Inventories are assets:
a. Held for sale in the ordinary course of business;
b. In the process of production for such sale;
c. In the form of materials or supplies to be consumed in the production process or in the
rendering of services (raw materials and manufacturing supplies).
Inventory management is the process of ordering, handling, storing, and using a company’s
inventory.
Inventory management all comes down to balance - having the right amount of stock, in the
right place, at the right time.
Importance of Inventory Management
Good inventory management helps with:
1. Customer service/ experience. Not having enough stock to fulfill orders you’ve already
taken payment for can be a real negative.
2. Improving cash flow. Putting cash into too much inventory at once means it’s not
available for other things - like payroll or marketing.
3. Avoiding shrinkage. Purchasing too much of the wrong inventory and/or not storing it
correctly can lead to it becoming ‘dead’, spoiled, or stolen.
4. Optimizing fulfillment. Inventory that’s put away and stored correctly can be picked,
packed, and shipped off to customers more quickly and easily.
An effective inventory management should:
● Ensure a continuous supply of raw materials to facilitate uninterrupted production.
● Maintain sufficient stocks of raw materials in periods of short supply and anticipate price
changes.
● Maintain sufficient finished goods inventory for smooth sales operation, efficient
customer service, and to minimize the carrying cost and time.
● Control investment in inventories and keep it at an optimum level.
Types of Inventory
There are several different types of inventory a company might come across. All are critical to
understand in the pursuit of effective inventory management.
1. Raw Materials Inventory - Raw materials are any items used to manufacture finished
products or the individual components that go into them. These can be produced or
sourced by a business itself or purchased from a supplier.
2. Work-in-progress (WIP) Inventory - again refers to retailers that manufacture their own
products. These are unfinished items or components currently in production, but not yet
ready for sale.
3. Finished Goods Inventory - Finished goods are products that are complete and ready for
sale. These may have been manufactured by the business itself or purchased as a
whole, finished product from a supplier.
4. Packing Materials Inventory - Packing materials are anything you use for packing and
protecting goods - either while in storage, or during shipping to customers.
Finished Good Types of Inventory
Companies have different kinds of inventory. They also use inventory for different purposes. Let's look at six ways
of using inventory.
1. Anticipation Inventory or Seasonal Inventory - Items built in anticipation of future demand. Allows company
to maintain a level production strategy.
2. Fluctuation Inventory or Safety Stock - Protects against unexpected demand variations. Assures customer
service levels.
3. Lot-size Inventory or Cycle Stock - Results from the actual quantity purchased. Allows for lower unit costs.
4. Transportation or Pipeline Inventory - Items in movement between locations. Inventory moves from
manufacturer to distribution facilities.
5. Speculative Inventory or Hedge Inventory - Extra inventory built up or purchased to protect against some
future events. Allows for continuous supply.
6. Maintenance, Repair and Operations (MRO) Goods Inventory - MRO goods are items used within the
manufacture of products, but without directly making up any part of a finished product.
Level & Monitoring System and Inventory Control System
ABC PLAN/ABC INVENTORY CLASSIFICATION - A method for determining the level of control and frequency of
review of inventory items.
Pareto analysis can be done to segment items into value categories depending on annual dollar volume
A Items – typically 20% of the items accounting for 80% of the inventory value
B Items – typically an additional 30% of the items accounting for 15% of the inventory value
C Items – typically the remaining 50% of the items accounting for only 5% of the inventory value-use
Inaccurate inventory records can cause:
● Lost sales
● Disrupted operations
● Poor customer service
● Lower productivity
● Poor material planning and excessive expediting
Two Methods for checking record accuracy:
Periodic counting - physical inventory is taken periodically, usually annually
Cycle counting - daily counting of prespecified items
Inventory control using ABC Classification
(A) Continuous review system - updates inventory balances after each inventory transaction.
(B) Periodic review system - requires regular periodic reviews of the on-hand quantity to determine the size of
the replenishment order.
(C) Two-bin system - one bin with enough stock to satisfy demand during replenishment time is kept in the
storeroom; the other bin is placed on the manufacturing floor.
Order Quantity using Mathematical Model
ECONOMIC ORDER QUANTITY (EOQ) - An optimizing method used for determining order quantity and reorder
points.
FORMULA METHOD
TABULAR METHOD
ASSUMPTIONS
● Demand is known & constant - no safety stock is required
● Lead time is known & constant
● No quantity discounts are available
● Ordering (or setup) costs are constant
● All demand is satisfied (no shortages)
● The order quantity arrives in a single shipment
ECONOMIC PRODUCTION QUANTITY (EPQ) - A model that allows for product incremental product delivery.
Same assumptions as the EOQ except: inventory arrives in increments & draws down as it arrives
QUANTITY DISCOUNT MODEL - Modifies the EOQ process to consider cases where quantity discounts are
available
Determining Safety Stocks Level
Safety Stock - backup stock needed to meet unexpected supply problems and/or sudden changes in demand.
