INVENTORY MANAGEMENT

INTRODUCTION

Inventories constitute the most significant part of current assets for a large majority of

companies in India. On an average, inventories are approximately 60 percent of current

assets In public limited companies in India.

Because of the large size of inventories maintained by firms, a considerate

amount of funds is required to be committed to them. It is , therefore, absolutely

imperative to manage inventories efficiently and effectively in order to avoid

unnecessary investment.

A firm neglecting the management of inventories will be jeopardizing its long run

profitability and may fail ultimately. It is possible for a company to reduce its levels of

inventories to a considerable degree, e.g., 10 to 20 percent, without any adverse effect

on production and sales, by using simple inventory planning and control techniques.

The reduction in ‘an excessive inventory carries a favorable impact on a company’s

profitability.

What is inventory management?

Effective inventory management is all about knowing what is on hand, where it is in use,

and how much finished product results.

“Inventory management is the process of efficiently overseeing (supervising) the

constant flow of units into and out of an existing inventory.” This process usually

involves controlling the transfer in of units in order to prevent the inventory from

becoming too high, or dwindling (diminishing) to levels that could put the operation of

the company into jeopardy (harm/failure). Competent inventory management also seeks

to control the costs associated with the inventory, both from the perspective of the total

value of the goods included and the tax burden generated by the cumulative value of

the inventory.

Balancing the various tasks of inventory management means paying attention to

three key aspects of any inventory.

Three aspects of any Inventory

The first aspect has to do with time. In terms of materials acquired for inclusion in

the total inventory, this means understanding how long it takes for a supplier to

process an order and execute a delivery.

Inventory management also demands that a solid understanding of how long it

will take for those materials to transfer out of the inventory be established.

Knowing these two important lead times makes it possible to know when to place

an order and how many units must be ordered to keep production running

smoothly.

Calculating what is known as buffer stock is also key to effective inventory

management. Essentially, buffer stock is additional units above and beyond the

minimum number required to maintain production levels. For example, the manager

may determine that it would be a good idea to keep one or two extra units of a given

machine part on hand, just in case an emergency situation arises or one of the units

proves to be defective once installed. Creating this cushion or buffer helps to minimize

the chance for production to be interrupted due to a lack of essential parts in the

operation supply inventory.

Inventory management is not limited to documenting the delivery of raw materials and

the movement of those materials into operational process. The movement of those

materials as they go through the various stages of the operation is also important.

Typically known as a goods or work in progress inventory, tracking materials as they are

used to create finished goods also helps to identify the need to adjust ordering amounts

before the raw materials inventory gets dangerously low or is inflated to an unfavorable

level.

Finally, inventory management has to do with keeping accurate records of finished

goods that are ready for shipment. This often means posting the production of newly

completed goods to the inventory totals as well as subtracting the most recent

shipments of finished goods to buyers. When the company has a return policy in place,

there is usually a sub-category contained in the finished goods inventory to account for

any returned goods that are reclassified as refurbished or second grade quality.

Accurately maintaining figures on the finished goods inventory makes it possible to

quickly convey information to sales personnel as to what is available and ready for

shipment at any given time.

In addition to maintaining control of the volume and movement of various inventories,

inventory management also makes it possible to prepare accurate records that are used

for accessing any taxes due on each inventory type. Without precise data regarding unit

volumes within each phase of the overall operation, the company cannot accurately

calculate the tax amounts. This could lead to underpaying the taxes due and possibly

incurring stiff penalties in the event of an independent audit.

NATURE OF INVENTORIES

Inventories are stock of the product a company is manufacturing for sale and

components that make up the product. The various forms in which inventories exist in a

manufacturing company are: raw materials, work-in-progress and finished goods.

Forms of Inventories

Raw materials

Work-in-process

Finished goods

Raw materials :

Raw materials are those basic inputs that are converted into finished product

through the manufacturing process. Raw material inventories are those units

which have been purchased and stored for future productions

Raw materials are considered to be the input for the commencement of

manufacturing process. If there is no input , there is no transformation. Similarly if

there is no raw material then there is no manufacturing and further more there is

no finished products\Finished goods. So acquisition of raw material is the basic

step in order to achieve a finished product.

