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THE FUNDERMENTALS OF INVENTORY MANAGEMENT
- 1. INVENTORY MANAGEMENT PLU 07401 TOPIC:INTRODUCTION TO INVENTORY MANAGEMENT Prepared by; Uswege S. Ibrahim Msc-PSCM (MU) Bcom-PLM (UDOM) CPSP (T)
- 2. LEARNING OUTCOMES At theend of this chapter, the learner shall be able to do the following; a) To distinguish between inventory and stock b) To define inventory management and its scope c) To formulate objectives of inventory management d) To give reasons for and reasons against holding inventory e) To understand the economics of inventory management
- 3. INVENTORY MEANING Theterm inventory and inventory management may sound unfamiliar but all of us have practiced inventory management in various setting be it at home, school, hotel, etc. However, in this context our focus will be on inventory and inventory management in organizational setting particularly in manufacturing and retail context. To start it is important to have a common understanding on what is inventory and how does it differ from stock. Inventory and stock are two terms that at time are used synonymously while they are different even though the difference is less subtle.
- 4. INVENTORY VS STOCK Theterms inventory and stock are subtly different and the difference between the two terms was best given by Donald Waters (2007) as follows; Inventory refers as a list of items held in stock of an organization for future sale or use. Stock refers to the collection of or all materials and goods that are stored by an organization for future sale or use. Essentially, inventory is ‘list’ while stock is ‘collection’.
- 5. INVENTORY MANAGEMENT Inventory managementrefers to the branch of management science or function that deals with making key decision about inventory held in stock by an organization. Through inventory management an organization makes important decisions related to policies, activities and procedures to make sure the right amount of each item is held in stock at any time to streamline organizations operations. When an organization is at crossroad in terms of conflicting requirements inventory management plays a ‘balancing act’ role.
- 6. SCOPE OF INVENTORYMANAGEMENT Inventory management is one of the function within logistics management spectrum that includes materials management and physical distribution management. Materials management; this primarily addresses the issues related to acquisition or inflows of raw materials from suppliers. Alternatively called inbound logistics. Physical distribution management; this addresses the issue of outward movement of finished product to ultimate consumers. Alternatively called outbound logistics. Scope of inventory management differs from one organization to another but revolves around MM and PDM
- 7. SCOPE OF INVENTORYMANAGEMENT The following are the key activities that are executed under the umbrella or inventory management; Demand management to ensure that required operational and maintenance inventories are available in right quantities and at right time, Forecasting future demand requirements, Managing items with difficulty supply and demand patterns, Reviewing stock levels and controlling minimum and maximum amounts of inventory in terms of both quantity and value, Implementing lean inventory practices to minimize investment in inventory, Liaising with purchasing to ensure that supplies are replenished in accordance with corporate and procurement policies, Developing cost effective systems and procedures relating to ordering, procurement and budgeting of inventories,
- 8. SCOPE OF INVENTORYMANAGEMENT Controlling the receipt, inspection, recording, location and issue of inventories to users. Ensuring the security and safety of inventories and avoidance of loss as a result of theft, deterioration, waste and obsolescence. Coordination of inventory to ensure supplies can be rapidly located Variety reduction and standardization of inventory Preparation and interpretation of reports on stock levels, stock usage and surplus stock Liaison with auditors regarding all aspects of inventory Appropriate disposal of scrap, surplus and obsolete items
- 9. SCOPE OF INVENTORYMANAGEMENT
- 10. OBJECTIVES OF INVENTORYMANAGEMENT Inventory management as one of the functions of the organization should strive to achieve the following objectives/aims; Provide both internal and external customers with required service levels in terms of quantity and order rate fill. Ascertain present and future requirements for all types of inventory to avoid overstocking while ensuring there is no bottlenecks to production and operations. Keep costs to a minimum by variety reduction, economical lot sizes and analysis of cost incurred in obtaining and carrying inventories. Provide upstream and downstream inventory visibility in the supply chain.
- 11. REASONS FOR HOLDINGINVENTORY There are a number of reasons why companies might choose or need to hold inventories in stock of different products. It is imperative that when developing any distribution system an organization should accommodate inventory and hence it is important to understand the reasons of keeping materials. Keeping inventories is regarded as expensive as there are costs associated with keeping inventories. Regardless of the expensive nature of storing inventories organizations keep inventories for a variety of reasons
- 12. REASONS FOR HOLDINGINVENTORY The most important reason (general reasons) of holding inventory by organization is to provide a buffer between demand and supply. By keeping inventories organization will be capable of balancing between supply uncertainty against corresponding demand uncertainty. By keeping inventories as buffer it will allow for meeting demand at the exact time when customer places orders.
- 13. REASONS FOR HOLDINGINVENTORY The following are specific reasons for holding inventory by organizations; Stabilize production; inventory acts as a tool to make production predictable and safe. Supply unreliability; to safeguard operations at least over a short term when suppliers can’t make deliveries for various reasons. Manage buying costs; to circumvent an unideal situation of making frequent orders hence inflating ordering or buying costs. Protection against price volatility; when speculating about possible price increase or decrease inventory personnel can act accordingly. Take advantage of price discounts; when seller offer discounts buyer can buy in excess of immediate requirements. Decouple adjacent operations; to avoid direct dependency between two operations. Supplier minimum quantity condition; buy according to seller’s trading terms which maybe in excess of what is required.
