INVENTORY MANAGEMENT

Introduction
In a business accounting context, the word inventory is commonly used in American English to describe the goods and materials that a business holds for the ultimate purpose of resale. In the rest of the English speaking world stock is more commonly used, although the word inventory is recognised as a synonym. In British English, the word inventory is more commonly thought of as a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. In American English, the word stock is commonly used to describe the capital invested in a business, while in British English; the word share is more widely used in the same context. In both British and American English, stock is the collective noun for one hundred shares as shares were usually traded in stocks on Stock Exchanges. For this reason that the word stock is used by both American and British English forms in the context of the term Stock Exchange. Inventory management is primarily about specifying the shape and percentage of stocked goods. It is required at different locations within a facility or within many locations of a supply network to precede the regular and planned course of production and stock of materials. The scope of inventory management concerns the fine lines between replenishment lead time, carrying costs of inventory, asset management, inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical inventory, available physical space for inventory, quality management, replenishment, returns and defective goods, and demand forecasting. Balancing these competing requirements leads to optimal inventory levels, which is an on-going process as the business needs shift and react to the wider environment.

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What is Inventory Management

Inventory management is a collection of interdisciplinary processes that include a full circle from supply chain management to demand forecasting, through inventory control and including reverse logistics.

Inventory management starts and ends with supply chain management because many of the opportunities to improve efficiencies start with shortening order to receipt time without incurring additional cost. That said, the other stages of the inventory management cycle are no less important in attaining overall efficiency. Given that inventory in all its forms generally represents one of the top three expense lines for nearly all companies, there is a universal need for applying the right discipline to each step in the process. While in the perfect world, all inventories are consumed daily, we must operate businesses in a less than perfect environment. The challenge is: how close can you get to perfect before Just In Time inventory management becomes a little too late. Inventory management in its most efficient form incorporates many different technical applications of inventory management models. Such concepts as safety stock, economic ordering quantity, cost of goods, inventory turnover, customer managed inventory and a vendor managed inventory, whole spectrum of underlying inventory management tools play a critical role in what is inventory management. Different industries have different needs when asking the question what is inventory management, but many of the concepts are the same. While the key principles of inventory management remain the same across all industries, the areas which require emphasis vary from sector to sector. Learning to apply the right inventory management tools is part of executing the art and science of what is inventory management.

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Effective inventory management depends on understanding all the details of what is inventory management. By applying lean practices to all aspects of the inventory management cycle, businesses can reduce investment in standing inventory, plant rental, shipping costs, reverse logistics while maintaining or improving customer service levels and in-stock metrics on critical inventory. Effective inventory management is all about knowing what is on hand, where it is in use, and how much finished product results. Inventory management is the process of efficiently overseeing the constant flow of units into and out of an existing inventory. This process usually involves controlling the transfer in of units in order to prevent the inventory from becoming too high, or dwindling to levels that could put the operation of the company into jeopardy. Competent inventory management also seeks to control the costs associated with the inventory, both from the perspective of the total value of the goods included and the tax burden generated by the cumulative value of the inventory. Balancing the various tasks of inventory management means paying attention to three key aspects of any inventory. The first aspect has to do with time. In terms of materials acquired for inclusion in the total inventory, this means understanding how long it takes for a supplier to process an order and execute a delivery. Inventory management also demands that a solid understanding of how long it will take for those materials to transfer out of the inventory be established. Knowing these two important lead times makes it possible to know when to place an order and how many units must be ordered to keep production running smoothly. Calculating what is known as buffer stock is also key to effective inventory management. Essentially, buffer stock is additional units above and beyond the minimum number required to maintain production levels. For example, the manager may determine that it would be a good idea to keep one or two extra units of a given machine part on hand, just in case an emergency situation arises or one of the units proves to be defective once installed. Creating this cushion or buffer helps to minimize the chance for production to be interrupted due to a lack of essential parts in the operation supply inventory. Inventory management is not limited to documenting the delivery of raw materials and the movement of those materials into operational process. The movement of those materials as they go through the various stages of the operation is also important. Typically known as a goods or work in progress inventory, tracking materials as they are used to create finished goods also helps to identify the need to adjust ordering amounts before the raw materials inventory gets dangerously low or is inflated to an unfavorable level. Finally, inventory management has to do with keeping accurate records of finished goods that are ready for shipment. This often means posting the production of newly completed goods to the inventory totals as well as subtracting the most recent shipments of finished goods to buyers. When the company has a return policy in place, there is usually a subcategory contained in the finished goods inventory to account for any returned goods that

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are reclassified as refurbished or second grade quality. Accurately maintaining figures on the finished goods inventory makes it possible to quickly convey information to sales personnel as to what is available and ready for shipment at any given time. In addition to maintaining control of the volume and movement of various inventories, inventory management also makes it possible to prepare accurate records that are used for accessing any taxes due on each inventory type. Without precise data regarding unit volumes within each phase of the overall operation, the company cannot accurately calculate the tax amounts. This could lead to underpaying the taxes due and possibly incurring stiff penalties in the event of an independent audit

