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How To Calculate And Maintain Optimal Inventory Levels
Managing inventory levels is a balancing act for direct-to-consumer (DTC) brands. Too much inventory, and you’re left with dead stock that jacks up overhead costs. Too little leaves you with stockouts, unable to fulfill demand.
Somewhere between those 2 options are your optimal levels of inventory. AKA the goldilocks zone where your ecommerce brand can reach peak profitability.
So, how can you find your optimal inventory levels? Let’s find out.
“Inventory levels” refers to the amount of stock available throughout your distribution network. By tracking your inventory levels, you can consistently meet demand without accruing unnecessary holding costs that diminish gross profits.
For instance, when your inventory levels are low, you won’t have enough inventory to fulfill all the demand that comes your way. And as a result, you’ll go out of stock. During that stockout event, you miss out on sales and revenue if you don’t sell those products on backorder.
Meanwhile, holding too much inventory requires a hefty up-front capital investment. And the longer units sit in your warehouse, the more carrying costs they rack up, and the more likely they’ll turn to dead stock. So, by the time you sell these units, chances are good that their margins will have shrunk, and you’re no longer making a profit.
The sweet spot, then, is the point between too much and too little inventory. There, you achieve optimal inventory levels and only carry units guaranteed to sell.
There are 3 types of inventory levels you should track: Your minimum, maximum, and optimal levels of inventory.
Minimum inventory levels are the lowest amount of inventory you should have for each SKU. Anything below this threshold means you might stock out and fail to meet customer demand that comes your way.
As such, your low stock alert and reorder point should consider what’s happening with your supply chain and how variabilities affect your order lead times. That way, you can ensure replenishment arrives before you drop below this minimum stock level.
Advantages of low inventory levels |
Disadvantages of low inventory levels |
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Maximum inventory levels are the ceiling amount of stock you should have on hand for each SKU. Anything more above that threshold is considered excess inventory and introduces unnecessary inventory risks (like higher costs and waste).
As such, your maximum inventory levels should be calculated before you place a purchase order (PO) to prevent over-ordering.
Advantages of high inventory levels |
Disadvantages of high inventory levels |
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Optimal inventory levels are the ideal inventory quantities your brand should have on hand. These stock levels match your actual customer demand, so you always have enough inventory to fulfill that demand. All while keeping inventory costs down, cash flow moving, and profits as high as possible.
To calculate your optimal inventory levels, you need to first know where your minimum and maximum stock levels are. To do this, you’ll need to know your:
Normal delivery time (the average amount of time it takes to receive your replenishment at your warehouse once the PO is placed).
Once you have these numbers, you’re ready to calculate your inventory levels.
To calculate your minimum inventory levels, use the following formula:
| minimum inventory level = reorder point – [normal consumption × normal delivery time]. |
For example, say you sell t-shirts. Your reorder point is 10k shirts with a normal delivery time of 6 weeks. The normal consumption of these shirts is 1,200 units per week.
minimum inventory level = 10,000 shirts – (1,200 shirts per week × 6 weeks) = 2,800
In this example, your minimum inventory level would be 2,800 shirts.
To calculate maximum inventory levels, use the following formula:
| maximum inventory levels = reorder point + reorder quantity – [minimum consumption × minimum lead time]. |
Let’s go back to the t-shirt example. Your reorder point is still 10,00- shirts with a reorder quantity typically of 15,000 shirts. Minimum consumption is 1,000 shirts per week and your minimum lead time still hovers at the 6-week mark.
maximum inventory levels = 10,000 shirts + 15,000 shirts – (1,000 shirts × 6 weeks) = 19,000
In this example, the maximum inventory level is 19,000 shirts.
Optimal inventory levels are somewhere between your minimum and maximum levels. And you need to calculate this number to, well, maintain optimal inventory levels.
But calculating your optimal levels is more complex than just plugging numbers into a formula. It depends on your real-time inventory data and the growth assumptions your demand forecasts rely on.
