Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a business. It is also used for a list of the contents of a household and for a list for testamentary purposes of the possessions of someone who has died. In accounting inventory is considered an asset. Inventory management is primarily about specifying the size and placement of stocked goods. Inventory management is required at different locations within a facility or within multiple locations of a supply network to protect the regular and planned course of production against the random disturbance of running out of materials or goods. The scope of inventory management also concerns the fine lines between replenishment lead time, carrying costs of inventory, asset management, inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical inventory, available physical space for inventory, quality management, replenishment, returns and defective goods and demand forecasting.
Provide the desired level of customer service. Customer service refers to a company's ability to satisfy the needs of its customers. There are several ways to measure the level of customer service, such as: (1) percentage of orders that are shipped on schedule, (2) the percentage of line items that are shipped on schedule, (3) the percentage of dollar volume that is shipped on schedule, and (4) idle time due to material and component shortage. The first three measures focus on service to external customers, while the fourth applies to internal customer service.
Achieve cost-efficient operations. Inventories can facility cost-efficient operations in several ways. Inventories can provide a buffer between operations so that each phase of the transformation process can continue to operate even when output rates differ. Inventories also allow a company to maintain a level workforce throughout the year even when there is seasonal demand for the company's output. By building large production lots of items, companies are able to spread some fixed costs over a larger number of units, thereby decreasing the unit cost of each item. Finally, large purchases of inventory might qualify for quantity discounts, which will also reduce the unit cost of each item.
Minimize inventory investment. As a company achieves lower amounts of money tied up in inventory, that company's overall cost structure will improve, as will its profitability. A common measure used to determine how well a company is managing its inventory investment (i.e., how quickly it is getting its inventories out of the system and into the hands of the customers) is inventory turnover ratio, which is a ratio of the annual cost of goods sold to the average inventory level in dollars.
WHY KEEP INVENTORY?
Why would a firm hold more inventory than is currently necessary to ensure the firm's operation? The following is a list of reasons for maintaining what would appear to be "excess" inventory.
Table 1
January
February
March
April
May
June
Demand
50
50
0
100
200
200
Produce
100
100
100
100
100
100
Month-end inventory
50
100
200
200
100
0
MEET DEMAND: In order for a retailer to stay in business, it must have the products that the customer wants on hand when the customer wants them. If not, the retailer will have to back-order the product. If the customer can get the good from some other source, he or she may choose to do so rather than electing to allow the original retailer to meet demand later (through back-order). Hence, in many instances, if a good is not in inventory, a sale is lost forever.
KEEP OPERATIONS RUNNING: A manufacturer must have certain purchased items (raw materials, components, or subassemblies) in order to manufacture its product. Running out of only one item can prevent a manufacturer from completing the production of its finished goods. Inventory between successive dependent operations also serves to decouple the dependency of the operations. A machine or work center is often dependent upon the previous operation to provide it with parts to work on. If work ceases at a work center, then all subsequent centers will shut down for lack of work. If a supply of work-in-process inventory is kept between each work center, then each machine can maintain its operations for a limited time, hopefully until operations resume the original center.
LEAD TIME: Lead time is the time that elapses between the placing of an order (either a purchase order or a production order issued to the shop or the factory floor) and actually receiving the goods ordered. If a supplier (an external firm or an internal department or plant) cannot supply the required goods on demand, then the client firm must keep an inventory of the needed goods. The longer the lead time, the larger the quantity of goods the firm must carry in inventory. Example: A just-in-time (JIT) manufacturing firm, such as Nissan in Smyrna, Tennessee, can maintain extremely low levels of inventory. Nissan takes delivery on truck seats as many as 18 times per day. However, steel mills may have a lead time of up to three months. That means that a firm that uses steel produced at the mill must place orders at least three months in advance of their need. In order to keep their operations running in the meantime, an on-hand inventory of three months' steel requirement would be necessary.
HEDGE: Inventory can also be used as a hedge against price increases and inflation. Salesmen routinely call purchasing agents shortly before a price increase goes into effect. This gives the buyer a chance to purchase material, in excess of current need, at a price that is lower than it would be if the buyer waited until after the price increase occurs.