- 14. REASONS AGAINST HOLDINGINVENTORY Even though there are million reasons to cause organizations to store inventories there is also some bad sides of keeping inventories that acts as a basis of reasons against storing inventories and these includes; Inventories consume capital resources that might be put to better use elsewhere in an organization. This means keeping inventories represents a capital tied up in inventory and for this reason inventory is regarded as waste. They divert managements attention away from careful planning and control of their distribution channels by promoting insular attitudes about distribution channel management. Managers always have the option of falling back to inventory to amend for their errors in planning hence they don’t plan thoughtfully.
- 15. INVENTORY TO WORKINGCAPITAL RATIO Inventory is regarded to tie organization’s working capital and hence its imperative that too much of organization’s working capital isn’t invested in inventory as it will signify poor financial performance. Inventory to working capital ratio is computed as follows; IWR = Value Invested in Inventory Working capital If the IWR is greater than 1 it implies that too much of organizations working capital is invested in inventory and that the organization is not liquid. If the IWR is less than 1 it implies that less working capital is invested in inventory and that the organization is liquid.
- 16. ECONOMIES OF INVENTORY Theeconomics of inventory management and stock control are best described or determined through the analysis of costs incurred in obtaining and carrying (storing) the inventories. The economics of inventory are described by the following costs; • Unit cost • Acquisition costs • Holding costs • Cost of stock outs
- 17. ECONOMIES OF INVENTORY UNITCOSTS This is the most basic and easiest cost to quantify and track associated with inventory management. There are two ways in which a company can establish unit cost either inventory was manufactured or purchased and both ways have challenges attached to them. MEANING DETERMINATION CHALLENGES PURCHASED Unit cost translates to the price charged by suppliers for a unit of inventory. Hence it is common to see unit cost be termed as unit price Unit cost determined by looking at quotation or invoices sent by supplier Inaccuracy of unit cost may arise due to purchasing of similar inventory from multiple suppliers who offer differing purchasing conditions MANUFACTURED Unit cost translate to the expenses that a company incurs in converting raw materials or sub-assemblies into a finished unit of inventory Unit cost determined by summation of direct material cost, labour cost and other overheads. Inaccuracy may arise due to the difficulty of assigning true production cost as a result of some hidden cost not accounted for.
- 18. ECONOMICS OF INVENTORY ACQUISITIONCOSTS These are expenses that are associated with the process of receiving materials from suppliers through order placement. Most of the costs associated with placing orders are incurred irrespective of the order size, that is ordering costs are relatively fixed. The ordering costs are normally comprised of the following; Preliminary costs; these are costs associated with preparing the requisitions, supplier evaluation and administration of the procurement process Placement costs; these are costs for preparing the order, stationery and postage Post-placement of goods; these are costs associated with expedition, receipt of goods, handling, inspection, certification and payment of invoices. NB; in case an organization manufactures the inventory acquisition cost becomes batch set up cost.
- 19. ECONOMICS OF INVENTORY HOLDINGCOSTS This is the cost of storing/holding one unit of an item as stock for a given period of time. There are two types of holding costs; a) Capital costs of financial cost; these are costs that are expressed in terms of opportunity cost, that is financial resources committed on inventory cannot be immediately made available for other economic uses. The most common capital cost is interest on capital tied up in inventory. This cost is regarded as ‘proportional cost’ simply because it has a propensity to increase with the increase in value of inventory which implies increased capital outlay in inventory
- 20. ECONOMICS OF INVENTORY b)Physical storage costs; these are costs associated with physical storage of inventory and it include supply of storage space (warehouse construction, renting or purchase), light and heating, losses (damage, obsolescence, theft and pilferage), handling equipment costs, storage equipment costs, labor costs, administration costs (inventory auditing, insurance and documentation). These costs are determined by the characteristics of inventory maintained by an organization. If an organization has more characteristics variability in its inventory then these costs will increase with the variation but if the organization has stable or less variability in the characteristics of inventory then these costs will remain stable or minimal.
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- 22. ECONOMICS OF INVENTORY STOCKOUTCOST These are incidental costs that are triggered by the occurrence of shortages, that is inability of servicing customer demand from current or existing inventory. Stockout costs or shortage costs are the most difficult costs to measure and in most cases are in form of informed guesses. Stock out costs includes costs like lost profit from lost sale, loss of goodwill, loss of future sales. Stockout can trigger production costs due to production stoppage in form of rescheduling of operations, laying off employees (if stoppage is prolonged for a considerable period). Also stockout can lead to a call of measures to rectify the shortage which further exposes an organization to stockout costs in form of expensive processing of emergency orders, placing orders with expensive substitute suppliers, paying for expensive mode of transport etc.
- 23. READING ASSIGNMENT a) Rolesof inventory manager b) Organization of inventory management function c) Relationship between inventory management and other functions.