Businesses today have to navigate complex environments with fluctuating demand and intricate supply chains.
To stay ahead, they must manage inventories effectively—balancing demand fluctuations while avoiding excess stock. The ultimate goal is inventory optimization, which saves money, frees up capital, and maximizes sales. Achieving this relies on optimizing cycle stock.
Demand and supply planners have various tools and techniques for reducing inventories without risking stock-outs. In this article, we’ll explore these methods and show you how to use them effectively.
What is cycle stock?
Cycle stock, also known as operating inventory or working stock, supports production or expected sales. It’s the inventory a business keeps for use under normal working conditions.
Maintaining the right cycle stock level will support demand while minimizing inventory. Excess inventories drive up the inventory holding costs for no gain. Unless the business carries enough inventory, it runs the risk of stock-outs, lost sales, and reputational damage. Striking the sweet spot between too much and too little inventory is essential for optimizing stock levels.
In a perfect world with consistent demand, inventory management would be simple. However, demand seldom remains the same. Organizations hold safety stock to protect against unexpected demand increases. Safety stock is distinct from cycle stock, which buffers against unexpected demand spikes and supplier delays. Cycle stock exists to cover average demand during the order cycle.
Calculating cycle stock
The Economic Order Quantity (EOQ) calculates the ideal order quantity. This balances the cost of holding stock with the administrative cost of placing an order as you can see from the formula.
Economic Order Quantity (EOQ) Formula
The EOQ formula is: EOQ = √(2DS/H)
Where:
- D = Demand (annual)
- 𝑆 = Ordering cost per order
- 𝐻 = Holding cost per unit per year
Let’s use a simple example to illustrate how to use the EOQ formula.
Economic Order Quantity (EOQ)formula
We’ll make the following example of a retailer that sells desk pads
- Annual demand (D) = 1,000 desk pads
- Per order ordering cost (S) = $50
- Holding cost per unit per year (H) = $2
Using the EOQ formula:
EOQ = √(2DS/H)
EOQ = √(2 x 1,000 x $50 ÷ $2)
EOQ = √50,000
EOQ = 223.61
The optimal order quantity is approximately 224 units. The company must order 224 units to minimize inventory costs.
You’ll find a more detailed description here.
Factors influencing cycle stock levels
Cycle stock levels are influenced by various factors. Understanding these can help you optimize your inventory. Key factors include:
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- Customer demand and its variability: The higher the demand, the higher the stock levels. Demand variability poses a challenge. Sudden changes can cause stock-outs or excess inventories. More accurate forecasts help to maintain appropriate cycle stocks.
- Supplier lead times and reliability: Cycle stocks increase with longer lead times. Businesses must hold extra stock to avoid stock-outs while waiting for order deliveries. Reliable suppliers make it easier to reduce cycle stocks.
- Production quantities and lead times: Organizations that depend on large, infrequent production runs must carry higher cycle stocks to cover periods between production runs. Flexible manufacturing processes enable lower cycle stocks.
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- Seasonal changes and their impact on inventory levels: Cycle stocks must increase ahead of the peak sales season. Seasonal forecasting and promotions can help to reduce seasonality and cycle stocks.
- SKU proliferation and the challenges of managing diverse product lines: Each SKU must carry its own cycle stock. More stock-keeping units (SKUs) result in higher stock levels, complicating inventory management.
Analyzing cycle stock
Efficient cycle count analysis depends on accurate data. You cannot make informed decisions unless you work from precise inventory data. Regular inventory audits help to ensure inventory accuracy.
Regular audits should identify discrepancies in the actual vs. theoretical inventory levels. Use this information to trace inventory errors and correct the cause. In this way, you can prevent future problems and reduce the risk of stockouts.
Predict stock levels with demand forecasting
Use historical sales data and demand forecasting to predict cycle stock levels. Historical sales can help you recognize trends and patterns like seasonality. Use the information to plan cycle stock levels and cash flow requirements.
Demand forecasting and historical sales can help you to understand demand variability and plan appropriate safety stock in addition to the cycle stock. Use demand forecasting to match your inventory management with business goals, ensuring you meet customer demand and revenue targets.
Use inventory metrics
You can only manage what you measure. Monitor key inventory metrics for effective inventory management. These metrics include:
- Inventory turnover: Inventory Turnover Rate = Cost of Goods Sold (COGS) / Average Inventory. High turnover shows that inventory is moving through the system quickly. It shows efficient inventory management.
- Stock-outs: Accurate demand forecasting should reduce stockouts, improving customer satisfaction and sales performance.
- Excess inventory: Surplus inventories incur unnecessary costs and tie up capital. Accurate forecasts can help to bring down excess stocks.
Optimizing cycle stock
Use the available tools and techniques to optimize your cycle stock.
ABC analysis
Prioritize inventory management by categorizing inventories according to the ABC analysis. This system uses the Pareto method to separate inventory items according to their value and sales velocity. A-items need careful control as they have the biggest impact on financial performance. B-items need regular monitoring but not as much as the high-impact A-items. C-items are low value and need less frequent attention.
Demand forecasting
Accurate demand forecasting is a prerequisite for optimal cycle stocks. Advanced analytics and software tools analyze historical sales data, market trends, and other demand factors to provide planners with accurate forecasts. Use these to reduce stockouts and excess cycle stocks.
Setting reorder points
Reorder points trigger replenishment orders. They ensure that goods are ordered with enough time to prevent stockouts without creating excess inventories. For more detailed information on setting reorder points, visit Netstock’s blog on the reorder point formula.
Safety stock integration
Safety stock acts like your insurance policy, it’s a buffer against demand fluctuations. It ensures that you have stock when demand exceeds expectations. Safety stock prevents stock-outs and lost sales. It maintains service levels and enhances customer satisfaction.
Supplier collaboration
Through supplier collaboration and shared data, you can reduce lead times and cycle stock levels.
Technology and automation
Modern inventory management systems can provide real-time visibility and control over inventory levels. These systems provide accurate real-time information. They streamline processes and reduce errors through process automation.
Embrace the tools and techniques
Efficiency is vital in today’s competitive business environment. Effective inventory management maximizes cash flow, supports sales, and controls costs.
Achieving optimized inventories means finding the perfect balance between minimal stock and avoiding stock-outs. Use the right tools and techniques to reach that sweet spot and secure your success.
