day, then a five-day supply would be 15 reams of paper.
Your minimum stock level is 15 reams of paper. , This is the level at which it is time to re-order stock.
It is typically somewhere between the maximum and minimum levels.
When stock reaches this level, a staff member needs to initiate a purchase requisition.
This will start the process of restocking inventory with fresh materials.Using the above example, it might not be the best practice to always let your supply of paper dwindle to the minimum level before initiating a replacement order.
Any number of circumstances could delay the delivery, and you would be left without any paper in the office.
To determine a reordering level, you would consider the reliability of your supplier.
For example, suppose you know that on a few occasions during the winter months, bad weather delayed your delivery for a few days.
Based on your history with this supplier, you decide to reorder when your inventory of paper falls to 10 days’ worth of paper, or 30 reams.
The reordering level for paper would be 30 reams. , This is the quantity of materials above which you should not keep stock.
Setting this level is influenced by many factors.
For example, you need to consider the amount of space you have available and the cost of storage.
In addition, depending on the type of stock you have, government requirements may limit the amount you can store.
Also, seasonal needs may impact how much you need to have on hand.
Finally, depending on your industry, changes in fashion or demand may influence your maximum level of certain materials.Some businesses use a the reordering level in a formula to calculate maximum stock levels.
This formula is:
Maximum Level = Re-ordering Level
- Consumption Rate * Lead Time + Economic Order Quantity.
Economic order quantity (EOQ) is a calculation used to determine a fixed amount when re-ordering inventory.
It is discussed later in this article.
For this example, assume the EOQ is 30 reams of paper.
Using the above information, the maximum stock level could be calculated with the formula 30−3∗5+30=27∗35=945{\displaystyle 30-3*5+30=27*35=945}.
The maximum level for paper would be 945 reams. -
Step 3: Understand the costs of holding inventory.
-
Step 4: Learn how the type of stock influences how much you need to store.
-
Step 5: Set a minimum level.
-
Step 6: Determine a re-ordering level.
-
Step 7: Set a maximum level.
Detailed Guide
Your inventory consists of everything you use to run your business and to provide your service or produce your products.
Inventory can be broken down into four categories.
The type of inventory determines how much of it you should keep on hand.Raw materials and components are items that you use to produce products.
Work in progress is your stock of goods that are in the midst of production.
They are unfinished.
Finished goods are your finished products that are ready to be sold.
Consumables are materials you use to run your business, such as office supplies or fuel.
You can choose to keep small amounts of stock on hand and have it delivered as you need it.
Alternatively, you can choose to keep a lot of stock on hand and store what you are not using currently.
Each method has advantages and disadvantages.Keeping little or no stock on hand saves you money in storage costs and allows you to always use the most up-to-date components.
However, you must have reliable suppliers, and you also run the risk of running out of materials in the midst of production.
This also means your costs are related to the latest prices, since every purchase reflects the current price and the purchased inventory is quickly used up.
Keeping a lot of stock on hand means you may be able to save money by buying materials in bulk, and you never have to worry about running out of materials.
However, you may have to pay for storage, and items may expire or become outdated before you can use them.
You also assume a price risk if purchases go down in price versus the price of your inventory (but make gain if prices rise). , Determining the optimum stock level involves balancing the different costs associated with storing and purchasing stock.
The costs of inventory involve purchasing costs, carrying costs and stock out costs.Ordering costs include paying for transportation, paying for staff to receive, store and control quality of materials and paying clerical staff to prepare requisitions, place orders and manage the ordering process.
Carrying costs include the cost of storage in outside facilities, insurance, taxes, capital costs and the cost of staff to handle the materials.
Stock out costs refer to the interruption in production if you run out of materials. , The levels of stock you keep may vary depending on the type of stock.
For each category, consider the reliability of your suppliers.
The price is also a consideration.
The price of some materials fluctuates, and you may get discounts for buying certain materials in bulk.With raw materials, the schedule and reliability of your suppliers drives how much you keep on hand.
It’s a good idea to have alternative sources of materials in case of a problem with your supplier.
Also, if the price of materials fluctuates, you may have to time purchases to take advantage of the best prices.
Keeping a stock of works in progress can come in handy if there is a problem with delivery of raw materials that interrupts production.
Only keep a supply of finished products on hand if you are producing items in batches or you are in the midst of producing a large order.
The level of stock for consumable supplies depends on how you use them, discounts for purchasing in bulk and the reliability of your suppliers. , This is the level below which stock on hand should never fall.
Lead time affects this level.
This means how much time it takes to replace stock you have used.
Also, the rate of consumption determines the minimum level.
Know how quickly you use materials and how much you will use during lead time.Lead time is the amount of time you need to replenish the inventory.
It is the number of days between when you place an order and when you receive it.
The rate of consumption is refers to how much of an item you use in a specified time frame.
Suppose, for example, that you run an office and you need to determine the minimum number of reams of printing paper to keep on hand.
You know that your supplier can get an order of paper to you within five business days.
This is your lead time.
Also, you know that the office uses an average of three reams of paper per day.
This is your consumption rate.
Since you know your lead time is five days, you must never allow your inventory of paper to fall below five days’ worth of paper.
If your office uses three reams of paper per day, then a five-day supply would be 15 reams of paper.
Your minimum stock level is 15 reams of paper. , This is the level at which it is time to re-order stock.
It is typically somewhere between the maximum and minimum levels.
When stock reaches this level, a staff member needs to initiate a purchase requisition.
This will start the process of restocking inventory with fresh materials.Using the above example, it might not be the best practice to always let your supply of paper dwindle to the minimum level before initiating a replacement order.
Any number of circumstances could delay the delivery, and you would be left without any paper in the office.
To determine a reordering level, you would consider the reliability of your supplier.
For example, suppose you know that on a few occasions during the winter months, bad weather delayed your delivery for a few days.
Based on your history with this supplier, you decide to reorder when your inventory of paper falls to 10 days’ worth of paper, or 30 reams.
The reordering level for paper would be 30 reams. , This is the quantity of materials above which you should not keep stock.
Setting this level is influenced by many factors.
For example, you need to consider the amount of space you have available and the cost of storage.
In addition, depending on the type of stock you have, government requirements may limit the amount you can store.
Also, seasonal needs may impact how much you need to have on hand.
Finally, depending on your industry, changes in fashion or demand may influence your maximum level of certain materials.Some businesses use a the reordering level in a formula to calculate maximum stock levels.
This formula is:
Maximum Level = Re-ordering Level
- Consumption Rate * Lead Time + Economic Order Quantity.
Economic order quantity (EOQ) is a calculation used to determine a fixed amount when re-ordering inventory.
It is discussed later in this article.
For this example, assume the EOQ is 30 reams of paper.
Using the above information, the maximum stock level could be calculated with the formula 30−3∗5+30=27∗35=945{\displaystyle 30-3*5+30=27*35=945}.
The maximum level for paper would be 945 reams.
About the Author
Frances Knight
Dedicated to helping readers learn new skills in crafts and beyond.
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