Inventory Management | Operations Management | Importance of Inventory | Inventory Cost | Dependent Demand | Independent Demand | Types of Inventory System | BBA Notes
Table of Contents
Inventory Management Definition
Inventory is a stock of goods in a firm for future use. In manufacturing, organization inventory refers to raw materials, parts and components, tools working progress, and finished goods. In a service organization, it refers to the tangible items to be sold and plays a vital role in the success of the organization. Inventory means not only maintaining stock. It refers to investment in the organization as well as the country. Therefore, inventory management is important in every organization. However, the management and control of inventory is a common problem for all organizations. There should be a good inventory policy and control to manage inventory.
Operation Management focuses on the conversion process of inputs into outputs of goods and services. It tries to maintain optimum inventory levels at each stock point to ensure a smooth flow of production. It also helps to meet the demand of customers at optimum cost.
Effective inventory management system is important operational management for the success of the business and supply chain. It affects operation, marketing, finance, customer satisfaction, etc. The different organization has a different type of inventory system which should fit the organization for effective business.
Importance of Inventory
Inventories play a vital role in every stage of business operation. Likewise, some of the importance of inventory management is explained below.
To take advantage of price discount
Inventory is maintained to gain economy in purchasing as suppliers offer a discount in a bulk purchase. Thus, to gain the price discount on materials any business must have good knowledge of inventory management.
For the smooth production requirements
The demand for products may fluctuate due to seasonality. So to fulfill such demand instantly inventory of finished goods is maintained to fulfill the fluctuated demand at any time.
To prevent loss of orders ( sales)
It is beneficial for a business to buy materials in bulk to take cost advantage. Similarly, bulk production also helps to reduce costs. It also helps to fulfill the order of every customer. In this competitive scenario, the business organization has to meet the delivery schedule at 100% service level so that, they cannot miss the delivery schedule. And it is assisted by the proper inventory management system.
To prevent uncertainties of demand and supply
When there is a proper inventory of finished goods any potential customers can be served. There would not be out of stock. Also during the renewal period business can easily supply the goods to any users. There will always be goods available at any kind of production disturbance, or strike, war, etc. Thus, good inventory management prevents such uncertainties.
To protect against stockouts
Delay in delivery and the unexpected increase in demand increases the risk of shortage. Delays can occur because of weather conditions, suppliers’ stock-outs, deliveries of wrong materials, quality problems, etc. The risk of shortage can be reduced by holding safety stock which helps to compensate for the variability in demand and lead time.
Types of Inventory Cost
Cost of inventory includes the price of raw materials, transportation, insurance, storage charge, etc. All these costs directly affect the price of goods to maximization of profit of an organization. Management should focus on the minimization of inventory costs. Inventory cost can be classified into the following categories.
Cost of items (purchase cost)
It is the price paid to the supplier or vendor for buying the items of inventories. It is the largest cost incurred in the business. It directly affects the cost of production.
Ordering cost/ Procurement cost/ setup cost/ Acquisition cost
It includes those cost which is incurred for placing an order or the setup cost. It focuses on the minimization of cost. It includes shipping cost, preparing invoice cost, cost of inspection of goods, etc. In general, it includes fixed cost and variable cost. Fixed cost does not depend on the number of orders whereas variable cost changes concerning the number of orders.
Carrying cost/ Holding cost/ Storage cost
It refers to physically having a certain level of items in-store or stock. The cost is directly proportionated to the amount of holding goods and the period of holding goods. The carrying cost includes interest, insurance, tax, depreciation, warehousing cost, etc. it also includes the opportunity cost of investing in the inventory.
Shortage cost
It refers to the shortage of stock to meet the demand of customers. It includes the cost of back or does, loss of goodwill, loss of private extra cost associated with urgency.
Dependent and Independent Demand
In inventory management, the demand for inventory can be classified into two types. That is dependent and independent demand.
Dependent Demand
It is directly related to the demand for other parts and components. The output of one production stage directly affects the availability of parts and components of the next stage of production. Instead of forecasting, dependent demand can be determined from the demand of other parts or components.
For example, if a car company plans to make 1000 new cars, then tire suppliers make a plan to supply 5000 tires including spares. Here, the production of a new car is dependent on the supply of tires.
Independent demand
It is the demand of product which is not interrelated to each other. It is created by outsiders like customers, competitors, etc. It should be forecasted by using various demand forecasting techniques. Retail items, grocery products, office supplies, etc are independent demand items. Independent demand items are final or finished products. It is determined by external market conditions. Thus, it is beyond the direct control of the organization.
Types of Inventory System
There are two types of inventory systems. They are;
Periodic Inventory System (P- model)
Under this system, inventory is counted in a fixed interval to determine the quality of inventory to place an order. In this system, order quantity depends on the actual quantity of the period. It is time-triggered, varies from time to time expanding upon usage rate. Generally, it requires a high level of safety inventory than the Q-model. It is also called a fixed-period inventory system. In this system, it is assumed that inventories can be counted as specific time intervals. As a result, it is unnoticed about stock position and storage.
Continuous Inventory System
This system first of all determines the fixed order quantity and reorder stock level. Fixed order may be in units or amounts but the reorder level should be in units. In another word, the order quantity of stock and order should be placed is pre-determined. Therefore it is also called fixed order quantity or perpetual inventory system or economic order quantity model (EOQ).
A fixed quantity of inventory is ordered when it reaches reorder level in this system. The order can be placed at any time which depends on the demand for the stock. Therefore, withdrawal and addition of stock should be recorded and mentioned regularly to update and ensure the reorder level.