QUANTITY DISCOUNT: Often firms are given a price discount when purchasing large quantities of a good. This also frequently results in inventory in excess of what is currently needed to meet demand. However, if the discount is sufficient to offset the extra holding cost incurred as a result of the excess inventory, the decision to buy the large quantity is justified.
SMOOTHING REQUIREMENTS: Sometimes inventory is used to smooth demand requirements in a market where demand is somewhat erratic. Consider the demand forecast and production schedule outlined in Table 1.
Notice how the use of inventory has allowed the firm to maintain a steady rate of output (thus avoiding the cost of hiring and training new personnel), while building up inventory in anticipation of an increase in demand. In fact, this is often called anticipation inventory. In essence, the use of inventory has allowed the firm to move demand requirements to earlier periods, thus smoothing the demand.
ACHIEVING EFFICIENT PRODUCTION RUNS: Maintenance of large inventories helps a firm in reducing the set up cost associated with each production run. For example: if a set up cost is rs.200 and the run produces 200 units, the cost per unit comes toRs.1. In case, the run produce is 2ooo units, the set up cost will stand reduce to Rs. 0.10 per unit. Thus, inventories assists the firm in making sufficiently high run resulting in lowering down the set up cost.
Inventory example
While accountants often discuss inventory in terms of goods for sale, organizations - manufacturers, service-providers and not-for-profits - also have inventories (fixtures, furniture, supplies, ...) that they do not intend to sell. Manufacturers', distributors', and wholesalers' inventory tends to cluster in warehouses. Retailers' inventory may exist in a warehouse or in a shop or store accessible to customers. Inventories not intended for sale to customers or to clients may be held in any premises an organization uses. Stock ties up cash and if uncontrolled it will be impossible to know the actual level of stocks and therefore impossible to control them. While the reasons for holding stock are covered earlier, most manufacturing organizations usually divide their "goods for sale" inventory into:
Raw materials - materials and components scheduled for use in making a product.
Work in process, WIP - materials and components that have begun their transformation to finished goods.
Finished goods - goods ready for sale to customers.
Goods for resale - returned goods that are salable.
Spare parts
NATURE OF INVENTORY: Inventory is defined as a stock or store of goods. These goods are maintained on hand at or near a business's location so that the firm may meet demand and fulfill its reason for existence. If the firm is a retail establishment, a customer may look elsewhere to have his or her needs satisfied if the firm does not have the required item in stock when the customer arrives. If the firm is a manufacturer, it must maintain some inventory of raw materials and work-in-process in order to keep the factory running. In addition, it must maintain some supply of finished goods in order to meet demand. Sometimes, a firm may keep larger inventory than is necessary to meet demand and keep the factory running under current conditions of demand. If the firm exists in a volatile environment where demand is dynamic (i.e., rises and falls quickly), an on-hand inventory could be maintained as a buffer against unexpected changes in demand. This buffer inventory also can serve to protect the firm if a supplier fails to deliver at the required time, or if the supplier's quality is found to be substandard upon inspection, either of which would otherwise leave the firm without the necessary raw materials. Other reasons for maintaining an unnecessarily large inventory include buying to take advantage of quantity discounts (i.e., the firm saves by buying in bulk), or ordering more in advance of an impending price increase. Generally, inventory types can be grouped into four classifications: raw material, work-in-process, finished goods, and MRO goods.
RAW MATERIALS: Raw materials are inventory items that are used in the manufacturer's conversion process to produce components, subassemblies, or finished products. These inventory items may be commodities or extracted materials that the firm or its subsidiary has produced or extracted. They also may be objects or elements that the firm has purchased from outside the organization. Even if the item is partially assembled or is considered a finished good to the supplier, the purchaser may classify it as a raw material if his or her firm had no input into its production. Typically, raw materials are commodities such as ore, grain, minerals, petroleum, chemicals, paper, wood, paint, steel, and food items. However, items such as nuts and bolts, ball bearings, key stock, casters, seats, wheels, and even engines may be regarded as raw materials if they are purchased from outside the firm. Generally, raw materials are used in the manufacture of components. These components are then incorporated into the final product or become part of a subassembly. Subassemblies are then used to manufacture or assemble the final product. A part that goes into making another part is known as a component, while the part it goes into is known as its parent. Any item that does not have a component is regarded as a raw material or purchased item. From the product structure tree it is apparent that the rolling cart's raw materials are steel, bars, wheels, ball bearings, axles, and caster frames.