Objectives of Inventory Management

Through the efficient Management of Inventory of the wealth of owners will be maximised. To reduce the requirement of cash in business, inventory turnover should be maximised and management should save itself from loss of production and sales, arising from its being out of stock. On the other hand, management should maximize stock turnover so that investment in inventory could be minimized and on the other hand, it should keep adequate inventory to operate the production & sales activities efficiently. The main objective of inventory management is to maintain inventory at appropriate level so that it is neither excessive nor short of requirement Thus, management is faced with 2 conflicting objectives. (1) To keep inventory at sufficiently high level to perform production and sales activities smoothly. (2) To minimize investment in inventory at minimum level to maximize profitability. Both in adequate & excessive quantities of inventory are undesirable for business. These mutually conflicting objectives of inventory management can be explained is from of costs associated with inventory and profits accruing from it low quantum of inventory reduces costs and high level of inventory saves business from being out of stock & helps in running production & sales activities smoothly. The objectives of inventory management can be explained in detail as under:(i) To ensure that the supply of raw material & finished goods will remain continuous so that production process is not halted and demands of customers are duly met. (ii) To minimize carrying cost of inventory. (iii) To keep investment in inventory at optimum level. (iv) To reduce the losses of theft, obsolescence & wastage etc. (v) to make arrangement for sale of slow moving items (VI) to minimize inventory ordering costs.

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What Is The Importance Of Inventory Management To A Business

Two primary factors control inventory turnover. The average amount of inventory you keep on hand, and the total cost of all the inventory you sold in a given time period. Average inventory will largely be determined by your business model and your business finances. Are you a small specialty shop that primarily deals in service? In that case, you might keep a little inventory on hand, but mainly you deal with special orders. If you have a large retail store that aims to move a higher volume of goods, you need to have sufficient capital and financing to hold that inventory. A report from your accounting software should give you your total cost of goods sold. The Formula Inventory turnover over a specific period of time is calculated by the following formula. Inventory turnover = Cost of Goods Sold / Average Inventory In plain English, the inventory turnover ratio tells you how many times your inventory sold through. To calculate, take the total cost of goods sold for the year and then divide this by the average inventory. First, choose a period of time to examine. The most useful period for small retailers is one year. Average inventory can quickly be calculated by adding your inventory at the beginning of the period to your inventory at the end of the period, then dividing by 2. A more accurate calculation for average inventory In the method described above, the equation does not account for fluctuations in inventory. Following our example, if Saras shop kept $90,000 worth of inventory from April to September, then her average inventory would be much higher for the year. To get a more accurate measure, add up your inventory from your balance sheet for each month and divide by 12. To illustrate inventory turnover, lets look at an example. The cost of goods sold in Saras Bike Shop was $110,000 in 2010. On January 1, 2010, she had $50,000 worth of inventory assets. On December 31, 2010, she had $60,000. To get her inventory turn, we calculate: 110000/((60000+50000)/2) = 2. In other words, Sara sold through the average amount of inventory on her sales floor 2 times that year. Put another way, every 182.5 days she sells through her inventory. Whats a good number? Inventory turnover is a reflection of holding costs the cost of storing inventory. A low inventory turnover reflects a high holding cost. This is bad, right? Costs are our enemy! Not so quick. The problem with just looking at that number is that the number doesnt provide the context. Every retailers inventory situation will be different.

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In our example, if Saras revenue depends completely on inventory sales and her terms with her vendors are net 30, then its true her low inventory turnover indicates a struggling business. Shell struggle to pay her vendors. She only has 30 days to pay the vendors, but it takes 182.5 days for her to sell through what she bought from the vendors on average. This situation is hand-to-mouth at its worst. Without additional capital, more lenient terms with her vendors, or faster sales, Sara will most likely run out of cash to operate her business. This is not just because she has a low inventory turnover; its also because she is so dependent on inventory sales for cash. When is low inventory turnover OK Lets say Saras Bike Shop is located in a tourist town on a bike path. During the summer, Sara rents bikes to the visiting tourists. She has 30 rental bikes that cost $500. So $15,000 (27% of her average inventory) is in rental bikes. She paid cash for these bikes with the initial capital she put into the business. Every two years, she sells the bikes at a small profit. In addition to the rental bikes, she has $12,000 in clothing inventory. Shes a savvy buyer and is known in town for having a great selection of womens clothing, and shes able to sell through most of the clothing every few months. Shes worked out a deal with her clothing vendors for net 90 terms, meaning she has 3 months to pay her invoices once shes received the goods. Almost half of Saras average inventory is in goods that, by their nature, dont sell quickly. The remaining inventory is in parts, accessories, and other bikes. Additionally, her rental business means that she has a solid revenue source that is not tied to selling inventory. A lower inventory turn might be fine in this case. High Turnover Problems In an ideal world, you, the retailer, has every item that every customer walking through the door wants, and you dont have to pay for it until the customer buys it. In the real world, its a challenge to have the right mix of products for your customers. You cant possibly have everything that every customer wants. A high inventory turnover ratio might indicate that youre losing sales. Imagine a bike shop that just sells tubes. They might have a high turnover ratio because they sell tubes without a large inventory, but theyre probably losing tire sales. Checklist for Managing Inventory Suspect that a high inventory turnover is not a problem for most small retailers. In my business, Ive found it is much easier to add new inventory than it is to sell it. The more stuff that collects on your shelves the greater the holding cost, and by end of the year all that stuff is obsolete. With that in mind, here is a checklist to increase your inventory turnover and manage inventory: 1. Know your inventory! Use an inventory tracking software or spreadsheet to track how much and what types of inventory you have. If youre a ski shop, you might have 100 new skis on the floor in

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2.

3.

4.

5.

