DotOne team1. Safety stock
Safety stock is the extra stock you hold to cover late deliveries and demand spikes. There are two common ways to set it.
Simple method: days of cover
Safety stock = average daily usage × safety days
120 units a day × 4 days = 480 units. Pick the safety days from how late your vendor has actually been.
Statistical method: service level
Safety stock = Z × σd × √L
Z = service level factor · σd = standard deviation of daily usage · L = lead time in days
For a 95% service level, Z ≈ 1.65. If daily usage varies with a standard deviation of 20 units and lead time is 10 days: 1.65 × 20 × √10 ≈ 104 units. Use 2.33 for 99%.
2. Reorder point
Reorder point = average daily usage × lead time + safety stock
120 × 10 + 480 = 1,680 units. When stock falls to this level, raise the next purchase order.
3. Economic order quantity (EOQ)
EOQ = √(2 × D × S ÷ H)
D = annual usage · S = cost per order · H = holding cost per unit per year
36,000 units a year, ₹1,500 per order and ₹24 a unit a year to hold: √(2 × 36,000 × 1,500 ÷ 24) ≈ 2,121 units per order. Try your own figures in the EOQ and reorder point calculator.
4. Inventory carrying cost
Carrying cost = average inventory value × carrying cost %
Carrying cost % = (cost of capital + storage + insurance + damage and obsolescence) ÷ average inventory value
A plant holds ₹40 lakh of stock on average. Interest on that money, warehouse space, insurance and write-offs together come to about 20% a year, so carrying cost is ₹8 lakh a year. Cutting average stock by ₹10 lakh saves about ₹2 lakh a year, plus the cash it frees.
5. Inventory turnover and days of inventory
Inventory turnover = cost of goods sold ÷ average inventory
Days of inventory = 365 ÷ inventory turnover
Cost of goods sold of ₹9 crore and average inventory of ₹1.5 crore give a turnover of 6 times a year, or about 61 days of stock. Compare it item by item: a few slow movers often hold most of the cash. See also working capital.
6. Backorders and fill rate
A backorder is a customer order you accept but cannot ship in full right now because the item is out of stock. It stays open until stock arrives. Unlike a lost sale, the customer waits, but backorders delay revenue and strain the relationship.
Fill rate = quantity shipped on time ÷ quantity ordered
If customers ordered 5,000 units this month and 4,600 shipped on time, fill rate is 92% and 400 units are on backorder. A falling fill rate is usually the first sign that safety stock or reorder points are too low.
7. Inventory valuation: FIFO vs weighted average
Under Indian accounting standards (Ind AS 2 and AS 2), inventory is valued at the lower of cost and net realisable value, with cost worked out by FIFO or weighted average. LIFO is not permitted.
Example: opening stock of 100 units at ₹50, a purchase of 200 units at ₹56, and an issue of 150 units.
| FIFO | Weighted average | |
|---|---|---|
| How the issue is costed | 100 @ ₹50 + 50 @ ₹56 | 150 @ ₹54 (₹16,200 ÷ 300) |
| Cost of the 150 units issued | ₹7,800 | ₹8,100 |
| Value of the 150 units left | ₹8,400 | ₹8,100 |
When prices are rising, FIFO shows a lower cost of goods sold and a higher closing stock value. Pick one method and apply it consistently.
Putting the formulas to work
Formulas only help if stock figures are right and someone acts on them. In DotOne Inventory Management, reorder levels are set per item, purchase indents are raised automatically when stock falls below them, and stock is valued in real time by item, category and warehouse, with batches and serial numbers traced from receipt to the customer.