Inventory management is a challenge for any business that sells physical products. Holding too little inventory risks losing sales, while holding too much ties up cash and increases storage costs. A straightforward method for navigating this is a par level inventory system. This approach provides a systematic way to maintain stock, ensuring you have what you need without unnecessary excess.
Defining Par Level Inventory
Par level inventory is a system that establishes the minimum amount of an item that a business should have in stock at all times. The term “par” stands for Periodic Automatic Replacement, and it represents the target quantity needed to meet customer demand without interruption. Once inventory of a specific product drops below this predetermined number, a replenishment order is triggered to bring the stock back up to the designated level.
Consider a coffee shop that knows it needs at least five gallons of milk to get through a morning rush. That five-gallon quantity is its par level. If the manager sees only three gallons in the refrigerator, they immediately know to order at least two more. This simple rule removes guesswork and ensures the business can consistently serve its customers.
The Importance of Setting Par Levels
One of the primary reasons businesses implement par levels is to prevent stockouts. Running out of a popular item leads to lost sales and can damage a business’s reputation. When customers cannot purchase what they want, they may go to a competitor. Consistently having products available builds customer trust and loyalty.
This system also helps to reduce holding costs. Excess inventory represents tied-up capital that could be used elsewhere in the business. Overstocking leads to increased expenses for storage, insurance, and potential spoilage, particularly for perishable goods. By setting calculated par levels, a business can minimize these costs and improve cash flow.
Setting par levels streamlines the ordering process for employees. It replaces subjective decision-making with a clear, data-driven rule. This makes the reordering task faster and less prone to human error, as staff simply follow the established guidelines.
How to Calculate Par Levels
Determining the right par level is not a matter of guesswork; it is based on a calculation that considers demand and supply chain realities. The formula provides a structured way to set a minimum inventory target that is tailored to each product.
The standard formula is: Par Level = (Average Daily Usage × Lead Time in Days) + Safety Stock. The result gives you the minimum quantity of an item you should have on hand to cover demand between supplier deliveries.
Let’s define each part of the formula. Average Daily Usage is the amount of a product sold or consumed each day, on average. Lead Time is the duration, in days, from when you place an order with your supplier to when you receive the delivery. Safety Stock is a small buffer inventory held to protect against unforeseen circumstances, such as a sudden surge in demand or a delay in the shipment from your supplier.
To see how this works, imagine a hardware store calculating the par level for a specific type of screw. The store sells an average of 50 boxes of these screws per day. Their supplier takes four days to deliver a new order. To guard against unexpected demand, the store wants to keep an extra two days’ worth of sales on hand, which is 100 boxes (50 boxes/day × 2 days). In this case, the Safety Stock is 100.
Using the formula, the calculation would be: Par Level = (50 boxes/day × 4 days) + 100 boxes. This results in a par level of 300 boxes. Therefore, whenever the store’s inventory of these screws drops to 300 boxes, it is time to place a new order.
Implementing a Par Level System
Putting a par level system into practice involves a consistent, cyclical process. The steps are as follows:
- Physically count the current inventory for each item. All subsequent decisions rely on having an accurate count of what is on the shelves.
- Compare this number to the established par level for that item. This comparison reveals whether a reorder is necessary.
- Place an order if the count falls below par. The quantity to order is the par level minus the current on-hand amount.
- Review and adjust par levels periodically. Factors like changing sales trends, seasonality, or new supplier lead times can make the original calculation obsolete.
It is important to understand that par levels are not static. Regularly re-evaluating and updating them ensures the system remains accurate and effective over time.
Advantages and Disadvantages of Par Levels
The par level method offers several advantages, particularly for businesses with predictable demand. Its greatest strength is its simplicity. The system is easy to understand and implement, making it accessible for staff without extensive training. This leads to consistent ordering and reliable stock availability for staple items.
However, the system has its limitations. Par levels are less effective for products with highly volatile or seasonal demand. Because the calculation relies on historical averages, it cannot easily adapt to sudden shifts in sales, potentially leading to stockouts or overstocking.
Another drawback is the labor involved, especially for businesses with a vast number of products. Manually counting many different items can be time-consuming and prone to error. While software can automate this process, a manual system can become a significant operational burden as a business grows.