WORK-IN-PROCESS: Work-in-process (WIP) is made up of all the materials, parts (components), assemblies, and subassemblies that are being processed or are waiting to be processed within the system. This generally includes all material-from raw material that has been released for initial processing up to material that has been completely processed and is awaiting final inspection and acceptance before inclusion in finished goods. Any item that has a parent but is not a raw material is considered to be work-in-process. A glance at the rolling cart product structure tree example reveals that work-in-process in this situation consists of tops, leg assemblies, frames, legs, and casters. Actually, the leg assembly and casters are labeled as subassemblies because the leg assembly consists of legs and casters and the casters are assembled from wheels, ball bearings, axles, and caster frames.
Case: Work in process of any company will be depends on the capacity to produce the goods. At Dulux paint Total time required to manufacture paint varies between 7-24hrs depending on the type of goods. At one particular time only one size of product is manufactured. Currently company has 150 kl of goods Work In Progress (WIP). Company has capacity of 200kl WIP.
FINISHED GOODS: A finished good is a completed part that is ready for a customer order. Therefore, finished goods inventory is the stock of completed products. These goods have been inspected and have passed final inspection requirements so that they can be transferred out of work-in-process and into finished goods inventory. From this point, finished goods can be sold directly to their final user, sold to retailers, sold to wholesalers, sent to distribution centers, or held in anticipation of a customer order. The levels of the above 3 kinds of inventories differ depending upon the nature of business. For example: a manufacturer will have high level of all 3 kinds of inventories. While a retailer or wholesaler will have level of inventories for finished goods but will have no inventories of raw material or work-in -progress . more over depending upon the nature of business, inventories may be durable or non-durable, valuable or inexpensive, perishable or non-perishable etc. Inventories can be further classified according to the purpose they serve. These types include transit inventory, buffer inventory, anticipation inventory, decoupling inventory, cycle inventory, and MRO goods inventory. Some of these also are known by other names, such as speculative inventory, safety inventory, and seasonal inventory.
TYPES OF INVENTORY:
TRANSIT INVENTORY: Transit inventories result from the need to transport items or material from one location to another, and from the fact that there is some transportation time involved in getting from one location to another. Sometimes this is referred to as pipeline inventory. Merchandise shipped by truck or rail can sometimes take days or even weeks to go from a regional warehouse to a retail facility. Some large firms, such as automobile manufacturers, employ freight consolidators to pool their transit inventories coming from various locations into one shipping source in order to take advantage of economies of scale. Of course, this can greatly increase the transit time for these inventories, hence an increase in the size of the inventory in transit.
Case: Take the case of HPCL the transports are done from refinery to the customer through different modes of transport i.e. Pipeline, Roadways (Tankers), Shipping, etc. the time takes to reach a goods from refinery to the customer are called Transit inventory.
BUFFER INVENTORY: As previously stated, inventory is sometimes used to protect against the uncertainties of supply and demand, as well as unpredictable events such as poor delivery reliability or poor quality of a supplier's products. These inventory cushions are often referred to as safety stock. Safety stock or buffer inventory is any amount held on hand that is over and above that currently needed to meet demand. Generally, the higher the level of buffer inventory, the better the firm's customer service. This occurs because the firm suffers fewer "stock-outs" (when a customer's order cannot be immediately filled from existing inventory) and has less need to backorder the item, make the customer wait until the next order cycle, or even worse, cause the customer to leave empty-handed to find another supplier. Obviously, the better the customer service the greater the likelihood of customer satisfaction.
