Calculating dynamic optimal levels

On hand stock over time

The saw-tooth diagram is a quantity-versus-time graphical representation of inventory being received, used up or sold, and reordered. Essentially, the saw-tooth represents the units of on hand stock over time

 

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The following repeating sequence of events will result in the above diagram, over time:

  • A: as time passes, we sell/use stock and the units on hand reduces
  • B: the quantity in units is at its lowest point when the next delivery arrives
  • C: once stock is receipted, the units on hand increase to its highest point

 

The saw-tooth also illustrates the various components of inventory.

 

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  • Safety stock (SS): the quantity of stock planned to be in inventory to protect against fluctuations in demand and/or supply (the two major inventory risks in your business). Safety stock can be seen as an insurance policy against running out of stock – the bigger the risks, the more expensive the premiums (or the more safety stock required!).
  • Cycle stock (RC): the replenishment cycle defines how often each item is ordered.
  • Lead time (LT): the number of days from when the order is placed until the inventory is receipted into stock.
 

Computing dynamic levels by converting days to units

The LT, SS and RC within the app are in days – this is essential in order to deal appropriately with future demand, which may be seasonal. For example: 10 days of safety stock (SS) out of season might equate to 5 units while 10 days in peak season might equate to 300 units. Using days is key to computing dynamic optimal levels that react to changes in demand.

In order to decide WHEN to order and HOW MUCH to order, the “days” need to be converted to units so they can be tested against your available on hand stock.
 

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Starting from today, your lead time days are converted to LT units by accumulating the forecast demand streams (including manufacturing and central warehouse demand streams, if present) over that period.
 

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Next, your safety stock days are converted to units using the forecast demand over that period. Together the LT units + SS units give you the “reorder point” for this item. When your available on hand stock hits the reorder point, you need to place an order – so the reorder point answers the question “WHEN should I order?
 

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Then replenishment cycle days are converted to units. Together LT units + SS units + RC units gives you the “order up to” for this item – answering the question “HOW MUCH should I order?
 

Testing these dynamic levels against on hand stock

As you move through time, the app continually tests whether you need to place an order today by comparing available on hand stock with the reorder point.

 

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As soon as your available on hand inventory hits the “reorder point” (A), the app triggers an order for delivery in a lead time from now (B). The recommended order quantity (C) is the order up to less available on hand stock.

Over the lead time you will continue to sell, and in a perfect world your order will arrive as your available on hand stock equals your safety stock level (B).