Inventory Management
Types of Inventories
Work in Progress
Finished goods
Raw materials and components
These inventories can be drawn upon at any time and allow the firm to meet increases in demand by increasing the rate of production quickly.
At any one time the production process will be converting raw materials and components into finished goods
Having been through the complete production process, goods may then be held in storage until sold and despatched to the customer
Costs of not holding enough inventories
Why do inventories need to be managed effectively?
Out-of-date inventories might be held if an appropriate
rotation system is not used
Inventory wastage might occur due to mishandling or
incorrect storage conditions
Very high inventory levels may result in excessive storage
costs and a high opportunity cost for the capital tied up.
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Poor management of the supplies purchasing function can result in late deliveries, low discounts from suppliers or too large a delivery for the warehouse to cope with
There might be insufficient inventories to meet unforeseen
changes in demand
Inventory holding cost
Opportunity cost
Storage Cost
Risk of wastage and obsolescence
Working capital tied up in goods in storage could be put to another use. It might be used to pay of loans, buy new equipment or pay of suppliers early to gain an early-payment discount.
Inventories have to be held in secure warehouses. They often require special conditions, such as refrigeration. Employees will be needed to guard and transport the goods.
If inventories are not used or sold as rapidly as expected, then there is an increasing danger of goods deteriorating or becoming outdated.
Idle Production resources
Sepcial orders could be expensive
Lost Sales
Small order quantities
If a firm is unable to supply customers from goods held in storage, then sales could be lost to firms that hold higher inventory levels
If inventories of raw materials and components run out, then production will have to stop.
If an urgent order is given to a supplier to deliver additional materials due to shortages, then extra costs might be incurred in administration of the order and in special delivery charges.
Keeping low inventory levels may
mean only ordering goods and supplies in small quantities.
Controlling Inventory levels
Maximum Inventory level
Re order quantity
Buffer Inventories
Lead time
Re order stock level
the minimum inventory level that should be held to ensure that production could still take place should a delay in delivery occur or should production rates increase.
This may be limited by space or by the financial costs of holding even higher inventories.
the number of units ordered each time.
the normal time taken between ordering new stocks and their delivery.
This is the level of stocks that will trigger a new order to be sent to the supplier.
Just in time
this inventory-control method aims to avoid holding inventories by requiring supplies to arrive just as they are needed in production and completed products are produced to order.
Production staff must be multiskilled and prepared to
change jobs at short notice
Equipment and machinery must be flexible
Relationships with suppliers have to be
excellent
The latest IT equipment will allow JIT to be more
successful
Accurate demand forecasts will make JIT a much more
successful policy
Excellent employee–employer relationships are essential
for JIT to operate smoothly
Advantage
Disadvantage
Capital invested in inventory is reduced and the opportunity cost of inventory holding is reduced.
Costs of storage and inventory holding are reduced. Space released from holding of inventories can be used for a more productive purpose.
Much less chance of inventories becoming outdated or obsolescent. Fewer goods held in storage also reduces the risk of damage or wastage
Delivery costs will increase as frequent small deliveries are
an essential feature of JIT
Order-administration costs may rise because so many
small orders need to be processed.
Any failure to receive supplies of materials or components in time caused by, for example, a strike at the supplier’s factory, transport problems or IT failure will lead to expensive production delays.