ANTICIPATION INVENTORY: Oftentimes, firms will purchase and hold inventory that is in excess of their current need in anticipation of a possible future event. Such events may include a price increase, a seasonal increase in demand, or even an impending labor strike. This tactic is commonly used by retailers, who routinely build up inventory months before the demand for their products will be unusually high (i.e., at Halloween, Christmas, or the back-to-school season). For manufacturers, anticipation inventory allows them to build up inventory when demand is low (also keeping workers busy during slack times) so that when demand picks up the increased inventory will be slowly depleted and the firm does not have to react by increasing production time (along with the subsequent increase in hiring, training, and other associated labor costs). Therefore, the firm has avoided both excessive overtime due to increased demand and hiring costs due to increased demand. It also has avoided layoff costs associated with production cut-backs, or worse, the idling or shutting down of facilities. This process is sometimes called "smoothing" because it smoothens the peaks and valleys in demand, allowing the firm to maintain a constant level of output and a stable workforce.
Case: Let's take a case of Dulux paint, in paint industry there will be a seasonality of demand. Which means there production will be throughout the year and distribution will be on pick time i.e. market demand will be more in the month of March to May and June to Nov. this will be done for smooth distribution.
DECOUPLING INVENTORY: Very rarely, if ever, will one see a production facility where every machine in the process produces at exactly the same rate. In fact, one machine may process parts several times faster than the machines in front of or behind it. Yet, if one walks through the plant it may seem that all machines are running smoothly at the same time. It also could be possible that while passing through the plant, one notices several machines are under repair or are undergoing some form of preventive maintenance. Even so, this does not seem to interrupt the flow of work-in-process through the system. The reason for this is the existence of an inventory of parts between machines, a decoupling inventory that serves as a shock absorber, cushioning the system against production irregularities. As such it "decouples" or disengages the plant's dependence upon the sequential requirements of the system (i.e., one machine feeds parts to the next machine). The more inventory a firm carries as a decoupling inventory between the various stages in its manufacturing system (or even distribution system), the less coordination is needed to keep the system running smoothly. Naturally, logic would dictate that an infinite amount of decoupling inventory would not keep the system running in peak form. A balance can be reached that will allow the plant to run relatively smoothly without maintaining an absurd level of inventory. The cost of efficiency must be weighed against the cost of carrying excess inventory so that there is an optimum balance between inventory level and coordination within the system.
Case: Take a case of Book making industry. The manager knows that paper making machine will be not working after two days & production will be stop because of that so they will be produce in advance the more quantity of papers and when the machine will not working at that time binding will be done and distribution will not be affected by stopping the production.
CYCLE INVENTORY: Those who are familiar with the concept of economic order quantity (EOQ) know that the EOQ is an attempt to balance inventory holding or carrying costs with the costs incurred from ordering or setting up machinery. When large quantities are ordered or produced, inventory holding costs are increased, but ordering/setup costs decrease. Conversely, when lot sizes decrease, inventory holding/carrying costs decrease, but the cost of ordering/setup increases since more orders/setups are required to meet demand. When the two costs are equal (holding/carrying costs and ordering/setup costs) the total cost (the sum of the two costs) is minimized. Cycle inventories, sometimes called lot-size inventories, result from this process. Usually, excess material is ordered and, consequently, held in inventory in an effort to reach this minimization point. Hence, cycle inventory results from ordering in batches or lot sizes rather than ordering material strictly as needed.
MRO GOODS INVENTORY: Maintenance, repair, and operating supplies, or MRO goods, are items that are used to support and maintain the production process and its infrastructure. These goods are usually consumed as a result of the production process but are not directly a part of the finished product.
Examples of MRO goods include oils, lubricants, coolants, janitorial supplies, uniforms, gloves, packing material, tools, nuts, bolts, screws, shim stock, and key stock. Even office supplies such as staples, pens and pencils, copier paper, and toner are considered part of MRO goods inventory.
VARIOUS COSTS RELATED TO INVENTORY MANAGEMENT:
Ordering costs or Costs of Acquisition:
For a large organization, it becomes necessary to have a separate purchase office to purchase thousands of items. The demands received are technically scrutinized and for purchasing them, inquiries are issued, tenders are received and evaluated, orders are progressed, materials are received and inspected and lastly, the payments are arranged. All these mean additional costs to the organization. All these costs together constitute what is called cost of ordering or cost of acquisition.