November, and only 20 new skis in April. It also helps to categorize your inventory. A bike shop might simply use categories like rubber, parts, accessories, and new bikes. Constantly evaluate your business plan. Every inventory purchase you make should reflect your goals for the business and what sets you apart from the competition. A baby clothing store that buys a size run of pants for teenage boys should not be surprised if those baggy pants are collecting dust next year. Pause before you buy Ask yourself: If this product Im buying doesnt sell within my vendors terms, can I afford to have it on the floor? Is it worth the risk? I made the mistake when I first opened my store of bringing on more inventory than I could possibly afford. It wasnt worth the risk! Time is your friend. Many distributors are moving towards the just in time model, getting products to the retailers just in time for sales. This model means you need to carry fewer products on your shelves because the vendor can have it to you quickly. The trade-off has to order more frequently and possibly incurring more shipping costs. Churn and burn. If a new product line didnt work out or you get to the end of the year with more inventory on hand than you can manage, be prepared to dump it! You might promote an in-store sale, or in todays connected world it might behoove you to have a means for inventory clearance outside of your brick and mortar store. EBay, craft fairs, swap meets, and discount websites reach customers beyond your usual geographic reach, plus you avoid having customers think of your store as a discount store.

Inventory management is vital for a business because an inventory very often incurs the biggest expense, and so it needs to be carefully controlled in order for the business to run effectively. Having the wrong inventory, or too much inventory can deplete resources to dangerous levels, so by managing it efficiently, the business will be aware of what stock they need to replenish and what needs to be shifted. If inventory management is taken seriously and done properly, a business will probably find that it can reduce its costs and increase sales. An effective way of achieving this is by having an inventory management system in place, which will track and maintain inventory so that customer demand can be met. They can also be linked to the accounting or management departments, so that all operations can become more effective, reducing costs and maximizing profit. An inventory management system works by recording customer sales in a real time format, and automatically re-ordering stock when it reaches a pre-determined level. This electronic ordering is called EDI (Electronic Data Interchange) and means that companies will always carry necessary stock, and so will not waste money on ordering what is not needed. These systems can also differentiate between different styles of the same stock, such as size

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or colour variations, so a company will not have an excess of one and not enough of the entire range. This process enables management to see what is selling and what is not, so future decisions can be made using facts, rather than hunches, again making inventory more cost effective. It is also possible to be able to look at trends and see when particular items are selling best, so they can be exploited to realise the most profit. Inventory control is an important part of any business that sells physical products. Inventory represents money tied up in goods awaiting sale. As long as money is tied up in inventory, it can't be used for other businesses expenses. Effective management of inventory can reduce the length of time money is tied up.

Meet Demand

Effective inventory control ensures that products demanded by customers are available for sale when the customer is ready to purchase. This function requires careful coordination with the marketing efforts of the business to make sure that adequate stock is on hand during sales promotions and for gathering sales data over time to anticipate seasonal demand. The process is a delicate balancing act that takes into account likely demand, storage costs, transportation lag times and quantity discounts to identify appropriate stock levels

Control Costs

Inventory is a cost that must be carefully managed. Storage costs and available warehouse space are very real constraints. Even if the purchasing department can buy a large amount of stock at a low price, it may not make sense because the cost of storing the additional inventory may outweigh the savings. Product turnover is another important consideration. Inventory items that sell quickly will require more warehouse space and a larger inventory to ensure availability. Those products that sell infrequently or make up a small part of the company's profit should be stocked at a lower lever. Product availability and transit time from the vendor play an important role in determining inventory levels. If a fast-selling product is readily available and can be delivered from the vendor quickly and reliably, then it makes sense to maintain a lower level of inventory. On the other hand, if the product is only sporadically available or can't be delivered quickly or reliably it may make sense to increase inventory levels. Ideally, inventory levels should be maintained at the minimum level possible while still being able to meet every order.

Identify Opportunities

Effective inventory management gives business managers a window into the operation of the business. The data collection component of inventory management provides valuable information that can be used to find opportunities for savings on purchases, periods of peak demand, eliminating unprofitable product lines, and focusing on product lines that

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sell well. Over time, inventory data can be used by the marketing department to identify those products that are the most profitable so they can focus their promotion efforts more accurately.

Inventory

Inventory management systems help businesses order inventory by accurately recording consumer sales. Electronic inventory systems can track sales in a real-time format, ordering inventory automatically when current stock hits a predetermined minimum level. Electronic ordering, known as Electronic Data Interchange (EDI), allows companies to maintain the proper amount of stock by not increasing costs through over-ordering of inventory. EDI also ensures that orders are placed immediately, ensuring short amounts of lead time to receive new inventory.

. Price Levels

Properly managing goods is largely based on the cost of the goods incurred by the business. Using inventory management systems will help companies find the lowest price on inventory items and ensure that the best deals are reached when purchasing these items. Purchasing goods by volume also helps companies to lower their cost on inventory, ensuring that low prices are assured to consumers. Inventory management systems track costs from purchased goods and can prepare a report indicating which vendors have the lowest cost on goods.

Count Methods

All inventories need to be counted and reconciled to the information provided by inventory management systems. Computerized systems will generate current inventory reports for management to use when conducting physical counts of on-hand inventory items. These systems will also prepare reports showing the current sales or transfers of inventory to allow management to track sold or moved goods. After conducting a physical count, inventories can be adjusted in the inventory system to ensure accurate reporting.

