LESSON FOUR

INVENTORY MANAGEMENT
4.0 Introduction
Inventory is the stock of any item or resource used in an organization. Inventory includes:
raw Materials, finished products, component parts, supplies, and work-in-process.
Inventory management refers to the process of ordering, storing, and using inventory in an
organization. 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 different methods and systems for inventory management

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. A large inventory carries the
risk of spoilage, theft, damage, obsolescence 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 risk e.g. it can lead to huge
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, e.g. Calendars or fast-fashion items, for example—sitting on inventory is not an
option, and misjudging the timing or quantities of orders can be very costly.

4.1 Objectives of Inventory Management

The main objective of inventory management is to maintain inventory at appropriate level to

avoid excessive or shortage of inventory because both the cases are undesirable for business.
Thus, management is faced with the following conflicting objectives

 To supply the required materials continuously: there should be a continuous available

of materials in the factory or finished goods for trade. The main objective of inventory
management in to maintain required inventory so that production and sales process run
smoothly.
 To minimize the risk of under and over stocking of material: if a company keeps
inventory without proper analysis, there will be a chance of overstocking, which will
increase the cost of carrying the inventory or under stocking of inventory that create
problem in smooth operation of a business. So one of the main objectives of the inventory
management is to minimize the risk caused due to under and over stocking of inventory.
 To maintain systematic record of inventory: management needs different information
regarding inventory for planning and decision-making. A systematic recording of
inventory helps provides such information to the management. It also assists to evaluate
the current inventory management policy.
 To reduce losses through deterioration, pilferage, wastages, damages and
misappropriation of materials: inventory management aims to reduce or remove the
losses and misappropriate of materials. This is done by maintaining the proper stocks of
materials with utmost care.
 To minimize the cost associated with inventory: the proper maintenance of the
information regarding inventory helps to make decisions like whether to take discounts or
not, the size of order to be placed, when to order etc. the total cost associated with
 inventory may be minimized by analyzing the lot size to be acquired, the offer of
discount on variable lot size and the timing of order. Such analysis helps to reduce the
unnecessary inventory in inventories. This will enable the organization to keep materials
cost under control so that they contribute in reducing cost of production and overall cost.
 To make stability in price: an effective inventory management system minimizes the
effects of regular price fluctuation. This is turn helps to gain the stability is selling price.
 To maintain investment in inventories at the optimum level as required by the operational
and sales activities.
 To eliminate duplication in ordering or replenishing stocks. This is possible with the help
of centralizing inventory control and purchases
 To ensure accountability of stocks- ensure perpetual inventory control so that materials
shown in stock ledgers should be actually available in the stores.

4.2 Functions of Inventory

 To meet anticipated customer demand. These inventories are referred to as anticipation
stocks because they are held to satisfy planned or expected demand.
 To smooth production requirements. Firms that experience seasonal patterns in demand
often build up inventories during off-season to meet overly high requirements during
certain seasonal periods. Companies that process fresh fruits and vegetable deal with
seasonal inventories
 To decouple operations. The buffers permit other operations to continue temporarily
while the problem is resolved. Firms have used buffers of raw materials to insulate
production from, disruptions in deliveries from suppliers, and finished goods inventory to
buffer sales operations from manufacturing disruptions.
 To protect against stock-outs. Delayed deliveries and unexpected increases in demand
increase the risk of shortages. The risk of shortages can be reduced by holding safety
stocks, which are stocks in excess of anticipated demand.
 To take advantage of order cycles. Inventory storage enables a firm to buy and produce
in economic lot sizes without having to try to match purchases or production with
demand requirements in short run.
  To hedge against price increase. The ability to store extra goods also allows a firm to
take advantage of price discounts for large orders.
 To permit operations. Production operations take a certain amount of time means that
there will generally be some work-in-process inventory.
4.3 The Purposes of Inventories
 To maintain independence of operations
 To meet variation in product demand
 To allow flexibility in production scheduling
 To provide a safeguard for variation in raw material delivery time
 To take advantage of economic purchase order size
4.4 Reasons for Holding Stock in an Organization

 To take advantage of low prices where inflation is expected

 To attract quantity discounts on large/bulk purchases
 To take care of production during lead time
 To minimize ordering costs related to frequent orders
 To guard against expected shortages in supply- buffer/safety stock
 To guard against increases in demand/ to ensure continuous service to customers
 To cater for Large scale/ Mass production
 To stabilize market prices – holding finished product to create shortage in the market in
order to cause a price increase In case of unsustainable decrease in prices

4.5 Demand Forecasting

This refers to the process of estimating the quantity of materials required to meet
organizational requirements. Factors Considered When Forecasting Demand for Materials
includes:

 Anticipated levels of operation / output/production

 Previous usage data/ information
 Special materials requirements
  The demand/ customers’ requirements
 Current rates if consumption / usage
 The availability of materials

4.6 Inventory Control

 Process of ensuring proper matching of demand and supply of materials to meet

organizations requirements
 Process of ensuring that the right quantity of materials are held in the organization to
avoid overstocking, under stocking or stock outs
Features of an efficient stock control system

 Clear inventory policies

 Clear limits of inventory to be held
 Clear plans on expenditure relating to inventories/ cost effective
 Methods of ensuring Compliance with inventory policies
 Flexibility to allow for changes when needed
 Simple to understand and operate
 Effective recording and retrieval of stock data/records
 proper matching of demand and supply of materials- no over/under stocking

4.7 Benefits of an effective stock control system

 Helps to reduce the amount of capital tied up/investments in stocks- funds are
released for other purposes
 Increased profitability by ensuring savings on stock
 Improved customer service by checking on stock outs, deterioration and obsolescence
 Improved ability to respond to fluctuations in demand and emergencies
 Enables the firm to take advantage of better prices in the supply market
 Enables the organization to match purchases with production schedules
4.8 Inventory Control Systems

An inventory management/control system is the set of policies and controls that monitors
levels of inventory and determines what levels should be maintained, when stock should be
replenished, and how large orders should be. Inventory Control Systems can be classified
into:

a) Traditional/ manual systems

 Periodic review system
 Fixed order quantity systems
 Continuous review system
b) Modern/ computerized control systems
 ABC Analysis
 Economic Order Quantity (EOQ)
 JIT System
 MRP Systems
 Input-output ratio analysis
 Vendor Managed Inventory
 Consignment Stocking