In the Railways, we do not have a system of working out these costs. But it is necessary that for a given stores organization, total number of purchases are ascertained and average cost per purchase order worked out. When we work out the costs, we may find that some costs are fixed while some are variable. We should be interested in knowing the variable costs.
As we are using 3 major systems of purchasing viz., advertised tender, limited tender and cash purchase systems, it is advisable to work out the ordering costs for these three different procedures of purchasing.
Based on some of the studies made ordering costs may be as follows:
Cash Purchase Rs.50 to Rs.100 per purchase
Limited Tender Purchase Rs.300 to Rs.600 "
Advertised Tender Purchase Rs.1000 to Rs.2000 "
These are just approximate and may vary considerably depending upon various factors. It is repeated that every Railway should establish these costs from time to time so that they can be used in designing proper inventory models.
2) Carrying Costs: The very fact that the items are required to be kept in stock means additional expenditure to the organization. The different elements of costs involved in holding inventory are as follows:
(a) Interest on capital / cost of capital / opportunity costs: When materials are kept in stock money representing the value of materials is blocked. In a developing economy, capital is extremely scarce and as such, the real value of capital is much higher than the nominal rate of interest which the organization like Railways may be paying. The money which is blocked up is not available to the organization to do more business or to use it for alternative productive investment. This opportunity to earn more profits which we loose can be expressed as opportunity cost.
While working out the inventory carrying cost in an organization, the higher of the three factors viz., interest, cost of capital or opportunity cost should, be taken into consideration. This may be roughly 20% per annum.
(b) Obsolescence and depreciation: The costs because of obsolescence and depreciation are very important even though they are very difficult to assess. This factor is relatively higher for spare parts inventory as against raw material inventory. Larger the stock we keep more the risk of obsolescence and as such, the costs are expressed as the percentage costs to the average inventory holding and can be between 2 to 5%.
(c) The cost of storage, handling and stock verification: There are additional costs because of the clerical work involved in handling of materials in the ward, in stock verification, in preservation of materials as well as the costs because of various equipment's and facilities created for the purpose of materials. A part of this cost is of a fixed nature. The major portion of the cost including the cost of staff, however, can be treated as variable costs at least in the long run. This cost can be roughly 3 to 5% of the inventory holding.
(d) Insurance Costs : Materials in stocks are either insured against theft, fire etc., or we may have to employ watch & ward organization and also firefighting organizations. Cost of this may also be 1 to 2%. The average inventory carrying costs can, therefore, be as follows:
Interest/costs of capital/opportunity cost 15 to 25%
Obsolescence and depreciation cost 2 to 5%
Storage, handling, etc. 3 to 5%
Insurance costs 1 to 2%
Total 21 to 37%
In the Indian Railways, the reasonable assessment of inventory carrying costs shall be about 20 to 25% per year of the average inventory holding. It is again clarified here that these costs are not normally reflected in our accounting system and as such are required to be established by individual Railway.
3) Shortage Or Stock Out Costs:
Whenever an item is out of stock and as such cannot be supplied, it means that some work or the other is delayed and this, in turn, leads to financial loss associated with such stoppage or delay of work.
For example, if a locomotive remains idle for want of spare parts, the earning capacity of the locomotive is lost for the duration of this period. On the other hand, the spare parts required will have to be purchased on emergency basis or have to be specially manufactured resulting in additional costs.
Stock out costs can vary from item to item and from situation to situation depending upon the emergency action possible. No attempt therefore, is normally made to evaluate a stock out cost of an item. Nevertheless, it is important to understand the concept of stock out costs, even though the actual quantification is not possible. We should have a rough grading of the items depending upon the possible stock out costs.
4) Systems Costs :
These are the costs which are associated with the nature of the control systems selected. If a very sophisticated model of the relationship between stock out costs, inventory holding cost and cost of ordering is used and operated with the help of a computer, it may give the theoretical minimum of the other costs but the cost of such control system may be sufficiently high to offset the advantages achieved.
