What Is Threshold Inventory Quantity?
It’s no trivial task to handle the purchase, receipt and storage of dozens, hundreds or thousands of different inventory items in an accurate and timely manner. Timeliness in this context means that you know how much of each inventory item you have on hand and in the ordering pipeline. Threshold inventory quantity is one of several metrics for managing inventory.
In an ideal world, you would stock only the amount of inventory you will sell until you receive the next shipment -- this is the optimal stocking level. Any inventory you hold above the optimal stocking level is safety stock, meant to ensure you don’t run out of inventory. The threshold inventory quantity, also called the stock-out threshold, is the minimum count of an item you keep on hand. When inventory levels fall below the threshold quantity, you reorder stock to replenish your items on hand.
Perpetual inventory management systems maintain real-time information about stocking levels by tracking receipts, movements and sales as they occur. Normally, this requires the deployment of inventory tracking equipment such as bar code readers, point-of-sale cash registers and radio frequency scanners. In a periodic inventory system, you might or might not track sales of inventory, but you do rely on physical counts to re-establish your current stocking levels. Because periodic inventory systems do not reflect the most current information, they require higher threshold quantities and safety stock levels to avoid stock-outs.
The economic reorder point is the quantity level that triggers new purchases such that the cost per item is minimized. Costs stem from activities such as the pricing, purchasing, shipping, storing and retrieving of inventory items. Additional cost factors include discounts on volume purchases, back orders, the cost of lost sales due to stock-outs and the amount of working capital tied up in safety stock. Ideally, the economic reorder point should equal the threshold inventory point, but often this proves to be not feasible. For example, a supplier might offer quantity discounts that would cause you to hold too much inventory on hand.
It’s not uncommon for perpetual inventory system software to automatically reorder inventory items when the number on hand drops to the threshold quantity. In fact, many systems share inventory data with suppliers and allow the suppliers to maintain the required inventory levels. This vendor-managed inventory system is superior because it allows suppliers and distributors to anticipate needs based on the inventory levels of customers rather than waiting for the receipt of purchase orders. For example, if a supplier hooked into your system sees you are within 10 percent of your threshold level, it can plan production so that it can quickly fill your order once the threshold is hit.