Placing an order after stock runs out is a delayed decision. During the period until the product arrives, sales are lost and customers turn to alternatives.
The right question is not "when did it run out", but "when should I place an order". The critical stock level is the answer to this question.
In this article, we explained the logic behind calculating the critical level, safety margins, and alert configurations.
Table of Contents
The logic of calculation
The critical level is the quantity you will sell during the time elapsed from the moment you place an order until the goods arrive. A safety margin is added on top.
The formula is simple: average daily sales multiplied by lead time, plus safety stock. The difficulty lies not in the formula, but in the accuracy of the inputs.
Let's look at an example. For a product that sells an average of five units per day with a lead time of ten days, the baseline need is fifty units. Together with the safety margin, the critical level can be set at sixty-five units.
An order is placed when stock drops to sixty-five; when the goods arrive, fifteen units remain on hand. That is how the system works.
Measure lead time realistically
The most common mistake is using the lead time stated by the supplier. The actual time is usually longer.
Accurate measurement is the duration from the order date to the goods receipt date. It includes approval waiting times, shipment delays, and the acceptance process.
You can extract this data from your past purchasing records. The average of the last ten orders is much more reliable than the supplier's claim; you can check out the supply chain visibility article.
For imported products, the lead time is much longer and more variable. Critical levels require separate attention for these products.
Calculate sales velocity accurately
Using annual averages can be misleading. For seasonal products, the average incorrectly represents both peak and slow periods.
A better approach is to take the average of the last ninety days and update it during seasonal transitions.
Take channel distribution into account as well. Marketplace sales can surge suddenly; daily averages become meaningless on campaign days. We covered planning in the seasonal demand planning article.
Sales data is extracted from sales reports; product-based period comparison is the foundation of this calculation.
What should the safety margin be?
Safety stock is insurance against uncertainty. The more uncertainty there is, the larger the margin required.
If lead time varies, the margin should increase. If you sometimes receive the same product in seven days and other times in twenty days, planning based on twenty days is safer.
The criticality of the product is also a determining factor. A raw material that halts a production line does not deserve the same margin as a rarely sold accessory; check out the raw material stock control article.
On the other hand, safety stock ties up cash. An excessive margin means letting cash sit idle in the warehouse. Balance is established according to the product's turnover rate.
Alert configuration
Defining a critical level is not enough on its own; someone needs to be notified when that level is reached.
The alert must go to the right person. It should reach the person authorized to place orders, not the warehouse manager. Notifications handle this distinction.
Alert frequency is also important. A system that sends notifications every day for the same product is quickly ignored; we covered noise management in the notification management article.
Transitioning from alerts to orders should also be easy. Having the notification lead directly to the purchase order screen completes the action in minutes; see the purchase order process article.
Keeping the level up to date
A critical level defined once eventually becomes incorrect over time. Sales velocity changes, suppliers change, and seasons arrive.
Reviewing every three months is a reasonable frequency. Updates are especially necessary during seasonal transitions.
There is an easy way to figure out which products have incorrect levels: those that frequently stock out versus those that sit well above the critical level for months. Both extremes require updates.
Critical level definitions are kept on the product card in the inventory module; it is also possible to define separate levels per warehouse.
Which products should you start with?
In a business with thousands of products, defining a critical level for all of them takes weeks, and most are of little value. Prioritization is essential.
Grouping products by value and movement speed is the most practical method. A small number of products usually generates the major part of revenue; start with them.
The second group consists of products whose stockouts cause lost customers. These may not generate high revenue, but they trigger complementary sales.
The third group includes items with long lead times. A delay in imported products costs months; level definitions are mandatory for these products.
It is not necessary to define levels for the remaining long tail; ordering when demand arises is sufficient. Turnover rate data is used for grouping; check out the stock turnover rate article.
The real cost of stockouts
When determining critical levels, most businesses only look at the cost of excess inventory. However, the cost of stockouts is usually higher and less visible.
The first cost is lost sales. The customer buys that product elsewhere, and the profit from that order is lost.
The second and heavier cost is the customer discovering an alternative supplier. Once satisfied, future orders go there as well.
The third cost is emergency procurement expenses. Purchases made when stock runs out generally carry higher prices and extra shipping costs; we touched upon this leakage in the purchase reports article.
There is an additional cost in marketplace sales: canceled orders due to stockouts lower the store rating. This impact is an indirect yet long-term loss; you can check out the marketplace stock sync article.
Frequently asked questions
Should I define a level for every product?
No. Start with fast-moving and critical products; it is unnecessary for items in the long tail.
Can warehouse-based levels be defined?
Yes, and it is usually necessary. Store warehouses and main warehouses operate with different levels; check out the multi-warehouse inventory management article.
Should open orders be factored in?
Yes. If goods on the way are ignored, unnecessary orders are placed; you can check out the open order tracking article.
Can orders be generated automatically?
Generating recommendations is possible; keeping the approval step in human hands is generally safer.
The critical stock level is not a complex planning tool, but a simple early warning system. When set up with correct inputs, it largely eliminates the problem of stockouts.
By meeting with the EQLEM team, you can plan your critical level and alert configuration.