Defining INVENTORY MANAGEMENT
Inventory management is the supervision on non-capitalized assets also called as Inventory and stock items. It refers to the process of ordering, storing, and utilizing a company’s inventory. These include the management of raw materials, components, and finished products, as well as warehousing and processing finished products.
Inventory could be any of the following nature.
- Raw materials
- Finished Products
- MRO (Maintenance, Repair & Operations)
Inventory in any organization can be perceived as either Asset or Liability based on respective company policy. Inventory can be treated as one of the most valued asset, especially in retail, manufacturing, food & beverage and any other inventory concentric sectors where company’s Raw material and finished products are the core of its business, where non-availability of inventory when and where it’s required can be catastrophic.
In another perspective Inventory can be seen as Liability because of the fact that large amount of inventory holding carries a risk of additional storage cost, damage, theft or being obsolete which becomes a liability to the company, in such cases the inventory had to issued out of the company’s books by various means like selling at lower price, scrapped or destroyed.
Due to this, Inventory management is one of the key areas in Supply chain management, especially in the industries with volatile Demand patterns.
And most importantly Inventory should always be insured to mitigate any loss incurred in inventory due any reason, so it is also important to keep the inventory levels within the Insurance coverage limits to make sure the company doesn’t lose financially in case of any unfortunate events.
IMPORTANCE OF INVENTORY MANAGEMENT
Skill full management of inventory is very important in today’s competitive business environment, in any inventory concentric business whether its Manufacturing or Retail a lot of investment by the firm is tied up in inventory, hence a good inventory management should aim at reducing the inventory holding, while ensuring the product availability.
For the companies who run complex supply chains in manufacturing and distribution, balancing the risk of excess or shortage of Inventory is especially very difficult.
Inventory management practices vary from industry to industry, a hardware or metal business can carry large amount of inventory for a longer period and can wait for demand to pick up, whereas for perishable goods like food and in fashion clothing industry where the change in trend is frequent, sitting on large inventory is not an option, where misjudging the time and demand can be costly.
For these reasons and many more, inventory management is very important, a good inventory management practice not only helps in reducing the capital employed but also directly results in good customer satisfaction.
TYPES OF INVENTORY
- RAW materials.
- Work-In-Progress.
- Finished Goods.
- Transit Inventory
- Decoupling Inventory.
- Buffer Inventory.
- Anticipation Inventory.
- Cycle Inventory.
- MRO Inventory.
RAW MATERIALS
Raw materials are inventory items that are used in the manufacturer’s conversion process to produce finished products, this activity is also known as WIP. These inventory items may be commodities or extracted materials that the company has produced or extracted. They also may be materials or commodities that the company has purchased from outside the organization. Even if the item is partially assembled or is considered a finished good to the supplier, the purchaser may classify it as a raw material if the company had no input into its production. Typically, raw materials are commodities such as ore, grain, minerals, petroleum, chemicals, paper, wood, paint, steel, and food items. However, items such as nuts and bolts, ball bearings, key stock, casters, seats, wheels, and even engines may be regarded as raw materials if they are purchased from outside the firm.
WORK-IN-PROCESS
Work-in-process (WIP) is a combination of all the materials, parts, assemblies, and sub-assemblies that are being processed or are waiting to be processed within the manufacturing unit. This generally includes all material—from raw material that are awaiting to be processed up to material that has been completely processed and is awaiting final inspection and approval before inclusion in finished goods.
This is the stage where all the Raw materials are pulled in to WIP process and assembled or converted into final product.
FINISHED GOODS
A finished good is a completed part that is ready for a customer order. Therefore, finished goods inventory is the stock of completed products. These goods have been inspected and have passed final inspection requirements so that they can be transferred out of work-in-process and into finished goods inventory. From this point, finished goods can be sold directly to their final user, sold to retailers, sold to wholesalers, sent to distribution centers, or stored in warehouses for future demand.
Below diagram illustrates the basic material flow in a Car manufacturing process, it list outs the raw materials required and the transition of these raw materials into finished goods moving through the WIP process.
Inventories can be further classified according to the purpose they serve, Viz., transit inventory, buffer inventory, anticipation inventory, decoupling inventory, cycle inventory, and MRO goods inventory. we will now discuss each in more detail.
TRANSIT INVENTORY
Transit inventories result from the need to transport items or material from one location to another, and from the fact that there is some transportation time involved in getting from one location to another. Sometimes this is referred to as pipeline inventory. Shipment can sometimes take days or even weeks to go from a source location to destination location. Some large firms, which have multiple source locations appoint freight consolidators to pool their transit inventories from various locations into one shipping source to take advantage of economies of scale. This can greatly increase the transit time for these inventories, hence an increase in the size of the inventory in transit.
