How can you optimize inventory levels using variance analysis?

Optimizing inventory involves attaining the perfect balance between demand and supply to avoid high storage costs as well as stockouts. There are several ways to optimize inventory: implementing inventory technology to track inventory in real time, calculate and automate reorder points, and forecast demand. Or By adopting strategies such as accurate demand forecasting, JIT inventory management, collaborative planning, data analysis, and technology utilization, businesses can optimize inventory levels, reduce costs, and improve customer satisfaction

Variance analysis assesses the difference between actual and expected outcomes in inventory management. To optimize inventory levels, monitor discrepancies in quantities and costs. Positive variances may indicate overstocking, while negative variances suggest stockouts. Regularly analyze variances to identify trends, improve forecasting accuracy, and enhance demand planning. Utilize technology for real-time tracking and automate data collection to streamline the analysis process. Adjust ordering and production based on variance insights to maintain optimal inventory levels, reduce holding costs, and improve overall operational efficiency.

Inventory optimization requires implementing a reporting process whereby, according to a certain frequency, actual inventory levels are compared against a set of pre-defined targets. From my experience it is key to segment your inventory according to certain criteria like material types or markets (for finished goods) and to set target inventory turns for those material groups. A meaningful SIOP (Sales, inventory & production operational planning) process with process ownership is then fed with the results of the inventory levels variance against targets and should interpret those results and yield specific and timed action plans to tackle those areas where inventory levels are above target levels.

To calculate inventory variances, subtract the expected inventory value from the actual value. For quantity, it's actual quantity minus expected quantity. The result indicates the variance, with positive values suggesting overstock and negative values indicating understock. For cost, subtract the expected cost from the actual cost. Regularly conduct these calculations for different inventory items to identify trends. Utilize variance analysis tools, automate data collection, and employ technology for accurate and efficient calculations. Adjust inventory practices based on insights to optimize levels and improve overall supply chain management

Understand the types of variances such as: Quantity variance: Difference between the physical inventory count and the expected inventory level according to accounting records. A positive variance indicates overstock, while a negative variance indicates understock. Value variance: Difference between the actual cost of the inventory and the expected cost based on accounting records. A positive variance indicates an increase in cost (unfavorable),

Set Standard Performance Levels: Define standard performance levels for inventory, including optimal stock levels, reorder points, and lead times. These standards act as benchmarks against which you can measure actual performance.

In the Cost Accounting module of the ERP used by the company you can define the standard quantity for the inventory, at the end of the month the system will provide the differential between the standard quantity and the actual quantity in order to track, identifying causes and improvement opportunities to minimize losses. If you do not have an ERP, you can also perform control with a utility such as Excel.