Inventory control

Describe inventory
Inventory refers to the stock of materials of any kind stored for future use, mainly in the
production process. Semi-finished goods, which are awaiting use in the next process, or finished
goods, which are waiting for sale, are also included in this broad category. Inventory is a key
determinant of profitability. Inventory velocity turns assets into profits. The faster inventory
turns, the greater the profitability. Inventory is the key issue to supply chain management
success. Customers demand that their orders be shipped complete, accurate and on time. That
means having the right inventory at the right place at the right time. xcess of inventory within
the pipeline increases the overall working capital re!uirements of the pipeline and places a large
cost burden on the agents of the chain. The levels of inventory need to be reduced throughout the
logistics pipeline, which will lead to an effective operation.
Functions of Inventory
1. Striking a balance between supply and demand"
It is very difficult to achieve a match between the production and consumption cycle. #henever
there is a sudden re!uirement of product in large !uantities, it is not possible to produce such
!uantities immediately. Thus, products are manufactured in advance, and kept in stock during the
peak period to avoid any shortage.
2. Minimize costs at acceptable inventory levels"
#hen inventories are replaced in extremely small !uantities, they result in low investments but
high ordering costs. There has to be a point where, the total carrying cost of inventory is
minimum but the level of inventory is such that it doesn$t affect production.
. !rovide t"e desired customer service levels#
Customer demands are satisfied through inventory. The location of inventory determines time in
which customer will be served, the company$s policies concerning the economic order !uantity,
safety stocks, etc will determine the cost at which customer is getting served.
$. !rotecting t"e operating system# from uncertainties
Inventory ensures that the operating system does not have any disruption. %or example, if a
worker in one work center falls sick or if there is a machine breakdown, the work need not be
affected if the inventory is available and others can continue the work.
%. &dvantage of 'uantity discounts from suppliers" Inventory helps the firms in getting the
advantage of !uantity discounts from suppliers.
(eed for inventory control#
1. Increase in t"e size of manufacturing units# #ith the increase in the si&e of manufacturing
units, there is a necessity to have sufficient inventory control so that increasing inventories do
not become non-value added expenditure. In fact, increasing inventory can erode the profits of
the company and the possibility of inventory control arises.
2. )ide variety and comple*ity of t"e re'uirements# The re!uirements of the modern industry
have necessitated the need for conscious inventory management.
. +ig" idle time cost of mac"ine and men# If men and machines are kept idle, it is highly
uneconomical for the firm. Inventory levels have to be managed keeping this factor in mind.
$. ,i'uidity# There is an increased stress on li!uidity in today$s organi&ations, where it becomes
a necessity to maintain li!uidity at the levels of nearly '(-)( per cent of the total capital invested
in finished goods
-eason for "olding inventory
#hether a business is in retailing or manufacturing, there are several cogent reasons for holding
inventory. *usinesses may hold stocks of raw materials, spare parts for machinery, work in
progress or finished goods. +iven that there are costs involved with purchases, orders and
carriage inwards, a firm might want to minimi&e its order costs and utili&e storage space
efficiently. #hile a business would incur holding costs when storing inventory, these costs can be
offset if there are good business reasons for so doing.
.o meet e*pected demand
, business must ensure that it has ade!uate supplies to meet expected demand for its goods,
regardless of whether it is a retailing or production environment. -articularly where a business
has a high demand and rapid turnover, having stock in storage ensures that the firm can
comfortably meet anticipated demand.
.o guard against s"ortages
.olding inventory can act as insurance against future shortages. /nexpected shortages in the
supply of raw materials or finished goods can affect the production run of a business or its ability
to meet demand. .olding inventories allows a degree of continuity for the activities of an
enterprise.
.o benefit from discounts
Suppliers often offer trade discounts for bulk purchases, once those purchases are above a certain
amount. , business can reduce the unit cost of materials and its ordering costs 0delivery, import
duties1 by purchasing a large amount of goods2 raw materials to hold in stock.
.o deal wit" variations in usage or demand
3/sage3 refers to production consumption in a manufacturing process. Increased usage can
increase the demand for materials. This is the result of either increased inefficiency or increased
production levels. Sometimes a business might cater for special orders or have high seasonal
demand that it must address, re!uiring additional stock to facilitate such occurrences.
.o facilitate t"e production process
Stock can allow the manufacturing process to flow smoothly and help the business to respond
!uickly and effectively to contingencies.
In times of "ig" inflation/ supply s"ortages
.olding vast supplies of inventories can be a deliberate strategy in response to unusual or
difficult economic circumstances. In times of high inflation, a business might not wish to
purchase stock at increasingly higher prices. 4nce the business determines that it is feasible to
hold additional inventory beyond the usual levels, this is a very sensible strategy.
Some processes re'uire "olding work in progress
Inventory can also include work in progress. Some products might have longer production cycles
than others 0like wine or cheese for instance1. It is necessary to hold a high volume of inventory
to cater for the inherent nature of production in some business contexts.
Inventory cost
."e various costs in inventory are broadly classified as follows#
Interest or 0pportunities 1ost# , company may obtain a loan or forgo an opportunity
to invest in an attractive return. Interest or opportunity cost whichever is higher is the
largest component of holding cost.
Storage and +andling 1osts# This cost is incurred when a firm rents out space. .ere
again there is an opportunity cost, as the firm can utili&e the storage space productively
for some other purpose.
.a*es2 Insurance and S"rinkage #hen inventories are high, the insurance on the assets 0i.e.
Inventories1 also increases. Shrinkage takes place in three forms.
-ilferage or theft of inventory by customers or employees.
4bsolescence occurs when inventory cannot be used or sold to the full value due to
change in model, engineering modifications or low demand.
5eterioration through physical spoilage or damage results in lost value.
0rdering 1ost# This refers to the cost involved in the ordering process. The paperwork faxes,
phone calls etc. will add to inventory related costs.
1arrying cost# ,lso called holding cost, carrying cost is the cost associated with having
inventory on hand. It is primarily made up of the costs associated with the inventory investment
and storage cost. %or the purpose of the 46 calculation, if the cost does not change based upon
the !uantity of inventory on hand it should not be included in carrying cost. In the 46 formula,
carrying cost is represented as the annual cost per average on hand inventory unit. *elow are the
primary components of carrying cost.
a1 0ut of stock costs Incurred when the order placed by the customer cannot be filled from
the available inventory.
b1 0ver stock costs Incurred when the company is having some stock in hand even after the
demand for the product has been terminated.