Trend Analysis

A great function of inventory management systems is the trending analyses that are generated for management review. These trends are used to see which months have high inventory levels or the effectiveness of inventory purchases. Trends also ensure that companies can order inventory if the inventory management system does not accurately reflect upcoming busy seasons, such as holidays or back-to-school shopping.

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The Advantages of an Inventory Management System

Inventory is necessary for many businesses including retail and manufacturing facilities. Maintaining appropriate inventory levels is crucial, as too much inventory can be costly. An inventory management system helps to control and balance the flow of incoming and outgoing merchandise. For most businesses, a strong inventory management system is advantageous for several reasons.

. Supply and Demand

Having an adequate supply of a particular product to meet customer demand is crucial to both sales increases and customer service. If a customer comes to a business to purchase a product and it is out of stock, the sale is lost forever and the customer will probably go to a competitor to find what they need. A good inventory management system, whether computerized or manual, will identify sales trends and prepare for customer needs.

Streamline Operations

Manufacturing facilities should always maintain proper inventory of the supplies necessary to produce their products. If one component is missing from the inventory, the whole production process is interrupted. Streamlined operations are an important benefit of an effective inventory management system.

Lead Time Adjustments

Inventory management systems are important for determining when to order certain items, especially for products with varying lead times. Some products take longer to receive from the manufacturer than others, and its important to have an inventory management system that accounts for lead time. If for example, a grocery store was going to have a sale on hotdogs, relish and mustard, but the hotdogs took longer than three days to receive while the condiments took five days; the inventory management system would need to ensure that all items were in stock in time for the sale.

Reduce Liabilities

Another significant advantage to an inventory management system is it reduces the liabilities and loss created by overstock. Similar to monitoring supply and demand, a good inventory management system will notice declines in sales or identify one-time occurrences to prevent over-ordering certain products. For instance, if a clothing store was having a sale on a certain style of jeans; it may order additional stock to meet customer demands. The inventory management system should take the sale into account before ordering more of the jeans based on the spike in sales. Otherwise, they store may have to offer even deeper discounts to get rid of the excess inventory.

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Why Inventory Management is So Important

There are many different reasons why inventory management is so important in today's world. One of them is being able to know exactly how many of each product you have in stock, so you know exactly how much needs to be ordered. Without proper inventory management, you may order too many of one thing, and not enough of something else. What does this translate too? Running out and having to order more, and having an over stock of other products, costing you not only money, but available storage space. Proper inventory management also allows you to track the products you sell. You can see at a glance what items sell the most, what time of the year that more are sold, and have a chance to see what patterns develop so you can plan your buying accordingly. For an example, if you are a clothing merchandise store, and you find that you sell more coats and hats during the fall, just before winter, or during the spring, then you can order more of these items before then, so there is enough merchandise beforehand. It also helps you track products that don't sell as often, or at all, so you can either not order as much as you would routinely do, or maybe even decide to discontinue this product line altogether. Having the right inventory management software is just as important. Today, inventory has become streamlined, with bar codes, scanning devices, and computers, so you need software that keeps up with the latest technology. You need to be able to find out at a glance if you are running out of something, rather than going in the back or having to call the warehouse to find out. Your inventory managers need to be able to quickly and easily count how many items there are, and be able to scan the bar code and have it downloaded into the computer automatically, without having to physically write down the information and then input it into their inventory computer. Inventory management is vital to today's businesses, especially in the retail market. In order to keep up with sales, trends, and popularity of a certain product, or line of products, the only way to do this is if you can track what sells, how much does at certain times of the year, and what products are losing ground. This really is the only way to keep up with your competition, order the right amount at the right time, and know whether to eliminate products that just aren't selling, saving you space, time, and money. There are an abundance of different kinds of inventory management software available on the market. These are compatible with just about any type of computer operating system you have. Not all software is the same, so you really have to take the time and make sure
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that it is right for your needs, and for those people, who are starting off small, will be able to expand and grow as you do, without having to buy new software all the time.

Importance of inventory management in supply chain

Supply chain management . A collection of resources and commentary providing an introduction to supply chain management and related systems for students, practitioners, and anyone else interested in learning more about how to design, manufacture, transport, store, deliver, and manage products Efficient management of Inventory has played a vital role in deciding a firms ability to operate with good profit margins. High Inventory Turnover ratio indicates that a company is efficient in managing its inventories and is having high sales. Having no prior knowledge of financial concepts or relevant industry experience, I was forced to think that if the Sales factor in the equation was not in our control, having less inventory would be the way to achieve high Inventory Turnover ratio. The reality however is different. Having low inventory might often result in company not being able to meet the committed service levels, which obviously means that more often than not, customers will be sent back home without the product they wanted or would be directed to other stores. This situation stresses the importance of efficient inventory management and its significance in efficiently managing your supply chain. While Inventory was regarded as an asset, the Japanese changed the way inventory was perceived by the introduction of concepts like Just in Time and considered inventory as a necessary evil. The key to the just in time methodology are factors like inventory being closely managed, understanding the customers buying behaviors, having reliable suppliers and removing unnecessary inspection steps. Concepts such as these have changed the way companies perceive the idea of inventory management. Firms now believe that excessive cash tied up in unwanted inventory can be utilized in other avenues that would generate profits. Many companies have been successful in achieving this through improvement of flow of materials in their supply chain. These companies in addition to focusing on the efficient ways to do things also focused on the strict donts such as purchasing huge stock and treating them as an asset, excessive changes to schedules, treating all types of stock in the same way without any regard to the value of the good. With the new reengineering in management and companies not just adopting just-in-time inventory practices but engaging in more integrated supply chain management, attention has recently been more focused on creating processes that reduce or eliminate inventories, mainly by reducing or eliminating uncertainties that make them necessary. These efforts have been motivated in part by the recognition that metrics describing the performance of

