How to Best Understand Inventory Planning

Click Link to Jump to Section

Executive Summary

  • Inventory planning differs from supply chain execution.
  • We cover the major aspects of inventory planning.


This article will provide an overview as to many topics related to inventory planning, stock planning and inventory and stock inventory.

How to Best Understand Supply Chain Inventory

In supply planning, inventory is that product that his held in the company’s supply network to satisfy demand.

In this article, you will learn the various reasons for holding supply chain inventory. 

Inventory and the Manufacturing Environment

Finished goods inventory is necessary for make to stock environments. Component inventory is necessary in assemble to order environments. In make to order environments, if followed faithfully, no inventory should be necessary. Fundamentally inventory is necessary due to the lag between when a product is demanded, and when it can be supplied.

Sales and Statistical Forecasting Combined: Mixing Approaches for Improved Forecast Accuracy

Like the question of what is inventory, the reasons for holding inventory or stock inventory boil down to the fact the lead-times for production and procurement are longer than the customer demand lead-time.

Not all companies need to forecast all of their finished goods products. One example of this is defense contractors that frequently know years in advance, what they will build as they have firm contracts containing quantities and dates from the government.

However, even these companies are still required to create forecasts for the service parts that support the products that they sell.

How is Inventory Positioned? 

Inventory is positioned in different locations by the supply planning system. The assumptions that the software uses to perform positioning very much depends upon the supply planning method selected. Most methods of supply planning plan each location independently of other locations. Only inventory optimization software position inventory while considering the inventory position of the related locations. This is covered in the article The Multiechelon Definition.

What Makes Up Inventory?

The total inventory at a location is the total stocking level, which is made up of cycle stock (the stock held between ordering) and safety stock (the stock designed to ensure there is enough stock to satisfy demand while mitigating demand and supply variability)

  • The total stocking level is not necessarily the correct amount of stock that should be held.
  • This is referred to as the target stocking level (only MEIO vendors refer to it like this, but it is quite a logical term)

What are the Functions of Inventory to Keep Inventory, or the Reasons for Holding Inventory and to Stock Inventory?

Fundamentally the functions of inventory are to allow the company or entity to have something available at the time of sale. The reason for holding inventory or to stock inventory is because, in the vast majority of cases, the lead time required by the customer, or the order period is shorter than the

The reason to keep inventory or to stock inventory is because, in the vast majority of cases, the lead time required by the customer, or the order period is shorter than the replenishment lead time. This is the reason to keep inventory or stock inventory because not to do so will result in not being able to fulfill demand.

Understanding how the various lead time connects is required to get to the essence of the functions of inventory.

The True Reasons for Holding Inventory

This is important to consider the true reasons for holding inventory. This is because many Lean inventory advocates propose that stock can be drastically cut and in fact refer to inventory as a liability.

That is technically inaccurate. When inventory is excessive that portion of the stock is a liability, but it is only really a liability if the inventory is either not used or if it is significantly marked down when sold.

The costs of carrying inventory for short periods of time is quite low. And of course, the cost of having a stock out is much higher than having too much inventory. Therefore the reasons for holding inventory really required illumination.

What is Inventory Planning and Stock Planning and the Stock on Hand?

Inventory planning or stock planning is the analytical process of determining the stocking levels throughout the supply network. This means planning for every product location combination in the supply network. Inventory planning or stock planning can be based on two primary approaches; one is forecast based planning and the second is consumption based planning.

The stock on hand is the stock at each product location combination (if the overall supply network that is being discussed) that the company has in inventory. The stock on hand can also apply to a specific product location combination, such as a particular product material in a specific distribution center.

What is the Difference Between Forecast Based Planning and Consumption Based Planning?

These two major approaches, which contain a large amount of detail below each are the following:

  1. Forecast Based Planning: This is where a forecast is used by the system to drive the ordering logic.
  2. Consumption Based Planning: This is where the consumption of the stock drives the ordering logic.

There is no need for a company to choose exclusively forecast based planning or exclusively consumption based planning as all supply planning applications contain settings for both, and their forecast based planning or consumption based planning can be used for specific product location combinations.

What is an Inventory List, a list of Inventory Items, Product Inventory or an Inventory Database?

The inventory list or the list of inventory items is the product inventory or inventory database that the company maintains. The inventory list or list of inventory items is not specific to a location, so will always be far lower than when locations are brought into the analysis. This is why it is always important to specify whether one means the inventory database or the inventory database per location.

Any inventory list should be reviewed for whether some of the products on the list of inventory items should be removed. This is because the inventory list has a way of proliferating over time due to things like new product introductions.

