Chapter 3: Topic: Inventory

Inventories

Inventories

are goods that are found in the warehouses of the company. These are the materials used in the production process or they meet customer demand, and consist of raw materials, materials pulled into the production in process, and finished products. These products usually belong to the company itself and it represents its most important asset. Inventories are stockpiles of raw materials, supplies, components, work in process, and finished goods that appear at numerous points throughout a firm’s production and logistics channel.

inventory strategy

is a day-to-day methodology to follow for ordering, maintaining and processing items in your warehouse.

CYCLE INVENTORY

varies in proportion to order quantity—larger orders result in higher inventory, while smaller orders result in lower.

SAFETY STOCK INVENTORY

is excess inventory that a company holds to guard against uncertainty in demand, lead time, and supply. Safety stock is used to improve customer service and reduce stocksouts resulting from unpredictable changes in demand, lead time, or supply.

ANTICIPATION INVENTORY

is inventory that is held for future use at a time when demand will exceed available capacity.

PIPELINE INVENTORY

is inventory that is process of moving from one location in the supply chain to another.

WORK-IN-PROCESS (WIP) INVENTORY

is inventory that is in the process of being transformed from one state to another.

REMANUFACTURED/ RECONDITIONED INVENTORY

consists of products that have been used by a customer and then reacquired by a company and either remanufactured or reconditioned for resale.

Wholesale Pricing

Many business owners can take advantages of lower costs when they buy larger quantities of units. This makes sense for regular items that the business knows will sell, because the business is confident it will move product effectively and not be left with it. The lower costs could be significant depending on the price points of the product.

Fast Fulfillment

When things are in stock, customers get products in hand much faster. Even when customers don't have an immediate need for the product, when the decision to buy is made, the customer likes to walk out with the product in hand. This is a fundamental part of quality customer service.

Low Risk of Shortages

There are times when demand spikes higher. For some items, demand might be cyclical around a specific holiday or season. When you have excess inventory, you don't run the risk of being the business that ran out of stock when everyone was looking for one particular product.

Full Shelves

When you keep just enough inventory to get through the normal sales cycle, shelves can look sparse as you get closer to the next time to order. The appearance of full shelves sends a positive message to the customer that business is good and the store is ready for business.

Keeping a store stocked with items to sell requires adequate inventory. Business owners should look at several types of inventory control to determine the best method.

Obsolete Inventory

Overstocking on products runs the risk of the product becoming obsolete. This is true especially in technology sectors such as smartphones and televisions, but no industry is exempt. Even the latest kid's game craze might inspire you to place a large order. If the buzz dissipates quickly and kids aren't looking for the game, you'll be left holding a lot of inventory you can't move.

Storage Costs

The more stuff you have, the more space you need. Commercial space is leased per square foot. Consider the costs to store excess inventory compared to the savings on wholesale orders. It also costs to do more inventory control and audits, potentially requiring additional manpower to work the warehouse.

Potential Insurance Costs and Loss

Insurance costs go up with larger storage areas and larger inventory values. This factor needs to be considered and compared to wholesale savings. If there is a fire, theft or another natural disaster, not only will the business be recuperating, it will need to pay higher premiums as insurance rates go up.

Tying Up Capital

When you have excess inventory, you pay for the order, the storage and insurance. You can't get around this. For businesses that are working with small margins and on tight monthly budgets, this can hamper business development decisions because they don't have cash on hand.

Business owners might examine the disadvantages pertinent to the business and then decide whether carrying excess inventory makes sense. It is up to each business owner to review the financial health of his company. Inventory is one key factor in that.

Independent Demand

If the demand for inventory of an item is dependant upon another item, such demands are categorized as Independent demand. Raw materials and component inventories are dependant upon the demand for Finished Goods and hence can be called as Indendent demand inventories.

Inventory Model

a mathematical model that helps business in determining the optimum level of inventories that should be maintained in a production process, managing frequency of ordering, deciding on quantity of goods or raw materials to be stored, tracking flow of supply of raw materials and goods to provide uninterrupted service to customers without any delay in delivery.

Fixed Reorder Quantity System

an Inventory Model, where an alarm is raised immediately when the inventory level drops below a fixed quantity and new orders are raised to replenish the inventory to an optimum level based on the demand. The point at which the inventory is ordered for replenishment is termed as Reorder Point. The inventory quantity at Reorder Point is termed as Reorder Level and the quantity of new

Fixed Reorder Period System

an Inventory Model of managing inventories, where an alarm is raised after every fixed period of time and orders are raised to replenish the inventory to an optimum level based on the demand. In this case replenishment of inventory is a continuous process done after every fixed interval of time.

