Earlier in this inventory management series, we saw how important it is to have the right amount of a product in stock. Too much and you’re spending money you don’t have to. But too little could mean customers go elsewhere and you miss out.
One tool used by many companies to help them pick out the right number divides inventory into types.
We looked at the ‘four types of inventory’ and how they affect warehouse management last week. That groups inventory by process. It’s also possible to group inventory by importance to stock level.
Types of Inventory and Stock Level
Safety Stock/Buffer Inventory
There are multiple terms for safety stock. However, they all mean the same thing.
Safety stock is an inventory margin you would sell only if sales spike unexpectedly. Usually when a customer returns a defective product, its replacement will be safety stock. Otherwise, it’s used only when sales jump without warning. The business gets to avoid stockouts even when the market surges unexpectedly.
Businesses which take customer service seriously usually also take safety stock seriously.
Having a decent level of safety stock year-round is helpful ahead of your busy season, too. Your company won’t have to spend so much at once to be ready for peak orders. Instead, you can eat into your safety stock and replenish it after busy season, when cashflow is strongest.
And that brings us to another type.
The rest of the stock bought in ahead of your busy season is anticipation inventory. In general, anticipation inventory is stock built up for a future event.
Reasons to build up anticipation inventory include:
- Building up stocks at their current price ahead of a price rise
- Being ready for Christmas/”back to school” or other seasonal demand
- Spreading the cost to stock an upcoming retail outlet over several months, a little at a time
Manufacturers use anticipation inventory differently. For example, running at standard capacity even when demand is lower, to minimise overtime costs to keep up with busy season.
It can also be used to prepare for layoffs by building up stock before production capacity drops.
Decoupling inventory is only used by manufacturers. In a multi-step production cycle, some steps inevitably take longer than others. This could lead to delays in production as one station waits for another.
Having a store of work-in-progress from the completion of slower points ‘decouples’ the production line from that restriction. Decoupling inventory helps to smooth out production irregularities. It can also help when a machine needs maintenance but production continues.
Because these speed issues are built into the production line, no amount of inventory can completely erase them. It’s essential to find the right balance between storage costs and production rate for your business.
Less vital to inventory calculations, but still something to be tracked carefully, transit inventory is any unsold stock currently in transit between locations.
If you have multiple facilities you will sometimes need to transfer stock between locations.
Having a transit inventory category means you never lose track of that stock. This is especially important because stock in transit is at a higher risk of damage or loss.
Using Types of Inventory in Stock Control
A basic understanding of inventory management starts with the ‘run rate’ – the rate at which your stock runs out. But that doesn’t take anticipation inventory into account – or safety stock.
So how do these affect your calculation?
For now, let’s set anticipation inventory aside. Consider safety stock.
How to handle safety stock depends on how you go about re-ordering. You might re-order a (mostly) fixed amount whenever stock falls below a certain level. Because sales numbers can change, and because a single breakthrough can mean unexpected sales in a short time, this is the common way to do it.
Some businesses, though, like to re-order once a month, at a specific point in their monthly financial cycle. So, you might re-order up to a certain level after a fixed period of time.
Another way to think of these are minimum stock driven and maximum stock driven.
Minimum stock driven businesses will need to decide how deeply they cut into their safety stock before re-ordering. Maximum stock driven businesses must decide how large an inventory to add to their order after the baseline inventory. That baseline inventory is the stock they expect to sell before they next re-order, based on their run rate.
Anticipation inventory adds an extra challenge. It should be accounted for separately (and possibly stored separately) from your baseline and buffer inventory – the point of it is that it’s not to be sold until the event being anticipated.
Factors that affect how much anticipation inventory you want include:
- How much you expect to sell once the event arrives.
- How large a budget you have available.
- How much storage space you have for it.
- Carrying costs – the cost of storing and moving the inventory.
- Shrinkage rate – the rate at which inventory is lost, damaged, or stolen before it can be sold.
The goal is to have enough to make the event profitable. Cutting into your profit is the increased carrying costs for long-term inventory. Your assets are the inventory you have left after shrinkage.
Increased carrying costs can make each batch more expensive to purchase than a single bigger order, but you benefit from being able to pay bit by bit rather than having to find all of the money at once.
