Measuring Residual Stock

April 1, 2003
To run a truly efficient warehouse operation, you must have the proper on-hand inventory levels when your replacement stock arrives. This simple exercise

To run a truly efficient warehouse operation, you must have the proper on-hand inventory levels when your replacement stock arrives. This simple exercise will help you do exactly that.

If you want to measure the performance of your inventory planners or buyers, you may want to start measuring the day's supply of a product on-hand when a replenishment shipment is received. The term for this "left on shelf" inventory is residual stock. This may seem like a strange measurement, but let's look at why it's important.

A buyer must answer two kinds of questions when replenishing the stock of a product: when to place a replenishment order, and how much of a product should be reordered. Economic lots, price-break analysis, and the economic order quantity formula provide the answer to how much to order that minimizes the company's cost of inventory. The new measurement, a day's supply on-hand when a replenishment shipment is received (residual stock), helps ensure that we order at the right time.

We don't want the replenishment position (on-hand - committed + on order) of an item to fall below the order point before we issue a replenishment order. There are three components to consider in calculating the order point:

Demand-Anticipated usage of the product.

Anticipated lead time-How long it will take to receive the replenishment shipment and prepare it for use or sale.

Safety stock-Safety stock is insurance against running out of an item because of unexpected demand during the anticipated lead time or vendor shipment delays.

These three components are used to calculate the order point:

Order point = (Demand per day x anticipated lead time) + safety stock

If the residual stock is greater than "x" day's supply at the time of the last three stock receipts, one or more of the following conditions probably exists:

Demand forecast predictions consistently exceed the actual usage and must be evaluated for accuracy.

*The anticipated lead time is greater than the actual experienced lead times.

*The maintained safety stock quantity exceeds the amount necessary to protect customer service-that is, there are not great variations in lead time or demand from month to month.

To decrease the residual stock to its target of "x" days supply, we can reduce inventory levels by correcting demand or the anticipated lead time, or by maintaining less safety stock. If demand, anticipated lead time, and safety stock are properly maintained for the item, our target order from the vendor (i.e. free-freight amount, truckload, lot size, etc.) may be too large to optimize the company's turnover and net profitability.

If the residual stock is less than "y" day's supply at the time of the last three stock receipts, one or more of the following conditions probably exists:

*Demand forecast predictions are consistently less than actual usage and must be evaluated for accuracy.

*The anticipated lead time is less than the actual experienced lead times.

*The maintained safety stock quantity is not adequate to protect customer service-that is, great variations exist in lead times and/or usage from month to month.

We need to correct demand or the anticipated lead time, or maintain more safety stock. There are no fixed values for the "x" and "y" day's supply parameters. The target residual day's supply for each item depends on such factors as the importance of the item to the company's sales or processes and its general availability.

While residual stock analysis doesn't provide a measurement that can be compared to other company's results, it does bring to the attention of the buyer products that have the potential of turnover improvement or that may be hindering customer service-that is, it's a valuable tool for the company to achieve its goal of effective inventory management.