INVENTORY MANAGEMENT

Inventory: the raw materials, components and finished goods a company sells or uses in production.

An organization’s inventory, which is often described as the step between manufacturing and order fulfillment, is central
to all its business operations as it often serves as a primary source of revenue generation.

13 Types of Inventories

There are four different top-level inventory types: raw materials, work-in-
progress (WIP), merchandise and supplies, and finished goods. These four
main categories help businesses classify and track items that are in stock
or that they might need in the future. However, the main categories can be
broken down even further to help companies manage their inventory more accurately and efficiently.

Types
Raw Materials Raw materials are the materials a company uses
to create and finish products. When the product is
completed, the raw materials are typically
unrecognizable from their original form, such as
oil used to create shampoo.
Components Components are like raw materials in that they are
the materials a company uses to create and finish
products, except that they remain recognizable
when the product is completed, such as a screw.
Work In Progress WIP inventory refers to items in production and
(WIP) includes raw materials or components, labor,
overhead and even packing materials.
Finished Goods Finished goods are items that are ready to sell.
Maintenance, MRO is inventory — often in the form of supplies
Repair and — that supports making a product or the
Operations maintenance of a business.
(MRO) Goods
Packing and There are three types of packing materials.
Packaging Primary packing protects the product and makes it
Materials usable. Secondary packing is the packaging of the
finished good and can include labels or stock
keeping unit (SKU) information. Tertiary packing
is bulk packaging for transport.
Safety Stock and Safety stock is the extra inventory a company
Anticipation buys and stores to cover unexpected events.
Stock Safety stock has carrying costs, but it supports
customer satisfaction. Similarly, anticipation
stock comprises of raw materials or finished items
that a business purchases based on sales and
production trends. If a raw material’s price is
rising or peak sales time is approaching, a
business may purchase safety stock.
Decoupling Decoupling inventory is the term used for extra
Inventory items or WIP kept at each production line station
to prevent work stoppages. Whereas all
companies may have safety stock, decoupling
inventory is useful if parts of the line work at
different speeds and only applies to companies
Example
A company that makes T-shirts has
components that include fabric, thread,
dyes and print designs.
A cell phone consists of a case, a
printed circuit board, and components.
The process of assembling the pieces at
a dedicated workstation is WIP.
Maintenance, repair and operating
supplies for a condominium
community include copy paper,
folders, printer toner, gloves, glass
cleaner and brooms for sweeping up
the grounds.
At a seed company, the primary
packing material is the sealed bag that
contains, for example, flax seeds.
Placing the flax seed bags into a box
for transportation and storage is the
secondary packing. Tertiary packing is
the shrink wrap required to ship pallets
of product cases.
A veterinarian in an isolated
community stocks up on disinfectant
and dog and cat treats to meet customer
demand in case the highway floods
during spring thaw and delays delivery
trucks.
In a bakery, the decorators keep a store
of sugar roses with which to adorn
wedding cakes – so even when the
ornament team’s supply of frosting mix
is late, the decorators can keep
working. Because the flowers are part
 that manufacture goods.
Cycle Inventory Companies order cycle inventory in lots to get the
right amount of stock for the lowest storage cost.
Service Inventory Service inventory is a management accounting
concept that refers to how much service a
business can provide in a given period. A hotel
with 10 rooms, for example, has a service
inventory of 70 one-night stays in each week.
Transit Inventory Also known as pipeline inventory, transit
inventory is stock that’s moving between the
manufacturer, warehouses and distribution
centers. Transit inventory may take weeks to
move between facilities.
Theoretical Also called book inventory, theoretical inventory
Inventory is the least amount of stock a company needs to
complete a process without waiting. Theoretical
inventory is used mostly in production and the
food industry. It’s measured using the actual
versus theoretical formula.
Excess Inventory Also known as obsolete inventory, excess
inventory is unsold or unused goods or raw
materials that a company doesn’t expect to use or
sell but must still pay to store.
of the cake’s design, if the baker ran
out of them, they couldn’t deliver a
finished cake.
As a restaurant uses its last 500 paper
napkins, the new refill order arrives.
The napkins fit easily in the dedicated
storage space.
A café is open for 12 hours per day,
with 10 tables at which diners spend an
average of one hour eating a meal. Its
service inventory, therefore, is 120
meals per day.
An art store orders and pays for 40 tins
of a popular pencil set. The tins are
enroute from the supplier and,
therefore, in transit.
A restaurant aims to spend 30% of its
budget on food but discovers the actual
spend is 34%. The “theoretical
inventory” is the 4% of food that was
lost or wasted.
A shampoo company produces 50,000
special shampoo bottles that are
branded for the summer Olympics, but
it only sells 45,000 and the Olympics
are over — no one wants to buy them,
so they’re forced to discount or discard
them