Decoupling inventory may be the one ‘extra’ inventory type where modern inventory management software can’t help you work out the right amounts. This is because it’s not just an inventory management problem – it’s also a project management challenge.
Fortunately, decoupling inventory is produced in-house. Its purpose is to streamline and speed up production. So, the correct amount is the lowest amount that allows you to reach and maintain a maximum production rate; you can find it by slowly increasing the amount of decoupling inventory until you don’t see any more benefit.
Inventory Types and Stock Audits
Most inventory management tasks can be given over to technology – especially with barcode scanning technology to take inventory in and book it out on despatch.
Shrinkage isn’t like that. Shrinkage has to be detected by eye, either when picking stock to ship or during a stock audit. Of course, discovering shrinkage during despatch may be too late.
How Often Should You Carry Out a Stock Audit?
If you have an inventory management system in place, it’s usually recommended that warehouses or manufacturing facilities carry out a full physical inventory once a year. These are generally scheduled for quiet periods of work.
Retailers are a very different proposition. Depending upon your market and your sales, you may want to do full inventory twice a year, once a month, or (for supermarkets) even two or three times a week.
Specialist stores selling high-margin products will often be on the lower end of this scale. Supermarkets and bargain stores can see entire lines sell out in a few days, and will need to check inventory more often.
If you’re doing inventory once a month or less, consider spot checking specific lines more often. A spot check will usually cover 2-3 of your best-selling product lines and a few less popular lines on rotation.
As you’ll be using these audits to assess shrinkage rate and other key metrics, it’s important to compare your count with your ideal counts for the different types of inventory.
Since full audits usually take place in slow periods, your safety stock margins will probably be higher than usual. If your slow period is just before a busy period, anticipation inventory may be high. If it follows a busy period, anticipation inventory will be low or non-existent.
Stock Audits For 3PLs
If you use third party logistics firms (3PLs) to handle your shipping, some of your inventory will be in the hands of other companies at any given time.
If your 3PL uses a temporary-employee model (over Christmas, for example) you may need to request more regular audits.
One reason for this is the risk of theft being higher with casual employees. The biggest issue is damage or loss due to inexperienced personnel who need training.
To keep your records accurate, make sure you cross-check inventory with your 3PL regularly.
Carrying Out a Stock Audit
The first step in an accurate stock audit is the cutoff. This is simple enough; it involves setting aside new inventory coming in (and any outgoing inventory that’s already been counted) so that you’re not trying to count a number that keeps changing.
In stock audits, ‘cutoff analysis’ tests your process for doing this. Your numbers should reconcile with the last few orders and purchases before the inventory begins, and with orders processed afterward.
Next up is the physical inventory count itself. If you have multiple locations, we recommend carrying out counts at one at a time. This also helps with outgoing orders that might complicate the cutoff.
Reconcile your physical count against your expected quantities. It’s likely the physical count will be a little lower. For some products, it might be much lower or a little higher.
If it’s higher, your warehouse storage will need adjusting. A higher physical count means that some has been misplaced and not found for some time. By revamping your warehouse, you may prevent these phantom losses.
If the physical count on a product is much lower than expected, you have to work out why. If the count specifically turned up a higher number of damaged products than expected, it’s easy.
But lost and stolen inventory can be difficult to tell apart. Usually what type of product it is will be your main clue. Theft is more likely on smaller products with either a short use life (so one thief may want several items over a year) or a high resale value.
Bulky or low-value items are less tempting (or harder to hide) targets for theft. So, in an odd situation, large items are more likely to have been lost than stolen.
Types of inventory can also be useful indicators here. Top selling products tend to have a higher level of safety stock, as a run on them will be larger. That can tempt unscrupulous employees.
The last step is to check inventory allowances. Inventory allowances are categories for obsolete or scrapped inventory – stock that’s still physically there but which is the victim of shrinkage.
Inventory allowance are based on historical patterns of shrinkage, reports of inventory usage, and your procedures (how much damage does it take to write stock off?)
If inventory allowances are higher than expected, storage procedures may need changing. Too much damaged stock indicates an inventory problem.