INVENTORY MANAGEMENT

WHAT IS INVENTORY?

• INVENTORY – often called “merchandise”

• It refers to goods and materials that a business holds for sale to customers in the near future.
• In other words, these goods serves no purpose in the business except to be sold to customers for profit.
• They are not used in to produce things or promote the business.
• The sole purpose of these current assets is to sell them to customers for a profit, but just because an asset is for sale
does not mean that it is considered an inventory .

There are three main characteristics of inventory to determine whether an asset should be accounted as merchandise.

WHAT ARE THE CATEGORIES OF INVENTORY?

1. RAW MATERIALS
• These are products that are necessary to the life of any business.
• These are made up of the materials your business uses to produce goods.

2. WORK-IN-PROGRESS
• These are products that are yet lacking in production process before they are ready for sale like parts and components,
assemblies and subassemblies.

3. FINISHED GOODS
• These are products that are completed at production and are ready for sale.

4. PACKING MATERIALS
• These are goods or materials use to pack and ship goods, which can include:
▪ Primary Packing
▪ Secondary Packing
▪ Miscellaneous Packing

5. SAFETY STOCK
• These are extra stocks that is maintained to mitigate risk of stockouts (shortfall in raw material or packaging/products)
caused by uncertainties in supply and demand.
• Adequate safety stock levels permit business operations to proceed according to their plans.

6. SMOOTHING INVENTORY a.k.a “Anticipation Inventory”

• It is a type of inventory in which a manufacturer purchases and stores in exess of current needs in anticipation of a
future event.

A pen manufacturer will build up components, supplies and complete stocks in the months leading up to the start of a new
school year when demand is at its peak.

The manufacturer slowly reduces the excess inventory during the rush of back to school time.

7. DECOUPLING INVENTORY
• It is the term used when product manufacturers set aside extra raw materials or work in progress items for all or some
stages in a production line, so that a low- stock situation or breakdown at one stage does not slow or stop operations.

8. CYCLE INVENTORY – “Cycle Stock / Working Inventory”

• It is the part of total inventory that is available to meet the usual demand.
• It is comprised of the products that will be used first to fulfill customer orders in the standard business cycle of a
company.

9. MRO – Maintenance, Repair, and Operation Inventory

• It comprises the consumable materials, equipment and supplies needed for maintenance, repair and operations
activities.
• MRO includes items that are used in a production process but unlike raw materials are not incorporated into a
company’s finished products.
WHAT IS INVENTORY MANAGEMENT?

• Inventory management is a systematic approach to sourcing, storing, and selling inventory-both raw materials (components)
and finished goods (products).
• In business terms, inventory management means the right stock, at the right levels, in the right place, at the right time, and
at the right cost as well as price.
• Effectively tracking and controlling physical inventory, will help you know how many of each item you have, when you
might be running low on products and whether you should replenish that item in order to keep selling it.
WHY IS INVENTORY MANAGEMENT IMPORTANT?
1. IT ENSURES YOU NEVER RUN OUT OF STOCK.
• Part of inventory management is figuring out how much inventory you should have on hand at all times.
• Too much inventory, and you risk ‘dead stock: inventory that can no longer be sold due to being outdated.
• Too little, and you will run out of stock, fail to meet customer demands, and miss out on potential sales.
By using a reorder point formula, you can ensure that you keep an eye on your inventory so that it does not dip below a critical
level.
REORDER POINT (ROP) = LEAD TIME DEMAND + SAFETY STOCK
Lead time is the number of days between the time when you place a purchase order with your manufacturer or supplier for a
product and the time when you receive the product.
Your lead time will be longer if your supplier is overseas as compared to a domestic or in-house production facility.
Lead time demand is the total demand between the time you place your order and the anticipated time for the delivery.
LEAD TIME DEMAND = LEAD TIME x AVERAGE DAILY SALES
To find lead time demand, just multiply the lead time (in days) for a product by the average number of units sold daily:
Example:
Lead time = 10 days Average daily sales = 5 units Lead time demand: 5 units/day x 10 days = 50 units

Reorder Point (ROP) = Lead Time Demand + Safety Stock ➜ Reorder Point (ROP) = 50 units + 25 units = 75 units
2. IT HELPS YOU SAVE MONEY ON STORAGE.
• Too much inventory can result in too much money spent on storage space.
• Storing inventory is a variable cost-it is based on how much space your inventory takes up at any given time.
• When you have more products on hand than you need, you end up paying more for inventory storage.
• Being smart about inventory levels can help you reallocate those funds.