Replenishment Lead Time, Procurement Lead Time, Manufacturing Lead Time and Shipping Lead Time or Lead Time for Delivery

The various lead times connect in the following way:

For Manufactured Products

Replenishment Lead Time = Manufacturing Lead Time + Procurement Lead Time (for raw materials, components, and subassemblies) + Shipping Lead Time or Lead Time for Delivery

For Procured Products

Replenishment Lead Time = Procurement Lead Time (for raw materials, components, and subassemblies) + Shipping Lead Time or Lead Time for Delivery

There is often discussion of expediting the various lead times, but in many cases, the only lead time that is reasonably capable of being expedited is the shipping lead time or lead time for delivery. The shipping lead time or lead time for delivery can normally only be expedited at a considerable expense (unless the product in question is of high value and low weight)

There are cases where the opposite occurs, where the total fulfillment lead time is shorter than the order lead time. Examples of this include defense contracting and custom suits. While it receives a very high amount of coverage, this is in actuality a very small portion of the overall market that is as made to order. Make to order products tend to be premium priced, and many products that are thought to be made to order (such as configurable computers) are not made to order at all, but in fact, assemble to order.

Introduction to Inventory Segments

In this article, we will cover many of the different ways that inventory can be divided or segmented.

The Concept of Types of Inventory, Inventory Types, Categories of Inventory, Inventory Categories and Inventory Classification

There are many concepts of the types of inventory, inventory types, categories of inventory or inventory categories that are used in supply chain management. Some of these have to do with how the types of inventory or inventory types are treated by the supply planning system. For instance, high-value product inventory may be set on different supply planning settings that low-value product inventory.

Categories of inventory or inventory categories can be based upon what that inventory does. That is, is the inventory a raw material, a finished good, a component, work in process, etc. Understanding these categories of inventory is important both for working with others (so you can have a shared understanding of the meaning of different categories of inventory) but also to decide which of the inventory categories one may want to use themselves.

Target Stocking Level, Safety Stock Level, and the Initial Stock Level

One way of looking at inventory is the total amount of inventory in the system or the inventory at a stocking location in total. This can be viewed as the actual inventory versus the target inventory.

The target inventory or target inventory level is often made up of the following conceptual components.

  • TSL: The Target Stocking Level
  • SS: The Safety Stock Level
  • ISL: The Initial Stock Level

Each of these different stocks is shown in the following graphic:


  • Using this inventory optimization construct, a portion of the total stocking level is the safety stock, and another portion is called the ISL or initial stocking level.
  • The initial stocking level would be the target stocking level if no supply or demand variability were to exist.

Segmentation Of Inventory by Inventory Usage

  • Inventory has multiple inventory uses.
  • It can be categorized into multiple inventory types.
  • By categorizing inventory and evaluating the allocation of the overall inventory into the different uses and types, one can gain a measure of the relative impact on overall inventory of these segments.
  • It is also valuable to consider what the actual function is the inventory that is carried.

Types of Inventory, Inventory Classification, and Inventory InfoGraphic

The following infographic shows the types of inventory and inventory classification by two different dimensions.


Functions of Inventory: Anticipation Inventory, Goods in Transit or Stock in Transit, or Transportation Inventory, Pipeline Inventory, Lot Size Inventory and Hedge Inventory or Speculative Inventory

Another way to categorize inventory is by its function.

  •  Fluctuation Inventory: Fluctuation inventory is inventory that is carried to account for variability in either demand or supply. The technical definition of this is safety stock.
  • Anticipation Inventory: Anticipation inventory is inventory that is held in anticipation of specific or unusual demand. It goes without saying that all inventory is “anticipatory” in nature unless the stock has been sold already, but what makes anticipation inventory different from normal inventory is that there is a reason that can be pointed to for carrying more inventory than normal. A very common example of anticipation inventory is inventory carried specifically for weather events.
  • Goods in Transit, Stock in Transit or Transportation Inventory: Goods in transit, stock in transit or transportation inventory is stock that is somewhere in the process.
  • Pipeline Inventory: Pipeline inventory is a subset of transportation inventory. However, pipeline inventory is only the portion of the stock in transit inventory that it is outbound to the customer.
  • Lot Size Inventory: A lot size is an order size that in many cases are larger than the demand. The lot size is applied to keep companies from purchasing in “non-economic” quantities, which means quantities that would incur overly high transaction costs. The resultant lot size inventory, therefore, is the inventory that is carried not because of need, but because the lot size required the quantity to be increased. Lot size inventory is differentiated from inventory that is purely demand driven.
  • Hedge Inventory or Speculative Inventory: Hedge inventory or speculative inventory is inventory that is carried above what would ordinarily be carried to meet the demand for a speculative purpose. If an entity were to conclude that some input material has a high chance of becoming more expensive in the future, then it would make sense for that entity to purchase and carry hedge inventory or speculative inventory which would reduce its cost of material acquisition. Hedge inventory or speculative inventory would tend to be the most common in raw materials, as the raw material can be converted into so many output items and never really becomes obsolete.

Classes of Inventory: Raw Materials Inventory and Raw Materials Examples, Components Inventory, Work in Process Inventory, Finished Goods Inventory

Another way to classify inventory is of its class.

