For executing the business operations successfully, it is important for an organization to bridge the gap between the quantity demanded and quantity supplied. The inventory of an organization keeps increasing and decreasing everyday because of its daily operations. Such constant changes call for inventory management. Inventory Management is concerned with providing right stock at right place on right time at right cost. Before moving to inventory management, it is important to get a clear idea of what inventory is.
What is Inventory?
Inventories are basically the tangible assets kept with the intention to sell or process them further to sell eventually. Inventory comprises of raw materials, WIP, finished goods, semi-finished goods, loose tools, spare parts, jigs, maintenance supplies, packing materials, etc. It comprises major portion of current assets.
Not only the purchase cost but there are a number of costs associated with acquiring inventory. These costs include ordering cost, carrying cost, transportation cost, storage cost, insurance, etc. A proper and time to time strategic analysis is required to manage these inventories well and for minimizing its cost.
What is Inventory Management?
Role inventory management begins far earlier from purchasing of raw material and it keeps continuing even after the sale is made. It involves answering to a lot of questions like what to purchase, how much to purchase, from where to buy, how much to produce, where to store, where to sell, etc. Management of inventories is important for undisturbed supply of raw materials as well as finished goods whenever required.
Inventory being the most important part in process of running a successful business, be it manufacturing, wholesale, retail, also e-platforms nowadays and in some cases of services industry, demands inventory management.
Activities and working method of manufacturing concerns will help to understand this better. A manufacturer, on deciding the product he wants to manufacture and sell, have to take several decisions regarding the quantity to produce, quality of raw material, processing, packaging, warehousing, after sales services like repairs and much more. It becomes necessary to build strategies for efficient and smooth production of goods.
Now, let’s talk about online shopping platforms trending these days. The main advantage of these platforms is to receive the product you want, from wide variety of options available, at your door steps without going out. It is crucial to maintain a regular inventory level for quick execution of deliveries.
To conduct business operations smoothly without any hurdles, inventory management is a must. In all, we can say that inventory management refers to optimal investment in administration of inventory.
Objectives of Inventory Management
It is necessary that one should know the purpose behind carrying out inventory management. Some of the objectives are listed below:
- No disturbance in supply chain.
- To order the required quantity of raw material.
- Waste reduction.
- Forecasting.
- Consistency in maintaining stock registers.
- Quality control.
- Regular supervision.
- Ease at the time of assessment.
- Protection from theft, spoilage, damage, etc.
- Early error detection.
- Process planning.
- Control on purchases.
- Prevention from blocking unnecessary investment in inventory.
- Continuous supply in peak seasons.
- Reduction in carrying cost.
- Customer satisfaction.
Inventory Management vs Inventory Control
The terms inventory management and inventory control are quite similar to each other and mostly used interchangeably but there is a very significant difference between both the terms. Therefore, it becomes important to have a clarity on the difference between both.
Inventory control is practice carried out on the goods which are already in existence under the control of producer or trader while inventory management is exercised at all times that is before and after the goods are procured.
Inventory management is a broader concept while the inventory control is just a part of it. Inventory management collects data from records made under inventory control. Hence, for an efficient inventory management, a strong inventory control system is a essential.
Inventory Management Systems
There are two most popular system of inventory management. These are as follows:
Perpetual Inventory System
In a perpetual inventory system, a process of continuous stock taking is followed. A proper record of each action like stock added, sold, spoiled, returned is to be maintained. This system provides a better control over stock as it maintains a real-time data. It constantly tracks the activities that impacts the inventory level.
Periodic Inventory System
Periodic system of inventory management is process of recording data of stock at regular intervals. It does not require a continuous follow up of stock. It is a less expensive but a time-consuming process. The probability of goods getting spoiled is higher under this system.
Among the two, perpetual inventory system and periodic inventory system, the former is better as it provides more up to date and accurate data for decision making process.
Accounting of Inventory
In order to record inventories in books, the most common methods to calculate the cost of inventories are discussed below:
First In First Out (FIFO)
As the name suggests, under FIFO method, inventories are priced in the order of their purchase. This method stands beneficial when the current market price of inventory is high and is comparatively easy to operate.
Last In First Out (LIFO)
Under this method, inventories are issued at a price in the reverse order of their purchase. It does not use current market price to record inventories. This method is suitable in inflationary period.
Weighted Average Costing Method
Weighted average cost method considers the quantity of material to determine the cost. Here, the aggregate cost of material in stock is divided by the aggregate quantity of material in stock.
Standard Price Method
Under standard price method, materials are recorded at an already estimated price rather than its actual cost. This cost is estimated after considering various factors such as current market price, market trends and other factors.
Techniques of Inventory Control
As stated earlier, inventory control provides base for inventory management. The organization requires to adopt the technique which best suited for their working atmosphere.
Economic Order Quantity (EOQ)
EOQ is the ideal level of inventory to be ordered. At this level of inventory, both, carrying cost and ordering cost are lowest. It derives its quantity to be ordered on the basis of demand. The formula to calculate EOQ is as follows:
EOQ = √(2AO/C)
Where, A = Annual Demand,
O = Ordering Cost,
And, C = Carrying Cost.
ABC Analysis
ABC analysis broadly categorizes inventory into three parts, that is, A, B and C types of inventories. Where,
A type of inventory includes those stock items which are used or sold more frequently.
B type of inventory include items which cost more than A type of inventory in case of carrying cost.
C type of inventory comprises of all the leftover portion of stock.
VED Analysis
VED analysis is the short form for Vital, Essential and Desirable analysis. This type of analysis is basically preferred for controlling or managing spare parts.
Spare parts whose absence will put a brake on production are covered under category of vital spare parts.
All those materials or spare supplies whose absence is unbearable after few hours are termed as essential.
And spare parts, without which we can work for even few weeks are grouped under the category of desirable materials.
FSN Analysis
Under this analysis, materials are grouped on the basis of speed and frequency of their movement. FSN stands for fast moving, slow moving and non-moving items.
Fixing Levels of Material
Management calculates the various levels of material at which the stock is to be issued, reordered or produced or other measures required to be taken by the management. These levels are termed as maximum level, minimum level, re-ordering level, danger level & safety stock.
Just In Time (JIT)
This strategy works on the principle of providing right inventory at the right time and hence excludes the problem of out-dated items. It prevents unnecessary investment in stock. And also reduce the probability of resource to become idle.
Inventory Turnover Ratio
Inventory turnover ratio signifies the times inventory gets consumed in a specific period. To calculate inventory turnover ratio, the value of material consumed during the period is divided by value of average stock held during the year.
Material Requirement Planning
Materials Requirement Planning (MRP) is a method for determining the quantity as well as timing for procuring dependent demand items that are required to satisfy master production schedule requirements.
Conclusion
A proper use of these tools and techniques helps management to conduct business operations smoothly. These will help in proper forecasting, recording, analyzing and taking corrective measures to prevent hurdles in functioning of the organization.