Raw materials are being purchased from suppliers keeping in mind the elements

of lower possible cost and best availability of quality within the raw material

purchased \ acquired.

Work-in-process

Work-in-process are semi manufactured products. They represent products that

need more work before they become finished products for sale.

When raw material is being acquired, the operations department starts to

process or transform the raw material in such a way that it is in the state of

neither raw material nor finished product.

The material is being processsed in such a way that it is nearly a finished product

but it requires some final touch-ups to take a concrete shape in terms of quantity

as well as quality before it reaches in the hands of a consumer. Whatever the

remaining requirements, are being fulfilled in the next step i.e. finished goods.

Finished goods

Finished goods inventories are those completely manufactured products which

are ready for sale. Stocks of raw material and work-in-progress facilitate

production, while stock of finished goods is required for smooth marketing

operations. Thus, inventories serve as a link between the production and

consumption of goods.

The levels of three kinds of inventories for a firm depend on the nature of its business.

A manufacturing firm will have substantially high levels of all three kinds of inventories,

while a retail or wholesale firm will have a very high level of finished goods inventories

and no raw material and work-in-progress inventories. Within manufacturing firms, there

will be differences. Large heavy engineering companies produce long production cycle

products; therefore, they carry large inventories. On the other hand, inventories of a

consumer product company will not be large because of short production cycle and fast

turnover.

Firms also maintain a fourth kind of inventory, supplies or stores and spares. supplies

include office and plant maintainance materials like soap, brooms, oil, fuel, light bulbs,

etc. These materials do not directly enter into production, but are necessary for

production process. Usually these supplies are small part of the total inventory and do

not involve significant investment. Therefore, a sophisticated system of inventory control

may not be maintained for them.

NEED TO HOLD INVENTORIES

The question of managing inventories arises only when the company holds inventories.

Maintaining inventories involves tying up of the company’s funds and incurrence

(unfavorable situation) of storage and handling costs.

Now the question arises, If it is expensive to maintain inventories, Why do companies

hold inventories?

There are several motives for holding inventories

Transactionary motive :

Transactionary motive emphasizes the need to maintain inventories to facilitate

smooth production and sales operations.

Precautionary motive :

Precautionary motive necessitates (compels/forces) holding of inventories to

guard against the risk of unpredictable changes in demand and supply forces

and other unseen factors.

Speculative motive :

Speculative motive influences the decision to increase or reduce inventory levels

to take advantage of price fluctuations.

This motive mainly aims to get advantage from fluctuations in price and

emphasizes on whether to purchase new inventory in case of reduction in price.

It also emphasizes on whether to utilize or sell the current inventory in case of

increase in price.

So, speculative motive aims at serving the purposes of cost reduction and profit

maximization.

To meet variations in customer demand :

Inventories are also being held in companies to meet variations in customer

demand. As we know customers are the people who demand particular product

or service and their demand changes according to the changes in their tastes

and preferences as well as market trends. So, we don’t know what would be the

exact level of demand of a particular product in near future; it may be higher or

lower as compared to the previous demand levels of a particular product.

So inventories are being held by companies in expectation of

higher level of demand by the customers and also to ensure to meet seasonal

demand.

Process and supply surprises

Internal surprises: If there is an unfavorable event occurred in operations like

machine breakdown, in such case there would be spoilage of inventory which

was occupied by the machine then the extra level of inventories which were held

can be utilized when the machine is ready to perform. This would help to

overcome the gap which could have been occurred in case of absence of the

extra level of inventories held.

External surprises: Sometimes it may happen that the supplier of raw material

is unable provide demanded level of material in stipulated time. In such case to

ensure the smooth flow of operation, the production/operation manager utilize the

inventories which are kept aside to meet these kinds of unexpected situations.

Transit :

Some inventories like petrol, diesel have attribute of evaporation. They tend to

evaporate if are kept open. They also tend to evaporate in small margin if it is

kept in an enclosed place. These kinds of inventories are also evaporated while

in transit. So in order to overcome such normal loss due to evaporation and other

unseen incidents in transit, companies hold inventories.