Inventory, Inventory Control – Theory Notes

Inventory simply means ‘a stock of goods’. It can simply be divided into three categories i.e. raw materials, finished goods, and work in process. It is any tangible property that is:

• held for sale in the ordinary course of a business (Finished Goods)
• held in the production process (Work in process)
• consumed in the production process (Raw Materials)

It includes –

• Raw Material
• Consumables
• Finished goods
• Supplies and spares
• Equipment and Components

According to Bolten S.E., “It refers to a stock-pile of a product, a firm is offering for sale and components that make up the product.”

 

Motives for Holding Inventory

• Transaction Motive i.e. finished goods for the purpose of sale, raw materials for production.
• Precautionary Motive i.e. raw materials and finished goods to meet unforeseen circumstances or emergencies
• Speculative Motive i.e. to capitalize on market opportunities (shortage in market) and make profit

Types of Inventory

(1) Movement Inventory – It refers to stock of goods that take substantial amount of time to be transported from one place to another. They are also known as transit inventories.

(2) Buffer Inventory – Goods held in stock to meet the uncertainties related to demand and supply of goods are called buffer inventories. These are goods that require a substantial lead time (time taken between placing an order and having the good ready for use) and hence are held in excess of the expected demand to meet emergency situations and fluctuations in demand or supply.

(3) Anticipation Inventories – It refers to stock of goods that are held in bulk due to an anticipated shortage or expected demand rise in the future. For e.g. Rain coats and Umbrellas kept in stock just before a rainy season, or stock of Air conditioners before summers.

(4) Decoupling Inventories – Stock of goods held between different stages in a production process to decouple or disengage one stage from the other are known as decoupling inventories. The main purpose of holding such goods is to ensure smooth running of the production process, therefore, even if one machine required for a particular stage breaks down, work on other stages in production won’t be hampered.

(5) Cycle Inventories – Cycle inventories are maintained for goods that are sold in bulk or big quantities, therefore, rather than making frequent purchases in small amounts which increases the cost of obtaining the products, goods are bought in very large lots to reduce to cost of obtaining goods.

 

Inventory Costs

• Purchase Costs – Cost of purchasing raw materials from various sources.
• Ordering Cost / Procurement Cost – Cost associated with replenishment of raw material i.e. processing of order, transportation, quality inspection etc.
• Carrying Cost / Holding Cost – Cost related to storage of goods like rent of warehouse, electricity, heating and lighting, staff salaries etc.
• Stock Out Cost – Cost associated with lack of goods or not serving the customers due to shortage of goods

Inventory Control

It refers to the process employed to maximize a company’s inventory.  It is a systematic control and regulation of purchases, storage and usage of materials to maintain a smooth flow in production and to avoid excessive investment in inventory.

Inventory System / Policy – A set of policies and controls that monitor stock levels and determine

• What inventory level should be maintained?
• When stock should be replenished?
• Quantity of stock that should be purchases?

 

Methods of Inventory Control

• FIFO (first in first out) – This method assumes that goods that are added to the inventory first must also be removed from the inventory first i.e. goods that are bought first must be sold first. This method is generally used by firms dealing with perishable goods or goods that are subjected to quick obsolescence.
• LIFO (last in first out) – This method assumes that goods that are added to the inventory last must be sold first or removed from the inventory first. This method is usually used by firms dealing with goods that are not perishable or do not become obsolete quickly.

 

Techniques of Inventory Control

 

• EOQ Model – Economic Order Quantity
• ABC Analysis – Always Better Control
• HML Analysis – High, Medium, Low
• VED analysis – Vital, Essential, Desirable
• MRP – Material Requirement Planning
• Max Mini System
• Two Bin system
• Buffer Stock
• JIT – Just in Time etc.