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a company's inventory management practices can be important signals to shareholders regarding the efficiency of the company's operations and hence its profitability2 The idea of an integrated inventory management has helped companies through Optimization and Coordination. The integrated system allows companies to optimize the linkage between supply chain and inventory and coordinate the inventory management to reduce costs and enhance differentiation. The maintenance of lower transaction costs and optimum inventory control management is not without some costs and tradeoff. Past experiences have shown that managing inventory effectively in our economy and the business environment is often difficult. For example, in 1993, Dell Computer's stock plunged after the company predicted a loss. Dell acknowledged that the company was sharply off in its forecast of demand, resulting in inventory write-downs. Also, in 1993, Liz Claiborne experiences an unexpected earnings decline as a consequence of higher-thananticipated excess inventories. And in 1994, IBM struggled with shortages in the ThinkPad line due to ineffective inventory management (Simchi-Levi et al., 2000). In recognition of these difficulties and the urgency to pursue effective integrated supply chain management, Barsky and Ellinger (2001) pointed out that to generate lower levels of inventory and fewer stock-outs for customers, suppliers and manufacturers may have to hold significantly more inventory and expend considerably more staff time to administer the program effectively2. Some thoughts and questions that come across with respect to inventory management are how do companies decide the inventory levels, relevance to the current demand, how forecasting is done efficiently to avoid loss due to improper inventory management, and how much reliance can be on transport and how transit times impact the inventory planning and management. Many argue that the focus point (and perhaps the linchpin) of successful supply chain management is inventories and inventory control. So how do food and agribusiness companies manage their inventories? What factors drive inventory costs? When might it make sense to keep larger inventories? Why were food companies quicker to pursue inventory reduction strategies than agribusiness firms? In 1992, some food manufacturers and grocers formed Efficient Consumer Response to shift their focus from controlling logistical costs to examining supply chains (King & Pumped, 1996). Customer service also became a key competitive differentiation point for companies focused on value creation for end consumers. In such an environment, firms hold inventory for two main reasons, to reduce costs and to improve customer service. The motivation for each differs as firms balance the problem of having too much inventory (which can lead to high costs) versus having too little inventory (which can lead to lost sales). A common perception and experience is that supply chain management leads to cost savings, largely through reductions in inventory. Inventory costs have fallen by about 60% since 1982, while transportation costs have fallen by 20% (Wilson, 2004). Such cost
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savings have led many to pursue inventory-reduction strategies in the supply chain. To develop the most effective logistical strategy, a firm must understand the nature of product demand, inventory costs, and supply chain capabilities. Firms use one of three general approaches to manage inventory. First, most retailers use an inventory control approach, monitoring inventory levels by item. Second, manufacturers are typically more concerned with production scheduling and use flow management to manage inventories. Third, a number of firms (for the most part those processing raw materials or in extractive industries) do not actively manage inventory. Many agribusiness firms do not actively manage inventory. This does not mean that they ignore inventory. Rather, they hold large inventories because any potential savings from inventory reductions are far outweighed by the inventory-induced reductions in production, procurement, or transportation costs. Often economies of size cause long productions runs which lead to inventory accumulation. Simultaneously, seasonality leads to inventory buildups of key inputs like seed as well as outputs like corn. Economies in procurement such as forward buying in the food industry and quantity discounts increase inventories. Similarly, unit trains and other forms of bulk shipping discounts contribute to inventory buildups. Yet, such firms must be alert to changing conditions that may require more exact inventory management. One example would be if crops are marketed as small lots of value-added grain instead of commodities. Production proliferation in the seed industry may be another instance. Finally, whether due to food safety concerns, GMOs, food labeling, or the growth of organic food markets, identity preservation requires more precise inventory control.

The Importance of Demand

Inventory management is influenced by the nature of demand, including whether demand is derived or independent. A derived demand arises from the production of another product. For example, when John Deere knows its demand for a tractor, it can simply compute the demands for the parts, materials, and components needed to produce that tractor. Manufacturers of all sizes use such calculations which are part of flow management to manage inventories, schedule deliveries for inputs, and manage capacity. Flow management software has evolved from Materials Requirements Planning (or MRP) in the 1960s to the much more complex Enterprise Resource Planning (or ERP) of the 1990s. A flow management system is set in motion by the demand for end products. Independent demand arises from demand for an end product. End products are found throughout a supply chain. Wheat is an end product for a grain elevator, as is flour for a miller or cereal for a grocer. By definition, an independent demand is uncertain, meaning that extra units or safety stock must be carried to guard against stock outs. Managing this
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uncertainty is the key to reducing inventory levels and meeting customer expectations. Supply chain coordination can decrease the uncertainty of intermediate product demand, thereby reducing inventory costs.