  • Raw Materials Inventory: Raw Materials Inventory is the material that is in a very basic stated with little manufacturing or other processing performed by the supplier. Raw materials examples are things like gold, copper, grain, industrial powders, raw milk, etc. Raw materials examples will tend to be shipped in bulk.
  • Component Inventory: Component inventory is inventory that is a recognizable part or assembly that goes into the finished goods. When component inventory is held until a sales order is received, this is called assemble to order manufacturing.
  • Work In Process Inventory: Work in process inventory is material that has is somewhere along in the manufacturing process but is not yet a finished good or finished product.
  • Finished Goods Inventory: Finished goods inventory may be in storage at the factory right after manufacture, or finished goods inventory can be anywhere in the outbound supply chain. For entities that distribute an item rather than manufacture an item, these entities receive finished goods inventory from suppliers.

What is The Role of the Inventory Clerk and the Inventory Manager?

The inventory clerk is the individual how touches the inventory and does things like the physical inventory. Although the term inventory clerk is a bit dated. The inventory manager performs inventory planning and also expediting of things like purchase orders and production orders. While the inventory clerk is entirely execution-focused, the inventory manager must often keep inventory stock on hand below a certain cap, while attaining service level targets.

What is an Inventory Planning System?

An inventory planning system can refer to either an approach or to software applications that implements a particular inventory planning system.


The functions of inventory are to have the right amount of stock on hand when demands are received to meet expected service levels expectations. The foundational functions of inventory are to compensate for where the order lead time is shorter than the replenishment lead time.

While inventory planning and stock planning is certainly not a high profile activity, it is of great importance.

Inventory planning and stock planning has been greatly changed through the introduction of both inventory planning or supply planning software and the use of general tools like spreadsheets. These tools allow the inventory manager and others to manage far more inventory more effectively than they did in the past.

Inventory is controlled by the supply planning system and is designed to be moved and stocked to satisfy future demand. The reasons for holding inventory are often not fully explained and the costs of maintaining inventory versus not having inventory when it is needed, are in most situations not quantified.

The Problem: Maintaining Inventory Parameters

A major part of inventory management is inventory parameters. These parameters include values like safety stock or days of supply, rounding value, reorder point, lot size/economic order quantity and minimum order quantity. Whatever the planning procedure that is used, these parameters control what the supply planning system does.

Testing of the extracted parameters of ERP and external supply planning systems clearly shows that these values are poorly maintained. The result is far worse planning results than could be obtained otherwise.

Being Part of the Solution: Our Evolution of Thinking on Maintaining Reorder Points in ECC or APO

Maintaining reorder points in APO or ECC comes with a number of negatives that tend to not be discussed. One issue is that when using APO or ECC, the reorder points are typically managed on a “one by one” basis. This leads to individual planners entering values without any consideration for how inventory parameters are set across the supply network. We have developed a SaaS application that sets the inventory parameters for ECC or APO or both systems externally, and that allows for simulations to be created very quickly. These parameters can then be easily exported and it allows for far more control over the parameters in APO and ECC. Both APO and ECC are designed to receive parameters, they are not designed to develop the parameters.

In our testing, the approach, which is within the Brightwork Explorer is one of the most effective methods for managing planning in SAP applications.

Brightwork MRP & S&OP Explorer for Order Optimization

Order Sizing and Optimization

Order optimization is necessary in order to get the predicted value from ERP and other supply planning applications. The Brightwork MRP & S&OP Explorer does exactly this, and it is free to use in the beginning until it sees “serious usage.” It is permanently free to academics and students. See by clicking the image below:


Search Our Other Inventory Management Content


Safety Stock and Service Level Book

Safety Stock

Safety Stock and Service Levels: A New Approach

Important Features About Safety Stock

Safety stock is one of the most commonly discussed topics in supply chain management. Every MRP application and every advanced planning application on the market has either a field for safety stock or can calculate safety stock. However, companies continue to struggle with the right level to set it. Service levels are strongly related to safety stock. However, companies also struggle with how to set service levels.

How Systems Set Safety Stock

The vast majority of systems allow the setting of safety stock by multiple means (static, dynamic, adjustable with the forecast in days’ supply, etc..). However, most systems do not allow the safety stock to be set in a way that is considerate of the inventory that is available to be applied.By reading this book you will:

  • Understand the concepts and formula used for safety stock and service level setting.
  • Common ways of setting safety stock.
  • Service levels and inventory optimization applications.
  • The best real ways of setting both service levels and safety stock.


Chapter 1: Introduction
Chapter 2: Safety Stock and Service Levels from a Conceptual Perspective
Chapter 3: The Common Ways of Setting Safety Stock
Chapter 4: The Common Issues with Safety Stock
Chapter 5: Common Issues with Service Level Setting
Chapter 6: Service Level Agreement
Chapter 7: Safety Stock and Service Levels in Inventory Optimization and Multi-Echelon Software
Chapter 8: A Simpler Approach to Comprehensively Setting Safety Stock and Service Levels