Inventory Management

Inventory management refers to the process of ordering, storing, and using a company's

inventory. These include the management of raw materials, components, and finished products,
as well as warehousing and processing such items.

For companies with complex supply chains and manufacturing processes, balancing the risks of
inventory gluts and shortages is especially difficult. To achieve these balances, firms have
developed two major methods for inventory management: just-in-time and materials
requirement planning: just-in-time (JIT) and materials requirement planning (MRP).

 Some firms like financial services firms do not have physical inventory and so must rely on
service process management.

Inventory Management
How Inventory Management Works
A company's inventory is one of its most valuable assets. In retail, manufacturing, food service,
and other inventory-intensive sectors, a company's inputs and finished products are the core of
its business. A shortage of inventory when and where it's needed can be extremely detrimental.

At the same time, inventory can be thought of as a liability (if not in an accounting sense). A
large inventory carries the risk of spoilage, theft, damage, or shifts in demand. Inventory must
be insured, and if it is not sold in time it may have to be disposed of at clearance prices—or
simply destroyed.

For these reasons, inventory management is important for businesses of any size. Knowing
when to restock certain items, what amounts to purchase or produce, what price to pay—as well
as when to sell and at what price—can easily become complex decisions. Small businesses will
often keep track of stock manually and determine the reorder points and quantities using Excel
formulas. Larger businesses will use specialized enterprise resource planning (ERP) software.
The largest corporations use highly customized software as a service (SaaS) applications.

Appropriate inventory management strategies vary depending on the industry. An oil depot is
able to store large amounts of inventory for extended periods of time, allowing it to wait for
demand to pick up. While storing oil is expensive and risky—a fire in the UK in 2005 led to
millions of pounds in damage and fines—there is no risk that the inventory will spoil or go out of
style. For businesses dealing in perishable goods or products for which demand is extremely
time-sensitive—2019 calendars or fast-fashion items, for example—sitting on inventory is not an
option, and misjudging the timing or quantities of orders can be costly.

KEY TAKEAWAYS

 Inventory management refers to the process of ordering, storing, and using a company's
inventory. These include the management of raw materials, components, and finished
products as well as warehousing and processing such items.
 For companies with complex supply chains and manufacturing processes, balancing the
risks of inventory gluts and shortages is especially difficult.
 To achieve these balances, firms have developed two major methods for inventory
management: just-in-time and materials requirement planning: just-in-time (JIT) and
materials requirement planning (MRP).
Inventory Accounting
Inventory represents a current asset since a company typically intends to sell its finished goods
within a short amount of time, typically a year. Inventory has to be physically counted or
measured before it can be put on a balance sheet. Companies typically maintain sophisticated
inventory management systems capable of tracking real-time inventory levels. Inventory is
accounted for using one of three methods: first-in-first-out (FIFO) costing; last-in-first-out (LIFO)
costing; or weighted-average costing.

An inventory account typically consists of four separate categories: 

1. Raw materials
2. Work in process
3. Finished goods
4. Merchandise

Raw materials represent various materials a company purchases for its production process.
These materials must undergo significant work before a company can transform them into a
finished good ready for sale.

Works-in-process represent raw materials in the process of being transformed into a finished
product. Finished goods are completed products readily available for sale to a company's
customers. Merchandise represents finished goods a company buys from a supplier for future
resale.

Inventory Management Methods

Depending on the type of business or product being analyzed, a company will use various
inventory management methods. Some of these management methods include just-in-time (JIT)
manufacturing, materials requirement planning (MRP), economic order quantity (EOQ), and
days sales of inventory (DSI).

Just-in-Time Management
Just-in-time (JIT) manufacturing originated in Japan in the 1960s and 1970s; Toyota Motor
Corp. (TM) contributed the most to its development. The method allows companies to save
significant amounts of money and reduce waste by keeping only the inventory they need to
produce and sell products. This approach reduces storage and insurance costs, as well as the
cost of liquidating or discarding excess inventory.

JIT inventory management can be risky. If demand unexpectedly spikes, the manufacturer may
not be able to source the inventory it needs to meet that demand, damaging its reputation with
customers and driving business toward competitors. Even the smallest delays can be
problematic; if a key input does not arrive "just in time," a bottleneck can result.

Materials Requirement Planning

The materials requirement planning (MRP) inventory management method is sales-forecast
dependent, meaning that manufacturers must have accurate sales records to enable accurate
planning of inventory needs and to communicate those needs with materials suppliers in a
timely manner. For example, a ski manufacturer using an MRP inventory system might ensure
that materials such as plastic, fiberglass, wood, and aluminum are in stock based on forecasted
orders. Inability to accurately forecast sales and plan inventory acquisitions results in a
manufacturer's inability to fulfill orders.

Economic Order Quantity

The economic order quantity (EOQ) model is used in inventory management by calculating the
number of units a company should add to its inventory with each batch order to reduce the total
costs of its inventory while assuming constant consumer demand. The costs of inventory in the
model include holding and setup costs.
The EOQ model seeks to ensure that the right amount of inventory is ordered per batch so a
company does not have to make orders too frequently and there is not an excess of inventory
sitting on hand. It assumes that there is a trade-off between inventory holding costs and
inventory setup costs, and total inventory costs are minimized when both setup costs and
holding costs are minimized.

