The level of customer service as a starting point for calculating inventories is a good starting point. It makes it easier for as many of your customers as possible to be satisfied with the deliveries they receive from you. After all, the reason you have items in stock is to meet the customer's expectation of fast delivery.

Step 1. Sort by number of inventory movements

To determine which items you should have in stock, you must first sort your items by quantity stock movements.

Inventory movement means that you are starting from the number of orders made by the item, not the number of items that are in an order. Thus, it does not matter whether the customer orders one, ten or thousand pieces of an item, it is considered one warehouse movement anyway.

As you can see in the table below, you have item 1 of which 3000 quantities are ordered within 12 months, but only through two single orders. Item 3, 700 items will be ordered from, but through 80 individual orders. Even if the total value is greater for item 1, it will still be item 3 that is most profitable to stock because it is ordered multiple times.

This is to ensure that the largest share of your customer base gets their goods as quickly as possible.

After defining the number of inventory movements on your items, you should sort all your items into the number of inventory movements that have occurred over the past twelve months and the total number of products purchased in each order.

Free Guide: Efficient logistics. Here's how to succeed in inventory management.

Step 2. The Pareto Principle for Calculating Inventories

It's now time to sort your items into larger categories. The method we choose to use is based on Pareto Principle, also known as The 80-20 rule.

The rule can be applied in many contexts, and is, in short, about the fact that a relatively small proportion controls a large proportion of the result. In the field of logistics, applying Pareto's principle has also yielded good results;

80 percent of profits come from 20 percent of goods, and the remaining 20 percent of profits come from 80 percent of goods.

Example of the Pareto Principle

Items categorized by the Pareto Principle

In the table above, we have ranked the goods in a warehouse by the number of inventory movements per year. As you can see, items 1-3 represent a whopping 80 percent of the total inventory movement. We then define these items as Category A goods, which are your most important goods. Items 4 and 5 represent the next 15 percent share of total inventory movement, thus becoming category B goods. Furthermore, item 6 and 7 are category C, while item 8-12 are in category D and X, representing only 5 percent or less of inventory movement.

Now you know that the goods in categories D and X only account for the last percent of the number of inventory movements or no share of total inventory movements whatsoever. Maybe it's time to not stock these items anymore?

Read more: Create a competitive inventory with inventory management.