Literature Review on Inventory Management with Practical Examples
In today’s world every business tries to strike a balance in inventory between what is needed and what is demanded, considering the major factor of cost cutting/reduction. This control is called Inventory management or inventory control. Inventory is basically assets (goods and materials) which are stock of any business. Inventory management focus on the capacity of the inventory, the place in which it is located so that one can use it when needed, the supply chain management of the raw materials and goods. Inventory management deals with the demand forecasting, asset management of the raw materials and goods, inventory carry cost, forecast, pricing of goods, validation of goods, to forecast the demand of future. This helps the top level manger to understand and coordinate with the supply chain management or production management, and quality management.
The three important objectives of Inventory management are
Satisfactory level of service
Most company measures the ability to satisfy the customer by the following 3 factors / methods
- Number of order which act per schedule
- Number of order which are shipped as per schedule
- The idle time in inventory as well as shortage
Minimizing inventory investments
Most company try to minimize the money associated with inventory so as to improve profitability of the company. This is measured using inventory turnover ratio
(Measures how quickly the inventory is getting out of system to the consumer)
Its calculated using formula- Sales / inventory or cost of goods sold / average inventory 
Efficient inventory control
Efficient inventory control includes how the inventory are scheduled properly, no delays between sniffing of raw materials and goods. The amount of raw materials determines the workforce and other factors. Every company will incur fixed cost and vertical cost. There should be a balance between the fixed cost and variable cost.
Necessity of inventory of a company
|Customer Demand||Goods Produced||Inventory Month-end|
Table 1- To illustrate how an inventory is used in end of month
Factories which a company considers to get excess demand
Fulfil demand- Consider an instant where a customer wants to buy 100 DVD disks from shop A. But the shop A has only 50. So the customer goes to Shop B. He gets the 100 DVD disks he wanted. So from next time onwards the customer may go only to shop B directly. Hence to avoid this the shop has to evaluate and forecast property how much is required
2) To have progress in operations: A company must have certain purchased items like the raw materials and goods sold in order to manufacture its product. Running out of only one item can prevent a manufacturer from completing the production of its finished goods.
3) Lead Time: the time that lapses between the order placing (production and purchase order issued in the factory floor) and actually receiving the ordered. The more and more the lead time, the more and more of the quantity of goods the company should must carry in stock.
“Illustration: Just-in-time manufacturing firm, like Nissan in Smyrna, Tennessee, maintain extremely low levels of inventory. 18 times per day it takes delivery on truck seats. But the steel mills may have a lead time of 3 months. That means to say a firm which uses steel produced at the mill must order minimum 3 months in advance.”.
Requirements leveler: Inventory is mainly used to maintain a steady rate of output [mainly to avoid the hiring cost and training the new personnel], while determining the forecast of inventory , increase in demand is called anticipation inventory
There are four types of inventory
- Raw materials – basic materials used for manufacturing of goods.
- Work in process- goods which have started to transformation to finished goods
- Finished goods –final finished product for consumer.
- MRO goods- maintenance ,repair and operational goods
RAW MATERIALS: The materials that are used in a conversion process of manufacturing to convert them into partly or completely finished goods. These items include commodities or materials extracted by the firm or its subsidiaries. They can also be bought by the firm. A partially completed item may be considered as finished goods by the supplier, but this could also be the raw material of the purchaser. Some examples of raw materials include
- Examples of raw materials bought from outside the firm:
- Nuts and bolts
- Ball bearings
WORK IN PROCESS: This includes all the materials, components, assemblies, subassemblies, etc. which are being incorporated into the system. They include all the materials from the start till they are ready and are awaiting inspection before they form the completed product.
CASE: At Dulux paint the total time taken to produce paint varies from 7 to 24 hrs. This time depends on the type of goods.
FINISHED GOODS: Finished goods are those which have gone through the entire process of manufacturing and are completely ready to be sold to customers. Finished goods inventory is the collection of completed products. Finished goods also mandatorily have to pass all tests and inspections before they are sold to either retailers, distributors or directly to customers. Typically a manufacturer has a good stock of raw materials, work in process and finished products. A retailer or wholesaler has a big collection of finished goods ready to be sold.
TYPES OF INVENTORIES:
TRANSIT INVENTORY: Inventories many times have to be transported from one location to the other as they pass through the levels of manufacturing. These inventories are called transit or pipeline inventories as they are in transit from a location to another. Automobile manufactures make use of freight consolidators to pool in their inventories.
CASE: HPCL handles the transportation from refineries to customers through various modes like roadways, shipping, pipelining etc.
BUFFER INVENTORY: Inventories are sometimes used to counter attack the uncertainties of demand and supply. They could also be used to take care of unforeseen situations like poor transportation, poor quality etc. Buffer inventory or safety stock is the amount of stock which is in excess compared to the current demand of goods. The more safety stock a firm has very small is its probability of running into a stock out situation.
