Inventory Management

1. Function of Inventory Management:

2. Goals of Inventory Management.

The primary objectives of inventory management are:

(i) To minimize the possibility of disruption in the production schedule of a firm for want of
raw material, stock and spares.
(ii) To keep down capital investment in inventories. So it is essential to have necessary
inventories. Excessive inventory is an idle resource of a concern. The concern should
always avoid this situation.

The investment in inventories should be just sufficient in the optimum level. The major dangers of
excessive inventories are:

(i) the unnecessary tie up of the firm’s funds and loss of profit.
(ii) excessive carrying cost, and
(iii) the risk of liquidity. The excessive level of inventories consumes the funds of business,
which cannot be used for any other purpose and thus involves an opportunity cost. The
carrying cost, such as the cost of shortage, handling insurance, recording and inspection,
191 are also increased in proportion to the volume of inventories. This cost will impair the
concern profitability further.

On the other hand, a low level of inventories may result in frequent interruptions in the production
schedule resulting in under-utilization of capacity and lower sales. The aim of inventory management
thus should be to avoid excessive inventory and inadequate inventory and to maintain adequate
inventory for smooth running of the business operations.

Efforts should be made to place orders at the right time with the right source to purchase the right
quantity at the right price and quality. The effective inventory management should:

 maintain enough stock of raw material in the period of short supply and anticipate price
changes.
 ensure a continuous supply of material to production department facilitating uninterrupted
production.
 minimize the carrying cost and time.
 maintain sufficient stock of finished goods for smooth sales operations.
 ensure that materials are available for use in production and production services as and when
required.
 ensure that finished goods are available for delivery to customers to fulfil orders, smooth sales
operation and efficient customer service.
 minimize investment in inventories and minimize the carrying cost and time.
 protect the inventory against deterioration, obsolescence and unauthorized use.
 maintain sufficient stock of raw material in period of short supply and anticipate price
changes.
 control investment in inventories and keep it at an optimum level.

3. Types of inventories +Value chain diag

 Raw materials: Are ingredients or components used to manufacture a finished product. A
brewer, for example, will use grain, yeast and hops as ingredients in the fermentation
process to produce a volume of beer.
 Components:
 Work-in-process: (WIP) represents inventory in production and not yet ready for sale, for
example, beer still in the process of fermenting.
 Finished goods: Are products in your inventory that are ready to be sold to your customers.
This inventory type is common to all companies that sell products.
 Vendor inventories: Vendor-managed inventory is an inventory management practice in
which a supplier of goods, usually the manufacturer, is responsible for optimising the
inventory held by a distributor.
 Non-moving/slow moving stock: Slow-moving stock is that merchandise which simply stays
locked up in the store’s space and has a low sales rate. It generally includes the inventories
which are greater than three months old. For instance, in a retail outlet of apparels, Woollen
pullovers would be slow-moving stock during summer months.
 Safety stock: An additional quantity of stock kept in inventory to protect against
unexpected fluctuations in demands and/or supply. If demand is greater than forecast or
supply is late, a stock shortage will occur. Safety stock is used to protect against these
unpredictable events and prevent disruptions in manufacturing. Safety stock is also called
buffer stock.
 In-transit inventories: Refers to raw materials, WIP, finished goods and MRO being moved
from location to other for any purpose. Long distances can mean that inventory is in transit
for anywhere from days to months. Also known as goods in transit.
 Service parts/Consumables: Consumable Inventory means all office, cleaning, engineering,
laundry and valet supplies; decorations, advertising and promotional materials and
supplies; and any and all usable inventory owned by Seller and used by guests of the
Property for consumption or usage in the course of their stay, including: printing and
stationery, guest supplies (including soap, matches, toilet and facial tissues); maintenance
and housekeeping supplies; Consumable Inventory shall include items in use and in
inventory or storerooms at the Property or as otherwise held in reserve.

4. Decoupling Inventory: Decoupling inventory involves separating inventory within a

manufacturing process so that the inventory associated with one stage of a manufacturing process
does not slow down other parts of the process. In simple terms, decoupling inventory is a safety
stock of sorts.
Much like safety stock, it establishes a buffer between product demand and product supply and
is used in work-in-process inventories. Where safety stock is seen as a buffer against increased
external demand, decoupling inventory is the buffer against increased internal demand.

Decoupling inventory consists of inventory stock which is held to cushion manufacturing assembly
against potential issues within the production line. Issues such as equipment breakdowns or
unevenness in machine production rates affecting output because one part of the production line
is working at a different speed to another.
If a production line stalls and work-in-progress products are unfinished, it causes a reduction in
the rate in which inventory stock is renewed. Decoupling stock is generally used the most in ‘built-
to-order’ production runs.
How does decoupling inventory work?
In optimised manufacturing, plant and equipment should always keep running. If machinery stops
or slows down it can cost the company in terms of repairs, additional set up costs and lost time
depreciation.
With production and assembly operations, work orders will pass from station to station where
inventory stock is held to enable each station to adjust to stock variations. Such variations can be
created by product mix changes or customised product cycles.
The strings of work that separate the processes, enables each station to deliver products slightly
independent of the other workstations. The aim is to prevent lost time and the associated expense
of having staff and labour-hire standing idle while the various process catch-up.

5. Role of Inventory in Value Chain:

6. Different types of Inventory cost:

Carrying Cost: Carrying costs include storage and space, taxes, insurance and more. They are the
costs your company incurs over the time it stores and holds its inventory.

Having an accurate view of these costs is critical to know how much profit your current inventory
can make.

Shortage Cost: These costs, also called stock-out costs, occur when businesses become out
of stock for whatever reason.
 Disrupted production - when the business involves producing goods as well as
selling them, a shortage will mean the business will have to pay for things like idle
workers and factory overhead, even when nothing is being produced
 Emergency shipments - for retailers, stock-outs could mean paying extra to get a
shipment on time, or changing suppliers
 Customer loyalty and reputation - aside from the loss of business from customers
who go elsewhere to make purchases, the company takes a hit to customer loyalty and
reputation when their customers are unhappy

Ordering Cost: Ordering costs include payroll taxes, benefits and the wages of the
procurement department, labor costs etc. These costs are typically included in an overhead
cost pool and allocated to the number of units produced in each period.

 Transportation costs
 Cost of finding suppliers and expediting orders
 Receiving costs
 Clerical costs of preparing purchase orders
 Cost of electronic data interchange
7. Inventory Order Cycle:
8. Continuous Review System and Periodic Review System:
9. Inventory Turn Over and Service Levels:
 It is the number of times a business sells and replaces its stock of goods during a
given period.
 It considers the Sales , relative to its average inventory for a year or in any a set
period of time.
 A high inventory turnover generally means that goods are sold faster and a low
turnover rate indicates weak sales and excess inventories, which may be
challenging for a business.

Limitations of Using Inventory Turnover

• When comparing or projecting inventory turnover one must compare similar products
and businesses.
• Example: Automobile turnover at a car dealer may turn over far slower than fast-
moving consumer goods sold by a supermarket.
10. Alternative Classification Schemes: