This article discloses the concept of target inventory level. It tells about the target inventory level, its formula, benefits, zones of stock level in inventory, and the difference between safety stock and target inventory level.
What is target inventory?
Target inventory level is the target amount of inventory, in terms of days’ supply, that a company will maintain. This level should be low enough to avoid stockouts and high enough to ensure that production capacity can meet demand during peak periods.
Target Inventory Level is the optimal amount of supplies for a company to have on hand at any given time. It’s important not only for preventing shortages but also for making sure there are sufficient materials available when needed most during periods of increased customer demand or other emergencies.
It is, in a min-max inventory system, the equivalent of the maximum. Thus, the target inventory is equal to the order point plus a variable order quantity.
In summary target inventory is the maximum stock quantity that the company holds at any time.
Advantages of target inventroy
- It helps to reduce the risk of running out of stock.
- It reduces the risk of loss of revenue.
- It increases the gross profit.
- It increases the efficiency of the production.
- It helps to develop a good relationship with customer.
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. The organization should maintain this minimum quantity for safety. Therefore, 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.
4. Green Zone
This zone refers to the maximum stock level of inventory. This is the ultimate 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. Over Stock Zone
This zone represents too much stock of inventory. Overstocking leads to an unfavorable effect on the organization.
Optimal inventory levels
These are the absolute quantities of items that a company should have in a fulfilment center at any given period.
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.
The 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 unsuitable for all industries as the factors that impact the supply chain differ from industry to industry.
Hence while calculating safety stock, industries need to consider those factors along with the standard formula.
Safety stock formula
Following are the different formulas for calculating safety stock. By knowing all these formulas, you can choose suitable formulas for your industry.
- Basic formula: It is the most common formula to calculate safety stock.
- Average-max formula: It is a general formula. But if you have an extended lead time, it is not suitable for your industry. The formula is SS= (maximum sale X maximum lead time) – (average sale X average lead time)
- 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
- Normal distribution with lead time uncertainty: Formula is SS = Z X average sale X lead time deviation. where Z is desired service level
- 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)
- 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 VS 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. At the same time, calculating the target inventory level, we consider safety stock.
Target inventory level (TIL) is also calculated using an initial stock level and safety stock. That is
Target inventory level (TIL)= Initial Stock Level (ISL) + Safety Stock (SS)
Conclusion
What are inventory levels?
Inventory levels meaning, the amount of on-hand inventory that you have to fulfill the demand at a given period. Having plenty of inventory will help ensure your company can meet current demand, while shortages in inventory could lead to downtime or lost revenue for your business.
How do you calculate the target inventory level?
A target inventory level is calculated by adding the initial stock level (ISL) and safety stock (SS) levels together which will give the required average monthly demand rate.
Safety stocks are needed for any company to comfortably manage its supply chain uncertainty, including shortages or unexpected jumps in customer demand. Safety stocks have another characteristic that they are held in higher locations so they can be delivered quickly when customers need them without spoiling.
The difference between an emergency stock and a safety stock is that emergency stocks are eventually distributed even if not right away because eventually, you don’t want to have any product still sitting around on shelves waiting for customers.
Target inventory level is the number of units that a company should have available for sale in order to satisfy demand at any given time.
The target inventory level depends on many factors, including how much it costs to produce an item and what percentage of items are likely to be sold during a certain period.
Get more definitions about Target inventory level and other ERP-related terms here.
