Inventory Management is a system by which stock is tracked as it enters and leave a destination whether your warehouse, seller or final point of sale. It involves inventory decisions like ordering, storage, processing, warehousing, supervising and re-ordering.

For any organization, inventory can be the biggest contributor of operating expenses. On one hand, low stock maintenance may lead to stock out situations; and contrary to this, high stock maintenance may lead to higher working capital requirement and increased cost of operations. To balance both of these situations, you must know various aspects of inventory management. A well-managed approach will help you prevent stock outs, allow for ample lead-time to replenish stock, and give you an idea of the value tied up in your stock at any given time.

Why is Inventory Management Important?

  • More profitability by lowering cost of goods sold

Application of sound inventory management principles will result in optimum inventory count and thereby help in elimination of unnecessary carrying cost and ordering cost, facilitating purchase economies and reducing shortage costs like disrupted production, idle time, etc.  to the best of business interests.

  • Accurate Inventory Record maintenance

Inventory record errors are costly, and no business will function properly if the transactions are not entered correctly at the right time. Unanticipated stock outs, unaccounted obsolete inventory, invalid data for inventory replenishment, high investment in slow moving stock, all of these can cause increased production costs and reduced profits.

  • Reduced Inventory Investment

If a business recognizes precisely what inventory size is needed and when to deploy them, it can free up other capitals for re-investment.

  • Increased sales and better customer satisfaction

Inventory control and planning is crucial for small business to know what products are selling more than others. This will enable them to adjust their product line and to make intelligent business decisions. On the contrary, inadequate inventory management can lead to a loss in sales due to unavailability of product at the time required, and poor customer satisfaction due to irregular product supply and delay in deliveries.

  • Increased efficiency

Without adequate inventory management, business can end up paying more for unproductive activities like manual record keeping, clearing stock reconciliation discrepancies, preparing multiple spreadsheets for calculating inventory value, manually writing all reports, or visit the warehouse every time there’s uncertainty regarding stock. Instead of wasting money on these tasks, it is better to substitute them with a good inventory management system.

 

Optimizing inventory costs:

Inventory decisions require a gentle balance between three classes of cost. These costs are:

  • Ordering Cost-

These are the costs of replenishing Inventory. Ordering costs include the cost associated with actually placing the order. These include labor costs as well as a material and overhead costs.

Some components of ordering costs are:

  • Time spent finding suppliers and expediting orders
  • Clerical costs of preparing purchase orders
  • Transportation costs
  • Receipt of inwards goods and unloading costs
  • Inspection and transfer costs

The more the number of orders, the higher will be the ordering cost. Hence ordering costs can be improved by reducing the number of orders.

 

  • Carrying Cost-

The costs of holding an item in inventory and include the cost of financing the inventory along with the cost of physically maintaining the inventory. Some components of carrying costs are:

  • Financing expenses
  • The cost of storage space and warehousing
  • Security, means securing restricted or hazardous materials
  • Insurance against theft, loss or damage
  • Opportunity cost – cost of capital tied up in inventory that could be spent elsewhere
  • Deterioration, theft, spoilage, or obsolescence

Holding costs will increase as we try to increase the order size to reduce ordering costs. Therefore, while trying to reduce the ordering costs, it would be better to consider the incremental holding costs that might have to be incurred in this regard and the decision should be taken where both of these costs can be optimized.

 

  • Shortage Cost-

These are the costs associated with temporary or permanent loss of sales when demand cannot be met. These also include additional costs associated with filling back orders through expedited shipping or replenishing stock at higher than wholesale prices. Some examples are given below:

  • Loss of time when raw materials are not available
  • Cost of shrinkage, pilferage and obsolescence
  • Idle employee time
  • Lost sales
  • Dissatisfied customer and loss of market share

 

You must analyze your business and understand the three categories of inventory costs. This will help your business to identify what works the best.

 

Adverse relationships will often exist between ordering costs and carrying costs. Higher orders placed less frequently will minimize ordering costs but will lead to an increase in carrying costs. So, reducing your carrying costs means placing smaller more frequent orders, which subsequently increases ordering costs for the period. Also, you can run into shortage costs if the smaller orders are not covering current demand.

 

A good inventory management system will be necessary to identify these costs and streamline operations to ensure accurate forecasting and real-time monitoring of inventory.

 

Inventory Analysis methods/Techniques:

There are variety of methods which a business can adopt based on the product line or whether you are a manufacturer, retailer or distributor. Some of the most popular inventory control models are listed below:

 

Economic Order Quantity (EOQ):

Economic Order Quantity model helps in determining the order quantity that minimizes the costs of ordering and holding inventory. It helps to lower down the total inventory cost by answering the following two questions:

1) How much should I order? (Economic Order Quantity)

2) How often should I place each order? (Cycle Time)

 

WHERE,

D=Demand in units (typically on an annual basis)

S=Order cost (per purchase order)

H=Holding costs (per unit, per year)

 

Total Inventory Cost = (Average Inventory)(Holding cost per unit) + (Number of orders per year)(Ordering cost per order)

 

Advanced version of this model includes consideration of safety stock, lead time, etc. Lead time is the time between an order is placed until it is received however safety stock is just like adding a buffer to a forecast. So, the reorder point, in terms of the inventory level, will be the daily demand rate multiplied by the lead time, plus the safety stock if required.