Customer Service and Inventory

The availability of inventory provides customer service. The Item Fill Rate (IFR) measures how often a particular product (often called a stock keeping unit or SKU) is available. A common metric of customer service, IFR is expressed as the percentage of time that a customer can obtain the item they seek. A firm may set its customer service order policy at 95%, seeking to fill 95% of the orders for an item from inventory. However, life is a bit more complicated. A customer might not obtain what they seek for several reasons. The seller may have run out of a product due to an inaccurate forecast. Or the supplier may have shipped an incorrect package size or flavor. Products in inventory may be unfit for sale because of damage or an expired shelf life. Finally, a seller may not have the capability to accurately track inventory in their stores or distribution centers. To avoid shortfalls or stock outs, firms carry extra inventory known as safety stock. As more customer service is provided, a firm can expect sales to increase (Figure 1). However, as a firm tries to provide perfect customer service, logistical costs increase exponentially. Also, if a firm holds too much inventory, it can lead to low inventory turnover and hide operational problems. For example, carrying too much stock means that you might not discover that your supplier is frequently late with delivery times.

The Product Life Cycle, Demand Uncertainty, and Inventory

The structure of independent demand and logistical requirements vary by stage in the product life cycle (introduction, growth, maturity, and decline). During introduction, logistics must support the business plan for product launch, while preparing to handle potential rapid growth by quickly expanding distribution. At market maturity, the logistical emphasis shifts to become cost driven. In the decline stage, cash management, inventory control, and abandonment timing become critical. Over-abundance of products in the late maturity or decline stage will eventually result in obsolete products. The obvious difficulty is predicting how long each stage will last and how abruptly sales will fall in the decline stage. The life cycle strategy typically involves getting to profitability quickly recuperating startup costs, then sustaining high profits for as long as possible, and finally acting decisively for products in decline to minimize losses. Understanding this life cycle can help managers select logistical tactics, inventory levels and supply chain designs. The ultimate goal for companies should be to have just enough inventories to satisfy consumer demand.

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Another life cycle attribute is that demand uncertainty shifts as we progress through time. Product managers face substantial uncertainty during the introduction and growth stages, relative stability during maturity, and increasing uncertainty in decline. This uncertainty drives forecasting accuracy and the level of safety stock required to meet customer service expectations. The coefficient of variation (CV) measures the stability of a product's demand, comparing the variability in demand to the size of the average demand (Figure 2). High demand variability in the introductory stage means it is difficult, if not impossible, to forecast demand. Thus, high levels of inventory must be held to meet even minimal customer service levels. In contrast, lower variability during maturity means that demand forecasts are quite accurate. However, inventory levels may still be large because they are based on larger sales volumes. In addition to the vagaries associated with product life cycle stage, two other sources of uncertainty also drive the level of inventory. First, demand can vary from day to day, week to week, or seasonally. Second, there may be variability in lead time, or the time from when an order is placed until delivery is made. Forecasting demand used to be more exact because products stayed in the mature product life cycle phase for a long time. Today many companies find it far more difficult to forecast sales because of product proliferation. Product line extensions result in more products that cannibalize sales and shorten the life cycle. Thus, more sales are coming from products in the erratic earlier stages of life, as opposed to sales from products in the mature stage of the life cycle.

Inventory Costs
Different models are used to manage inventory for products that are continually available (like milk) or products available for limited time (like seed). The Economic Order Quantity (EOQ) model determines the least cost level of inventory to carry, as well as costs. News Vendor models are used for products only available for a single period. EOQ and News Vendor models have proved useful for managing inventory for many years, analyzing tradeoffs among major cost components. These models are robust and easy to customize to particular industries. Their approach to costing is similar reflecting levels of inventory, as well as shipping costs or quantity discounts.

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Inventory costs fall into three classes: 1) Carrying costs of regular inventory and safety stock; 2) Ordering or setup costs 3) Stock out costs. Inventory control systems balance the cost of carrying inventory against the costs associated with ordering or shortfalls First, carrying cost (or a cost to hold inventory) is comprised of capital costs, service costs, storage costs, and risk costs. A carrying cost involves the opportunity cost for holding inventory. If the firm did not have money tied up in inventory, it could either use the savings to make investments in other assets or pay down debt. Thus, a firm should first determine what it would do with any savings from a reduction in inventory. If the dollars are used to buy capital equipment, an appropriate opportunity cost is the firm's hurdle rate or its "required rate of return." If the dollars are used to pay down debt, the interest rate on the loan should be used to value the inventory. The other three aspects of carrying cost are non-capital costs. The service costs are often masked in a firm's fixed costs. A firm should determine how much of its insurance and tax expense is associated with inventory. This is especially important in states that have an inventory tax. A firm has cash outlays for warehouses and materials handling equipment, either owning or leasing space from a distributor. In either case, the firm should determine how much is spent on space. Inventory risk reflects characteristics of the product. Some items are more prone to be stolen, others are more likely to be damaged, yet others may become obsolete before a sale is made. In any case, risk means that if too much inventory is held, a certain proportion of the inventory will be unavailable for production or sale. To determine the cost of carrying inventory, one needs to know the average quantity of inventory, an inventory carrying cost (as a percent of product cost), and the average cost per unit of inventory. If a firm plans to use inventory reductions to fund other capital assets, inventory carrying cost might be 30% (25% for an opportunity cost and 5% for the service, space, and risk costs). If the firm plans to use the savings to reduce debt, the appropriate rate might be 12% (7% for the interest rate and 5% for the other costs). Regardless of the carrying cost rate being used, as a firm holds more inventory, carrying cost increases Firms carry extra inventory to guard against uncertain events. Known as safety stock, the purpose of this inventory is to provide protection against stock outs. Safety stock is costed just like regular inventory, it is an interest rate times the level of safety stock. The level of

