Unit 4 inventory management techniques classification

Techniques of Inventory
Management – Classification
 
The forms of inventories existing in a manufacturing enterprise can be classified into three
categories:

(i) 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.

(ii) 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, work-in-progress inventories refer to ‘semi-manufactured
products.’

(iii) Finished Goods:

These are the goods after production process is complete. Say, these are final products of the
production process ready for sale. In case of a wholesaler or retailer, inventories are generally
referred to as ‘merchandise inventory’.

Some firms also maintain a fourth kind of inventory, namely, supplies. Examples of supplies are
office and plant cleaning materials, oil, fuel, light bulbs and the like. These items are necessary
for production process. In practice, these supplies form a small part of total inventory involving
small investment. Therefore, a highly sophisticated technique of inventory management is not
needed for these.

The size of above mentioned three types of inventories to be maintained will vary from one
business firm to another depending upon the varying nature of their businesses. For example,
while a manufacturing firm will have all three types of inventories, a retailer or a wholesaler
business, due to its distinct nature of business, will have only finished goods as its inventories. In
case of them, there will be, therefore, no inventories of raw materials as well as work-in-
progress.

These are broadly classified into two categories:

1. Material 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.

2. Carrying Costs:

These include costs involved in holding or carrying inventories like insurance charges for
covering risks, rent for the floor space occupied, wages to laborers, wastages, obsolescence or
deterioration, thefts, pilferages, etc. These also include opportunity costs. This 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 cost’.

The above facts underline the need for inventory management, i.e., to decide the optimum
volume of inventories in the firm/enterprise during the period.