Question
Essay on Inventory Management with the following outline
Thesis
A successful inventory strategy leading to a more efficient warehouse is to know exactly how much inventory is required.
A. What is Inventory Management?
1. The importance of Inventory Management
2. The types of Inventory
• Raw Material
• Work in Progress
• Finished Goods
• In-transit Inventory
• Cycle Inventory
B. When to order
1. Economic order quantity
2. Reorder point
3. Safety Stock
C. Inventory Control Systems
1. Perpetual Inventory System
2. Periodic Inventory System
• First-In-First-Out (FIFO)
• Last-In-First-Out (LIFO)
3. Barcode Inventory Systems
4. Radio Frequency Identification (RFID)
D. Inventory Management Cost
1. Ordering Cost
2. Carrying Cost
3. Holding Cost
E. Consequences of Poor Inventory Management
F. Conclusion
Solution
Inventory Management
Inventory management is an essential aspect of a business, especially in supply chain and logistics management. Primarily, stock decisions are a basis for significant business activities, such as transportation, warehousing, and handling of materials; hence, companies need to achieve a proper inventory balance to enhance efficiency. Inventory management is essential for every business as it allows efficient tracking of stock in the shelf, warehouse, all through to the multiple locations (Muller, 2019). As a result, it is an activity that prevents stock-outs, hence ensuring the company has enough supply for its customers, well-planned activities, especially on when to re-order, and tracks inventory value; thus, a successful inventory strategy is essential for an organization’s continuity.
Inventory Types
Different types of inventory classification occur according to their function, importance, nature, stages of completion, production value, manufacturing process conditions, end-use, and ease of handling. Notably, raw materials are components purchased from other companies for use in a business’s production or manufacturing process (Wild, 2017). On the other hand, work in progress is inventory used in the production process but is incomplete, while finished goods are inventories that are ready for sale after the production process. The in-transit inventory refers to goods that a firm has purchased, but remains on the way for some time due to the distance. Finally, the cycle inventory balances the carrying and holding costs. The stock accumulated optimizes inventory ordering during the calculation of order size using the Economic Order Quantity (EOQ).
When to Order
The inventory management process involves making decisions on when to make orders of a product. Generally, a company may choose to order a constant amount of stock while the time interval fluctuates. Such a system works well in a firm that has a predetermined inventory, which requires frequent monitoring of the levels of stock (Wild, 2017). On the other hand, a business may make inventory orders at constant time intervals, while the order fluctuates, which is a system that depends on the increase or decrease in sales. In such a case, the assessment of stock levels is low compared to other types of the process. Notably, a company may utilize both methods to make orders of different inventories.
Economic Order Quantity
Inventory management in an organization includes determining the size of stock order at a specific time. Economic Order Quantity (EOQ) is the calculation of the correct order size concerning carrying and ordering costs. The calculations determine where both prices are equal, hence minimizing a business’s total costs stock per piece. The EOQ model assumes certain factors, such as there is no inventory in transit, the availability of capital is unlimited, there is an infinite planning horizon, there is no inventory interaction, and there are no stock-outs (Muller, 2019. In addition, the framework also dons that the demand rate and replenishment are constant and known, the purchase price is constant, and the order quantity is independent. The EOQ formula in use when the model is utilized is:
ECQ = The square root of the ((2*annual usage *administrative costs per order of placing the order) /carrying costs of the inventory)
Re-order Point
At some point during inventory, the stock has to be replenished to ensure there is continuity. The re-order point is the unit quantity of inventory that determines the re-order of a predetermined amount of stock (Muller, 2019). The point is supposed to ensure that there is no interruption of production or other operations, while the firm maintains the minimum amount of capital at hand. The re-order is different across all inventories as it depends on usage and time taken to deliver the replenishment delivery. The formula for the re-order point is
(Average daily usage rate* Lead time) +Safety stock
Safety Stock
Safety stock is an extra quantity of inventory that firm stores in the warehouse to prevent running out of stock. Therefore, it is the buffer as it acts as the insurance against demand fluctuations (Muller, 2019). The safety stock keeps the business going even with delivery delays, and also protects a firm against inaccurate market forecasts and price fluctuations. The formula for calculating safe stock is:
Safety Stock = (Maximum daily usage*maximum lead time in days) – (Average daily usage*average lead time in days)
Inventory Control Systems
Perpetual Inventory System
Stock check takes place during designated times in different organizations. A perpetual inventory system is a management system that involves scheduling of stock check after almost every major purchase (Wild, 2017). The records account for received goods, sold inventories, moved inventories, inventory used in the production process, and scrap items. Consequently, gradual upgrading of the cost of stock sold in the accounting records ensures that stock size reflects the information in the books. Therefore, the method is most preferred for inventory tracking since it provides up-to-date information on the available stock and reduces the physical counting of inventory.
