By: Flor Danielle O.

Malingin

“The goal of inventory management is not to have

too little or too much.”

Introduction

The key decision in manufacturing, retail and some service industry businesses is
how much inventory to keep on hand. Inventory is usually a business’s largest asset.
The instant inventory levels are established, they become an important input to the
budgeting system. Inventory decisions involve a delicate balance between three
classes of costs: ordering costs, holding costs, and shortage costs.

Before we venture further, what does inventory mean? According to the Merriam-
Webster Dictionary, Inventory is defined as, “the quantity of goods or materials on
hand.”

Visible Costs of Inventory

As mentioned earlier, inventory decisions involve a delicate balance between three

classes of cost. These costs are:

Ordering Cost - Cost of replenishing Inventory

Carrying Cost - Cost of holding an item in inventory
Shortage Cost - Temporary or permanent loss of sales when demand cannot be
met

Examples of costs in each of these categories are:

What increases Inventory?

Inventories are increased “just in case”...

 order deliveries are late

 quality problems occur
 demand increases unexpectedly
 lead times are not accurately forecast

Inventory Management

Businesses must keep a careful rein on their inventories. Having too much inventory
and/or not having enough stock is considered primary direct causes of business
failures.

Having either too little or too much stock is unhealthy for the business and can
increase corporate expenses unnecessarily. Understanding the basics of inventory
management is a fundamental part of running a successful business.

There are several definitions of Inventory Management. Among them are:

Inventory Management is “the practice of planning, directing and

controlling inventory so that it contributes to the business'
profitability”. Inventory management can help business be more profitable by
lowering their cost of goods sold and/or by increasing sales.

Inventory Management is “making sure that items are available when

customers call for it, but not too much stock so that inventory turnover
goals are met”
- Juhi Gonzales, Inventory
Management and Systems Consulting-
Inventory Management is “the art and science of managing to have the
RIGHT PRODUCT, at the RIGHT TIME and PLACE, in exactly the RIGHT
AMOUNT, at the BEST POSSIBLE PRICE”.

Inventory management is directly linked to operating management the goal of which

is to provide the best service to customers! When a customer calls for a sales order,
delivery must be done at the fastest possible time and at the lowest possible costs.
Two common Inventory Management models

Traditional Inventory Management

•Companies maintain a large stock of inventories to meet
the challenge of serving the customers on time.

Modern Inventory Management

•Serving customers on time could be done by applying
technology and redesigning the process of production.

Inventory management models change as the environment of business changes. But

the core goal of inventory management remains the same, that is, “make the
customer happy” by delivering accurate service on time.

Criteria Traditional Inventory Modern Inventory

Management Management
Objective Deliver sales on time at the Deliver sales on time at the
lowest possible cost. most reasonable price.

Primary Strategy Maintain adequate inventory Efficient scheduling of

holdings of materials and production process through the
finished goods. use of technology and linkages
to suppliers.

Business  Production is  Production is

Environment labor-intensive technology-oriented
 Use of mechanical  Use of electronic and
equipment and mechanical equipment and
machineries machineries
 Product-oriented  Process-oriented
 Emphasis on  Emphasis on
company-customer suppliers-company-custom
relations er relations
 Less investment in capital  Heavy investment in
expenditures capital expenditures
 Generally, lesser cost of  Generally, lower cost of
production in the doing business in the
short-run. long-run.

Traditional inventory management techniques are based on old production

processes that include:
 purchase of materials
 receipt of materials
 materials warehousing
 materials issuances to production
 materials pre-production inspection
 conversion processes
 quality inspection of units produced
 finished goods warehousing
 pre-shipment inspection and,
 delivery to customers

Modern strategies and techniques of managing inventories depend on efficient

scheduling of production processes from the source of materials to the place of
customers. This change in strategy of inventory management comes to reality due
to the enormous contributions of technology. Databases of suppliers, company and
customers could now be shared on time and each other’s needs could be filled out
without waiting for an order. This is done through electronic data interchange.
Inventory management is essential for a business to succeed. Good management of
your company’s stock decreases excess inventory and ensures that you have enough
product on hand to meet customer demand. Develop an inventory management plan
to streamline ordering and reduce wasted time on inventory control.

Ensuring Safety of Inventory

One of the goals of inventory management is to keep products safe. Inventory should
be kept in a safe area, where it is protected against theft. Depending on the size of your
company, this could mean using surveillance equipment, guards or alarm systems.
The inventory should be handled carefully, as well, to avoid breakage. Broken or lost
inventory means a financial loss for your company.

Tracking Sales

Track and review company sales on a regular basis as part of your inventory
management plan. Note the items that don’t sell and have a tendency to sit for
prolonged periods of time. Also, track the best sellers and seasonal items that
experience increased sales at different times of the year. Use this data to manage the
quantity of items and when to order them. Although you want to avoid excess stock,
don’t be too safe with ordering inventory. You don’t want to be out of stock when new
orders are requested.

Ensuring Accuracy of Inventory Systems

Manage your computer inventory systems. Incorrect information displayed on

inventory databases can cause problems in your company. A goal of inventory
management should be to keep the inventory database up to date. Each item sold
should be removed from the inventory log promptly. Stock receipts should be entered
into the inventory database within a 24-hour period.

