Chapter – 24

Inventory management
Inventory management is also known as stock management or stock
control. Stock management occurs when the purchasing department aims
to minimise cost of stock by maintaining adequate levels of stock. Thus the
purchasing department must obtain the right quality at the right time in the
right quantity, from the right source at the right price.
Reasons for holding stock / Purpose of stock control
 Stock of raw materials is kept in order to meet production requirement
 Stock of work-in-progress is maintained in order to continue the
production process and allowing greater flexibility and better
utilisation of time and machinery.
 Stocks of finished goods are maintained in order to meet customers’
demand on time
 Stocks of equipment and spares are kept in order to support sales and
production
 To control cash tied up in stocks
 To control wastage
Types of Inventory
1) Raw materials-: the basic materials from which a product is made and
they are usually bought from outside.
2) Work-in-progress-: unfinished project that is still being developed or
partially completed goods.
3) Finished products-: goods that have completed the manufacturing
process and are stored before it is send to the customers.
Costs of holding high level of stock
 Opportunity cost: working capital is tied up in stored inventories
which could be put to some other use.
  Storage costs will increase as inventories have tobe stored in secured
warehouses. Some inventories requires refrigeration which increases
the warehousing costs further.
 Increased risk of wastage and obsolescence. The materials stored may
get spoiled or deteriorate in quality if they are not used or sold
rapidly.
 Increase in administrative and finance costs e.g insurance
 Risk of theft
Costs of holding inadequate / low level of stock
 Lost sales: If a firm is unable to supply customers on time, then sales
could be lost to other firms that holds high inventory.
 Idle production resources: The machines will be operating below
capacity or will have to be stopped if there are no raw materials.
 Ordering costs will increase since the firm places more number of
orders in a given period. Special orders can be expensive.
 The advantage of bulk buying cannot be achieved. Purchasing
economies in the form of bulk discounts and reduced transportation
costs cannot be enjoyed.
Benefits of holding high level stock
 The firm can enjoy the benefit of bulk buying
 There is production flexibility since the business will be having
enough stock at any given time
 Machine and factory plant will be operating at full capacity at all
times
 Enough stock will be available to support production and sales
Benefits of holding low level stock
 Storage costs are reduced
 Insurance costs are minimized
 Capital is not unnecessarily held or kept in stocks
 Minimum wastages in a period of reduced demand
  Risk of theft and spoilage is reduced
MANAGING INVENTORY
Buffer inventories: The minimum inventory level that should be held to
ensure that production could still take place even if there is a delay in
receiving the order or an unexpected increase in the demand.
Maximum inventory level: It refers to the highest amount of stock kept
with the business at any. It is limited by space and the financial costs of
holding higher levels of inventory.
Maximum stock = EOQ + Buffer Stock
Economic Order Quantity (EOQ): It is the optimum or least-cost
quantity of stock to re-order taking into account delivery costs and stock-
holding costs.
Minimum stock: is also known as buffer stock. This is the minimum
number of stock that should be held to ensure that production still continue
in case of delay in the delivery of raw materials.
Re-order stock level: It refers to the level of stock at which a new order is
placed with the supplier. The quantity of this order or the re-order quantity
will be influenced by the economic order quantity (EOQ).
Re-order quantity: The number of units ordered each time.
Lead time: It is the amount of time it takes for a stock purchased to be
received, inspected and made ready for use. If more time is required
between ordering new stocks and their delivery then a higher minimum
stock is needed.
Just-in-time (JIT) inventory control
JIT is basically a Japanese approach towards production. It is a stock
control system in which material is scheduled to arrive exactly when it is
needed for production and in the exact quantity. Raw materials are reduced
to zero and finished goods inventories are minimised by matching
production to demand. Thus JIT does not require any Buffer Stocks to be
held. The components arrive just at the time when they are needed and the
finished goods are delivered to customers as soon as they are completed.
Requirements for JIT Production
i. Employee Flexibility- Employees of the firm should be multi-skilled
and should be able to switch jobs quickly so that excess stocks of raw
materials won’t build up.
ii. Flexibility of Machinery- Modern, computerised machinery is
required for JIT production as it can produce a wide range of products
just by changing a single software
iii. Excellent relationships with suppliers- There should be a good
relation with the suppliers. The suppliers should be able to supply raw
materials at short notice.
iv. Accurate demand forecast- The business should be able to make a
reliable production schedule which would help in the calculation of
precise number of goods to be produced over a certain time
v. Extensive use of IT- Computerised records of sales and stock levels
would allow minimum stocks to be held. Electronic communication
with suppliers would enable accurate delivery of supplies.
vi. Strict quality control/ zero defect- Since there are no spare stocks,
therefore goods have to be produced correctly the first time otherwise
customer orders will not be completed on time.
Benefits of JIT
 Capital invested in inventory is reduced and the opportunity cost of
inventory holding is reduced.
 Costs of storage is reduced.
 Lesser chance of inventories becoming outdated obsolete.
 Increases the flexibility and firms can respond quickly to changing
demands or tastes.
 Higher profits due to overall decrease in costs
 Workers become more flexible and multi skilled. This increases
motivation.
Disadvantages of JIT
 Advantages of bulk buying are lost.
 Delivery costs rises as frequent small orders are delivered.
 Administration costs rises as so many small orders need to be
processed.
 Doesn’t work when demand is unpredictable.
 Delays in receiving supplies of materials and components will lead to
expensive production delays.