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safety stock required to guard against a stock out depends upon the customer service level, the standard deviation of demand of the product, and lead time. Let's explain in greater detail. Assume that it takes 10 days from the time an order is placed until a shipment arrives and that on an average 20 cases are sold each day. Thus, over the 10 days that we are waiting for the delivery (our lead time), we expect to sell 200 cases. If we trusted our forecast, supplier, and trucking company, we would simply hold 200 cases for the 10 days. But we realize that forecasts are inaccurate, some suppliers are unreliable, and shipping times vary. If less is sold than expected during the 10 days or if the shipment arrives early, we will still have inventory on the 10th day and no customer service problems are encountered. However, if sales are above expectations during the 10 days or deliveries are late, we might run out (or stock out) of product. Managing the uncertainty surrounding safety stock is the key to reducing inventory levels. But in today's competitive environment, it is difficult to lower safety stock requirements for two reasons. First, some buyers (especially large retailers) are requiring higher customer service levels, which raise safety stock levels. Second, the product mix for many firms includes more new products with the corresponding greater demand variability. Thus, most firms seeking to reduce safety stock can only do so by focusing on aggressively cutting lead times. The second cost to consider is ordering costs. Ordering costs include a cost for transmitting the order, receiving the product and placing it into storage, inbound transportation, and processing the invoice. Recent advancements in information technology have lowered this cost by a factor of six for many industries. A manufacturer uses the cost of a production setup instead of an ordering cost. Finally, stock out costs involves lost sales when no inventory is on hand. Such costs fall as inventory (and customer service) levels increase. The relationship between stock out costs and inventory depends upon the accuracy of the demand forecast and the ability of the firm to recognize and react to a change in demand. Stock out costs depend on how a customer reacts to a stock out, the frequency of stock outs, and the availability of substitute products. Stock out costs can be very high if a lack of substitute products means that a customer will switch suppliers. In contrast, if buyers simply substitute a different product, stock out costs may be inconsequential. In practice, many firms do not assess stock out costs because different divisions of a firm cannot reach agreement on what is the cost of running out. Marketing may desire a very high stock out cost to force a penalty cost on running out. Operations or finance may resist this as it leads to inventory buildups.

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Service level goals can differ by the value placed on stock outs and indirectly carrying costs. A high stock out valuation will result in higher inventories and higher service levels. One way to evaluate an inventory management policy is to choose a service level target. From this target, the inventory policy will determine the inventory requirements and associated costs of providing that level of service. A higher service level implies that more inventories will be held as safety stock. The tradeoff decision occurs at the point where the cost of carrying extra safety stock balances the stock out cost. Inventory levels are affected by customer service expectations, demand uncertainty, and the flexibility of the supply chain. For products with relatively certain demand and a long product life, it should be relatively easy to maintain desirable customer service standards even as inventories are reduced. However, for products characterized by erratic demand, a short life cycle, or product proliferation, a more responsive supply chain and larger buffer inventories may be needed to meet a desired customer service level. Consumers are demanding more customer service from firms throughout the supply chain. Firms with high customer service levels may gain a competitive advantage over those that do not have the supply chain capabilities in place or the ability to manage them. Firms who understand their demand recognize stock out costs and carry appropriate levels of inventory are ultimately better able to effectively manage inventory and provide the desired service level to customers. As industrialization affects agribusiness and agriculture in general, the importance of customer service and competitiveness will become critical for firms and supply chains. JIT, or just in time, inventory is a inventory management strategy that is aimed at monitoring the inventory process in such a manner as to minimize the costs associated with inventory control and maintenance. To a great degree, a just-intime inventory process relies on the efficient monitoring of the usage of materials in the production of goods and ordering replacement goods that arrive shortly before they are needed. This simple strategy helps to prevent incurring the costs associated with carrying large inventories of raw materials at any given point in time. Another application of a just in time inventory focuses not on raw materials but on finished goods. Again, the idea is to develop a solid understanding of what is needed to produce goods and schedule them for shipment to customers within the shortest time frame possible. As with raw materials, shipping finished goods shortly after producing them leads to minimizing storage costs and any taxes that may be applicable. This dual application of a just in time inventory strategy can significantly cut the operational expenses of a business in regards to the amount of inventory that must be stored at any one time and the amount of taxes that must be paid on larger inventories. A just in time inventory management process involves understanding how much of a given item is needed to maintain production while more of the same item is ordered. This involves two key factors. First, it is necessary to know how long it will take for the item to be shipped from the supplier and arrive at the manufacturing facility. Second, the
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anticipated life or usage of the item must be determined. By knowing these two pieces of information, it is possible to establish procedures that allow the item to be reordered just in time to arrive and replace a worn item, without having the replacement set in storage for an extended period of time. Many purchasing departments employ a just in time inventory for such key items as raw materials and machine parts. This means that records are kept that make it possible to place a new order for a given component when the number of units on hand decreases to a pre-determined point. In times past, this type of inventory control often was accomplished by maintaining a flip card inventory, such as the old Kardex system. Today, this same type of component usage is often managed with purchasing and inventory control software. The idea of a just in time inventory is not new. Henry Ford of the Ford Motor Company is known to have applied this principle to the purchase of raw materials for automobile manufacturing in the early years of the 20th century. Many small businesses engage in the use of a just in time inventory approach out of necessity. With limited resources on hand, maintaining a small inventory of materials and parts simply makes sense. However, even large corporations today realize that the savings associated with this type of approach can save a significant amount of financial resources, making it possible to redirect those resources toward other revenue generating processes.

