MODULE 5 – INVENTORY MANAGEMENT
Learning Outcomes:
At the end of this module, students should be able to:
1. Explain the nature and importance of inventories in business organization.
2. Analyze the different types of inventories adopted before, during and after production.
3. Appreciate the challenges, excitement and creativity associated with an ongoing
supply of materials between too much and too little, without ever running out of stock.
Module Content:
I – THE NATURE AND IMPORTANCE OF INVENTORIES
Inventory represents finished and unfinished goods which have not yet been sold
by a company. Inventories are maintained as buffers to meet uncertainties in demand,
supply, and movements of goods. These holdings are recorded in an accounting
system.
The verb “inventory” refers to the act of counting or listing items. As an
accounting term, inventory is a current asset and refers to all stock in the various
production stages. By keeping stock, both retailers and manufacturers can continue to
sell or build items.
II – OBJECTIVES OF INVENTORY CONTROL
Inventory management is important for operational efficiency, cost reduction, and
customer satisfaction. It helps businesses avoid excess stock and shortages, both of
which can be costly.
The objectives of inventory management are as follows:
1. To ensure a continuous supply of materials and stock so that production should
not suffer at the time of customers demand.
2. To avoid both overstocking and under-stocking of inventory.
3. To maintain the availability of materials whenever and wherever required in
enough quantity.
4. To maintain minimum working capital as required for operational and sales
activities.
5. To optimize various costs indulged with inventories like purchase cost, carrying a
cost, storage cost, etc.
6. To keep material cost under control as they contribute to reducing the cost of
production.
7. To eliminate duplication in ordering stocks.
8. To minimize loss through deterioration, pilferage, wastages, and damages.
9. To ensure everlasting inventory control so that materials shown in stock ledgers
should be physically lying in the warehouse.
10.To ensure the quality of goods at reasonable prices.
11.To facilitate furnishing of data for short and long-term planning with a controlled
inventory.
12.To supply the required material continuously.
13.To maintain a systematic record of inventory.
14.To make stability in price.
III – TYPES OF INVENTORY
Many different types of inventories are maintained throughout the value chain – before,
during and after production – to support operations and meet customer demands.
Inventory are classified into
four (4) types:
1. Raw materials, component parts, subassemblies, and supplies
- Raw materials, component parts, subassemblies, and supplies are inputs to
manufacturing and service-delivery processes.
2. Work-in-process (WIP) inventory
- Work-in-process (WIP) consists of partially finished products in various stages
of completion that are awaiting further processing. WIP inventory also acts as
a buffer to enable the operating process to continue when equipment might
fail at one stage or supplier shipments are late.
3. Finished-goods inventory
- Finished-goods inventory is completed products ready for distribution or sale
to customers.
Finished goods might be stored in a warehouse or at the point of sale in retail
stores. Finished-goods inventories are necessary to satisfy customers' demands
quickly without having to wait for a product to be made or ordered from the
supplier.
4. Safety stock inventory
- Safety stock inventory is an additional amount that is kept over and above the
average amount required to meet demand. Lack of sufficient
inventory can cause production lines to shut down or customers to
become dissatisfied and purchase goods and services elsewhere. To
reduce the risk associated with not having enough inventory, firms often
maintain additional stock beyond their normal estimates.
IV – INVENTORY CHARACTERISTICS
One of the first steps in analyzing an inventory problem should be to describe the
essential characteristics of the environment and inventory system that follow:
1. Number of Items. Most firms maintain inventories for a large number of items,
often
at multiple locations. To manage and control these inventories, each item is often
assigned a unique identifier, called a stock-keeping unit, or SKU. A stock-keeping
unit (SKU) is a single item or asset stored at a particular location.
2. Nature of Demand. Demand can be classified as independent or dependent,
constant or uncertain, and dynamic or static.
A. Independent demand is demand for an SKU that is unrelated to the demand
for other SKUs and needs to be forecasted. This type of demand is directly
related to customer (market) demand. Inventories of finished goods such as
toothpaste and electric fans have independent demand characteristics.
B. SKUs are said to have dependent demand if their demand is directly related
to the demand of other SKUs and can be calculated without needing to be
forecasted.
C. Demand can either be constant over some period of time (or assumed to be
constant), or we can assume that it is uncertain. Sometimes we might simply
assume that demand is constant in order to make our models easier to solve
and analyze, perhaps by using historical averages or statistical point
estimates of forecasts. When such an assumption is unwarranted, we can
characterize demand using a probability distribution.
D. Demand, whether deterministic or stochastic, may also fluctuate or remain
stable over time. Stable demand is usually called static demand, and demand
that varies over time is referred to as dynamic demand.
3. Number and Duration of Time Periods. In some cases, the selling season is
relatively short, and any leftover items cannot be physically or economically
stored until the next season.
4. Lead Time. The lead time is the time between placement of an order and its
receipt. Lead time is affected by transportation carriers, buyer order frequency
and size, and supplier production schedules, and may be deterministic or
stochastic (in which case it may be described by some probability distribution).
5. Lead Time. The lead time is the time between placement of an order and its
receipt. Lead time is affected by transportation carriers, buyer order frequency
and size, and supplier production schedules, and may be deterministic or
stochastic (in which case it may be described by some probability distribution).
