Optimal Inventory

From the Plant to the StoreFrom the perspective of a retail store, the inventory is the stock of tangible goods to be sold at that store. A store is interested in carrying an "optimal" inventory. Various factors come into place when considering what is an ideal inventory level, such as having the necessary products available in the right quantity at the right time, while minimizing the cost of ordering and carrying the goods.


Before calculating a store's optimal inventory, we need to give a simple definition of some basic inventory management terms, such as:

Optimal Inventory (OI) - How much of a product a store should have

(Re) Order Point (OP)  - When they should get more

Replenishment Quantity (RQ) - How much they should get

Safety Stock - How much additional inventory they should carry as a buffer for changes in sales, production and lead time.


Optimal inventory can be computed using the following formula:

OI = OP + 1/2 RQ

Where OI = optimal inventory, OP = order point and RQ = replenishment quantity

On the average, all items in the store should be halfway through their replenishment. The goal of any store is to minimize the optimal inventory. Stores can do that by better forecasting their demand (this will lower inventory) and by reducing lead time (this will lower replenishment quantity).