3. IT PREPARES YOU FOR THE UNEXPECTED.

• It pays to be prepared for:
 You unexpectedly sell out of a product  Incoming inventory from the manufacturer is
 You miscalculate your storage needs and run out of delayed
space  You run into a cash flow issue and can not
purchase more inventory.
Strategic inventory solutions can help you get out of these sticky situations.
Tracking inventory over time and having contingency plans in place for potential inventory problems will prepare you for
situations that would otherwise seriously impact your business.
4. IT SHOWS TRENDS IN CUSTOMER BEHAVIOR.
• Keeping track of what inventory sells like hotcakes versus what ends up covered in metaphorical cobwebs can share some
important insight about what your customers are – and are not – into.
• You can also gauge the success of prior promotions or product launches by assessing inventory levels before and after those
events.

5. IT PREDICTS THE FUTURE.

• Good inventory management lends itself to good inventory forecasting, which can help you predict and plan for demand.
• You can leverage past inventory trends on a monthly, seasonal, or SKU-by-SKU (stock- keeping units) level to better
prepare for future levels of sales and demand.
• Make sure to keep any planned marketing promotions or new product launches in mind, too.

6. IT HELPS YOU TRACK COSTS OF GOODS SOLD.

• Inventory accounting is when you track and account for changes in the value of inventory over time as it relates to
manufacturing and costs of goods sold.
• Keeping track of the value of your inventory can properly help to value your assets or goods sold and budget for the
inventory you need to buy for your business.
INVENTORY MANAGEMENT TECHNIQUES:
❑ Economic order quantity or EOQ ❑ Dropshipping
❑ ABC analysis ❑ Bulk Shipments
❑ Minimum order quantity. ❑ Consignment
❑ Just-in-time inventory management ❑ Barcode Scanning
❑ Safety stock inventory ❑ Backordering
❑ First-In-First-Out (FIFO) ❑ Demand Forecasting

1. ECONOMIC ORDER QUANTITY – EOQ

• It is a formula for the ideal order quantity a company needs to purchase for its inventory with a set of
variables like total costs of production, demand rate, and other factors.
• The overall goal of EOQ is to minimize related costs.
• The formula is used to identify the greatest number of product units to order to minimize buying.
• The formula also takes the number of units in the delivery of and storing of inventory unit costs.
• This helps free up tied cash in inventory for most companies.
Calculating Economic Order Quantity (EOQ):

Formula: √2 x D x CP / HC
D = Demand
• Quantity Sold Per Year
CP = Cost of the Purchase
• Per order, generally including shipping and handling.
HC = Holding Cost
• It refers to the total cost of holding inventory.
Example:
Demand = 3,000 units Cost of Purchase = $2.00/unit
Price = $20/unit Holding Cost = 3% of Price

EOQ = √2 x 3,000 x $2.00/.60

= √$12,000 / $.60

= √20,000
141 units
2. ABC ANALYSIS
• This inventory categorization technique splits subjects into three categories to identify items that have a
heavy impact on overall inventory cost.
▪ Category A serves as your most valuable products that contribute the most to overall profit.
▪ Category B is the products that fall somewhere in between the most and least valuable.
▪ Category C is for the small transactions that are vital for overall profit but don’t matter much
individually to the company altogether.

3. MINIMUM ORDER QUANTITY – MOQ

• On the supplier side, minimum order quantity (MOQ) is the smallest amount of set stock a supplier is
willing to sell.
• If retailers are unable to purchase the MOQ of a product, the supplier won’t sell it to you.
• For example, inventory items that cost more to produce typically have a smaller MOQ as opposed to
cheaper items that are easier and more cost effective to make.
 CALCULATING MINIMUM ORDER QUANTITY (MOQ)
Step 1: Calculate your cost on the road.

• Minimum Order Value (MOVs) are based on your expenses.

• Take into account the total cost of your driver’s wage, gas, and maintenance fees.
• For this example, let’s assume your delivery costs are $80/hour.

Step 2: Calculate your margins and break even point.

• Next, determine how much product you need to deliver every hour to break even on your deliveries.
• Start by calculating your gross margins or for every $100 of sales, establish your profit after expenses.
• Let’s say your margins are 25%.
• You can now calculate your break even point by dividing your cost on the road by your margins: 580 /25%
$320.
• This means you have to deliver $320 of product per hour to break even on your deliveries.

Step 3: Set your target profit.

• You know what it takes to break even on your deliveries, so now let’s set some profit goals.
• Let’s say you want to double your break even point.
• This means you would have to deliver $640 of product per hour.
• The revenue made from this sale would be $160 → ($640 x 25% = $160).
• After calculating for delivery ($160-$80/hour $80), your business would net $80 in profit.

Step 4: Determine how many deliveries you can make per hour.

• Knowing the number of deliveries you can make every hour is necessary to calculate your MOV.
• You’ll need to assess the travel distance for every city, as well as each city’s urban density.
• In other words, how long does it take to drive to a city and how long does it take to deliver to each customer
in that city?

For this example, let’s say you can make 3 deliveries every hour.

Step 5: Calculate your Minimum Order Quantity.

