Probability Approach:

The main principle over which it is based is that this approach assumed only the probability of running out of stock, not how many units we are short of. For finding the probability of stocking out over the time period, a simple plot of normal distribution for the expected demand is drawn and noted down the amount we have on hand lies on the curve. The situation shall be clearer by the following instance. Say we expect demand to be 100 units over the next month and standard deviation of it is known to us and this is 20. Now, if we go into the month with only 100 units, we know that our probability of stocking out is 50 per cent. Half of the months we would be expecting demand to be greater than 100 units; half of the months we would be expecting it to be less than 100 units.

Furthermore, if we ordered a month's worth of inventory of 100 units at a time and attained it at the beginning of the month, over the long run we would be expecting to run out of inventory in six months of the year.