Don Johnston

Active Inventory

Active inventory is inventory which will probably be sold or used in the reasonably near future. How far into the future depends on how soon you are hoping to see the expected improvements.

The reason for finding out how much active inventory there is is that only active stock can be reduced, in the near future, by improving inventory management. Purchasing improvements, alone, will not reduce the amount of dead inventory but will reduce the creation of dead inventory.

There is no precise definition of active inventory and it differs from one organisation to another. A wholesaler of replacement parts might even consider inventory as being active if it might sit on the shelf for more than a year. The same might apply to an even greater extent to an organisation which stocks replacement parts which are critical to ensure that its machinery can be restored to operation quickly after a breakdown. However, the investment in inventory of items which rarely move is not going to be reduced quickly by improving purchasing. For this reason, I will not treat the stock of such items as being active. A retailer would probably consider inventory to be inactive if most of it will not be sold within a few months or, perhaps, weeks.

When considering the potential for reducing inventory within a certain amount of time, the only inventory which should be considered is that which will probably be sold within about that amount of time.

Suppose that you want to make an improvement to inventory management and you intend to judge its effect on the basis of the service level and total inventory value in four months time. On the basis of the above definition, the amount of active inventory of each item could be calculated as the forecast demand or sales of the item within the next the next four months or the quantity currently in stock, whichever is least. I would not recommend this approach unless the forecasting technique takes into account how long ago the item was first stocked. The quantity which is expected to be sold within the above-mentioned four months should not be rounded to an integer. Also, the forecasting technique used should take into account all of the available sales history. Techniques based on exponential smoothing come into this category. Simply using the average demand or sales in a certain number of months is not very suitable because, if there have been no sales or demand for the item in that time then the forecast demand will be zero. If there have been sales an item then its forecast demand rate should not, normally, be zero. Zero demand forecasts are of little use for inventory management purposes and will cause some calculations to fail.

An approach which is simpler and is usually adequate is to treat all inventory of items which have been received within the not too distant past as being active and the inventory of all the other items as being inactive. For example, if the effects of an improvement to inventory management are to be judged in four months time, then the inventory of items received in the last four months should be treated as being active. In addition to simplicity, this approach also has the advantage that it will treat inventory of new items as being active. This is sensible because, presumably, the items concerned would only have been purchased if they were expected to sell. Another advantage of this approach is that it doesn’t require forecasts of demand. This approach is very easy to implement using a report generator.

You can get a vague idea of the amount of active inventory from your company’s aged inventory valuation report. All inventory systems should provide such a report because it is needed for depreciation purposes. It should show the value of inventory which has been received either during the current financial year or within the last twelve months.

2 Responses to Active Inventory

  1. Swaminathan Thiyagarajan 27/12/2016 at 11:02 pm #

    Dear Don,

    Greetings to you.

    Could you please share the rationale behind the numbers shown in the table.

    For example, how a 10% reduction in lead time could contribute for 5% reduction in inventory.

    • Don Johnston 28/12/2016 at 4:08 pm #

      I presume that you are referring to the table in the article entitled “Reducing Lead Times” and for which the link is http://www.inventoryadvice.com/shortening-lead-times/

      The table is not precise. Also, it is important to note that it only refers to active inventory. Reducing lead times will not reduce existing dead stock but it will tend to reduce the amount of stock which becomes dead.

      The table is based on two assumptions, viz.
      1. that the amount of active inventory of an item is proportional to the standard deviation of lead time demand and
      2. that the daily demands for an item are independently and identically distributed.

      The first assumption tends to be roughly correct overall provided that safety stocks are the main contributor to overall active inventory value. This tends to be roughly correct unless ordering costs or minimum order quantities are a major issue. Even if this assumption is not valid, it should be borne in mind that order quantities, as well as safety stocks, contribute to service levels.

      If the second assumption is incorrect then the reductions in average total active inventory value would probably be greater than those shown in the table.

      On the basis of the above assumptions, the average total active inventory value is proportional to the square root of the lead time. This is because the variance (the square of the standard deviation) of the sum of independent random variables is equal to the sum of the variances of the individual variables.

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