Planning Purchasing of Inventory
A Practical Guide to Planning Purchasing Inventory
Managing inventory purchasing effectively is one of the most crucial aspects of running a smooth and profitable operation. The goal is simple: ensure you have the right amount of stock to meet demand without over-committing cash or storage space. Achieving this requires careful planning, balancing forecasted demand with lead times, safety stock, and vendor requirements.
In this post, I’ll guide you through a structured approach to inventory purchasing, utilising a review cycle, safety stock, and lead time to calculate how much to buy. We'll also factor in vendor minimums—whether it's minimum spend or minimum quantity—to ensure your purchases are optimised and cost-effective.
Step 1: Understand Your Review Cycle
Before making any purchase decisions, the first step is to determine the review cycle—the regular interval at which you’ll assess your stock levels and make purchasing decisions. The review cycle is crucial because it sets the horizon date over which you’ll plan your inventory purchases.
Key Considerations for Review Cycle:
Frequency of Reorders: How often do you want to assess and reorder stock? This could be weekly, fortnightly, or monthly, depending on your business’s needs.
Vendor Minimums: Take into account any vendor-imposed minimum order quantities or minimum spend amounts, as these will influence how frequently and in what volumes you place orders. Vendors with high minimums may push for longer review cycles.
For instance, if you plan to review your stock every two weeks (14 days), this cycle becomes the time horizon over which you'll forecast your inventory needs and plan purchases accordingly.
Step 2: Factor in Safety Stock
Once you’ve established the review cycle, the next step is to account for safety stock. Safety stock is the buffer inventory that helps protect your business from unexpected demand surges, supplier delays, or forecast errors.
Safety stock should be calculated separately and kept distinct from your regular replenishment quantities. This ensures you're not mixing up buffer stock with operational stock that’s required to meet your normal demand.
Example Calculation:
Let’s say your average daily usage for a product is 100 units, and you’ve calculated that you need to hold 10 days' worth of safety stock based on supplier reliability and demand variability. This means you should hold 1,000 units of safety stock for that product.
Keep safety stock static during each review cycle. It’s there as an emergency buffer, not something you dip into regularly. However, review your safety stock levels periodically to ensure they are still appropriate as business conditions or demand patterns evolve.
Step 3: Determine Lead Time
Next, look at your lead time—the amount of time it takes for an order to arrive after it's been placed with a vendor. Understanding lead times is critical because it ensures that you order stock far enough in advance to avoid stockouts.
For example, if your supplier’s lead time is 20 days, and you’re working on a 14-day review cycle, you need to consider both the review cycle and the lead time in your purchasing calculations. The horizon date for your purchases should now include both the review cycle and the lead time.
Example:
If you have a review cycle of 14 days and a lead time of 20 days, your horizon date will be 34 days into the future. This means you’ll need to buy enough inventory to cover 34 days of demand.
It’s important to regularly review lead time performance. If lead times fluctuate, adjust your calculations accordingly to prevent over-purchasing or running out of stock.
Step 4: Forecast Your Demand for the Review Cycle
Now that you have your horizon date (review cycle + lead time), the next step is to forecast demand over that period. Forecasting involves estimating the amount of each product you expect to sell or use during that timeframe.
Let’s assume you’re working with a review cycle of 14 days and a lead time of 20 days, making the horizon date 34 days. Using historical data, forecast the expected demand for that 34-day period.
Example:
If your average daily demand for a product is 100 units, multiply that by 34 days:Forecasted demand=100 units/day×34 days=3,400 units.Forecasted demand=100 units/day×34 days=3,400 units.
This number represents how much inventory you’ll need to cover demand during the review cycle and lead time.
Step 5: Adjust for Vendor Minimums
Many suppliers have minimum order requirements, either in terms of quantity or spend. These constraints can affect your purchasing decisions and force you to buy more (or less) than you’d like.
Minimum Order Quantity: If your supplier requires a minimum purchase of 500 units, but your forecasted demand is only 400 units, you’ll need to adjust your order to meet their requirement.
Minimum Spend: If your supplier requires a minimum order of $5,000, ensure that your planned purchase meets or exceeds this amount. If your forecasted purchase falls short, you may need to consolidate orders for multiple products or adjust your review cycle to place larger, less frequent orders.
Step 6: Calculate How Much to Buy
With all these factors in mind, you can now calculate your order quantity. Add your forecasted demand for the horizon period to any adjustments needed to meet vendor minimums.
Final Formula:
Order Quantity=Forecasted Demand+Vendor Minimum Adjustments.Order Quantity=Forecasted Demand+Vendor Minimum Adjustments.
Remember to subtract on-hand inventory from the final number to avoid overstocking.
Step 7: Review and Refine
Inventory purchasing is not a one-time exercise. It’s important to regularly review your processes, especially:
Safety Stock: Reassess your safety stock periodically to ensure it still reflects the actual variability in demand and lead time.
Lead Times: Continually monitor supplier lead times and adjust your horizon date and safety stock accordingly.
Vendor Performance: Keep track of whether vendors consistently meet their lead times and minimums, and adjust your strategies if they don’t.
Over time, you may find that you need to refine your review cycle or adjust your safety stock levels based on performance.
Conclusion
Effective inventory purchasing is a balancing act between meeting demand and minimising excess stock. By utilising a review cycle, calculating safety stock separately, and factoring in lead time, you can create a robust purchasing plan that protects your business from variability without tying up unnecessary capital.
Vendor minimums, while a potential constraint, can be managed through careful planning and strategic adjustments. Ultimately, the key is to stay flexible, continually review performance, and adjust your approach as business conditions change.
If you need guidance on setting up a comprehensive inventory purchasing strategy, I’d be happy to share more insights based on my experience in managing inventory planning for complex operations.
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