Inventory management:

 Inventory management is a precise discipline that relies on keeping just enough inventory to cover demand without
holding so much that it unnecessarily increases costs.
 Refers to the process of ordering, storing, using, and selling a company's inventory. This includes the management of
raw materials, components, and finished products, as well as warehousing and processing of such items.
 It is the science and art of ordering, storing, and using a company’s inventory — the materials and components a
business sells or uses to make its products. It includes the systems and processes companies use to track their
inventory and determine when to order more.

Inventory management techniques/methods

Inventory management uses several methodologies to keep the right amount of goods on hand to fulfill customer demand
and operate profitably. This task is particularly complex when organizations need to deal with thousands of stock-keeping
units (SKUs) that can span multiple warehouses. The methodologies include:

1. ABC Analysis
ABC (Always Better Control) Analysis is inventory management that separates various items into three categories
based on pricing and is separated into groups A, B, or C.
A inventory: A inventory includes the best-selling products that require the least space and cost to store. Many
experts say this represents about 20% of your inventory.
B inventory: B items move at a similar rate to A items but cost more to store. Generally, this represents about
40% of your inventory.
C inventory: The remainder of your stock costs the most to store and returns the lowest profits. C inventory
represents the other 40% of your inventory.

Each category can be managed separately by an inventory management system. It's important to know which
items are the best sellers to keep enough buffer stock on hand. For example, more expensive category A items may
take longer to sell, but they may not need to be kept in large quantities. One of the advantages of ABC analysis is that it
 provides better control over high-value goods, but a disadvantage is that it can require a considerable amount of
resources to continually analyze the inventory levels of all the categories.

2. EOQ Model
Economic Order Quantity is a technique utilized for planning and ordering an order quantity. It involves making a
decision regarding the amount of inventory that should be placed in stock at any given time. The order will be re-
ordered once the minimum order has been reached.

Factors that affect Economic Order Quantity

Reorder point: It is the time when you need to reorder another set of stock or replenish the existing stock. EOQ
always assumes that you order the same quantity at each reorder point.
Purchase order lead time: This is the time period from placing the order until the ordering is delivered. EOQ
assumes that the lead time is understood.
Purchasing cost per unit: The cost per unit never changes, over the period of time, even though the quantity of
the order is changed. EOQ always assumes that you pay the same amount per product, every time.
Stockouts: There are no chances for stockouts. You have to always maintain enough inventory to avoid stockout
costs. This clearly states that you always have to strictly monitor your customer demand along with your
inventory levels, carefully.
Quality costs: EOQ never focuses on the quality costs, rather the carrying costs.
Demand: It’s about how much the customer wants the product for a specific time period.
Relevant ordering cost: The cost per purchase order.
Relevant carrying cost: The cost involved in the entire maintenance and carrying the stock, for the specific
period.

3. FSN Method
This method of inventory control refers to the process of keeping track of all the items of inventory that are not used
frequently or are not required all the time. They are then categorized into three different categories: fast-moving
inventory, slow-moving inventory, and non-moving inventory.

Fast-moving goods are the items in your stock that are utilized regularly. They are usually the basic day to day
items that are used by customers on a regular basis. There can fast moving and need to be produced on regular
basis. Fast moving goods usually have a low profit margin. They are non-durable and sell at relatively low cost.
Examples, include milk, eggs, fruit and vegetables and over-the-counter drugs like paracetamol and asprin.
Slow-moving goods are only used for a particular timeframe. Slow moving inventory is defined as stock keeping
units (SKUs) that have not shipped in a certain amount of time, such as 90 or 180 days, and merchandise that has
a low turn rate relative to the quantity on hand. Slow moving goods can be problematic and can contribute to
waste of capital and resources.
Non-moving goods are not utilized at all over a specific timeframe and has a turnover rate below one. These are
goods that are stocked up over a long period of time.

Particulars Fast-moving goods Slow-moving goods Non-moving goods

Stock High Intermediate Low
Control High Intermediate Low
Check Tight Intermediate No
Safety stock High Low Rare

Non- moving items constitute around 70% of the average cumulative stay
Slow-moving stocks are 20% of the average cumulative stay
Fast-moving products are 10% or less of the average cumulative stay

4. JIT Method
Just In Time inventory control is a process utilized by manufacturers to control their inventory levels. This method
saves them money by not storing and insuring their excess inventory. However, it is very risky since it can lead to
stock out and increase costs.