Just-In-Time Method:

Under the JIT philosophy, the aim is to keep all inventories as low as possible. The vital system to the JIT method is the “pull” approach to control manufacturing. Any inventory holding costs are unproductive and wasteful. Moreover, under JIT purchasing, ordering costs are diminished by dropping the number of vendors, negotiating long- term supply agreements, making less frequent payments, and eliminating inspections. The suggestion of the JIT philosophy is that inventories should be minimized by more regular deliveries in reduced quantities.

 

Under JIT, quality and productivity are key and equal partners. As quality improves, so does

productivity,  as  only  good  units  are  assembled.  No  work  is  wasted  on  preparing  inferior  quality

items. Both are necessary in the JIT philosophy.

The principle of null/zero inventory in JIT system involves production flow to be a “pull system” that

declines workers waste time, in other words, workers waste time can be decreased through multi-

purposes  activities.  Workers perform  some  operations  such  as  switching  one  machine  to  another

one, preventive maintenance, machineries tune up and preparation. Multi-purposes skills increase

workers efficiency, a purpose which is achieved by proper training.

Under JIT, quality and productivity are key and equal partners. As quality improves, so does

productivity,  as  only  good  units  are  assembled.  No  work  is  wasted  on  preparing  inferior  quality

items. Both are necessary in the JIT philosophy.

The principle of null/zero inventory in JIT system involves production flow to be a “pull system” that

declines workers waste time, in other words, workers waste time can be decreased through multi-

purposes  activities.  Workers perform  some  operations  such  as  switching  one  machine  to  another

one, preventive maintenance, machineries tune up and preparation. Multi-purposes skills increase

workers efficiency, a purpose which is achieved by proper training.

Components/Tools of JIT:

  1. Factory Layout Revision
  2. Set up time Reduction
  3. “PULL” system of production – each work station pulls the output from the preceding station as it is needed; the output of final operation is pulled by the customer demand or the master schedule.
  4. Better co-ordination with suppliers – factories can work with suppliers to reduce raw material inventories and solve quality problems.
  5. Flexible workforce-  to  ensure  a  smooth  production  process,  it  is necessary that the workers be skilled in number of functions to be able to  operate  different  types  of  machines  required  for  different  jobs
  6. Automated  production
  7. Preventive maintenance – since JIT emphasize no work-in-process inventory between the work stations, any unplanned machine break down can cause the plant disruption. Preventive maintenance is provided on scheduled basis which reduce the frequency and duration of machine breakdown.

 

ABC Analysis

ABC analysis is a classification method based on the Pareto Principle to determine which items should get priority in the management of a company’s inventory. This analysis classifies items based on their annual consumption value.  An example of ABC analysis using Pareto’s Principle:

A: 10% of total inventories contribute 70% of total consumption value.

B: 20% of total inventories, contributing 20% of the total consumption value.

C: 70% of total inventories, contributing 10% of the total consumption value.

 

Annual consumption value = annual demand x item cost per unit

 

Through this technique, it can be determined which goods bring in the most value and accordingly separate those from the numerous goods that provide little profit.

 

Other Methods:

Other methods include inventory control using different analysis, such as:

  1. FSN Analysis (Fast, Slow moving and Non-moving inventory)
  2. VED Analysis (Vital, Essential, Desirable)
  3. SDE Analysis (Scarce, Difficult, Easy)
  4. HML Analysis (High, Medium, Low)

 

Are you all set? Ask yourself if transfers of inventory between locations are quick, easy, and accurately recorded. Or do you wait to reorder inventory based on discovering you are running low or out? The answers can result in your success or failure.

Inventory Management is one of the crucial components in the Supply Chain cycle. Many businesses bank on manual tools such as Excel and Google Sheets to manage Inventory and make significant ordering decisions. But, knowing when to reorder, how much to order, where to store stock, and so on can quickly become a complex process.

Managing inventory through sound calculations, inventory management systems and automation can give you the confidence you need to grow your business successfully.

At MAS, we can support you with a precise Inventory Management strategy based on the types of products being sold and the channels being used to sell these products, plus ensuring the accurate record keeping. This way you minimize the stock out situations and have a well-balanced approach which can minimize the working capital and operational cost and also raise cash flows by not less than 30%. Our services include:

  • Setting up inventory control system
  • Review of current processes to make them better
  • Inventory accounting
  • Inventory audits
  • Analysis of Inventory turnover performance

Please leave your comments and tell us if you tried any of the tips and how it went.

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