Days Sales of Inventory

Days sales of inventory (DSI) is a financial ratio that indicates the average time in days that a
company takes to turn its inventory, including goods that are a work in progress, into sales.

DSI is also known as the average age of inventory, days inventory outstanding (DIO), days in
inventory (DII), days sales in inventory or days inventory and is interpreted in multiple ways.
Indicating the liquidity of the inventory, the figure represents how many days a company’s
current stock of inventory will last. Generally, a lower DSI is preferred as it indicates a shorter
duration to clear off the inventory, though the average DSI varies from one industry to another.

Qualitative Analysis of Inventory

There are other methods used to analyze a company's inventory. If a company frequently
switches its method of inventory accounting without reasonable justification, it is likely its
management is trying to paint a brighter picture of its business than what is true. The SEC
requires public companies to disclose LIFO reserve that can make inventories under LIFO
costing comparable to FIFO costing.

Frequent inventory write-offs can indicate a company's issues with selling its finished goods or
inventory obsolescence. This can also raise red flags with a company's ability to stay
competitive and manufacture products that appeal to consumers going forward.

Accounts Receivable Management

Accounts Receivable – Meaning and its Management

A sale is realized as and when the invoice is generated but usually, a time period is provided to
the customers for the payment of the amount due. This practice of conducting business on
credit terms give rise to Accounts Receivable (AR) in the financial statements. This credit facility
is laid down to ensure a smooth flow of the working capital into the businesses. There are
complexities involved with the accounts receivable i.e its management, the process of recording
in financial statements, credit period etc.  Let’s discuss briefly on all the terms connected to
Accounts Receivable.

 1. What is Accounts Receivable?

The word receivable stands for the amount of payment not received. This means the company
has extended credit facility to its customers.

Accounts receivable is the money that a business has a right to receive after a certain period of
time when the business has sold goods or services on credit. For example, the accounts
receivable is the record of fact that a company has done some work for customer X and that
customer X owes money to the company. Generally, the credit period is short ranging from a
month or two to a year.

2. Why are Accounts receivable important?

The businesses usually have invested money in selling a product or delivering a service. After
selling the goods, the inventories reduces and in turn businesses need an asset to balance the
financial statements. Either that assets are cash-in-hand or receivables in case of credit sales
and that’s why accounts receivable appear in the assets side of the balance sheet.

As accounts receivables form a major part of the organization’s asset, it leads to the generation
of cash in-flow in the books of the organization. The idea behind providing a credit facility to the
customers is to facilitate and ease the process of the transaction and establish a strong credit
relation between the parties involved. It may lead to better deals or increase the chances of
improving the working capital management.

3. How is Accounts receivable recorded in the financial statements?

Usually, the businesses expect to receive money in the future, so it is to be added to the assets
in the financial statement of the business. The accurate record keeping of this money that is
receivable (accounts receivable) in the books of accounts are required to avoid any default in
the payment due.

Few pointers connected to recording accounts receivable are as follows :

a. Establishing the practice of credit transactions :

The business may establish a practice of providing a credit policy to its buyers. This credit can
be extended for a specified time period and any default in this payment usually attracts penalty.
This practice of credit facility requires two parties to come to an agreement on the terms and
conditions for such credit transactions. The provider of this facility should also verify the paying
ability of the customer before agreeing to any terms and conditions.to prevent loss of cash
inflow.

b. Generating invoices for the customer :

The businesses are required to generate invoices of the sales made or services delivered. The
invoice should have details of the cost of goods and services sold to the customers. This
generating of invoice ensures the recording of the credit transaction clearly in the accounts of
the business. Further, a copy of the invoice is given to the customer to make the payment as
per the agreed terms.

c. Tracking the payments received and the payment that is due to be received :

An accountant is required to track the payments received or due from the customers. The
details of the method of payment and date of receiving payment have to be recorded in the
customer’s ledger account. This ensures correctness of accounting of the credit amount. The
businesses shall also generate timely reminders for dues pending to the customers.

d. Accounting for the accounts receivable

The accountant or the person responsible for taking due care of the accounts receivables must
record all the due dates of the payments to be received. The timely and prompt recording of the
accounts receivable leads to receiving the payments on time from the customers. Once the
account receivable is recorded and payment is received, the account for the said party can be
settled for good.

4. What is Accounts receivable management?

Accounts receivable management is the process of ensuring that customers pay their dues on
time. It helps the businesses to prevent themselves from running out of working capital at any
point of time. It also prevents overdue payment or non-payment of the pending amounts of the
customers. It builds the businesses financial and liquidity position. A good receivable
management contributes to the profitability by reducing the risk of any bad debts. Management
is not only about reminding the customers and collecting the money on time. It also involves
identifying the reasons for such delays and finding a solution to those issues.

5. What is the process involved in the Accounts receivable management?

An Account receivable management process involves the following :

a. Credit rating i.e the paying ability of the customers shall be reviewed before agreeing to any
terms and conditions

b. Continuously monitoring any risk of non-payment or delay in receiving the payments

c. Customer relations should be maintained and thus to reduce the bad debts

d. Addressing the complaints of the customers

e. After receiving the payments, the balances in the particular account receivable should be
reduced

f. Preventing any bad debts of the receivables outstanding during a particular period.

ASSESMENT AND ACTIVITIES:

1) What is Current Assets and give examples?
2) How Inventory Management works?
3) What is Account Receivable and give examples?