In most of the situations, however, there is no substantial increase in costs because of the proposed control system and in such cases, these costs can be overlooked.
PRICING OF RAW MATERIALS:
Several methods are used for pricing inventories used in production. The important ones are :
First-in first-out(FIFO)method
Last-in first-out(LIFO)method
Weighted average cost method
Standard cost(price)method
FIFO method: This method assumes that the order in which materials are received in the stores is the order in which materials are issued from the stores. Hence, the materials which is issued first is priced on the basis of the cost of material received earliest, so on and so forth. The advantages of this method seemed to be: 1. The pricing of material is perhaps consistent with the practice of issuing oldest material first followed in many manufacturing organization. 2. The value of material in stock is fairly closed to the current cost. The disadvantages of this method are: 1. Issue of material at different prices complicates stores accounting. 2. Comparison of job cost becomes difficult when similar jobs may be charged with different prices for the same material. 3. In this period of rising prices, the charge to production is low. This tends to inflate reported profits, increase tax burden & push up dividends-as a consequence, the firm is sapped financially.
LIFO method: This method is the opposite of FIFO method: It assumes that the material which is acquired last is issued first. Hence material issues are priced on the basis of the cost of most recent material purchases. The advantages associated with this method are: 1. The cost of production reflects the current cost of materials better. 2. In a period of rising prices, reported profits are depressed, dividends are kept low, & working capital is conserved. The disadvantages of this method are: 1. Issue of material at different prices complicates stores accounting. 2. The pricing of materials is not consistent with the commonly followed practice of issuing the oldest material first. 3. Comparison of job cost becomes difficult when similar jobs may be charged for the same material at different prices.
Weighted Average Cost Method: Under this method, material issues are priced at a weighted average cost of materials in stock. To get an up-to-date weighted average cost figure, a new weighted average cost is calculated each time a delivery is received. The merits of this method are: (i) It tends to smooth out price fluctuations. (ii) It provides a fairly acceptable figure for stock values. The limitations of this method may be the tedium involved in calculating the weighted average cost each time a new delivery is obtained.
Standard Price (cost) Method: Under this method a standard price is predetermined. When materials are purchased the stock amount is debited with the standard price. The difference between the actual price & standard price is carried to a variance account. Material issued are charged as per the standard price. The advantages of this method are: (i) All material issued are priced identically. The possibility of jobs using the same material being charged with different cost-a problem with the FIFO or LIFO method does not exist. (ii) Stock accounting is fairly simplified. There is no need for specific prices attributable to specific issues of materials. The short comings of this method are: (i) Determining the standard price may be somewhat difficult, particularly when prices tend to increase somewhat unpredictably or are characterized by wide fluctuations. (ii) the issue of how variance should be treated may be thorny.
INVENTORY MANAGEMENT TECHNIQUES:
In managing inventories, the firm's objective should be in consonance with the shareholders, wealth maximization principle. To achieve this, the firm should determine the optimum level of inventory. Efficiently controlled inventories make the firm flexible. Inefficient inventory control results in unbalanced inventory and inflexibility. The firm may sometimes run out of stock and sometimes may pile up unnecessary stocks. This increases the level of investment and makes the firm unprofitable. To manage inventories efficiently, answers should be sought to the following two questions:
How much should be ordered?
When should it be ordered?
The first question, 'how much to order' relates to the problem of determining economic order quantity (EOQ) and answered with an analysis of costs of maintaining certain level of inventories. The second question, when to order, arises because of uncertainty and is a problem of determining the reâ€order point.
Economic Order Quantity (EOQ):
One of the major inventory management problems to be resolved is how much inventory should be added when inventory is replenished. If the firm is buying raw materials, it has to decide lots in which it has to be purchase on replenishment. If the firm is planning a production run, the issue is how much production to schedule (or how much to make). These problems are called order quantity problems, and the task of the firm is to determine the optimum or economic order quantity (or economic lot size). Determining an optimum inventory level involves two types of costs: (a) ordering costs and (b) carrying costs. The economic order quantity is that inventory level that minimizes the total of ordering and carrying costs.