Periodic Inventory System
The system schedules inventory checks throughout the year, with intervals of bi-annually, annually, or monthly. The availability of lapse between the inventory check and accounting for the cost of goods sold between inventories may lead to misinformation of executives and managers.
First-In-First-Out (FIFO)
The FIFO method is used to evaluate the cost of the sold inventory. The model is preferred by firms dealing with perishable goods as it assumes that the inventory purchased first should be the first to be sold (Muller, 2019. In addition, it assumes that products are sold at no profit or loss; hence, the business stock is of higher value. The method is simple to use and ensures less wastage of inventory.
Last-In-First-Out (LIFO)
The LIFO technique, which means last in, first out, is used to value the cost of goods sold. The system assumes that the last inventory purchased on the shelf is the first to be sold and is preferred by firms that sell unperishable goods (Muller, 2019). The method recommends maintaining cheaper items on the shelf and selling the higher-priced ones during price increases. As a result, the company reduces tax liability by increasing sales and decreasing net income. The method also improves cash flows and eliminates challenges of matching the stock expenses with their revenues (Muller, 2019. However, the process does not incorporate the cost of replacing stock and understates the closing stock value, hence leaving very little room for adjustments
Barcode Inventory Systems
Barcode systems tools are essential for the control and management of inventory as they speed up business processes, such as receiving and shipping of goods by ensuring accurate counting of stock at hand (Wild, 2017). In addition, they reduce the operational costs of a business and allow inventory tracking as it goes in or leaves the warehouse. Notably, it enables multiple purchases of inventory from various suppliers with real-time database update.
Radio Frequency Identification (RFID)
The method helps companies to keep track of specific inventory from the production to sale. The Radio Frequency Identification (RFID) is a technology that uses radio waves to communicate between a tag and a reading device. The inventory management system is favored since tags are read from a distance and an organization can read several tags at once, hence enabling the management of different inventory at the same time (Wild, 2017). Furthermore, by allowing tracking of specific products, the company can give the tags unique identification codes. Lastly, the company can be update inventory information as it moves from one location to another. Therefore, the technology is useful and reliable in stock taking and tracking.
Inventory Management Cost
Carrying Costs
Companies must achieve a trade-off balance between the several costs associated with inventory. Specifically, the highest inventory cost is the holding costs, also known as the carrying costs, whose value involves the price of holding a specific inventory and is expressed as a percentage. Notably, the percentage is vital for companies since the change in holding charges affect the expense of the stock (Wild, 2017). Therefore, businesses struggle to maintain less inventory as the holding costs increase, although the costs vary from product to product, depending on how soon a product loses its value. There are several examples of inventory carrying costs, which include: shrinkage, storage, handling, insurance, and interest costs. As a result, the carrying costs are the highest as they entail other hidden charges when stock is being held.
Ordering Costs
Ordering costs arise from inventory orders, such as set-up costs and order costs, which involve the whole process, from transmission, processing, to cycle charges. Notably, these are expenses incurred when doing a credit check, confirming stock availability, receiving an order, receiving payment, preparing invoices, and entering orders in the system (Wild, 2017). On the other hand, the set-up expenditures are incurred during the production modification process of a product to meet particular needs, while ordering and carrying fee depends on the order size. Consequently, an increase in order size decreases carrying costs and increases ordering costs (Wild, 2017). The charges are both directly and indirectly related to inventory, as they ensure continuity of the process.
Consequences of Poor Inventory Management
Poor inventory management may lead to either a company having too little inventory or too much of it, where insufficient stock may lead to missed sales and loss of customers. On the other hand, excess inventory results in too much warehousing costs, and the company’s money held by the inventory leading to reduced availability of operational funds (Wild, 2017). On the other hand, too much stock may lead to obsolescence material degradation and spoilage; hence, the company may lose to competitors due to lack of proper planning (Muller, 2019). Indeed, poor management may also lead to keeping track of trends and forecasting; hence the company may fail to properly control inventory.
Conclusion
Companies must have a proper inventory management system in an increasingly competitive business environment. The system will ensure that the company makes the right decisions across all its processes, especially when it comes to maintaining a balanced inventory. In addition, it ensures effective plans around inventory purchase as well as cost management are properly developed, which leads to business’s awareness of the appropriate ordering time and the size of their orders. Therefore, a proper system ensures that the company can manage all the costs associated with inventory, thus reducing the overall operational costs. Indeed, a successful inventory strategy determines precisely how much stock is required.
References
Muller, M. (2019). Essentials of inventory management. HarperCollins Leadership.
Wild, T. (2017). Best practice in inventory management. Routledge.