Ask any supply chain pro how much inventory she or he (or, really, their company) has on hand and you will be met with a pause.
Not a pause because that supply chain pro doesn’t know how much inventory they have on hand—no.
The pause is because supply chain pro's know too much about how much inventory they have on hand. While you might think your question—“How much inventory do you have on hand?”—was a simple one, that supply chain pro knows there is more than one way to measure their inventory.
- How much money did you spend to acquire that inventory?
- How much money is that inventory worth as potential revenue?
- How many units of inventory do you have?
- How long will the inventory you have on hand last you?
While that last bullet point (“How long will the inventory you have on hand last you?”) might not seem like a unit of measure, it actually defines a very important unit of measure.
You may not have thought to ask “How many days of inventory do you have?”—but you should have.
[Unit of time] on Hand or [Unit of Time] of Inventory
You may have head the term “Days on Hand” or “Weeks on Hand” or “Months on Hand” or even “Hours on Hand”. But did you know that Days on Hand (let's use "Days" as a term to mean all units of time, for the sake of this article) is one of the most important and ubiquitous units of measure used by supply chain pros?
"Days of Inventory" or "Days on Hand" basically lets you know how long you have until the amount of inventory that you have at your disposal will run out.
Having inventory at your disposal may not mean just having it in your warehouse, ready to ship to your customers. It can also mean what you have on order from your suppliers—and the common theme is that it is all of the inventory that you have a financial commitment to own.
So—how long until your inventory runs out?
There’s a relatively simple formula that will help you calculate that. But as in most things, the devil is in the details.
- How many units of inventory do you have?
- How many of units will you need to sell?
That’s mostly it. If you have 100 units and you know you will sell 10 units a day, then you have 10 Days of Inventory on hand.
Let’s try another one.
You have 50 units on hand and you’re going to receive 25 units from a supplier tomorrow. You will sell 25 units each day.
That means you have 75 units total (on hand plus on order), so you have 3 Days of Inventory.
How Do I Know What I’m Going to Need?
One of the trickiest parts of knowing your Day of Inventory is knowing how much you’re going to need. If you have discrete orders from your customers, that helps.
But let’s say that you have 100 units and you only have customer orders for 10 each to ship tomorrow and 10 each to ship the day after that. Does that mean that you have 2 Days of Inventory or an infinite amount of inventory (i.e. with 100 each on hand and orders for 20 each, will you never run out?)?
That’s when forecasts are typically used to help with the Days of Inventory calculation.
If you have 75 each on hand and orders to sell 20 each tomorrow, 10 each the next day and 15 each the day after that, then you can use a daily average forecast to calculate that you have 5 days of inventory (20 each + 10 each + 15 each = 45 each; divided by 3 equals 15 each).
You may want to use historic usage to calculate forecasts or another more robust forecasting method.
But, simply, you can calculate your Days of Inventory by dividing your on hand inventory by your daily demand.
But How Many Days of Inventory Should I Carry?
The answer to how much inventory you should carry is the same as most answers in supply chain:
- Does your company have enough money to pay for all of the inventory you’ll ever need? (This is almost never the case.)
- Does your company measure any kind of metric at all when it comes to inventory? (This is almost certainly true.)
- How long does it take to replenish your inventory? (This is typically the key.)
Understanding your supplier lead times is one of the most important factors when it comes to understanding how many Days of Inventory you should carry.
If you have 10 Days of Inventory but it takes your supplier 21 days to resupply you, then you may have a gap in customer delivery. For example, if you ordered more inventory from your supplier today—it would take them 21 days to deliver that inventory to you. But you are going to run out of inventory in 10 days. You’ll have 11 days when you are unable to fulfill customer demand.
How to Carry Zero Days of Inventory and Still Stay in Business
If you were able to carry zero Days of Inventory, that means that you haven’t spent any money up front for inventory. Your CFO will love you.
But you still need to sell products to be a viable company.
So—here’s the secret.
- Work with your suppliers to drive their lead times down
- Manage your customers so that they place orders with a lead time that aligns with your customer lead times
- Once you receive an order from your customer, place an order with your supplier
- Your supplier can supply you in 3 days
- Your customer knows that you’ll ship their order 4 days after they place it with you
- Your customer places its order and you order from your supplier
- Your supplier’s order shows up in 3 days
- It takes you 1 day to receive and in-process and prepare the customer order
- You ship your customer their order on the 4th day
Everyone’s happy. And you owned very little inventory along the way.
Remember, Days of Inventory is a unit of measure that helps drive optimized inventory management. By understanding it, you can manage inventory levels, reorder points and reduce stock outs.