Inventory Management: Maintenance a Balance Between Stock and Profit
(Source: http://cepr.org)
Inventory Management: Maintenance a Balance Between Stock and Profit
By Reinaldo Ragil Rompas
The ordering, storing, using, and selling of a company’s inventory is referred to as inventory management. This involves managing the components, raw materials, and final goods in addition to processing and storing them. Depending on the needs of a company, there are various types of inventory management, each with pros and cons. It can be difficult to manage inventory effectively, though. While having too much inventory can increase storage costs and freeze working capital, having too little inventory can result in lost sales.
Benefit
Inventory is one of a company’s most valuable resources, especially In industries such as retail, manufacturing, and food services, as well as in inventory-intensive industries, an organization’s inputs and finished goods are at the heart of its operations. A lack of inventory where and when it’s needed can have serious consequences. On the other hand, inventory can also be considered as a liability (although not necessarily in the accounting sense). With a large inventory, there’s always the risk of it spoiling, being stolen, damaged, or changing demand. You’ll need to insure it, and if you don’t sell it in time, you’ll likely have to sell it at clearance prices — or worse, throw it away. All of this means that inventory management is essential for businesses of all sizes, so it’s necessary for figuring out when to replenish inventory, how much to buy or produce, how much to pay, when to sell, and what price to sell it at can quickly become complicated decisions.
Types of Inventories
There are three methods, which are usually used for inventory accounts: first-in, first-out (FIFO) costing; last-in, first-out (LIFO) costing; or weighted average cost. Inventory types typically consist of four separate categories:
- Raw Materials, every product starts as raw materials. These could be anything from metal and plastic to fabric and wood. These materials are delivered by suppliers and used in the initial stages of production.
- Work in Progress, not quite finished products yet. WIP refers to items partially completed as they move through the production process. The cost of labor, raw materials, and equipment used for WIP is eventually factored into the final price of the product.
- Finished Goods, the culmination of the production process. Finished goods are complete products ready for customers to buy. When a WIP is finished, it joins the ranks of finished goods inventory, waiting to be sold.
- MRO stands for maintenance, repair, and operations goods. These are the essential supplies that keep the production process going, such as safety gear, office supplies, and cleaning equipment. While not part of the final product, MRO is vital for overall production efficiency.
Inventory Management Methods
Businesses need the right tools to keep their inventory levels in check. This depends on the kind of business they run and the products they sell. Here are four of the most common methods used to analyze and manage inventory, including Just-in-Time (JIT), Material Requirement Planning (MRP), Economic Order Quantity (EOQ), Days Sales of Inventory (DSI). These are the most common methods in Inventory Management.
1. Just-in-Time (JIT)
This inventory management helps companies save money and reduce waste by having minimal stock on hand. This cuts storage, insurance, and excess inventory disposal costs. However, JIT is risky. Unexpected demand surges or delays in receiving key supplies can cause production stoppages, leading to unhappy customers and lost business.
2. Material Requirement Planning (MRP)
MRP is an inventory management method that relies heavily on accurate sales forecasts. Manufacturers using MRP need good sales data to plan their inventory needs and communicate them to suppliers on time. This ensures they have the right materials in stock to fulfill forecasted orders. If sales forecasts are inaccurate, manufacturers using MRP risk not having enough materials to meet demand, leading to unfulfilled orders.
3. Economic Order Quantity (EOQ)
The Economic Order Quantity (EOQ) helps businesses optimize inventory ordering by calculating the ideal order size. This minimizes total inventory costs, which include storage fees (holding costs) and the cost of placing new orders (setup costs). By finding the right order quantity, companies avoid frequent small orders (high setup costs) or holding too much inventory (high holding costs). Essentially, EOQ helps strike a balance between these two cost factors.
4. Days Sales of Inventory (DSI)
Days Sales of Inventory (DSI) is a metric that tracks how long it typically takes a business to sell its current inventory. Sometimes called “average age of inventory,” DSI helps businesses monitor sales and inventory levels to understand how quickly products are moving.
In conclusion, Inventory management is an important process that can help businesses achieve operational efficiency and increase profitability. By implementing the right inventory management method, businesses can maintain a balance between having sufficient inventory to meet customer demand and avoiding unnecessary costs due to excess inventory.
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