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.

5. Minimum Safety Stocks

The minimum safety stock refers to the level of inventory that an organization maintains to avoid a possible stock-
out.

The safety stock approach also provides a signal that it's time to reorder merchandise before dipping into the
safety stock. It's a good idea for businesses to work safety stock into their warehouse management strategy in case
their supply chain is disrupted.

Reasons to Keep Safety Stock

Offset Demand Uncertainty: Fluctuations in demand are among the primary reasons to maintain safety stock.
Many factors can influence spikes in demand, including seasonal impacts, sudden shifts in customer trends, panic
buying or a competitor's departure. Safety stock gives companies enough breathing room to replenish stock while
meeting this increased demand.
Avoid Stockouts: Safety stock can help companies reduce the risk of completely running out of a certain product
and prevent operations from coming to a halt while the business locates, purchases and delivers this inventory.
That process can take days, or even weeks, making safety stock an invaluable bridge that keeps the business
running while resolving the stockout.
Minimize the Effects of Supply Disruptions : Unexpected disruptions on the supplier side, such as raw material
shortages, production issues, legislative or political measures and operational shutdowns, can have a major impact
on your inventory levels. These interruptions have far-reaching impacts on the rest of the supply chain, including
delaying the completion of other product components, derailing customer delivery schedules or causing retail
disruptions. Safety stock mitigates the impact of supplier interruptions and lead time uncertainty and keeps the
supply chain moving until the disruption passes or the company has found a new supplier.
Reduce Administrative and Staff Hours : Beyond keeping each step of the supply chain running smoothly,
safety stock also cuts down on time spent on communication, paperwork and warehouse duties. Supply chain
managers won't find themselves frequently scrambling to find and reorder additional stock with an adequate
buffer in place, avoiding all of the calls, emails, rush requests and invoice processing that comes with it.
Likewise, warehouse staff isn't unexpectedly unloading trucks and restocking racks, which can interrupt other
day-to-day warehouse activities.
Compensate for Forecast Inaccuracies: Maintaining adequate safety stock ensures consistency and allows
decision-makers to develop more accurate forecasts across the organization. Although demand forecasts are
usually reliable, sudden changes can cause them to become inaccurate. The effect of stock disruptions compounds
in other forecasts, such as supply chain staff scheduling. These issues are especially troubling when stock
disruptions cause a loss of revenue or customers as sales and other financial forecasts become invalid.
Limit Rushed Shipping: A lack of inventory can result in lost revenues, but that isn't the only cost that
businesses incur. Increased administrative and warehouse payroll costs are also likely, as is the risk of suppliers
charging a premium for rushed delivery. These costs may not be a big problem if the stockout results from higher
demand expected to continue. However, for stockouts caused by disruptions or other issues, the cost may not be
recouped quickly, if at all.
Ensure Customer Satisfaction: Safety stock is one of the best ways to sustain customer satisfaction and loyalty.
If customers can rely on a company to always have what they need in stock, they will not only keep coming back
but likely provide valuable word-of-mouth advertising as well. That pays off in a big way over the long term and
helps your business grow.
Maintain Market Share : Being unable to meet demand and losing customers often also means losing market
share. Mitigating the risk of stockouts is a significant part of sustaining customer satisfaction and reducing the
risk of losing ground to competitors. 
Increase Efficiency : Safety stock allows for more efficient operations, even during supply disruptions. Suppliers
aren't rushed, warehouse staff isn't over-worked, delivery drivers stay on schedule and there are steady,
trustworthy inventory numbers for reporting and forecasting purposes.
Improved Supplier and Retailer Relationships : Stockout situations often result in urgent reorders, but most
suppliers don't like to be rushed because it can disrupt their operations and customers. Keeping safety stock on
hand reduces the need to put in rush orders and provides suppliers with a steady workload. Likewise, companies
that work with retailers can maintain good relationships by keeping the items they sell in stock.

6. First in, first out (FIFO) methodology

The oldest inventory is sold first to help keep inventory fresh. This is an especially important method for businesses
dealing with perishable products that will spoil if they aren't sold within a specific time period. It also prevents items
 from becoming obsolete before a business has the chance to sell them. This typically means keeping older
merchandise at the front of shelves and moving new items to the back.

