Effective inventory management relies on mathematical models and clear performance metrics. The EOQ formula calculates the optimal order quantity by balancing ordering costs against holding costs, while safety stock calculations use the formula \(Z \times \sigma_{LT}\) to determine buffer inventory needed to achieve a target service level. The reorder point (ROP), calculated as average daily demand multiplied by lead time plus safety stock, indicates when to place a new order. Lead time itself, the total time between order placement and receipt, must be estimated accurately because lead time variability directly increases safety stock requirements and complicates production scheduling.
Several specialized inventory concepts support operational efficiency. Cycle stock is the inventory consumed between replenishment orders based on expected demand, while pipeline stock refers to in-transit inventory not yet available for use. FIFO (First In, First Out) and LIFO (Last In, First Out) are accounting methods for valuing inventory flow, with FIFO better reflecting physical flow and LIFO offering potential tax advantages during inflation. FEFO (First Expiry First Out) prioritizes items with the earliest expiration dates, essential for perishables and pharmaceuticals. Dead stock represents unsellable inventory that ties up capital and warehouse space, often requiring write-offs. Inventory days of supply indicates how many days current inventory will last based on average daily usage.
Key Performance Indicators (KPIs) measure the efficiency and effectiveness of supply chain activities. The perfect order metric measures the percentage of orders delivered on time, complete, undamaged, and with accurate documentation, providing a comprehensive view of execution quality. OTIF (On-Time In-Full) and the stricter DIFOT (Delivered In Full On Time) similarly track delivery performance. Inventory turnover ratio, calculated as cost of goods sold divided by average inventory value, indicates how efficiently inventory is managed. Fill rate measures the percentage of customer demand met immediately from stock, while service level measures the probability of not stocking out during a replenishment cycle. Cash-to-cash cycle time measures liquidity by calculating the duration between paying for raw materials and receiving customer payment.