Admittedly, calculating your exact optimal level of stock is complicated because these factors are constantly changing.
While some brands calculate this number with spreadsheets, it’s time-consuming and typically unreliable. So, the better (and error-proof) option is to use an inventory management software or ops optimization tool. (More on this in a minute.)
Optimal inventory levels ensure you never have too much or too little inventory at any given time. And when a DTC brand maintains that kind of inventory control, they benefit in a myriad of ways.
Having the right amount of inventory on hand means none of your generated demand goes unfilled. Instead, you always have exactly what your customers what at the moment they want it. This keeps customers happy and revenue flowing.
A whopping 17% of customers will leave a brand after just 1 bad experience (and 59% after multiple instances). But when you continually meet demand with optimal inventory levels, you create positive experiences for your new and old customers. And that means they’re more likely to come back and purchase from you again and again.
Optimal inventory levels ensure you have constant inventory turnover. That’s because you’re constantly selling through and replenishing the stock you have in your warehouse. This eliminates excess inventory (so you’re not stuck paying storage costs), reduces your insurance liability, and keeps you from collecting dead stock.
By forecasting your optimal inventory levels, you also improve your inventory optimization, inventory planning and inventory management processes. That’s because you have a better sense of what customers will want to buy in the coming months. So, you only order the inventory that you’ll actually sell through (nothing more, nothing less).
Optimal levels ensure that you never invest too much capital upfront for unnecessary inventory. And the stock you do invest in is guaranteed to sell quickly. This way, your cash flow keeps, well, flowing. And you get a bigger return because the inventory isn’t accumulating unnecessary carrying costs that deplete margins.
Determining your optimal inventory levels comes down to monitoring several factors like order lead times, safety stock, and forecasted sales.
As I mentioned earlier, order lead time is the amount of time it takes to receive your replenishment at your warehouse once the PO is placed. And it impacts when you need to place your next PO to ensure you get your order long before falling below your optimal stock levels.
Typically, lead times are somewhere between 8-10 weeks. But with ongoing supply-chain disruptions, many DTC brands are seeing longer than usual lead times closer to the 6-month mark.
To calculate your order lead time, use the following formula:
| order lead time = [delivery date – order entry date] |
Here, the delivery date is the day the order arrives at your warehouse. Meanwhile, the order entry date is the day the PO was originally submitted.
Safety stock is the extra inventory you keep on hand to protect against demand and supply chain uncertainty.
And its primary purpose is to prevent stockouts when your brand experiences unprecedented spikes in demand or supply chain delays.
You can use the following formula to calculate your safety stock:
| safety stock = products sold per day × desired days of safety stock |
The amount of safety stock you need depends on the supply chain capabilities and customer demand. And that makes it a time-intensive task to manually (and constantly) rerun this calculation.
Alternatively, an ops optimization tool like Cogsy will automatically calculate safety stock into your optimal stock levels and have your POs reflect that information.
Weeks of supply (WOS) is how long it’ll take to sell through your on-hand inventory based on current demand trends. And the ideal time to replenish is when WOS is roughly 2 weeks longer than your order lead times.
To calculate weeks of supply, use the following formula:
| weeks of supply = on-hand inventory / average weekly units sold |
Knowing your WOS prevents lost revenue by ensuring you always replenish at the right time to avoid a stockout. Similarly, it keeps excess inventory from accumulating by ensuring you don’t place POs sooner than needed.
Demand forecasting relies on historical sales data and real-time demand trends to predict how many units a brand will need to meet customer demand.
Most retail brands rely on spreadsheets to forecast sales and determine optimal inventory.
But the problem is that manual forecasts are time-consuming and prone to human error. Plus, by the time you gather and input the most recent data, it’s likely already outdated.
Cogsy, on the other hand, tracks inventory levels 24/7 and considers how this data will affect your brand’s forecasts in real-time. This way, you always have a wildly more accurate forecast to determine when, what, and how much stock to order.
