Inventory

Management
Unit – 4
Chapter - 24
Why business hold stocks?
1. Stock (inventory): materials and goods required to allow for the production and
supply of products to the customer.
2. Manufacturing businesses hold inventories in three distinct form:
• Raw materials and components: purchased from outside suppliers and will be held
in storage until they are used in the production process.

• Work in progress inventory: partly finished goods that come in between raw
materials and final products. The value of work in progress depends on the length
of time needed to complete production and on the method of production. Batch
production tends to have high work-in-progress levels.

• Finished goods: goods may then be held in storage until sold and dispatched to the
customer. They are also held to cope with sudden unpredicted increases in demand
Why do inventories need to be managed
effectively?
• There might be insufficient inventories to meet unforeseen changes in
demand.
• Out-of-date or obsolescence inventories might be held if an effective
rotation system is not used, for example, for fresh foods or for fast-changing
technological products.
• Inventory wastage might occur due to mishandling or incorrect storage
conditions.
• High inventory levels have high storage costs and a high opportunity cost.
• Poor management of the supply purchasing function can result in late
deliveries, low discounts from suppliers or a delivery too large for the
warehouse to cope with.
Cost of holding inventory
• Opportunity cost: The higher the value of inventories held and the
more capital used to finance them, then the greater will be this
opportunity cost. During periods of high interest rates, the
opportunity cost of inventory holding increases.
• Storage cost: Inventories have to be held in secure warehouses.
Employees will be needed to guard and transport the goods.
Insurance of inventories is recommended in case they are stolen or
damaged by fire or flood.
• Risk of wastage and obsolescence: They can then onlybe sold for a
much lower price.
Optimum order size (EOQ)
• Holding cost: Holding costs (otherwise
known as carrying costs) are the costs to
store the inventory and include the storage
space, rent, deterioration, obsolescence,
property tax, insurance, etc.
• Ordering cost: the costs that arise every
time inventory is ordered. Include the
costs of creating a purchase order,
processing an order, receiving and
inspecting orders, etc.
• Stockout cost: the costs associated with
running out of inventory or not having
enough stock to meet customer demand
for a particular product.
Inventory control charts
• Used to monitor a firm’s inventory position.

• They help an inventory manager to determine the appropriate order

time and order quantity.

• They also allow an analysis of what would happen to inventory levels

if an unusual event occurred
• Buffer inventories: extra inventory kept on hand in case of manufacturing
delays or an unexpected increase in demand. The greater the degree of
uncertainty about delivery times or production levels, then the higher this
buffer level will have to be.
• Maximum inventory level: the largest number of goods a company can store
to provide its customers with service at the lowest possible cost.
• Re-order quantity: the total number of units of a particular product that
needs to be recovered in the stock. Influence by EOQ
• Lead time: Lead time is the minimum time needed between placing an order
and receiving it. If suppliers are unreliable and the lead time is long, the
buffer inventory level will have to be relatively high
• Re-order level: the inventory level at which an entity should issue a purchase
order to replenish the amount on hand. This depends on how long it takes
suppliers to deliver new supplies and the rate ofusage of inventories.
Just-in-time (JIT) Inventory Management
Conditions for JIT to operate successfully
• Excellent supplier relationships: Suppliers must be prepared and able to
deliver additional supplies at very short notice (i.e. on a short lead time).
• Production employees must be multi-skilled and flexible: Workers must be
able to switch to making different items at very short notice so that no
excess supplies of any one product are made.
• Equipment and machinery must be flexible: Modern, computer-controlled
equipment is more flexible. It is able to quickly switch to making another
type of product with no more than a different software program. Very
small batches of each item can be produced, which keeps inventory levels
to an absolute minimum. However, such equipment is expensive, so JIT
may not be appropriate for small or under-financed firms
• Accurate demand forecasts: If it is difficult for a firm to predict likely
future sales levels, then keeping zero inventories of materials, parts
and finished goods could be a risky strategy.
• IT equipment is needed for JIT: Communication with suppliers should
use the latest electronic data exchanges. Automatic and immediate
ordering can take place when it is recorded that more components
will shortly be required.
• Quality must be everyone’s priority: As there are no spare
inventories to fall back on, it is essential that each component and
product must be right first time. Any poor-quality goods that cannot
be used will mean that a customer will not receive goods on time

right product - right quantity - right place - right time"