Methods of Planning and Calculating Inventory Levels
Inventory levels are planned by employing certain methods such as
- Basic stock method;
- Percentage variation method;
- Week’s supply method; and
- Stock to sales method.
1. Basic stock method
The basic stock method is followed to derive a basic level of stock. The basic level of stock is a particular level of inventory available at all times. It meets sales expectation and allows for a margin of error. This approach ensures that stock levels are not depleted. Customers are satisfied as the products they intend to buy are always available.
Basic stock method assumes particular importance if sales are higher than expected or if there could be any problem with the shipment and delivery of stocks.
This method is suited to a low turnover or when sales may be erratic.
Stock at the beginning of the month = Planned monthly sales + basic stock
Average stock for season = Total planned sales for season / Estimated inventory turnover
Average monthly sales = Total planned sales for season / Number of months
2. Percentage variation method
Percentage variation method is followed when stock is stable. When stock does not change considerably, the plan and monthly inventories are closer to the monthly average. The monthly percentage fluctuations from average stock should be half as great as the percentage fluctuations in monthly sales from average sales. This would be calculated as follows:
Beginning of month planned inventory level = Planned average monthly stock for season x 1/2 (1+( Estimated monthly sales /Estimated average monthly sales))
3. Week’s supply method
Week’s supply method forecasts average sales on a weekly rather than a monthly basis. This method assumes that the inventory carried is in direct proportion to sales. This method is suitable for retailing organizations such as supermarkets where sales do not fluctuate by significant amounts. The predetermined number of weeks’ supply is linked to the stock turnover rate desired. This method has a proportional link between the value of the stock and the forecast of sales.
Beginning of month stock = Average weekly sales x Number of weeks to be stocked
Average weekly sales = Estimated total sales for the period / Stock turnover rate for the period
Number of weeks to be stocked = Number of weeks for the period / Stock turnover rate for the period
4. Stock to sales method
Stock to sales method is appropriate when a retailer wants to maintain a specified ratio of inventory to sales. Generally, the beginning of the month stock to sales ratio is used. This ratio reflects the amount of inventory required to effect that month’s estimated sales.
For example, a ratio of three would require a retailer thrice that month’s expected sales available in inventory at the beginning of the month.
Factors affecting methods of estimating inventory requirements
All the methods of estimating inventory requirements are affected by a host of factors. These include shrinkage, markdowns, and employee discounts. These factors cause reduction in the retail value of inventory. Therefore, an appropriate estimate should be included in the merchandise.
Shrinkage represents the difference between the amount of merchandise as reported on the inventory system and what is physically available for sale on the shelves. The reasons for the difference may be shoplifting, pilferage, vendor over-billing, distributor theft, clerical errors, breakage, spoilage etc.
Shrinkage results in reduction in the total retail value of the merchandise. The level of shrinkage depends upon the merchandise type and the department.
Markdowns mean reduction in the price of the merchandise. Lowering of the prices of merchandise acts as a promotion. Markdowns are followed for special sales periods, moving sluggish lines because of the soiling of merchandise. Further, greater competition from competitors or manufacturers compels markdowns to be followed.
3. Employee discounts
Employee discounts are the value offered to the employees working in the retail store. All such discounts are accountable and the sales should be recorded.