INVENTORY

MANAGEMENT

Unit 2
Module one
LEARNING OBJECTIVES
■ understand why businesses hold stocks (inventories)
and the costs of stock holding
■ analyse the advantages and disadvantages of
traditional stock-management systems
■ discuss the just-in-time (JIT) stock-management
system.
INVENTORY MANAGEMENT
STOCK MANAGEMENT
This is also kwon as stock control. Stock management
occurs when the purchasing department aims to
minimise cost of stock by maintaining adequate levels of
stock. Thus the purchasing department must obtain the
right quality at the right time in the right quantity, from
the right source at the right price.
REASONS FOR HOLDING STOCK ( OR PURPOSE OF STOCK
CONTROL)
1. Stock of raw materials is kept in order to meet production
requirement
2. Stock of work-in-progress is maintained in order to
continue the production process and allowing greater
flexibility and better utilisation of time and machinery.
3. Stocks of finished goods are maintained in order to meet
customers’ demand on time
4. Stocks of equipment and spares are kept in order to
support sales and production
5. To control cash tied up in stocks
6 To control wastage and pilferage (stealing of small
items/amounts at a time)
7. They have the necessary storage space
8. There is not the likelihood that stocks will become
outdated
9. The firm will receive the economies of bulk buying
10. As a precaution against disruption, e.g. strikes, transport
problems affecting suppliers
11. If the firm anticipates an increase in price of the stock
12. If the firm anticipates an increase in demand for its
output, i.e. prevent stock-outs
TYPES OF INVENTORY
1) Raw materials-: the basic materials from which a
product is made and they are usually bought from
outside.
2) Work-in-progress-: unfinished project that is still being
added to or developed or partially completed goods
3) Finished products-: goods that have completed the
manufacturing process
COSTS OF HOLDING HIGH LEVEL STOCK
1. Opportunity cost as capital is tied up in stored stocks
2. Storage costs will increase
3. Increase in spoilage
4. Rise in administrative and finance costs e.g insurance
5. Wastage of resources in a period of lower demand in
the market
6. Risk of theft
COSTS OF HOLDING INADQUATE OR LOW
LEVEL OF STOCK
1. Lost sales which are known as out-of-sale costs
2. Idle production resources example the machines will
be operating below capacity
3. Ordering costs will increase since the firm places
more number of orders in a given period
4. The advantage of bulk buying cannot be achieved
BENEFITS OF HOLDING HIGH LEVEL STOCK
1. The firm can enjoy the benefit of bulk buying
2. There is production flexibility since the business will
be having enough stock at any given time
3. Machine and factory plant will be operating at full
capacity at all times
4. Enough stock will be available to support production
and sales
BENEFITS OF HOLDING LOW LEVEL STOCK
1. Storage costs are reduced
2. Insurance costs are minimised
3. Capital is not unnecessarily held or kept in stocks
4. Minimum wastages in a period of reduced demand
5. Risk of theft and spoilage is reduced
MANAGING INVENTORY
This involves the stock control techniques
a)BUFFER STOCK
This refers to the reserves of stock kept to cater for eventual
stock out or uncertainties. To avoid the risk of running out of
stock, the business must have reserved stock
this technique is used to avoid stock out costs which are:-
1. Lost production
2. Lost contribution from lost sales
3. Loss of customer good will
4. High unit costs associated with urgent purchases
5. Loss of bulk buying discounts
b)RE-ORDER LEVEL
This refers to the level of stock at which a new order is placed
with the supplier. The quantity of this order or the re-order
quantity will be influenced by the economic order quantity
(EOQ)
EOQ refers to the quantity of materials ordered at cash point
to minimise the total annual stocking costs or the least cost
quantity of stock to re-order taking into account delivery costs
and stock holding costs. EOQ depends on -:
-interest on capital
-storage costs
-wastage costs
-insurance costs
In order to calculate the quantity of stock that will
minimise total costs, the following formula is used:

EOQ = √2CD
H
where:
C is the cost of placing the order
D is the annual rate of demand or quantity
H is the cost of holding one unit of stock for a year.
For example: A firm’s annual demand for an item of
stock is 36 000 units. It incurs a cost of $60 to hold one
unit of the stock for the year and the delivery cost of the
stock is $4,000. Its economic order quantity would
therefore be:
EOQ = √2 x 4,000 x 36,000
60
=
MAXIMUM STOCK- refers to the highest amount of stock
kept and it is limited by space and the financial costs of
holding higher levels
Maximum stock = EOQ + Buffer Stock
MINIMUM STOCK- is also known as buffer stock. This is the
minimum number of stock that should be held to ensure that
production still continue in case of delay in the delivery of raw
materials
RE-ORDER LEVEL- this is the level of stock at which a new
order is placed with the supplier. The quantity of the new
order will be influenced by the EOQ
LEAD TIME- it is the amount of time it takes for a stock
purchased to be received, inspected and made ready for use. If
more time is required between ordering new stocks and their
delivery then a higher minimum stock is needed
f).JUST-IN-TIME
-it is a stock control system in which material is scheduled to
arrive exactly when it is needed for production and in the
exact quantity. Raw materials are reduced to zero and
finished goods inventories are minimised by matching
production to demand. Thus JIT does not require any Buffer
Stocks to be held.
The components arrive just at the time that they are needed
and the finished goods are delivered to customers as soon as
they are completed
Stock Levels
 see
REQUIREMENTS FOR JIT PRODUCTION
i).Employee Flexibility- employees of the firm should be
multi-skilled and should be able to switch jobs quickly so
that excess stocks of raw materials won’t build up.
ii)Flexibility of Machinery- modern, computerised
machinery is required for JIT production as it can
produce a wide range of products just by changing a
single software
iii)Excellent relationships with suppliers- it should be
possible for suppliers to be able to supply raw materials
at short notice.
iv)Accurate demand forecast- this will enable the
business to produce a reliable production schedule which
would help in the calculation of precise number of goods
to be produced over a certain time
v)Extensive use of IT- computerised records of sales and
stock levels would allow minimum stocks to be held.
Electronic communication with suppliers would enable
accurate delivery of supplies
vi)Strict quality control/ zero defect- since there are no
spare stocks, therefore goods have to be produced
correctly the first time otherwise customer orders will not
be completed on time.
BENEFITS OF JIT
1. The right quantities are produced or purchased at the
right time
2. Improvements on product quality
3. Improved customer service
4. Reduction in storage costs
5. Less chance of stock being out-dated or obsolescent
6. Less stock reduce the risk of damage and wastage
7. Higher profits due to overall decrease in costs
DISADVANTAGES OF JIT
1. It is associated with high start-up cost
2. Advantages of bulk buying are lost
3. Delivery costs rises as frequent small orders are
delivered
4. Administration costs rises as so many small orders
need to be processed
5. Doesn’t work when demand is unpredictable
6. It will be difficult for the firm to cater for an increase
in demand.
Costing