You’ve got a limited amount of space to store products, and a set open-to-buy budget to stick to when purchasing new inventory. The last thing you want is to stock too little of a product and turn potential customers away or overstock and face stale inventory, sinking your profile margins.
Optimal inventory levels tell you the range of inventory you must have in stock at all times—without under or over stocking a particular product.
The real question retailers are asking is: how do you set these inventory levels when supply chain issues are rife and customer demand constantly changes? This guide shares the answer, complete with metrics and best practices for monitoring inventory levels.
What are inventory levels?
“Inventory levels” is a broad term that describes how much inventory you’re holding at any given time. This includes products in your retail store, warehouse, or in transit. In other words: it’s the big picture view of how many products you have and where they are.
There are different types of inventory levels you’ll need to consider as a retail store owner:
- Safety stock levels: How many units you’ll have on-hand as a buffer. These are usually in your warehouse and reserved for products that go out of stock—like an insurance policy that ensures you’ve still got sellable products before a new shipment comes in.
- Reorder points: The minimum number of units you’re comfortable holding. Any products that fall below this reorder point are prioritized for a restock.
- Maximum stock levels: The maximum number of units you have the capacity to hold. These can be broken down by storage space. A warehouse will have a higher maximum stock level than a retail store, for example.
Why accurate inventory levels are important
Cash flow
High inventory levels mean you’ve tied a lot of cash up in inventory which could impact cash flow. You’ll need to resell these items before turning a profit.
Maintaining optimal inventory levels helps you anticipate when you’ll need to reorder stock in advance. You won’t be scrambling around for last-minute cash to invest in inventory that needed to be ordered yesterday.
Inventory turnover and storage costs
The more inventory you’re holding, the more storage space you’ll need. The problem is: storage space is costly. The average cost per square foot of warehouse space has increased by over 27% from 2017—and that’s before you take other costs like lighting, insurance, and salaries into consideration.
Properly managed inventory levels mean you’ll optimize available storage space at your warehouse and your retail locations by only holding as much stock as you need. This not only results in a lower investment (since you’re spending less to acquire fewer units), but also less money you’ll need to spend on storage fees for excess stock.
Customer satisfaction
The availability of a product has a major impact on the customer experience. Think about it: if you’d browsed a product online and saw that your nearby store had 5 units available for immediate pickup but you got there and they were all out of stock, you wouldn’t be happy.
Real-time inventory levels means customers can always get their hands on products, even during peak seasons like Black Friday. You know exactly how much inventory you’ve got and systems in place to reorder stock when you’re running low.
Risk of overstock and stockouts
If your inventory is siloed across different platforms, it can be difficult to strike the right balance having too little inventory or excess inventory. You don’t risk turning customers away with zero stock to sell, but more stock equals higher inventory costs and a bigger upfront investment. Minimum and maximum inventory levels help you land somewhere in the middle.
Methods for tracking inventory levels
Manual tracking
A physical inventory count involves going through your inventory and manually counting which products you have, how many units you’re holding, and where they’re stored. It’s typically done with a spreadsheet or paper and pen.
It’s the most traditional approach, but it’s not always the most efficient. Manually counting inventory is time consuming—you’ll not only need to do the initial count, but also manually upload the data into your inventory tracking system. It can also be costly when managed manually, resulting in shutting down the retail location for periods of time to complete counts.
Manual counting is also prone to errors. It’s easy to double count or forget a product when you’ve been counting all day long. You could be making inventory decisions based on inaccurate data.
Barcode scanning systems
Barcode inventory systems are considered a step up from manual counting. Instead of making a mental note of how many products you’re counting, this method uses barcode scanners to log how many items you’re holding. It automatically syncs this data with your inventory management tool.
The benefit of barcode scanners is that you’re less likely to make mistakes. The scanner makes a note of which product you’re scanning and the quantity. It’s ideal if you have products that look similar (e.g. clothing in different sizes), which is harder to track with manual counting.
RFID technology
RFID technology works similarly to barcode systems. Both tools can scan a product to retrieve information and record inventory levels. The difference is that RFID doesn’t need a direct line of sight and can scan multiple items simultaneously.
Although it’s expensive to integrate RFID technology in your retail storage space, it helps maintain accurate inventory levels since you can accurately pinpoint where each item is. If you’re processing a new shipment from a supplier, for example, RFID scanners can confirm that the contents match the packing slip and that you’ve got all of the units you’ve ordered.
Inventory management software
An inventory management system is the central platform you’ll use to collate inventory data. Retailers can use it to manage inventory levels, orders, and report on sales transactions.