- A backorder occurs when a customer is willing to wait for the item; a lost sale
occurs when the customer is unwilling to wait and purchases the item
elsewhere. Backorders result in additional costs for transportation, expediting,
or perhaps buying from another supplier at a higher price.
- “A lost sale has an associated opportunity cost, which may include loss of
good- will and potential future revenue.”
- Stockouts Matter
According to the Food Marketing Institute and Grocery Manufacturers of
America, Blockouts in the fast-moving consumer goods sector are as high as
8.3 percent, with promotional products even higher. As a result, retailers lose
around 4 percent of their sales because consumers will buy the item
elsewhere, substitute the product with another brand, or just forget about it.
V – FUNCTIONS OF INVENTORY
The main function of inventory is to provide operations with an ongoing supply of
materials. To achieve this function effectively, your business should strive to find a sweet spot
between too much and too little, without ever running out of stock. This successful balance will
improve cash flow and profitability, and keep your company running smoothly.
Inventory is there to provide your business with exactly right amount of resources: not
so few that you run out of materials, and not so many that you accumulate more than you can
use.
Inventories serve a number of functions. Among the most important are the
following:
1. To meet anticipated customer demand.
- A customer can be a person who walks in off the street to buy a new stereo
system, a mechanic who requests a tool at a tool crib, or a manufacturing
operation. These inventories are referred to as anticipation stocks because
they are held to satisfy expected demand.
2. To smooth production requirements.
- Firms that experience seasonal patterns in demand often build up inventories
during preseason periods to meet overly high
requirements during seasonal periods. These inventories are aptly named
seasonal inventories.
3. To decouple operations.
- Historically, manufacturing firms have used inventories as buffers between
successive operations to maintain continuity of production that would
otherwise be disrupted by events such as breakdowns of equipment and
accidents that cause a portion of the operation to shut down temporarily. The
buffers permit other operations to continue temporarily while the problem is
resolved.
4. To protect against stock outs.
- Delayed deliveries and unexpected increases in demand increase the risk of
shortages. Delays can occur because of weather conditions, supplier
stockouts, deliveries of wrong materials, quality problems, and so on. The risk
of shortages can be reduced by holding safety stocks, which are stocks in
excess of average demand to
compensate for variabilities in demand and lead time.
5. To take advantage of order cycles.
- To minimize purchasing and inventory costs,
afirm often buys in quantities that exceed immediate requirements. Thisneces
sitates storing some or all of the purchased amount for later use. Similarly, it
is usually economical to produce in large rather than small quantities.
6. To hedge against price increases.
Occasionally a firm will suspect that asubstantial price increase is about to occur
and purchase larger-than-normalamounts to beat the increase. The ability to
store extra goods also allows a firm to take advantage of price discounts for
larger orders.
7. To permit operations.
- The fact that production operations take a certain amount of time (i.e., they
are not instantaneous) means that there will generally be some
work-in-process inventory. In addition, intermediate stocking of
goods—including raw materials, semifinished items, and finished goods at
production sites, as well as goods stored in warehouses—leads to pipeline
inventories throughout a production-distribution system.
8. To take advantage of quantity discounts.
Suppliers may give discounts on large orders.
VI – REQUIREMENTS FOR EFFECTIVE INVENTORY MANAGEMENT
Management has two basic functions concerning inventory. One is to establish a
system of keeping track of items in inventory, and the other is to make decisions about
how much and when to order. To be effective, management must have the following:
1. A system to keep track of inventory on hand and on order.
2. A reliable forecast of demand that includes an indication of possible forecast
error.
demand forecasting- refers to the process of predicting how much of a
product or service will be sold in a given period of time.
forecast error- the difference between the actual demand for a product or
service and the predicted demand.
3. Knowledge of lead times and lead time variability.
lead time- it is the amount of time it takes to receive an order of inventory
from a supplier. Lead times can vary depending on the supplier, the product, and
the shipping method.
lead time variability- refers to the variation in the time it takes to receive an
order from a supplier. This variation can occur due to various factors, such as
supplier efficiency, transportation delays, and unexpected events.
4. Reasonable estimate of inventory holding cost, ordering cost, and shortage
costs.
inventory holding costs - are the costs associated with storing inventory, such
as rent, utilities, and insurance.
ordering costs- are the costs associated with placing an order, such as
shipping and handling.
Shortage cost - are the costs associated with running out of stock, such as
lost sales and customer dissatisfaction.
5. A classification system for inventory items.
References:
https://www.google.com/search?q=nature+and+importance+of+inventory&oq=Nature+and+Imp
ortance+of+Inventory&gs_lcrp=EgZjaHJvbWUqBwgAEAAYgAQyBwgAEAAYgAQyDQgBEAAYh
gMYgAQYigXSAQkxMT
https://www.scribd.com/document/117945554/Functions-of-Inventory
https://www.google.com/search?q=types+of+inventory&oq=Types+&gs_lcr
p=EgZjaHJvbWUqDAgCEAAYQxiABBiKBTIGCAAQRRg5MgwIARAjGCcY
gAQYigUyDA
For clarifications:
1. Feel free to message me thru your class mayor.
2. Email me at [email protected] In the email title, type your
section and concern (example: BSHM 2B Question about Module in
chapter 4). Type your complete name at the body of the email too.
Checked by: EMILDA E. ESCOLANO, MBA / Camarines Sur Polytechnic
College
