Inventory management is the planning, coordinating, and control activities related to the flow of inventory into, through, and from the organization.
It ensures the availability of the right quantity of material of the right quality at the right time with the minimum amount of capital by purchasing them at the right price from the right source.
Inventory constitutes the largest proportion of current assets in a business organization.
Since material cost forms a major portion of the total cost, that is to say, 50% of the total cost, it is essential that the materials should be controlled to a large extent.
So that they should be purchased properly, safeguarded and correctly consumed and accounted for.
Thus, inventory management contributes to the efficiency of a business. By exercising the material control, the following advantages are obtained by the organization.
- Minimum investment
- Reduced cost of production
- Prevention of production delays
- Optimize fulfillment
- Provide better customer service
- Prevent loss from theft, spoilage, and returns
- Minimum wastage of materials
- Availability of materials at right price
Good inventory management is good finance management.
A company should maintain adequate stock of materials of right quality at minimum cost so that they are issued to production when needed in order to have an uninterrupted flow of production. For this purpose, inventory control is to be adopted.
The efficient management of inventory should finally result in the maximization of profit and consequently the maximization of shareholder’s wealth.
A business firm can have four types of inventory :
- Raw materials– the materials, components, fuels, etc. used in the manufacture of products.
- Work-in-Process (WIP)– partly finished goods and materials, sub-assemblies, etc. held between manufacturing stages.
- Finished goods – completely ready for sale or distribution.
- Consumables – for example, fuel and stationery
The particular items included in each classification depend on the particular firm, what would be classified as a finished product for one company might be classified as raw materials for another.
For example, steel bars should be classified as a finished product for steel mill and as raw material for a nut and bolt manufacturer. A trading organization will generally hold the third category of inventory.
The stock of finished goods is held for sale in the ordinary course of business.
The stock of raw materials, stores, and spares, etc. are to be currently consumed in the production of goods or services to be available for sales.
Inventory control covers the following areas:
The requirements for better control over materials is below:
- Centralized purchase function ie, all the purchases should through purchase department
- Material is purchased with authority.
- Proper planning purchase function.
- Materials purchased should be of proper quality and specification
- Standardisation of materials,
- Materials should be properly received and inspected.
- Planned storage of all materials in stores.
- Selection of suppliers keeping in view the quality, price and delivery,
- Direct materials used in production should be charged to production on an appropriate and consistent pricing basis.
- Indirect materials used in production and service departments should be appropriately apportioned and absorbed into product cost.
- Proper documentation and accounting of material receipts and issues.
- Material issues only with proper authority.
- Maintenance of bin cards and stores ledger and regular
- reconciliation of both the records.
- Adoption of a perpetual inventory system and continuous stock taking.
- Fixation inventory levels ie., maximum, minimum, re-order and danger levels.
- Proper internal checks.
- Proper procedures in dealing with shortages and discrepancies.
Inventory Management Techniques
The following are the techniques are used in manufacturing organizations for inventory management.
- Economic ordering quantity (EO0)
- Inventory Levels: Maximum, Minimum, and Reorder level
- Perpetual Inventory system
- ABC Analysis
- Ved Analysis
- Just in Time (JIT)
- Inventory Turnover Ratio
1. Economic Order Quantity(EOQ)
How much should be ordered when an order is placed?
This is a basic question pertaining to inventory management that must be answered.
The answer is the Econocime Order Quantity(EOQ). A firm can use the Economic Order Quantity (EOQ) procurement model to calculate the optimal quantity of inventory to order.
Read more: Economic Order Quantity(EOQ)
2. Inventory Levels: Maximum, Minimum & Reorder
When should an order be placed?
This is another basic question of inventory management that must be answered. The answer is the Reorder level.
The reorder level is the quantity level of the inventory on hand that triggers a new order. The reorder level is simple to compute:
Reorder Level = Maximum usage X Maximum lead time
The length of time between the placement of an order on a supplier and its receipt is called lead time.
Read more: Inventory Levels
The main objectives of an effective inventory control system are indicated below :
- Maintaining adequate inventory so as to avoid production stoppages. (Production stoppages will lead to dissatisfaction of customers, loss in revenue and finally loss of goodwill).
- Avoiding excess inventory holding thereby reducing the material holding cost, chances of obsolescence, storage loss, pilferage, etc.
- Fixation of EOQ, Maximum level, Minimum level, Optimum level Re-ordering level, Safety Stock level, etc.
- Avoiding slow-moving and non-moving, dormant, surplus and obsolete stock, etc.
- Avoiding the blocking of the capital. amount i.e., Minimum investment in the inventory.
The ultimate objective is to determine the optimum level of inventory holding which will ensure the smooth running of production and also ensure that excessive capital is not blocked i.e. the optimum level of inventory and minimum investment on inventory.