Inventory Management

Definition

Inventories are Materials and supplies that a business or Institution carries either for sale or to provide inputs or supplies to the production process. It is responsible for planning and controlling Inventory from the supplier stage to the Customer. I.e. from the raw materials to the Finished Goods.

Inventories are classified as follows:

Raw Materials

Raw Materials are Purchased Items which includes purchased materials, component parts and subassemblies.

Work in Progress

Raw Materials that have entered the manufacturing process and are being worked on or waiting to be worked on.

Finished Goods

Finished Products of the production process that are ready to be sold as completed Items.

Maintenance, Repair and Operational supplies

Items used in production that do not become part of the product. Example: Hand Tools, spare parts, lubricants etc.,

Functions of Inventories

Inventory serve buffer between

Supply and Demand
Customer Demand and Finished Goods
Finished Goods and Component availability

Costs used in Inventory Management

Item Cost
Carrying Cost
Ordering Cost
Stock out Costs
Capacity-associated Costs

Item Cost

Item Cost is the price paid for a purchased item, which consists of the cost of the item and any other direct costs associated in getting the item into the plant. These could include such things as transportation, custom duties, and insurance. The inclusive cost is often called the landed price.

Carrying Cost

It Include all expenses incurred by the firm because of the volume of inventory carried.

Ordering Costs

Ordering costs are those associated with placing an order either with the factory or a supplier.

Stock out Costs

Stock out cost is expected when demand during the lead time exceeds forecast.

Capacity-associated Costs

Costs expected at the time of Hiring, overtime, extra shifts, training and layoffs.

Inventory cost - accounting methods

First in First out (FIFO)

The Oldest (first) Item in stock is sold first.
When price of an Item increased in Market, replacement is at higher price than the assumed cost.

Last in First out (LIFO)

The newest (last) item in stock is the first sold.
When price of an Item increased in Market, replacement is at current price.

Average Cost

Average cost is an average of all prices paid for an Item.

Example: Purchasing High Storage External Hard disk

First Day : 10 units 1000$
Second Day : 5 units 700$
Third Day : 10 units 900$
Average Cost Calculated as,

(QtyonHand*Curr.wght.Ave.cost) + (Transqty*Trans.Unit.cost)/(Qtyonhand + Trans.qty)
: 1000+700+900/25
: 104$

Due to changing in cost (increasing or decreasing), cost used in this method is not related to the actual cost.

Standard Cost

Standard cost commonly used in manufacturing and this can be determined before production starts. It includes direct, materials and overheads. Difference between the standard cost and actual cost (how much consumed) is stated as a variance.

ABC Inventory

ABC Inventory is a classification of Item, based on usage of Items and usage of dollars.

According to Pareto’s law,

A approx.20% of Items account for approx.80% of dollar usage
B approx.30% of Items account for approx.15% of dollar usage
C approx.50% of Items account for approx.5% of dollar usage

Cycle counting

Cycle count is a system counting inventory continually throughout the year.

Advantage of cycle counting

1. Timely detection and corrections of problems
2. Complete or partial reduction of cost.

Terms and formula used in Inventory Management

Inventory Turns:

Inventory turns = annual cost of goods sold/average inventory in dollars

Days of supply:

Days of supply = Inventory on hand/average daily usage

Stock Keeping Unit (SKU)

SKU is a unique combination of all the components that are assembled into the purchasable item. Therefore any change in the packaging or product is a new SKU. This level of detailed specification assists in managing inventory.Stock out means running out of the inventory of an SKU.