Apps like Stocky, for example, shows inventory reports like:
- Best selling items
- Low stock vendors
- Low stock products
- Low stock variants
- Lost revenue from out of stock inventory
- ABC analysis
Metrics to track inventory levels
It’s difficult to determine the optimal inventory level for a particular product. Instead of restricting yourself to one rigid number, set maximum and minimum inventory levels using the following metrics:
- Inventory turnover ratio: the value of total inventory that is sold, used, or replaced during the reporting period. A low inventory turnover means you’re holding inventory that doesn’t sell fast and therefore needs a lower level available. High inventory turnover, however, requires a higher level of inventory to prevent stockouts.
- Days sales of inventory (DSI): the average number of days it takes to sell the entire quantity of a particular item. Again, products with a low DSI need lower inventory levels than those with a higher count.
- Stock to sales ratio: how much inventory you’re holding compared to the sales generated. A high ratio means quantities outweigh sales and you should prioritize selling existing inventory before reordering more.
- Reorder point formula: calculated by multiplying the average daily sales by lead time. If you sell 10 units on an average day but it takes 15 days to receive a restock from your supplier, the reorder point (or minimum inventory level) would be 150 units.
Best practices to maintain optimal inventory levels
Perform regular inventory audits
Sales can change on a weekly basis, so the minimum and maximum inventory levels you set today likely won’t be the same in a few month’s time. Regular inventory audits are the best way to keep track of fluctuating inventory levels.
Inventory audits also help you identify any discrepancies between your reported inventory levels and the actual quantities in your warehouse. Should these be left unresolved, it’ll impact stock availability for customers since your inventory management system displays a higher quantity than you actually have.
Implement just-in-time inventory
Just-in-time (JIT) is an inventory management strategy that optimizes storage space and ensures you’re not holding up too much cash in inventory that remains unsold for weeks. With this process, you’ll receive new inventory just before selling it.
To make this work for your retail business, you’ll need to track sales data inside your point-of-sale (POS) system or inventory management tool. Only when you have an accurate view of your inventory can you determine the optimal point to reorder more.
You’ll also need strong relationships with suppliers to mitigate any supply chain disruptions. Late deliveries can impact stock availability—you don’t want to risk turning customers away because there was a gap between an incoming shipment and your last quantities being sold.
Use automated inventory management systems
An automated inventory management system takes repetitive tasks off your plate and enlists the help of technology to do them for you. This includes things like:
- Creating inventory reports
- Flagging low-stock products with alerts
- Anticipating customer demand using historical sales data
- Drafting purchase orders for the appropriate vendor when a product falls below your minimum inventory levels
Platforms like Shopify have these features baked in—not just for your POS system, but everywhere you’re selling. Shopify’s inventory management software pulls data from your online store, POS system, social media storefronts, and marketplace profiles to get the big picture view of how much inventory your business holds. Stocky also integrates with external Inventory Management System (IMS) tools, ensuring that all connected systems receive real-time updates to your inventory levels.
Forecast demand accurately
Unfortunately, humans aren’t blessed with hidden talents that tell us the future. It’s what makes demand forecasting so difficult. New market trends emerge overnight; old products come back into fashion. How do you know that the inventory levels you’re setting now will prevent stock outs if demand changes?
Demand forecasting tools are a retailer’s secret weapon. The software uses statistical analysis, market research, and buying patterns to predict customer behavior. You can confidently predict which products will become more or less popular, allowing you to tweak your inventory levels accordingly.
Effectively manage inventory for your retail store
Inventory management is a challenge that only gets harder as your retail business grows. But with the right systems in place and a commitment to storing accurate data, it’s easier to calculate minimum and maximum inventory levels.
Prefer to take this task off your plate entirely? Shopify Fulfillment Network can connect your store with Flexport, a leading logistics service that can take care of inventory-related tasks for you. It will store your inventory in one of its warehouses and pick, pack, and ship orders directly to your customers.
Inventory levels FAQ
How to determine inventory levels?
Consider these four things when determining your ideal inventory levels:
- Safety stock: How many units do you need on-hand as a backup?
- Lead time: How long does it typically take to receive inventory from suppliers?
- Demand forecasting: How many units do you expect to sell?
- Capacity: How much storage space do you have to allocate to inventory?
What are the 4 types of inventory classifications?
There are four main ways to classify inventory: raw materials, work-in-progress, finished goods, and products that require repairs or maintenance.
What is the inventory level status?
Inventory level status is the real-time condition of the inventory your retail business is holding. It’s typically monitored with metrics like current stock levels, reorder points, safety stock levels, and maximum capacity.
