How to Calculate a Required Inventory Level

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Inventory is the lifeblood of retails stores. Through the sale of goods, businesses earn profits that pay for operations and the salaries. An important inventory management tool is knowing the proper amount of stock to have on hand. Required inventory levels are basic calculations that determine how much inventory a company needs to meet specific profitability goals.

  • Estimate annual expenses. Review the previous year's income statement and total your expenditures. Add a small percentage for growth and the owner's income to total expenses.

  • Compute the gross margin percentage from the previous year. Subtract cost of goods sold from total revenue and divide by total revenue. Subtract the gross margin percentage from 100 to determine the cost of inventory percentage.

  • Divide total estimated expenses by the gross margin percentage from Step 2. This gives you total expected sales for the upcoming year.

  • Multiply the total expected sales figure from Step 3 by the cost of inventory percentage from Step 2. This represents inventory need for sales.

  • Adjust the inventory figure from Step 4 by the expected number of inventory turns. Divide the total inventory figure from Step 4 by the number of inventory turns to determine the required inventory level.

References

  • "Intermediate Accounting"; David Spiceland, et al.; 2007
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