BUFFER INVENTORY
Sometimes firms needs to have certain levels of additional Inventories to mitigate the risk of uncertainties in supply and demand, as well as unpredictable events such as poor delivery reliability or poor quality of a supplier’s products or any event that will affect the primary resources required by the company throughout their supply chain . These additional inventories are often referred to as ‘safety stock’. Safety stock or buffer inventory is any amount held on hand that is over and above that currently needed to meet demand. Generally, the higher the level of buffer inventory, the better the firm’s customer service. This occurs because the firm suffers fewer “stock-outs” (when a customer’s order cannot be immediately filled from existing inventory) and has less need to back-order the item, make the customer wait until the next order cycle, or even worse, cause the customer to leave empty-handed to find another supplier. Obviously, the better the customer service the greater the likelihood of customer satisfaction. On the other hand if safety stocks or Buffer inventory is on higher side, the firm might risk the inventory running into obsolete in case of a sluggish demand.
ANTICIPATION INVENTORY
Sometimes firms are required to hold inventory that is more than their current need in anticipation of a possible future event. Such events may include a price increase, a seasonal increase in demand, or even a global or regional political issues or crisis such as war. This strategy is commonly used by retailers, who routinely build up inventory months before the demand for their products will be unusually high (i.e., Halloween or Christmas season). For manufacturers, anticipation inventory allows them to build up inventory when demand is low (this also helps in optimally running the production line and work force during slack time) so that when demand picks up the inventory will be slowly consumed and the firm does not have to react by increasing production time increase in hiring, training, and other associated labour costs. This helps the company to avoid both excessive overtime due to increased demand and hiring costs due to increased demand. It also avoids layoff costs associated with production cut-backs, or the idling or shutting down of facilities.
DECOUPLING INVENTORY
Very rarely, if ever, will one see a production facility where every machine in the process produces at the same rate. In fact, one machine may process parts several times faster than the machines in front of or behind it. Yet, if one walks through the plant it may seem that all machines are running smoothly at the same time. It also could be possible that while passing through the plant, one notices several machines are under repair or are undergoing some form of preventive maintenance. Even so, this does not seem to interrupt the flow of work-in-process through the system.
Very often in a manufacturing unit the machines require repairs due to break down or sometime taken offline for preventive maintenance, this could affect the company’s production capacity and not able to meet the demand, thereby affecting the company’s customer service. In such cases Decoupling inventory comes to the aid, Decoupling inventory the reason for this is the existence of an inventory of parts between machines, a decoupling inventory that serves as a shock absorber, cushioning the system against production irregularities. As such it “decouples” or disengages the plant’s dependence upon the sequential requirements of the system (i.e., one machine feeds parts to the next machine).
The more inventory a firm carries as a decoupling inventory between the various stages in its manufacturing system, the less dependence is needed to keep the system running uninterruptedly. A balance should be reached that will allow the plant to run smoothly without maintaining a high level of inventory. The cost of efficiency must be checked against the cost of carrying excess inventory so that there is an optimum balance between inventory level and coordination within the system.
CYCLE INVENTORY
Those who are familiar with the concept of economic order quantity (EOQ) know that the EOQ is an attempt to balance inventory holding or carrying costs with the costs incurred from ordering or setting up machinery. When large quantities are ordered or produced, inventory holding costs are increased, but ordering or setup costs decreases. Conversely, when lot sizes decrease, inventory holding or carrying costs decreases, but the cost of ordering/setup increases since more orders/setups are required to meet demand. When the two costs are equal (holding/carrying costs and ordering/setup costs) the total cost (the sum of the two costs) is minimized. Cycle inventories, sometimes called lot-size inventories, result from this process. Usually, excess material is ordered and, consequently, held in inventory to reach this minimization point. Hence, cycle inventory results from ordering in batches or lot sizes rather than ordering material as demand dictates.
MRO GOODS INVENTORY
Maintenance, repair, and operating supplies, or MRO goods, are items that are used to support and maintain the production process and its infrastructure. These goods are usually consumed because of the production process but are not directly a part of the finished product. Examples of MRO goods include oils, lubricants, coolants, janitorial supplies, uniforms, gloves, packing material, tools, nuts, bolts, screws, shim stock, and key stock. Even office supplies such as staples, pens and pencils, copier paper, and toner are considered part of MRO goods inventory.
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