Inventory

What it is:
Inventory is the collection of unsold products waiting to be sold. Inventory is listed as a
current asset on a company's balance sheet.

How it works (Example):

Inventory is commonly thought of as the finished goods a company accumulates
before selling them to end users. But inventory can also describe the raw
materials used to produce the finished goods, goods as they go through the
production process (referred to as "work-in-progress" or WIP), or goods that are
"in transit." 

There are generally five reasons companies maintain inventories:

 To meet an anticipated increase in demand;

 To protect against unanticipated increases in demand;
 To take advantage of price breaks for ordering raw materials in bulk;
 To prevent the idling of a whole factory if one part of the process breaks
down; and,
 To keep a steady stream of material flowing to retailers rather than making
a single shipment of goods to retailers.

Inventory can also be used as collateral to obtain financing in some cases.

The basic requirement for counting an item in inventory is economic control

rather than physical possession. Therefore, when a company purchases
inventory, the item is included in the purchaser's inventory even if the purchaser
does not have physical possession of those items.

Inventory is usually classified in its own category as an asset on the balance

sheet, following receivables. It is important to note that the balance sheet's
inventory account should also reflect costs directly or indirectly incurred in
making an item ready for sale, including the purchase price of the item as well as
the freight, receiving, unpacking, inspecting, storage, maintenance,
insurance, taxes, and other costs associated with it. 
Cost of holding inventory
Definition of Cost of Carrying Inventory
The cost of carrying inventory (or cost of holding inventory) is the sum of the following:
 Cost of money tied up in inventory, such as the cost of capital or the opportunity cost of
the money.
 Cost of the physical space occupied by the inventory including rent, depreciation, utility
costs, insurance, taxes, etc.
 Cost of handling the items.
 Cost of deterioration and obsolescence.
Often the costs are computed for a year and then expressed as a percentage of the cost of the
inventory items. Others may focus on the incremental costs of carrying or holding inventory.

The cost of carrying inventory will vary from company to company. For instance, if a company
has a large cash balance with no attractive investment options, has excess space for storage, and
its products have a low probability for deterioration or obsolescence, the company's holding or
carrying costs are very low. A company with enormous debt, little space, and products subject to
deterioration will have very high holding costs.

Example of Calculating the Cost of Carrying Inventory

Based on the above items, let's assume that a company's holding costs add up to 20% per year. If
the company's inventory has a cost of $300,000 the cost of carrying or holding the inventory is
approximately $60,000 per year.

Evaluating inventory management performance using a turnover curve

Abstract:
Managing inventory levels in the aggregate is a common concern of senior
management. A generalized formula (turnover curve) developed in previous
research that mimics practical inventory control is used to audit inventory
control performance of inventories in the aggregate and at multiple stocking
points. The same turnover curve is used to estimate the impact of changing
the inventory control procedures or to set new targets for inventory levels. It
is a simple yet powerful tool for evaluating inventory managerial performance
that can be developed from readily available company data. This research
provides additional examples to further validate the practical usefulness of
the turnover curve.
Need for Inventory Management - Why do Companies
hold Inventories ?
Inventory is a necessary evil that every organization would have to maintain for various purposes.
Optimum inventory management is the goal of every inventory planner. Over inventory or under inventory
both cause financial impact and health of the business as well as effect business opportunities.

Inventory holding is resorted to by organizations as hedge against various external and internal factors,
as precaution, as opportunity, as a need and for speculative purposes.

Reasons why organizations maintain Raw Material Inventory

Most of the organizations have raw material inventory warehouses attached to the production facilities
where raw materials, consumables and packing materials are stored and issue for production on JIT
basis. The reasons for holding inventories can vary from case to case basis.

1. Meet variation in Production Demand

Production plan changes in response to the sales, estimates, orders and stocking patterns.
Accordingly the demand for raw material supply for production varies with the product plan in
terms of specific SKU as well as batch quantities.

Holding inventories at a nearby warehouse helps issue the required quantity and item to
production just in time.

2. Cater to Cyclical and Seasonal Demand

Market demand and supplies are seasonal depending upon various factors like seasons; festivals
etc and past sales data help companies to anticipate a huge surge of demand in the market well
in advance. Accordingly they stock up raw materials and hold inventories to be able to increase
production and rush supplies to the market to meet the increased demand.

3. Economies of Scale in Procurement

Buying raw materials in larger lot and holding inventory is found to be cheaper for the company
than buying frequent small lots. In such cases one buys in bulk and holds inventories at the plant
warehouse.

4. Take advantage of Price Increase and Quantity Discounts

If there is a price increase expected few months down the line due to changes in demand and
supply in the national or international market, impact of taxes and budgets etc, the company’s
tend to buy raw materials in advance and hold stocks as a hedge against increased costs.

Companies resort to buying in bulk and holding raw material inventories to take advantage of the
quantity discounts offered by the supplier. In such cases the savings on account of the discount
enjoyed would be substantially higher that of inventory carrying cost.

5. Reduce Transit Cost and Transit Times

 In case of raw materials being imported from a foreign country or from a far away vendor within
the country, one can save a lot in terms of transportation cost buy buying in bulk and transporting
as a container load or a full truck load. Part shipments can be costlier.

In terms of transit time too, transit time for full container shipment or a full truck load is direct and
faster unlike part shipment load where the freight forwarder waits for other loads to fill the
container which can take several weeks.

There could be a lot of factors resulting in shipping delays and transportation too, which can
hamper the supply chain forcing companies to hold safety stock of raw material inventories.

6. Long Lead and High demand items need to be held in Inventory

Often raw material supplies from vendors have long lead running into several months. Coupled
with this if the particular item is in high demand and short supply one can expect disruption of
supplies. In such cases it is safer to hold inventories and have control.