7. Last in, first out (LIFO) methodology

The newest inventory is typically recorded as sold first. This is a good practice when inflation is an issue and prices
are rising. Because the newest inventory has the highest cost of production, selling it before older inventory means
lower profits and less taxable income. LIFO also means the lower cost of older products left on the shelves is what's
reported as inventory. However, this is a difficult technique to put into practice, as older items that sit around have a
chance of becoming obsolete or perishing.
8. MRP Method
Material Requirements Planning is a process utilized by manufacturers to control the inventory by planning the order
of the goods based on the sales forecast. The order is usually based on the data collected by the system.
This 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.

9. VED Analysis
VED is a technique utilized by organizations to control their inventory. It mainly pertains to the management of vital
and desirable spare parts. The high level of inventory that is required for production usually justifies the low
inventory for those parts.
VED Analysis classifies the inventory under three heads – vital, essential and desirable

Vital Essential Desirable

“Vital” category includes
inventory, which is necessary
for production or any other
process in an organization.
If any such inventory is
unavailable, entire production
may stop.
Therefore, order for such
inventory should be before-
hand.
The essential category includes
inventory which is next to
being vital.
Loss due to their unavailability
may be temporary, or it might
be possible to repair the stock
item or part.
Ensure optimum availability
and maintenance
The desirable category of
inventory is the least important
among the three.
Unavailability may result in
minor stoppages in production.
Moreover, the easy
replenishment of such shortage
is possible in a short duration
time.

Importance
Utmost importance to any organization to maintain an optimum level of inventory.
VED analysis is a crucial tool to understand and categorize inventory according to its importance.
Management can optimize cost by investing more in the vital and essential categories.

Process of Inventory Management

Before building an inventory management plan, you’ll need to have a solid understanding of each step in the inventory
management process. This is crucial to minimizing error and choosing the most effective inventory management software
for your business.

1. Goods are delivered to your facility. This is when raw materials and subcomponents for manufacturers or finished
goods for consumers first enter your warehouse.
2. Inspect, sort and store goods. Whether you use drop-shipping, cross-docking or a different warehouse
management system, this when inventory is reviewed, sorted and stored in their respective stock areas.
3. Monitor inventory levels. This may be through physical inventory counts, perpetual inventory software or cycle
counts and helps minimize the chance of error.
4. Stock orders are placed. Customers place orders either on your website or in-store.
5. Stock orders are approved. This is when you pass the order to your supplier, or it may be automated through your
POS system.
6. Take goods from stock. The necessary goods are found by SKU number, taken from stock and shipped to the
manufacturer or customer.
7. Update inventory levels. Using a perpetual inventory system, you can automatically update inventory levels and
share with necessary stakeholders.
 8. Low stock levels trigger purchasing/reordering. Restock inventory as needed.

To better visualize these eight steps, try creating an inventory process map like
the one at the left side. Track and review each step of the process in order to
minimize out-of-stock and overstocked inventory.

Inventory management systems

An inventory management system (IMS) is the program (typically software) that monitors and organizes all the elements
involved in inventory management. This includes tracking orders all the way from suppliers through to customers.
Perpetual inventory system: A perpetual inventory system is viewed as the most accurate option for inventory
management. Perpetual inventory systems are the most accurate because they continuously track inventory in real
time, and are usually supported by powerful software.
Periodic inventory system: Within a periodic inventory system, you take physical counts of inventory at the
beginning and end of a specific period. While this system is not as accurate as a perpetual system, it can be done
without having to purchase software.
Manual inventory system: A manual inventory system is the old-school pen-and paper-approach. While this might be
a viable option if your monthly sales are in the single digits, most businesses require something more robust.

Some of the benefits of strategic inventory management include:

Better warehouse organization: Good warehouse and stock handling techniques lead to a more organized
warehouse. For example, by preventing overstocking, you’ll have more room to dedicate to your highest priority
stock. Being able to identify unprofitable and slow-moving inventory better allows you to clean out unwanted
merchandise faster. Better warehouse organization contributes to better inventory management, too. When the
warehouse is organized, you’ll keep better track of your stock and be less likely to lose or damage products.
Saved time and money: The right inventory management strategies, especially paired with tools like inventory
control software, save you time and money. You’ll spend less time counting physical stock, tracking down inventory
discrepancies and working through preventable challenges. By optimizing stock levels, you’ll save storage costs and
prevent costly overstocking. You can also earn more revenue by keeping products in stock to take advantage of more
sales opportunities.
Improved customer satisfaction: Having stock when customers want to make a purchase is good for the customer
experience. It also prevents you from having to cancel customer orders or place shoppers on waitlists. Adequate stock
levels and an efficient inventory handling method also help you meet customers’ expectations for faster shipping.