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| By N2H | ||||||||||||||||||||||
Inventory Management
August 9, 2008
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Inventory can be classified as supplies, raw materials, work-in-process and finished goods which are essential to a businesses’ operations. Inventory management depends heavily on sales because inventory is purchased earlier than sales can be made and poor inventory levels leads to either lost sales or excessive carrying costs. Any changes in the products’ demand should be worked into the company’s purchasing and manufacturing schedules thus coordination among the sales, purchasing, production and finance departments is important.
The goal of inventory management is to:
- Ensure that the inventories needed to sustain operations are available
- Hold the costs of purchasing and carrying inventories to the lowest possible level
Inventory costs are divided into three categories:
- Carrying costs: are associated with inventory and include cost of capital tied up, storage and handling costs, insurance, depreciation, taxes, losses due to deterioration, obsolescence, or theft. They rise in direct proportion to the average amount of inventory held.
- Ordering costs: include the costs of placing and receiving orders. Are considered to be fixed costs and decline as the number of orders decrease.
- Low inventory costs: results in the loss of sales, customer goodwill and disruption of production schedules.
OBJECTIVES OF INVENTORY CONTROL
- To ensure uninterrupted production. This is essential for smooth flow of production.
- To provide for required quality of materials - to ensure quality production.
- To minimize wastages and losses of materials due to carelessness in storing, issuing and handling.
- To control investment in inventories – to ensure optimum investment of capital in the purchase of materials.
REASONS FOR HOLDING INVENTORY
Stocks are held to increase sales and profits. When stock is held, production can continue uninterrupted to meet customer demands. However, holding stock can be expensive. The objective of a stock policy should be to minimize the total annual costs associated with stock. The total costs associated with stocks include:
- Purchase costs
- Holding stock
- Ordering stock
- Stock-outs (the costs of being without stock when it is needed).
Holding costs include interest on capital, the costs of storage space and equipment, administration costs and losses from deterioration, pilferage and obsolescence.. These costs can be minimized by keeping stock levels to a minimum.
Order costs are incurred every time stock is purchased from a supplier. Order costs include the buyer’s time spent contacting the supplier, and the storekeeper’s time spent checking the goods received. These costs can be reduced by placing orders only at infrequent intervals. But this would mean that the order quantities would have to be large to avoid stock-outs between the orders and this would increase holding costs. To minimize order costs and holding costs, businesses purchase materials in their economic order quantity (EOQ). The EOQ is the purchase order quantity that minimizes total order costs plus stockholding costs.
Stock-outs also incur costs. Customers might go elsewhere if the goods they require are out of stock. Similarly, production will be disrupted when there is no material to use. Buffer stock is a basic level of stock held for emergencies to cover unexpected demand for the stock item.
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