Optimal inventory levels are critical for fulfilling customer demand while avoiding too much inventory. And while every DTC brand requires a unique inventory management strategy, there are some general tips for maintaining optimal inventory levels.
Often, you don’t know your inventory has shrunk until you take stock. And that’s why inventory audits are helpful — because they confirm inventory accuracy, so you’re working with counts that actually reflect your stock levels.
Let’s say one SKU’s optimal quantity is 200 units, and you have 25 units available right now. But because there’s a discrepancy in your data, your inventory management software shows you only have 30 units on hand.
An inventory audit would identify those 5 missing units. That way, you can actually replenish to the optimal 200-unit level. And start investigating where those missing units went (whether it’s human error, technical issues, or shrinkage) head-on.
The easiest way to stay in stock is to optimize your purchase order process, so that you always get your POs in at the ideal time. And that starts with calculating your reorder point.
Your reorder point (ROP) signals when inventory approaches the minimum inventory level and needs to be restocked. To calculate ROP, use the following formula:
| ROP = demand during lead time + safety stock |
For example, say your demand during lead time is 1,800 units (or 180 days x 10 units sold per day), and your safety stock is 1,700 units. In this scenario, your reorder point is when inventory hits 3,500 units.
1,800 units during lead time + 1,700 units safety stock = 3,500 units ROP
If you calculate this number manually, you’ll need to regularly set aside time to rerun this calculation. That’s because every time there’s a shift in your demand, your ROP shifts with it.
Alternatively, a tool like Cogsy can automatically calculate your ROP for you using your current inventory levels and real-time demand trends. Then, when you approach the reorder point, Cogsy will send you a replenish alert.
This alert lets you know it’s the perfect time to place your next PO. (The tool will even automatically draft an optimized digital purchase order to streamline your replenishment process.)
Maintaining optimal inventory levels is easier when your lead times are shorter — or at least reliable. That way, when you order replenishment, you can count on when they’ll arrive.
Obsolete inventory takes up space in warehouses and racks up holding costs over time. But if you proactively get rid of these dead stock items, you can get ahead of the problem and get closer to optimal levels.
To clear your obsolete inventory, offer the products at a majorly discounted rate. You can also create product bundles that kit dead stock items with more popular SKUs. And, if all else fails, you can always donate the obsolete inventory or write it off as a loss.
As you probably noticed, calculating and maintaining optimal inventory levels is a time-consuming task. One that often changes the moment you think you’ve got it right.
That’s why the best brands invest in an inventory management system (IMS) or ops optimization tool to do this work for them. An IMS typically tracks your inventory levels and could potentially help streamline how you place POs.
But Cogsy (and ops optimization tool) takes this one step further with demand planning. Because it tracks what your inventory levels are doing (every minute of the day) and translates this information into actionable steps.
So, for instance, you know to order 500 units of SKU A by this date and time. This helps brands proactively maintain optimal inventory levels by replacing manually-updated spreadsheets with predictive sales and inventory intelligence.
Plus, it automates a lot of the mundane replenishment tasks, saving time and eliminating human errors. This includes replenishing alerts and optimized POs to keep inventory at the optimal level. It also tracks your demand as it changes, so you avoid ordering low-performing SKUs.
Ready to make maintaining optimal inventory levels effortless? Try Cogsy free for 14 days.
The 2 biggest factors affecting inventory levels are customer demand and supplier lead times. Customer demand predicts how much product you’ll sell and how much stock you’ll need to fulfill those orders. And supplier lead times impact how soon you need to replenish inventory.
You can forecast inventory levels manually with historical data and a few simple formulas. But it’s more accurate and less time-consuming to use an ops optimization tool like Cogsy.
The best tool for reducing inventory levels is to rely on more accurate sales forecasts. This will ensure you only order what you need while avoiding less-popular SKUs that turn into dead stock. Already have too much inventory on hand? Try using a marketing promotion or bundling strategy to increase inventory turnover and eliminate that excess stock.
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