ANTICIPATION INVENTORY: Firms often purchase and hold stock which is much higher than their present requirements in anticipation of a future event. These event can include
- Seasonal variations in demand
- Price variations
- An impending labour strike
This method allows firms to build up their inventory reserves when the demand is declining and as the demand shoots up they can utilise the inventory. The firms need not increase their production capacity and overload their workers when there is a sudden rise in demand.
DECOUPLING INVENTORY: The production time of each machine used in a manufacturing plant varies. Some systems produce more products in the same time duration. The faltering of any machine must not affect the entire production process. Thus decoupling inventory acts as a shock absorber and decouples the dependence on sequential process.
CASE: Consider a book manufacturing firm. If it is known that the paper manufacturing machine is not working for few days then the manager forecasts the requirement and carries out other activities like binding so that the entire process is still intact.
VARIOUS COSTS RELATED TO INVENTORY MANAGEMENT:
Ordering cost and cost of acquisition:
Large organisations have separate purchase offices which handle the purchasing of huge inventories. Demands are technically analysed and decisions about inquiries, tenders and orders are made. An additional cost is included for each step this is all summed up to arrive at the Ordering cost and cost of acquisition
Carrying costs: holding inventory is an additional expense for every firm. Different elements of Carrying costs are
- Interest on capital / cost of capital / opportunity cost
- Obsolescence and depreciation
- Cost of storage, handling and stock verification
- Insurance cost
The average carrying cost could be expressed as follows:
Interest on capital / cost of capital / opportunity cost
15 to 25%
Obsolescence and depreciation
2 to 5 %
Cost of storage, handling and stock verification
3 to 5 %
1 to 2 %
21 To 37 %
Shortage or stock out cost:
Whenever an item is not available when required then it causes delay to all the process which require that item. This causes a loss since the work at a stage is delayed or even stopped at times. Consider an example of a locomotive, if its production is held up due to lack of availability of spare parts then it causes loss due to delay in completion. If the part has to be bought from outside the firm the additional expense is incurred.
These costs are related to the type of control mechanisms and systems being used to monitor the production process.
INVENTORY MANAGEMENT TECHNIQUES:
One of the vital objectives of a firm is to manage inventories efficiently in accordance with the shareholders. Optimum utilization of the inventories aids to achieve that objective, as well as reap profit. The inventories which are controlled efficiently make the firm flexible and avoid disasters like running out of stock and pilling up of unnecessary stock which increases the level of investment and does not bring the firm profit. The following questions help to manage the inventories properly.
How much should be ordered? (economic order quantity)
When should it be ordered? (re-order point )
ECONOMIC ORDER QUATITY
Economic order quantity deals with problems like the amount of stock to be furnished on the depletion of stock, the planning of production. So the firm has established the economic lot size. This involves two types of costs:
Ordering costs: it includes the cost of the following:
Ordering cost differ according to the orders placed. The clerical and the staff costs remain the same as long as they are committed costs. On the other hand if the quantity of the order increases, the clerical and staff costs may increase. If the quantity is reduced the clerical and the staff force can be used in other departments hence the cost can be included to the ordering cost. As the ordering costs is proportionate with the number of orders placed a large inventory helps in reducing the order cost as the number of orders reduce.
Carrying cost: it includes the cost of the following:
- Adolescence and to maintain the level of inventory.
- The storage costs include warehousing cost, stores handling cost and administrative cost. Carrying costs differ with inventory size and is in contrast with that of ordering cost which reduces with the increase in inventory level.
- Re-order point: it means the point at which the firm should restock its inventory. In order to be certain of the time of restock, the firm should know the following:
- Lead time (normal replenishing time i.e. reorder= lead*avg. usage)
- Average use
- Economic order quantity
Safety stock: the actual delivery time might differ from the normal lead time. If there is an increase in actual usage or delay in delivery of stock it may prove to be expensive for the firm so in order to protect themselves from such mishaps they can maintain a safety or back-up stock
JUST IN TIME:
Just in time became famous because of the Japanese firm. It means that the materials arrive in time for production and hence maintenance of inventories is not needed but then the delivery and production have to be well co-ordinated. It also has its drawbacks like if the quality of the material is poor it will be a hindrance for production. The success of just in time depends on quality management and the relationship with the supplier.
One truck transportation company obtains much of its business by catering to companies that must deliver parts to other companies “just in time”. The Toyota Company in Japan has developed a scheduling discipline for internal control of in process material movement, called Kanban, which substantially reduces WIP. Inventories and hence reduces the associated costs.
As times are changing so are the practices of companies. Nowadays companies tend to outsource. That is buying components from some other firms.
Example: Tata motors has developed number of ancillaries are able to maintain the high quality of the manufactured components. The car manufacturing company, Maruti, which is now controlled by Suzuki of Japan, has the similar system of supply.
COMPUTRIZED INVENTORY CONTROL SYSTEM:
Technology is made controlling of inventories easier by computerized inventory control that is everything from tracking, revising, counting. It also restocks the inventory by reordering when necessary that is possible because of the information system which is linked between the buyer and supplier. However it is not practical for large retail stores.
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