• Finally, to calculate your MOQ, divide your hourly order volume by the number of deliveries you can make
per hour: $640/3 = $213.
• This means, to net $80/hour, the smallest order at which a customer could purchase your product is $213.

4. JUST-IN-TIME INVENTORY MANAGEMENT.

• Just-in-time (JIT) inventory management is a technique that arranges raw material orders from suppliers
in direct connection with production schedules.
• JIT is a great way to reduce inventory costs.
• Companies receive inventory on an as-needed basis instead of ordering too much and risking dead stock.
• Dead stock is inventory that was never sold or used by customers before being removed from sale
status.
5. SAFETY STOCK INVENTORY.
• Safety stock inventory management is extra inventory being ordered beyond expected demand.
• This technique is used to prevent stockouts typically caused by incorrect forecasting or unforeseen changes
in customer demand.

6. FIRST-IN-FIRST-OUT (FIFO)
• FIFO (first in, first out) inventory management seeks to value inventory so the business is less likely to lose
money when products expire or become obsolete.

7. DROPSHIPPING
• Under this method, businesses are expected to outsource all aspects of managing the inventory.
• This method has some benefits but is suitable for only some businesses that do not rely on efficient
inventory management as the success factor.
• It is particularly useful for businesses that want to get into e-commerce but cannot afford or justify the cost
of a warehouse of inventory management.
• Dropshipping is a retail fulfillment method where a store does not keep the products it sells in stock.
• Instead, when a store sells a product using the dropshipping model, it purchases the item from a third party
and has it shipped directly to the customer.
• As a result, the seller does not have to handle the product directly.
➢ The biggest difference between dropshipping and the standard retail model is that the selling merchant
does not stock or own inventory.
➢ Instead, the seller purchases inventory as needed from a third party – usually a wholesaler or
manufacturer-to fulfill orders.

8. BULK SHIPMENTS
• Businesses following this technique assume that bulk buying is always cheaper.
• This is good for businesses where the products have consistent demand and will see a sudden increase in
demand level.
• It is useful for businesses that have a majority of manufacturing done in-house and can handle unexpected
demand surges.

9. CONSIGNMENT
• Under this method, the consignor (wholesaler) gives the possession of the goods to the consignee (retailer).
• The consignee is expected to pay the consignor only after selling the goods in the market.
• This method is most popular in the informal sectors of the economy.

10. BARCODE SCANNING

• This method involves scanning a barcode before you handle an item in the warehouse.
• The fact is that barcodes are affordable, and human mistakes are costly.
Therefore, it is important to have a system that lets you follow a scanning system to receive, ship, or alter an
item in a business.
• It is particularly relevant for companies with more than a handful of items to handle.
11. BACKORDERING
• A backorder is when a business is open to accepting orders for the stock that it does not have in the
warehouse when the order is placed.
• Backordering works well for pre-launch or products that have a strong hype driving their growth.
• It is particularly relevant for products with a history, or which have a celebrity driving strong word-of-mouth
marketing. A process of ordering products that are not currently in stock.

WHAT DOES A BACKORDER MEAN?

• An item on backorder is an out of stock product that is expected to be delivered by a certain date once it is
back in stock.
• Businesses will often still sell products on backorder with the guarantee to ship them to the buyer once
their inventory has been replenished.
• Backordering an item means the shopper can buy the item now and receive it at a future date when the
item is in stock and available.
• When an order contains a backordered item, it can’t be packed and shipped immediately given the lack of
physical inventory at the time.
• If there are other items in the same order that are in stock, the order may be split and shipped at different
times, with the backordered items being shipping at a later date.

12. DEMAND FORECASTING

• This method uses predictive analysis to forecast the possible changes in consumer demand in the
future.
• In today’s business environment, it is critical to have a strong demand forecasting strategy on your side to
foresee the expected changes in the marketplace.
• A good technology platform will let you access such data analytics, which can equip you to make such
demand forecasts.
• An Al-based forecasting solution uses an ensemble of machine learning algorithms to optimize forecasts.
• The system then selects a model that’s uniquely suited for the particular business metric that you’re
forecasting.

MACHINE LEARNING (ML) for SUPPLY CHAIN PLANNING (SCP)

• Supply chain planning is a crucial activity within SCM strategy.
• Having intelligent work tools for building concrete plans is a must in today’s business world.
• ML, applied within SCP could help with forecasting within inventory, demand and supply.
• If applied correctly through SCM work tools, ML could revolutionize the agility and optimization of
supply chain decision-making.
• By utilizing ML technology, SCM professionals – responsible for SCP – would be giving best possible
scenarios based upon intelligent algorithms and machine-to-machine analysis of big data sets.
• This kind of capability could optimize the delivery of goods while balancing supply and demand, and
would not require human analysis, but rather action setting for parameters of success.