What Is The 80/20 Inventory Rule?
share this article Almost every successful business begins with a good idea and hard work.
by Shaz K
Wednesday 2, Sep 2020
Inventory control, or stock control, is the art of optimizing and regulating everything your company stocks and stores. Here’s everything you need to know about inventory control.
Inventory control is the practice of carefully managing the amount of inventory maintained by a company. The goal of inventory control is to easily meet customer demand while keeping costs as low as possible. After all, who wouldn’t want happy customers and great profit margins!
Inventory control includes ordering the right amount of stock, of course. But it’s also about so much more. In order to truly practice inventory control, you’ll need to properly manage your warehouse, stockroom or storage closet. Inventory management software can help your business manage all its stuff, making inventory control that much easier.
While inventory management is all about tracking inventory, inventory control is a science-based approach to optimizing both customer service and profit margins.
Inventory control helps you keep your customers happy and satisfied while ensuring your business is as profitable as possible. That’s a win-win, for sure… but inventory control is a delicate balancing act, and mastering it isn’t simple.
Companies that try to keep costs down by keeping a bare bones stockroom may find that they’re not able to keep up with customer demand. Unhappy and impatient buyers will take their business elsewhere. On the other hand, companies that fill their warehouses to the brim risk tying up way too much cash in their inventory. There just isn’t enough customer demand to move inventory, and profits plummet.
By optimizing inventory control, your business can stock just the right amount of stuff to run your business smoothly and smartly.
In order to practice inventory control, you’ll need to figure out just how little inventory you can order without risking running out. To determine those thresholds, two formulas are helpful: economic order quantity (EOQ) and reorder point formula.
Economic order quantity (EOQ) reveals how much inventory you should order to keep costs to a minimum, while still comfortably meeting customer demand.
EOQ = √(2DK / H)
You’ll need the following data to calculate EOQ:
Annual fixed costs refer to how much you pay the suppliers for a product. Annual demand refers to how many units of a given product your customers demand a year. Carry costs per unit refer to how much your business spends carrying the product over the course of a year.
Once you have your numbers, you can use this EOQ formula to calculate how many units you should order. A free economic order quantity calculator can help you instantly determine EOQ for every product in your inventory.
If gathering all the data to calculate EOQ is proving to be a real challenge, you may want to consider getting organized with an inventory app. That way, you can use reports and item history to better gauge demand, costs and more.
Reorder point formula reveals when you should reorder stock for optimal inventory control.
Reorder point = lead time demand (in days) + safety stock (in days)
To calculate the reorder point formula, you’ll need the following information:
Lead time demand refers to the number of days it takes to receive your order once it is placed.
Lead time = supply delay + reordering delay
Sometimes, lead time is just a few days. Other times, it can take weeks or months to receive stock from a supplier. To calculate lead time, you’ll need to add together the reordering delay and supply delay.
A reordering delay occurs when, for whatever reason, you have to wait to place your order. If you place orders on Mondays but your supplier only accepts orders on Thursdays, you have a consistent reordering delay of 3 days.
A supply delay is how long it takes your order to arrive once your supplier has accepted it.
Safety stock is your insurance stock: that little bit of extra inventory you maintain just in case something out of the ordinary occurs.
Safety stock = (maximum daily usage x maximum lead time in days) – (average daily usage * average lead time in days)
Your safety stock is a buffer that can protect you if demand is higher than usual, for one reason or another. After all, part of practicing inventory control is keeping your customers happy. And no customer wants to wait for a backordered product.
To calculate safety stock, you’ll need the following information about a given product in your inventory:
You can review reports from your inventory management software, purchases orders and sales reports to determine this information.
Don’t have reports? Start tracking your inventory with a free trial of Sortly, and see how data-rich inventory insights can supercharge your inventory control strategy.
The three most common inventory control models are economic order quantity (EOQ), inventory production quantity and ABC analysis.
As previously mentioned, economic order quantity can help you practice inventory control by articulating exactly how much of a product you should order to meet demand without running out.
Inventory production quantity, which is another formula, is similar to economic order quantity, but is for companies that order parts, not complete items. Inventory production quantity can help these manufacturers determine how many parts to order at once. Using this formula to inform ordering protocols is a form of inventory control: it helps companies reduce carrying and setup costs, thereby increasing profits in the long run.
The formula is quite complex:
ABC analysis categorizes a company’s inventory based on how important it is, with “A” being the most important to the business, then “B”, and then “C.”
Category A inventory follows the Pareto Principle, also known as the 80/20 rule. The 80/20 rule stipulates that 20% of your inventory brings in most of your revenue. Identify the profitable items that account for about 70% of your revenue, and classify them as “Category A”. Make sure you never run out of this inventory!
Category B inventory is not the key to your business’s profits, but it’s still important. This inventory contributes to about 25% of your revenue, and should account for 30% of your stock. You should work hard to keep these products properly stocked, but they don’t need as much attention as your Category A items.
Category C inventory is half of your stock, but only 5% of your revenue. While you can continue to stock these items, you don’t need to dedicate tons of time and resources to Category C inventory control.
There are two ways to count inventory: periodic inventory or perpetual inventory. Periodic inventory refers to counting inventory at specified, regular intervals. Perpetual inventory means inventory counts are updated in real time.
Most businesses prefer perpetual inventory because information is always accurate and there’s no need to shut down operations to count, well, everything. However, some businesses (like restaurants) still prefer a physical, periodic count of stock.
Businesses use both perpetual and periodic inventory methods to keep customers happy and carrying costs low. No matter what kind of inventory control system you use, one thing is for sure: you cannot practice inventory control without accurate inventory management.
Inventory management helps with inventory control by providing accurate, instant information about a company’s inventory. After all, successful inventory control requires businesses to know what they’ve got, how much it costs, where it is and how long they’ve had it.
When choosing an inventory management system, you may find that modern inventory management software is far more powerful and effective than traditional pen-and-paper inventory or spreadsheet inventory methods. Inventory management software uses automation and technology to streamline and simplify some of the most tedious parts of inventory management, like checking items in and out or performing inventory audits.
Unfortunately, inventory management software can be quite expensive. Companies can easily spend $5,000 a year on inventory management software. And some behemoth corporations spend millions on inventory software.
Inventory apps like Sortly are a modern, far-more-affordable version of inventory management software. All the features you need are available–but for a fraction of the cost. Sortly, for example, offers a forever-free plan and premium plans that start at just $39 a month.
An inventory app should have all the same features as fancy inventory management software, but cost far less money. These features include:
Want to use Sortly to get your inventory under control? Get started with a free trial today!
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