Regular Intervals (R)

is the fixed time interval at the end of which the inventories would be reviewed and orders would be raised to replenish the inventory

Inventory on Hand (It

is the Inventory level measured at any given point of time.

Maximum Level (M)

It is the maximum level of inventory allowed as per the production guidelines. The maximum level is derived by analyzing historical data.

Order Quantity

In this system, inventory is reviewed at regular intervals (R), inventory on hand (It) is noted at the time of review and order quantity is placed for a quantity of (M) - (It).

Inventories

refer to those products or goods a firm is manufacturing for sale and components that make up the product.

Raw Materials:

These are those goods which have been purchased and stored for future productions. These are the goods which have not yet been committed to production at all.

Work-in-Progress:

These are the goods which have been committed to production but the finished goods have not yet been produced. In other words, inventories refer to ‘semi-manufactured products.’

Finished Goods:

These are the goods after production process is complete. Say, these are the final products of the production process ready for sale. In case of wholesaler or retailer, inventories are generally referred to as ‘merchandise inventories.’ Some firms also maintain the fourth type of inventories called ‘supplies.’ Examples of supplies are office and plant cleaning materials, oil, fuel, light bulbs and the like.

Ordering Costs:

These include costs which are associated with placing of orders to purchase raw materials and components. Clerical and administrative salaries, rent for the space occupied, postage, telegrams, bills, stationery, etc. are the examples of ordering costs. The more the orders, the more will be the ordering costs and vice versa. (:)

Carrying Costs:

These include costs involved in holding or carrying inventories like insurance charges for covering risks, rent for the floor space occupied, wages of labourers, wastages, obsolescence, or deterioration, thefts, pilferages, etc. These also include ‘opportunity costs.’ This simply means had the money blocked in inventories been invested elsewhere in the business, it would have earned a certain return. Hence, the loss of such return may be considered as an ‘opportunity costs.’ (:)

Deterministic Models

are built on the assumption that there is no uncertainty associated with demand and replenishment of inventories.

Probabilistic Models

take cognizance of the fact that there is always some degree of uncertainty associated with the demand pattern and lead time of inventories.

Economic Ordering Quantity (EOQ) Model

One of the important decisions to be taken by a firm in inventory management is how much inventory to buy at a time.

ABC Analysis

This is also called ‘Selective Inventory Control.’ The of selective inventory is based on the logic that in any large number, we usually have ‘significant few’ and ‘insignificant many.’ This holds true in case of inventories also.

Inventory Turnover Ratio

Inventory can also be managed by using accounting ratios like ( ) establishes relationship between average inventory and cost of inventory consumed or sold during the particular period.

Fast-Moving Items

This is indicated by a high inventory ratio. This also means that such items of inventory enjoy high demand. Obviously, in order to have smooth production, adequate inventories of these items should be maintained. Otherwise, both production and sales will be adversely affected through uninterrupted supply of these items.

Slow-Moving Items:

That some items are slowly moving is indicated by a low turnover ratio. These items are, therefore, needed to be maintained at a minimum level.

Dormant or Obsolete Items:

These refer to items having no demand. These should be disposed of as early as possible to curb further losses cause by them.

Single Period Inventory Model

is a business scenario faced by companies that order seasonal or one-time items. There is only one chance to get the quantity right when ordering, as the product has no value after the time it is needed. There are costs to both ordering too much or too little, and the company's managers must try to get the order right the first time to minimize the chance of loss.

Multiple Period Inventory Model

can have two variations. ... Levels of inventory in a fixed time period model are only checked at the time that an order is due to be placed. In the fixed order quantity model inventory levels are usually higher and this system tends to be used for more expensive, important items.

Inventory Cost

the costs associated with the procurement, storage and management of inventory. It includes costs like ordering costs, carrying costs and shortage / stock out costs.

Ordering cost

of inventory refers to the cost incurred for procuring inventory. It includes cost of purchase and the cost of inbound logistics. In order to minimise the ordering cost of inventory we make use of the concept of EOQ or Economic Order Quantity.

Carrying cost

of inventory refers to the cost incurred towards inventory storage and maintenance. The inventory storage costs typically include the cost of building rental and other infrastructure maintained to preserve inventory. The inventory carrying cost is dependent upon and varies with the decision of the management to manage inventory in house or through outsourced vendors and third party service providers.

Shortage or stock out costs

cost of replenishment are the costs incurred in unusual circumstances. They usually form a very small part of the total inventory cost.