Target Inventory Level – 5 basic zones

This article discloses the concept of target inventory level. It tells about the target inventory level formula, benefits, zones of stock level in inventory, and the difference between safety stock and target inventory level.

Target inventory level is, in a min-max inventory system, the equivalent of the maximum. The target inventory is equal to the order point plus a variable order quantity.

Target Inventory Level Formula

TI = d(RP+L)+SS

Here, d= Average period demand

RP= Review period(days,weeks)

         L= Lead time (days, weeks)

        SS= Safety Stock

Five major zones of stock level of inventory

1. NO STOCK ZONE: At this level, the stock is zero that is below the minimum stock level. This zone alerts the organization and the management of the organization should take action immediately. The most important thing is the organization should avoid this situation by getting the required materials in less time.
2. RED ZONE: This zone represents the minimum stock level of inventory. This minimum quantity should be maintained by the organization for safety. This zone is also called a safety level.
3. YELLOW ZONE: This zone refers to the average stock level. That means it is a level that is above the minimum stock level and below the maximum stock level. Most of the organizations held the average quantity of inventory for a given period of time.
4. GREEN ZONE: This zone refers to the maximum stock level of inventory. This is the maximum limit of stock that an organization can hold. If the stock quantity exceeds this level then that is called too much stock or overstock.
5. OVERSTOCK ZONE: This zone represents too much stock of inventory. Overstocking leads to an unfavorable effect on the organization.

Advantages of target inventory

• Helps to reduce the risk of run out of stock
• Reduces the risk of loss of revenue
• Increases the gross profit
• Increases the efficiency of the production
• Helps to develop good relationship with customer

Safety stock

Safety stock is an extra amount of an item held by the company to avoid the risk of an unexpected increase in demand. It helps to prevent stock-outs. The root cause of stock-outs is a sudden increase in demand, improper stock forecast, and up&downs in the lead time of raw materials.

Formula for safety stock is

Safety stock = (ISL X supply variability) + (ISL X demand variability)

where ISL means initial stock level.

This standard formula is not suitable for all industries as the factors that impact the supply chain are different from industries to industries. Hence while calculating safety stock industries need to consider those factors along with the common formula.

Following are the different formulas for calculating safety stock. By knowing all these formulas you can choose suitable formula for your industry.

1. Basic formula: It is the most common formula to calculate safety stock.
2. Average-max formula: It is a general formula. But if you have a long lead time it is not suitable for your industry. formula is SS= (maximum sale X maximum lead time) – (average sale X average lead time)
3. Normal distribution with demand uncertainty: To find standard deviation in demand first calculate average demand and then average variability in demand by taking the square of each month’s difference. Take the average of those squares together. SS = standard deviation of the demand X the root of average delay
4. Normal distribution with lead time uncertainty: Formula is SS = Z X average sale X lead time deviation. where Z is desired service level
5. Normal distribution with on-demand uncertainty and independent lead time: If your demand and lead time both are uncertain then this formula is an effective one. SS= Z X square root of (square of average LT multiplied by demand standard deviation) + (square of average sales multiplied by lead time standard deviation)
6. Normal distribution with on-demand uncertainty and dependent lead time: Formula is SS = Z X demand standard deviation X square root of average lead time + Z X average sales X lead time standard deviation.

Target Inventory level V/S Safety Stock

Safety stock is totally different from target inventory. Safety stock is an extra quantity of an item kept by the company to avoid the risk of out of stock of that item.

Target inventory is the quantity of an item that a company has at a given moment. Safety stock is a sub-component of the target inventory level. While calculating the target inventory level we consider safety stock.

Target inventory level (TIL) is also calculates using an initial stock level and safety stock. That is

Target inventory level (TIL)= Initial Stock Level (ISL) + Safety Stock (SS)

Get more definitions about Target inventory level and other ERP related terms here.