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Inventory Management!
Concept of Inventory:
What is inventory? Inventory refers to those goods which are held for eventual
sale by the business enterprise. In other words, inventories are stocks of the
product a firm is manufacturing for sale and components that make up the
product. Thus, inventories form a link between the production and sale of the
product.
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.’
1. Transaction Motive
2. Precautionary Motive
3. Speculative Motive
A brief description about each of these motives follows in seriatim:
1. Transaction Motive:
ADVERTISEMENTS:
2. Precautionary Motive:
Inventories are also held with a motive to have a cushion against unpredicted
business. There may be a sudden and unexpected spurt in demand for finished
goods at times. Similarly, there may be unforeseen slump in the supply of raw
materials at some time. In both the cases, a prudent business would surely like
to have some cushion to guard against the risk of such unpredictable changes.
3. Speculative Motive:
An enterprise may also hold inventories to take the advantages of price
fluctuations. Suppose, if the prices of raw materials are to increase rather
steeply, the enterprise would like to hold more inventories than required at
lower prices.
ADVERTISEMENTS:
Ordering costs, i.e., the costs associated with individual orders such as typing,
approving, mailing, etc. can be reduced, to a great extent, if the firm places
large orders rather than several small orders.
ADVERTISEMENTS:
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.
The either case results in less sale to less revenue to less profit or more loss.
On the other hand, surplus in inventories means lying inventories idle for
some time implying cash blocked in inventories. Speaking alternatively, this
also means that had the organization invested money blocked in inventories
invested elsewhere in the business, it would have earned a certain return to
the organization. Not only that, it would have also reduced the carrying cost of
inventories and, in turn, increased profits to that extent.
This benefits organization mainly in two ways. One, cash is not blocked in idle
inventories which can be invested elsewhere to earn some return. Second, it
will reduce the carrying costs which, in turn, will increase profits. In lump
sum, inventory management, if done properly, can bring down costs and
increase the revenue of a firm