Eliminating Excess Products

Inventory control also will keep dead stock off of the shelves. Stock that does not sell
drains company’s resources because it takes up space in your store or warehouse.
Sales events can be used to push stock that has not been performing well. Another
strategy would be to return stock that is not selling or offer the products at a
discounted rate to another company.

What are the objectives of inventory management?

The main objective of inventory management is to maintain inventory at
appropriate level to avoid excessive or shortage of inventory because both the cases
are undesirable for business. Thus, management is faced with the following
conflicting objectives:
1. To keep inventory at sufficiently high level to perform production and sales
activities smoothly.
2.To minimize investment in inventory at minimum level to maximize profitability.

Inventory Management Techniques That You Need to Know About

I want to start by saying that this is not an exhaustive list of all the possible inventory
management techniques available for all industries.

Rather, it’s a carefully curated list of inventory management techniques that work for
our wholesale and distribution customers around the world.

So you won’t find a customary listing of the Last-In, First-Out method. This is
commonly used in the States but it is prohibited in other countries. So we won’t cover
for the sake of mentioning it.

What we will cover are practical inventory management techniques that:

 Our customers use; and

 You can actually use in your business.

What Should You Care About Inventory Management?

Before we jump into the nitty-gritty of inventory management techniques, why
should you care about inventory management in the first place?

Shouldn’t sales and profits be at the top of your list?

Yes, revenue and profits are important but, as you know, what makes or breaks your
wholesale or distribution business is not whether you’re making a profit or running a
loss — it’s your cash flow.

Your business needs cash to pay your salary, your employee’s salaries, rent, supplier
invoices and all the running costs of running a business.

And purchasing inventory means that you’re tying up a valuable and finite resource —
working capital — in your stock. Your business could do with cash elsewhere. But,
this cash doesn’t materialise in your business until you sell your stock.

So, you need to keep an eye on inventory management because you are indirectly
managing your cash flow as well.

Manage your inventory efficiently with different techniques, and you manage your
cash flow at the same time.

Why is Inventory Management Important?

1. Inventory management can help business be more profitable by lowering their

cost of goods sold and/or by increasing sales.

2. Improve Customer Service

3. Reduce Inventory Investment

4. Increase Productivity

5. Prevent Poor Inventory Record Accuracy

Downside of Inventory Mismanagement

So what happens if you take your eye off the inventory management ball?

First of all, if you’re dealing with perishable products with expiry dates, then your
stock will spoil and need to be discarded if you don’t sell them in time. Think
foodstuffs, pharmaceutical drugs, some wines and even makeup and facial products!

Also, you want to avoid keeping deadstock around. You know, those products that
haven’t moved in the past 12 months, gathering dust in your warehouse.

These items don’t necessarily have an expiry date. But they can’t be sold because of
other reasons such as obsolescence, irrelevance or changes in styles and seasons.
I love giving examples here: CD/DVD cleaners, last year’s cellphone cases, charging
cables made obsolete by USB-C, any fashion or shoes tied to last year’s dance hit, and
it goes on!

And while we’re on deadstock, I did mention they’re taking up valuable space in your
warehouse right? These stocks aren’t moving but you could easily use the space and
racks for other profitable products. At the same time, you’re still paying rent,
insurance and associated costs with keeping stock.

So, let’s start with one inventory management technique that should be at the top of
everyone’s list.
First-In, First-Out (FIFO)
First-In, First-Out (FIFO) assumes that the first goods purchased are also the first
goods sold. It is an inventory valuation method used widely around the world.

For most businesses, this closely matches the actual flow of goods. So, it’s considered
the most “correct” inventory valuation method as opposed to “Last-In, First-Out”.

It’s also the most logical method since most businesses will want to sell their oldest
stock first to reduce the risk of obsolescence or expiry!

ABC Analysis
ABC Analysis is an inventory categorisation technique used in materials
management.
As the name suggests, it divides your inventory into three categories:

A items with very tight control and accurate records,

B items with less tightly controlled and decent records, and
C items with the simplest controls possible and minimal record keeping.

Economic Order Quantity (EOQ)

Economic order quantity (EOQ), in inventory management, is the order quantity that
minimises the total costs of inventory in a business.

These costs of inventory include holding costs, order costs and shortage costs.

It has its roots as a production scheduling model from 100 years ago! This formula
remains unchanged as:

EOQ = √2AB/C

A = annual requirement quantity

B = cost per order
C = yearly carrying cost per unit

EOQ is a tool used in a continuous review inventory system. Here, inventory levels
are continuously monitored and a fixed quantity is ordered each time the inventory
level reaches a specific reorder point.

So, EOQ provides a formula for calculating this appropriate reorder point and the
optimal reorder quantity. This ensures instant replenishment of inventory along with
no shortages or stock-outs.

Thus, it helps small and medium-sized businesses like yours to answer the following:

How much inventory to keep on hand?

What is the quantity of items to order each time?
When do I reorder to minimise inventory costs?
All this sounds too good to be true!
Just-In-Time (JIT)
Just-In-Time (JIT) is just what the name suggests: parts or raw materials are ordered
as and when they are needed in the production process. It was exported to the rest of
the world after Japanese manufacturers enjoyed success with it in the 1960s and
1970s.

So, if you’re doing simple manufacturing in your business, for example, assembling
knock-down furniture or making artisanal soap, then JIT may interest you.