Inventory represents a very important part of any business. Businesses that produce and/or sell goods hold inventory for production and resale. Businesses that provide services use inventories in the provision of services. Having inventory available as and when required is important and much money and time are spent on inventory management. The objectives of inventory management include maintaining availability, arriving at pricing, working capital management, eliminate duplication, lowering ordering costs and maintaining accurate records.
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What is Inventory Management?
Inventory management is a systematic approach to sourcing, storing, and selling inventory—both raw materials (components) and finished goods (products). This includes the management of raw materials, components, and finished products, as well as warehousing and processing such items as and when needed. We can see that inventory management has a lot of tasks involved and therefore multiple inventory management objectives can be identified. Many techniques and methods are used in inventory management to achieve their objectives.
Ensure a continuous supply of materials
In a manufacturing business, there are many concerns when it comes to the production and timing of the goods produced. A basic objective of inventory management is to ensure the supply of raw materials for production is always available when needed. Failure to do so may result in lost business with customer demand going unmatched. The same can be said of service businesses which rely on inventories to provide services. Take a cleaning business, for example, they require cleaning chemicals to provide their cleaning services. So the sup[ply of inventory is just as important to them as it is to a manufacturing business.
To avoid both overstocking and under-stocking of inventory.
In the pursuit of making sure goods and services are always available for customers a business cannot simply stock up on inventories. Firstly the business would tie money up in inventory which is also need to process the finished goods or pay for other parts of services. Secondly, there are costs associated with storing and organising inventory that must be considered. Inventory management’s objective is finding a balanced level of inventory for the business to hold without over or under-stocking. Overstocking would result in losses through the opportunity cost of tying up money in inventory that is not being utilised. Under-stocking costs could result in loss of business and costs of stopping production due to material shortages.
To maintain minimum working capital
As pointed out earlier inventory can represent a large amount of money invested by a business. If inventory levels among other working capital items are not managed carefully this threatens the liquidity of the business in the short term and long term solvency. Working capital management is an important inventory management objective. In the working capital cycle, businesses put money into inventory or raw materials which are processed then sold at a profit. This increases working capital. Holding inventory does not bring profit but rather selling it. Managing inventory levels to meet demand is critical to keeping the working capital cycle working to the advantage of a business.
To optimize various costs indulged with inventories
Inventory has more costs than just the cost of the items. Warehousing, carriage, and other ordering costs can constitute a heavy expenditure by an organisation. Another clear inventory management objective is the optimisation of these additional costs to inventory. A simple example is reducing the carriage costs by ordering the maximum quantity that can be held in storage in a single order rather than splitting it into several orders each incurring its own carriage cost. There are other considerations in the process though. Increasing the quantity purchased can also take advantage of fixed costs such as insurance, security and other warehouse related costs.
To minimize loss
Another important inventory management objective is minimising loss. Loss can occur for various reasons including deterioration, theft, damage and pilferage. Systems that keep regular inventory records make loss through pilferage more difficult. This inventory management objective is also responsible for the inventory management system known as FIFO – First In First Out. This, in the case of perishable materials, ensures that materials purchased first are sold or used first. This reduces the chances of perishable inventory being lost due to deterioration. Careful inventory management can also prevent damage to inventory. Given the huge investment that inventory can be it is understandable that this may be considered the most important objective of inventory management.
To facilitate furnishing of data
Another important inventory management objective is the provision of data for decision making and for costing. In a market where inventory prices change regularly, costing systems such as First In First Out (FIFO), Last in First Out (LIFO), Average Costing (AVCO) and Weighted Average Costing (WAVCO) can all be employed depending on the market conditions. These systems require regular data from inventory management to accurately provide information to management. The cost at which inventory was acquired and which inventory went out first is important to calculate the cost of sales line item in the income statement. The value of inventory that remains in the business is also important as this goes in the balance sheet under current assets.
To ensure the quality of goods at reasonable prices
Inventory management is not only an internal exercise. It also involves interactions with external parties who are important in the inventory supply chain. Ensuring favourable price and quality is another important of inventory management. This includes negotiating both prices and payment terms with suppliers of inventory and both these factors have a bearing on the ultimate price of inventory. Supply chain relationships also have a bearing on the quality of the inventory. A manufacturer or service business would want to maintain good relationships with sup[pliers that provide the best quality materials.
The various inventory management objectives can all be put together as assisting management with information, direction and coordination tools to assure that inventory is valued, stored, ordered, secured and documented appropriately at all times.