Managing inventory — common mistakes

In an exam, when asked to analyse the costs of holding stock, always try to explain the opportunity cost. It demonstrates a deeper understanding of business finance beyond the more obvious physical costs like storage. For example, explain that £50,000 of stock is £50,000 that cannot be used to pay off a loan and reduce interest payments.

Not necessarily. While high stock levels reduce the risk of a stock-out, they significantly increase holding costs (storage, insurance, opportunity cost) and the risk of obsolescence. Effective inventory management aims to find the optimal balance that minimises the total costs of holding stock and the costs of potential stock-outs, not simply to avoid stock-outs at any price.

Buffer stock is a strategic reserve, not simply 'extra' stock. Under normal conditions, inventory levels should not fall into the buffer zone. It is specifically there to be used during unexpected events, like a supplier delay or a surge in demand. It is a crucial component of risk management, and once used, it should be replenished.

Yes, always. The re-order level is the trigger point for placing a new order. It is calculated to cover the expected demand during the lead time, plus the buffer stock. A common formula is: Re-order Level = (Average daily usage x Lead time in days) + Buffer Stock. This ensures that the stock used while waiting for the new delivery does not deplete the safety buffer, which is reserved only for emergencies.