Ordering Costs:
The term ordering costs is used in case of raw materials (or supplies) and includes the entire costs incurred in the following activities:
Requisition
Purchase
Ordering
Transporting
Receiving
Inspecting
Storing (store placement)
Ordering costs increase in proportion to the number of orders placed. The clerical and staff costs, however, do not have to vary in proportion to the number of orders placed, and one view is that so long as they are committed costs, they need not be reckoned in computing ordering cost. Alternatively, it may be argued that as the number of order increases, the clerical and staff costs tend to increase. If the number of orders are drastically reduced, the clerical and staff force release now can be used in other departments. Thus, these costs may be included in the ordering costs. It is more appropriate to include clerical and staff costs on a proâ€rata basis. Ordering costs increase with the number of orders, thus the more frequently inventory is acquired, the higher the firm's ordering costs. On the other hand, if the firm maintains a large inventory levels, there will be few orders placed and ordering costs will be relatively small. Thus, ordering costs decrease with the increasing size of inventory.
Carrying Costs: Costs incurred for maintaining a given level of inventory are called carrying costs. They include storage, insurance, taxes, deterioration and adolescence. The storage costs comprise cost of storage space (warehousing cost), stores handling costs and clerical and staff service costs (administrative costs) incurred in recording and providing special facilities such as fencing, lines, racks etc. Carrying costs vary with inventory size. This behavior is contrary to that of ordering costs which decline with increase in inventory size. The economic size of inventory would thus depend on tradeâ€off between carrying costs and ordering costs.
Reâ€order point: The reâ€order point is that inventory level at which an order should be placed to replenish the inventory. To determine the reâ€order point under certainty, we should know:
Lead time
Average usage
Economic order quantity
Lead time: Lead time is the time normally taken in replenishing the inventory after the order has been placed. By certainty we mean that uses and lead time do not fluctuate. Under such a situation reorder point is simply that inventory level which will be maintained for consumption during the lead time .i. e ,
Reorder point = Lead * Average usage.
Safety stock: The demand for material may fluctuate from dayâ€toâ€day or from weekâ€toâ€week. Similarly, the actual delivery time may be different from the normal lead time. If the actual usage increases or the delivery of inventory is delayed, the firms can a problem of stockâ€out which can prove to be costly for a firm. Therefore, in order to guard against the stock out, the firm may maintain a safety stock. It is the minimum or buffer inventory as cushion against expected increased usage and/or delay in delivery time.
Just-In-Time(JIT) systems:
Japanese firms popularize the just-in -time (JIT)system in the world. In a JIT system material or manufactured components and parts arrive to the manufacturing sites or stores just few hours before they are put to use. The delivery of material is synchronized with the manufacturing cycle and speed. JIT system eliminates the necessity of carrying large inventories, and thus , saves carrying other related cost to the manufacturer. The system requires perfect understanding and co-ordination between the manufacturer and the suppliers in terms of the timing of delivery and quality of the material. Poor quality material and components could halt the production. The JIT inventory system complements the total quality management (TQM). The success of the system depends on how well a company manages its suppliers. The system puts tremendous pressure on suppliers. They will have to develop adequate systems and procedures to satisfactory meet the needs of manufacturers.
Example:
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.
Outsourcing:
A few years ago there was a tendency on the parts of many companies to manufacture all components in house. Now more companies are adopting the practice out sourcing. Out sourcing is a system of buying parts and components from outside rather than manufacturing them internally. Many companies develop a single source of supply, and many others help developing small and middle size suppliers of components that they require.
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.
Computerized inventory Control Systems:
More and more companies, small or large size, are adopting the computerized system of controlling inventories A computerized inventory control system enables a company to easily track large items of inventories. It is an automatic system of counting inventories, recording withdrawals and revising the balance. There is an in-built system of placing order as the computer notice that the reorder point has become reached. The computerized inventory system is inevitable for large retail stores. These carry thousands of items. The computer information system of the buyer and supplier are linked to each other. As soon as the suppliers computer receive an order from the buyer's system, the supply system process is activated.
