Chapter 24, Inventory Management, from the AS and A Level Business coursebook by Peter

Stimpson and Alastair Farquharson:

Key Terms and Explanations

1. Inventory Management
Definition: The process of controlling the levels of inventory in a business to ensure
an adequate supply of inputs and finished products while minimizing costs.
Importance: Ensures efficient production, reduces wastage, and prevents stockouts
or overstocking.
2. Buffer Inventory
Definition: The minimum level of inventory a business keeps to avoid running out of
stock due to unforeseen demand or supply delays.
Example: A hospital may maintain buffer inventory for essential medical supplies.
3. Re-order Level
Definition: The inventory level at which new stock must be ordered to avoid running
out.
Formula: Based on lead time, daily usage, and buffer inventory.
4. Lead Time
Definition: The time taken between placing an order with a supplier and receiving
the inventory.
Impact: Longer lead times require higher buffer inventory levels.
5. Maximum Inventory Level
Definition: The highest amount of inventory a business can hold, determined by
factors like storage space and financial constraints.
Example: Seasonal retailers may calculate this to prepare for peak periods.
6. Re-order Quantity
Definition: The number of items ordered each time inventory is replenished.
Influence: Economic order quantity (EOQ) calculations can optimize this.
7. Economic Order Quantity (EOQ)
Definition: The optimal quantity of inventory to order that minimizes total holding
and ordering costs.
Factors: Includes demand rate, ordering cost, and holding cost.
8. Opportunity Cost
Definition: The cost of tying up capital in inventory that could have been used
elsewhere.
Example: Money tied up in inventory could be used for investments or paying off
loans.
9. Storage Costs
Definition: Costs associated with holding inventory, including warehouse rent,
utilities, and insurance.
Example: Refrigeration costs for perishable goods.
10. Risk of Obsolescence
Definition: The risk of inventory becoming outdated or unsellable before it is used or
sold.
Example: Technology products that are replaced by newer versions.
 11. Just-in-Time (JIT)
Definition: An inventory system where goods are ordered and delivered only as they
are needed in the production process.
Advantages: Reduces holding costs, minimizes waste.
Disadvantages: Relies on reliable suppliers; disruptions can halt production.
12. Just-in-Case (JIC)
Definition: A traditional inventory system that involves holding high buffer inventory
to avoid stockouts.
Advantages: Prevents delays due to supply chain disruptions.
Disadvantages: Higher storage and opportunity costs.
13. Work-in-Progress Inventory
Definition: Items that are in the process of being manufactured but are not yet
completed.
Example: Semi-finished cars on an assembly line.
14. Finished Goods Inventory
Definition: Completed products that are ready for sale.
Purpose: Held to meet sudden demand or seasonal fluctuations.
15. Inventory Turnover
Definition: The number of times a business sells and replaces its inventory in a given
period.
Formula: Cost of Sales ÷ Average Inventory.
Importance: A higher turnover indicates efficient inventory management.
16. Stockout
Definition: When inventory runs out, causing delays in production or loss of sales.
Example: Retailers losing customers due to unavailable products.
17. Supply Chain Management
Definition: The management of the flow of goods and services from suppliers to
customers.
Benefits: Reduces costs, improves efficiency, and ensures timely delivery.
18. Inventory Control Chart
Definition: A visual tool to monitor inventory levels, re-order points, and buffer stock
over time.
Application: Helps prevent stockouts and optimize order quantities.

Costs of Holding Inventory

 Financial Costs: Interest on loans to finance inventory or lost returns on invested

capital.
 Storage Costs: Includes rent, insurance, and utilities.
 Wastage and Damage: Risks of spoilage, theft, or obsolescence.

Benefits of Holding Inventory

 Continuity of Operations: Prevents production delays.

 Customer Satisfaction: Ensures goods are available when needed.
  Bulk Discounts: Purchasing larger quantities often reduces costs.

Detailed Explanation of Just-in-Time (JIT) and Economic Order Quantity (EOQ)

Systems

Just-in-Time (JIT) Inventory System

1. Definition:
JIT is an inventory management approach where materials and components are
ordered and received only as they are needed for production or sales, minimizing
inventory holding costs.
2. Key Principles:
o Zero or minimal buffer stock.
o Production is demand-driven (pull system).
o Close collaboration with suppliers for timely delivery.
3. Advantages:
o Reduced Holding Costs: Minimal storage space required as inventory levels
are low.
o Lower Risk of Obsolescence: Materials are not held for long, reducing risks of
spoilage or becoming outdated.
o Improved Cash Flow: Capital isn’t tied up in large inventories.
o Focus on Quality: Frequent deliveries encourage better quality control, as
defects can disrupt production.
4. Disadvantages:
o Reliance on Suppliers: A disruption in the supply chain (e.g., delivery delays)
can halt production.
o Higher Ordering Costs: Frequent small orders can increase administrative
and transportation costs.
o Limited Flexibility: Businesses may struggle to meet sudden surges in
demand.
5. Best Used For:
o Industries where demand is predictable (e.g., car manufacturing, fast food).
o Businesses with reliable suppliers and short lead times.

Economic Order Quantity (EOQ)

1. Definition:
EOQ is a formula used to calculate the optimal order quantity that minimizes the
total cost of inventory, including holding and ordering costs.
2. Key Assumptions:
o Demand is constant and predictable.
 oLead time is fixed.
oNo stockouts occur.
oOrdering and holding costs are consistent.
3. Advantages:
o Cost Efficiency: Balances ordering and holding costs for optimal inventory
levels.
o Simplified Decision-Making: Provides a clear, mathematically derived order
quantity.
o Avoids Overstocking: Reduces excess inventory and associated costs.
4. Disadvantages:
o Simplistic Assumptions: Assumes constant demand and ignores variability in
real-world conditions.
o Ignores Bulk Discounts: Large orders might qualify for discounts, but EOQ
doesn't consider this.
o Not Ideal for Perishables: EOQ may suggest quantities larger than the usable
shelf life.
5. Applications:
o Ideal for non-perishable goods with predictable demand, such as office
supplies or manufacturing components.

Comparison: JIT vs EOQ

Aspect JIT EOQ

Optimize order quantity to
Objective Minimize inventory levels.
balance costs.
Balancing holding and ordering
Focus Reducing holding costs.
costs.
Reliance on Moderate (larger, less frequent
High (frequent, on-time deliveries).
Suppliers orders).
Assumes stable demand and
Demand Variability Handles predictable demand well.
costs.
Lower holding costs but higher Balances both ordering and
Cost Implications
ordering costs. holding costs.