Inventory Control – An Introduction

Inventory Control

Learning Objective:

To know the meaning, types and functions of inventories

Meaning of Inventory:

The word inventory refers to any kind of resource having economic value and is maintained to fulfil the present and future needs of an organization.

Fred Hansman has defined Inventory as “An idle resource of any kind provided such a resource has economic value”. Such resources may be classified into three categories:

A. Physical resources such as raw materials, semi-finished goods, finished goods, spare parts, lubricants etc.

B. Human resources such as unused labor (man power) and

C. Finance resources such as working capital etc.

Inventory of resources is held to provide desirable service to customers and to achieve sales turnover target. At the same time holding big inventory severely affects the cash flow and working capital of an organization if the production vs demand cycle is not stream-lined. Because inventory often represents more than 25% of total assets and therefore it becomes very essential to maintain an optimal level of inventory in each resource so that the total inventory cost is near its minimum.

Functions of Inventory:

Inventory serves several important functions that add flexibility to the operations of a firm.

• Provides stock of goods to meet the anticipated demand of customers. In the case of consumer goods with a seasonal demand, the establishment of inventories in distribution and production warehouses also ensures that production can run continuously at full capacity despite swings in seasonal demand.

• De-Coupling function: The down time in one manufacturing stage should not affect the whole manufacturing process and this vital purpose is solved by holding inventory which acts as a buffer between successful stages of production.

• Quantity Discounts: Many suppliers offer QD’s for large orders of inventory. Procurement warehouses can result from a company’s desire to get volume discounts from a supplier or more favorable conditions from a carrier.

• Price speculation – Inventory also helps to hedge against inflation and price changes. Inventories of procurement and distribution warehouses are increased if the price of a good is expected to rise. In such a situation, the purchasing company aims to amass the good at the current low price. The supplier may speculate that supply shortages will drive the prices higher, and he uses the warehouse to store the good.

• Shortages can occur regularly due to irregular supply of raw materials, weather, quality problems or improper deliveries. Inventory shall act as “safety stock’ – extra goods on hand which reduce the risk of stock-outs.

• Helps to permit operations to continue smoothly with the use of “work in process” inventory. This is because it takes time to make goods and because a pipeline inventory is stocked through-out the process.

Types of Inventory:

Inventory can be classified according to the basis of type of material maintained in the firms and also on the basis of the functions they tend to perform in an organization.

On the basis of type of material, the firms maintain four types of inventories:

1. Raw material inventory
2. Work in process inventory
3. Maintenance/operating supply (MRO) inventory and
4. Finished goods inventory

Raw material inventory is the one which has been purchased and yet to be processed. The work in process material has undergone some change but is not completed. Work in process exists because of the time it takes for a product to be made which is called the “CYCLE TIME.”

MRO inventory is devoted to maintenance/repair/operating supplies. They exist because the need and timing for maintenance and repair of some equipment are unknown.

Products completed and waiting for shipment are called finished goods inventory. Finished goods may be inventoried because customer demand for a given time period may be unknown.

Functional Classification of Inventories:

Lot-Size or Cycle Inventories:

These exist whenever one produces or buys in larger quantities than are actually needed to satisfy the immediate requirements.