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How to Establish Order Point Levels on Your Inventory

Your inventory is one of the single largest investments that your company has and it needs to be managed properly. It does not take a detailed analysis of inventory financials to realize that mismanagement of your inventory could lead to a series of other economic problems. That is why the logistics experts in your company need to work in concert with purchasing and manufacturing to make sure that you always have the inventory you need, but never more than you could ever use.

Before we discuss order point levels, we should first determine what they are and how they work. An order point level is considered the "zero point" of your inventory count. For example, if you determine that you always want to have six widgets on hand at all times, then your order point level for widgets would be six. If you let it get to five, then you have dipped below the zero point. Any number above six would figure into satisfying customer orders and keeping manufacturing on schedule.

But how do you establish order point levels on your inventory? The first step is to create a priority list of products that your company can never be without. The key to an efficient order point entry system is to avoid buying materials and products that you rarely use, while keeping the commonly used items on hand at all times.

Your priority list is based on your sales history and not your purchasing history. One of the ways that some companies wind up being stuck with inventory they cannot move is because they base their order point levels on their own purchasing history. The efficient way to do it is to look at what your customers have purchased over the past few years and then determine purchasing trends that you need to establish.

Your order point levels can be set by quarter or by business cycle. For example, if July to September is traditionally your slow period while February to April is your busy time, then your order point levels would drop in July and go up in February. Once again, these trends can easily be established by looking at your sales histories for the past few years.

Once you have your priority list and inventory schedule broken down, the final step is to determine exactly what your order point levels will be. There is a lot that goes into determining this and the Poole College of Management has developed a formula that will determine your levels.

In the Poole formula, everything revolves around the lead times and demand rates. The lead times are how long it takes for your suppliers to fulfill your orders, and your demand rate is how quickly product is being sold. You can compute your order point levels by having a comprehensive understanding of your supply chain and your consumer habits.

Obviously, these two items are variables and not constants. You could change suppliers and get a faster lead time. You can also see an upward swing in business that would alter your demand rates. But as long as you stay on top of your sales cycles and your consumer demand, then you can keep a good eye on your inventory levels.

The one variable that most companies are continually trying to change is lead time. But it is important to remember that a supplier that you can rely on is going to be more valuable to you than a supplier that is inconsistent with its shipping times. It is easier to compute your own order point levels when you have confidence in how quickly you can get product to your warehouse shelves.