In our last post, we defined inventory planning and described why it’s important for your business. Since we’ve covered the “what” and “why”, we thought we’d create a mini-guide that starts to cover the “how”. Here are some of the basic concepts and definitions that you can apply to your business to get you started:
1. Sell-Through Rate
Total sales divided by inventory stock at the beginning of the period. Sell-through is typically calculated on a monthly basis. So, if you sold 500 silk blouses in January but started with 1,000 silk blouses in inventory, your sell-through rate would be 50%. If you have a high sell-through rate (75%), you may have underbought and might need to re-stock. A low sell-through rate (5%), would indicate that you overbought and might want to markdown the product. Although it’s a very basic calculation, this metric can help you easily see how well certain styles are doing.
In many ways, weeks of supply and sell-through rate are two sides of the same coin. Calculated as total inventory / weekly sales, weeks of supply can be calculated based on historical results or as a forward looking metric based on your forecast. Many planners consider the forward looking approach to be best practice because historical metrics can be misleading. For example, if you’re going into a particularly busy selling season, looking at the prior month’s data won’t necessarily help you make a better buying decision. In Fuse, the calculation is done for you seamlessly - we connect your forecast to your existing inventory levels and provide you with a timely and accurate reorder recommendation based on your weeks-of-supply.
3. Buffer Stock (Safety Stock) and Service Level
No matter how accurately you predict demand, there is always some risk that you may have underestimated the inventory you need. For this purpose, companies keep some extra stock on hand. Some companies set a service level target which is the probability that all customer orders will be fulfilled. Younger companies might want to set this level quite high (99%) so as not to damage their brand. However, the flaw with service level is that it relies on relatively predictable demand. That’s why at Fuse, we set a weeks of supply target. So, if your target is to have five weeks of supply on hand at all times, we’ll prompt you to order more when you begin to dip below that threshold.
4. Lead Time
Perhaps the most basic concept on the list, lead time is simply the number of weeks or months between when an order is placed with a vendor and when the finished good can be delivered. Lead time is often not only based on how long it takes to produce the good, but also how long it takes to transport the good from the factory to your warehouse.
5. Reorder Point and Reorder Level
Closely tied to safety stock and lead time, the reorder point is the level of inventory at which a reorder is triggered. Typically, this minimum point is calculated as the forecast sales during the lead time plus safety stock. Although the reorder point can suggest when to reorder, it is difficult to know how much to reorder (the reorder level) without a robust demand forecast. Fuse seamlessly links the pieces together by providing a reorder recommendation based on the buffer you set, your lead time and the demand forecast you’ve created using our advanced algorithms.
6. Minimum Order Quantities
Depending on the size of your business, you might at times find yourself constrained by minimum quantity in units per SKU, units per category or dollars that your supplier will allow you to order. Although you might do a lot of sophisticated analysis to figure out the exact optimal quantity you need to reorder, your vendors might completely throw that analysis out the window by insisting that you meet a minimum order quantity.
7. Open to Buy
An open to buy puts all of these elements together to help you re-order more easily. It is a budget that highlights how much capital is available to spend in a given period, and how much already has open POs against it. For example, a retailer might need $100,000 of product next month to reach its sales targets. $75,000 may already be allocated to open POs, so the planner’s job is to optimize the allocation of the remaining budget ($25,000 in this case). In some instances, the planner may not have the budget that he or she needs to be able to meet the sales target. At this point, it often becomes an exercise in maximizing margin. The planner will evaluate not only which of the SKUs are the best sellers, but also which can generate the most profit given the limited budget available.
At Fuse, we’re implementing these concepts and best practices in our software to vastly simplify the analyses that planners have to do. We’re here to help you focus on your business, not your inventory.