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FORUM make supply chains lighting fast

. A leading consumer products company dealing in cosmetics and other personal care products was seeking ways to: Reduce inventory levels across their forward supply chain Improve Inventory Record Accuracy at their storage points Accurately track damaged goods at various points in the supply chain The above problems together were a significant burden to the company. Implementation of best practices after a detailed business analysis resulted in the following benefits: Inventory Record Accuracy improved to 95% within 2 months Stock levels reduced by about 30% across stocking points in the supply chain Complete visibility was achieved in the supply chain with respect to damaged goods inventory

Organisation Background:
The firm was a leading consumer Products Company dealing in cosmetics and personal care products with its head office located overseas. The company had a supply chain network of 3 factories with bonded stock rooms (BSR) attached for dispatch to the depots and 35 depots for servicing distributors. Goods move from the factory to the BSR. BSR dispatches stocks to Mother CFAs (depot). Other depots receive stocks from the Mother depot and sell them to distributors.

Key Concerns for the Company:

1. To reduce inventory level at the BSR and depots. 2. To improve inventory accuracy at stocking points including both BSRs and depots 3. To identify the damaged stocks across the chain and initiate action in a timely manner

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Focus of Study
A study was completed focusing on the 1. Inventory-related issues at BSRs and depots. These included: Inventory holding as a proportion of sales Practices employed for track goods in the warehouse Proportion of fast and slow moving stocks to the total inventory Linkages of factory dispatches to BSR with patterns of BSR dispatches to depots Accuracy of inventory records especially of fast selling lines Demand Planning process. The study looked at: Forecast Accuracy and process of reviewing and revising forecasts Level of safety stock at each location combined with process to review and reset the same Linkages of forecasts and consequent dispatches with relevant available closing stocks at depots

Findings
Key Business Indicators 1. Total average inventory holding at BSRs was 8.2 weeks of sales 2. Average inventory holding at the depots was 6.5 weeks of sales 3. Depots were holding High inventory of old/withdrawn stocks Damaged stocks for a long time (over 3 months) 4. Book and physical stocks had discrepancy of over 30%

Conclusions
1. High Inventory Levels: Inventory levels were very high across the distribution chain on account of: Sales and dispatch forecasts that were not in line with actual primary / secondary sales There was no process to periodically review and refine the Annual Forecasts, in line with market feedback Stocking across all points in the distribution chain was driven by a push-oriented system that did not have provisions to be tuned to market requirements Actual safety stocks maintained at depots were significantly higher that target safety stocks agreed at the beginning of the year. No system was in place to monitor and correct the same during the year Stock allocation from depots was manual. Orders received from distributors were manually processes and no process was in place to automatically collate orders and allocate stocks 2. High Levels of Old / Withdrawn / Damaged / Slow-moving stocks: Dead stocks were allowed to accumulate in the system mainly because:

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 There was an absence of visibility into inventory details across stocking points The process to monitor and act on dead stocks was not adhered to Records of slow-moving / old / withdrawn / damaged stocks were not maintained methodically at the stocking points. Records were inaccurate. Communication of details of dead stocks to the relevant teams was based on manually filed reports which was time-taking and open to error 4. Inaccuracy in inventory records: The organisation did not have a clear policy on periodic reconciliation of physical stock with book records Inaccuracies grew over time, compounded with process failure on accounting for dead stocks

Action Steps Advised and Undertaken

Process Improvements 1. Bin card system was implemented for each rack at the CFAs and the delivery staff was trained in relevant bind card maintenance practices. 2. A process to regularly reconcile physical and book stocks using the cycle-count process was mandated 3. An IT solution was identified and implemented for Accounting the Cycle count process, providing MIS on deviations and accounting the adjustment notes Computing the forecast using consolidated orders, with factoring for promotions and seasonality Calculating safety stock level based on number of weeks of sales target Facilitating communication of closing stock data from BSR and depots to logistics department Facilitating communication of damaged and un-saleable stock quantity to commercial department Automatically allocating stocks using FIFO principle at the depots 4. Demand planning and forecasting were made a periodic activity using the above IT solution to align forecasting with market orders and actual sales. The process of setting safety stocks at depots was made periodic and dynamic, based on updated sales data. 5. Norms were set to act on damaged / old and other dead stocks. Clear action steps were laid down to liquidate or destroy these stocks. Responsibility and accountability were set to in the organisation to monitor and authorise activities in this regard based on visibility provided by the IT solution.

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Benefits: 1. The organisation achieved an inventory record accuracy (book stocks correctly reflecting physical stocks) of 95% within 2 months. 2. The company achieved (Within 2 Planning cycles i.e. 2 Months) a. Stock level reduction From 8.2 weeks to 5.5 weeks at the BSR From 6.5 weeks to 4 weeks at the depot which included Damaged Inventory Reduction in stock Value holding across the supply chain b. Transparency of saleable and damaged stocks quantities across the supply chain resulting in more accurate demand planning, stock allocation and production. c. Better management of damaged and un-saleable stocks: Sales realizations on salvaging and selling damaged stocks at a discounted price Timely destruction of unusable and potentially harmful products Timely action on transport, handling, stock management and product development fronts i.e. to reduce damages Reduction in proportion of old and damaged stocks; Facilitation of ensuring fresher stocks in the market. This was achieved mainly by reducing inventory levels across the chain and also by better stock management at the depots

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