Inventory Management Policy
Inventory Management Policy

How does your organisation manage its inventory investment without an effective inventory managment policy? Its important to understand the significance of monitoring inventory investment to free up cashflow.

Inventory Management Policy

An inventory management policy is a standard set of guidelines with boundaries that provides the framework for an organisation to make informed make or buy inventory investment decisions. An Inventory management policy relies on an understanding of your supply chain's capability to support customer demand. ERP systems store critical planning parameters such as lead-time, safety stock, MOQ and should be changed regularly to support demand and supply variability. By measuring the variability businesses will be able to implement the right planning parameter settings to control inventory investment. 

Types of inventory management policies

Several stocking policies can be implemented to improve stock management performance, these being:

  • Reorder point: Fixed Replenishment point or fixed replenishment quantity is used when the stock falls below a certain point which then triggers an order release.
  • Min/Max: when stock falls to or below the minimum stock levels which triggers a replenishment or reorder qty equal to the maximum level. 
  • Lot for lot: demand flow generates a new replenishment order for the same qty at the time the previous order arrives to your facility or operation.
  • Days of supply: similar to the min /max, however this method relies on average daily sales using historical demand to calculate an order qty for a number of days supply.
  • Item location: A multi echelon optimisation approach that incorporates greater emphasis on the entire supply chain where there is variability in demand projections. 

Implementing an inventory management policy

A knowledge of the entire supply chain is the minimum requirement in establishing the right inventory policy. Break down your supply chain into segments and analyse the capability of each function to understand the working parts of the inventory system, how information is captured, processed and released in a timely manner.  Ask yourself "do we Make to Order", "Make to Stock" or is it a combination of the two. Then start to become more familiar with the following:

  • Inventory classification: Segment inventory by units and dollars into fast, medium and slow moving.  This provides and awareness of which items are contributing both cost, sales and effort to the business. This is also known as ABC classification or the 80/20 rule and is of value when inventory is in categories and reviewed regularly. 
  • Type of stock: It's the physical inventory that is purchased, manufactured or stored within a stocking point. There are usually four types of stock: Raw materials which are used as primary or secondary ingredients within an assembly of a semi-finished or finished good; Work in process which is that part of inventory being converted to a final state as a component, semi-finished or finished good; Finished goods which are purchased, assembled or manufactured to a final state and finally MRO spare parts that are used to support any final state machinery or equipment. 
  • Service level: Determine current service level by order and sku and review the inventory investment to support these service level targets. Extensive analysis needs to be undertaken to understand how much inventory is required to support a certain service level. Changing the service level target will have an immediate impact on warehouse space and resource effectiveness.
  • Safety stock levels: Review demand variability between forecasts and actual sales to establish the correct safety stock level by SKU. A blanket policy on safety stock is not the most effective approach as it contributes to increased inventory levels at the cost of high levels of maintenance.
  • Number of stocking points: Important to understand what locations across your supply chain hold stock in units and value. Within facilities, inventory can be managed within physical zones to assist in identification and kanban reordering to avoid systems interaction.
  • Order qty and order frequency: Review the order size and frequency for each vendor or work orders for a manufacturing facility. Significant contributions to inventory reduction can be achieved by controlling order qty requirements with vendors, although some may state that the MOQ is unavoidable without an increase in annualised volume spend.. 
  • Replenishment qty and frequency: Understand the impact of inventory movement between stocking points and the cost of transport. Too many organisations fail to recongnise that there is a transport cost to supplying stocking points from a primary DC, not to mention the centralised inventory approach of vendor returns back to DC, there is a cost.
  • Lead time: Review the leadtime from vendors to stocking point or within a manufacturing facility to a stocking point. Do not confuse leadtime with cycle time as these are entirely different.
  • Stock write offs: Understand the extent and nature of stock write offs to isolate damaged inventory and improve stock provisions.
  • Procedures:  The timing and accuracy of transaction processing along with procedural adherence to inventory control can impact on your inventory policy.
  • Inventory Reduction Strategies: Direct deliveries of purchase products or raw materials to a manufacturing line or processing point avoiding a warehouse receiving process. Reduce WIP by only making what is required. Direct to store deliveries of finished goods will avoid your logistics network.

Next Steps:

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