Inventory Management Techniques

The term inventory derives from the French word inventaire and the Latin word inventariom which simply means a list of things which are found. The term inventory includes materials which are in raw form, or are in process, in the finished packaging, spares and the others which are stocked in order to meet all the unexpected demands or distribution in the future. This term usually refers to the stock at hand at a particular period of time of all those materials which are in raw form, those goods which are in progress of manufacture, all the finished products, merchandise purchased products for resale of those products, tangible products which can be seen, touched, measured or are countable. In a connection with the financial statements and records of accounting, the reference may be to the amount assigned to the stock or the pile of goods owned by an enterprise at a particular period of time. Inventory controls transit and handling. The raw materials may be transported thousands of kilometers before they are converted into an end product. At the same time, materials which are in transit, may take a period of several days or months. During this process of transit, materials carry someone’s inventory. These Inventories serve to isolate the supplier, the producer and the consumer. Inventories permit the acquirement of raw materials in economic lot sizes as well as processing of these raw materials into finished goods in the most economical quantities. Raw material inventories distinguish the supplier of raw materials from the user of these raw materials. Finished goods inventories distinguish the user of the final goods from the producer of the goods. Inventories are held to facilitate product display and service to customers, batching in production in order to take advantage of longer production runs and provide flexibility in production scheduling.

Inventory management could as be defined as managing inventory with the primary objective been determining and controlling stock levels within the facility to balance the need for product availability against the need for minimizing stock holding and handling costs.

Success of an inventory management process entails the balance of costs of inventory with the benefits of the inventory. Inventory in business is one of the tangible and visible components of a company. Inventory management is the act of keeping and placing stock in a business. Many businesses have problem keeping the inventory. Each and every service provided anywhere is concerned with operation management technique in one way or another. Its objectives are to provide goods and services that the customers demand for in the right quantity, quality and cost at the appropriate time.    Some of the most important  techniques  of inventory control system are explained below:

1. ABC analysis

The ABC analysis groups inventory into three classes. Class A contains 80 percent of the total value of inventory. Class B contains 15 percent of the total value of inventory while class C contains 5 percent of the total value of inventory. The ABC analysis gives a simple and quick review of the inventory. The ABC analysis also gives a clear view and meaning of the whole assortment of products in the inventory, thereby making it an efficient method to control inventory investment. The ABC analysis makes it easy for an inventory manager to devote resources to only those places where it will have the biggest positive feedback. Nike, Inc is an American manufacturer of shoes. In their ABC analysis, leather forms class A, sole forms class B while shoe lace forms class C. ABC analysis is a vital method for management of inventory.

Read More: ABC Analysis

2. Economic Order Quantity (EOQ)

EOQ is a technique for inventory management that minimizes ordering and holding costs for the year. EOQ is a crucial accounting formula that determines when the combination of inventory carrying cost, order and costs are the least. The result obtained from the formula gives the most effective quality to order. There are two models used in EOQ: Q and P models. In the Q model, whenever the stock on hand reaches the recorder point, a fixed quantity of materials is ordered. Advantages of the Q model are that the inventory materials are at the most economical quantity and inventory control personnel automatically devote attention to stocking the only items that are needed, when they are needed. A major disadvantage of the Q model is that the suppliers may be inconvenienced by orders that are raised at irregular intervals. In the P model, the stock position of every item in the inventory is closely monitored. Advantages of the P model are that the inventory and ordering costs are low and the model can be used on materials that are used irregularly or in seasons. Sales estimates are easily calculated for seasonal materials and the purchase of these materials can be planned in advance. A disadvantage of the P model is that is inefficient because it compels a periodic review of inventory.

At Best Buy, the demand for desktop computers is 1000 units per month. Every time an order is placed, Best Buy incurs 4000 dollars in order cost. Best Buy incurs further costs in purchasing each computer at 500 dollars and the retailer charges a holding cost of 20 percent. The annual demand, D, is equal to 12000 dollars (1000 multiplied by 12). S, the order cost per lot is 4000 dolars. C, the price per unit, is 500 dollars. The annual holding cost, h, is 0.2. From these values the optimal order size and the optimal order frequency can be calculated. The formula for optimal order size, Q*, is given by SQRT((2DS)/hC). Substituting the letters with the corresponding values gives the number 980, which is the optimal order size.

3. Vendor Managed Inventory (VMI)

Vendor Managed Inventory (VMI)  is a process where the vendor makes orders for clients and customers according to the demand information they get form the customers. Both the customer and the vendor are held together by an agreement that conclude the costs, the inventory level and the fill rates. VMI use EDI (Electronic Data Interchange) to specify their delivery quantities which are sent to clients and customers by the use of distribution channel. VMI is an inbound logistic plan based on the idea that the dealer should be in charge of managing customer’s inventories by using the demand information provided by the customer himself. This eliminates a step in the information chain and creates a better demand visibility for the supplier, who can synchronize his manufacturing process to the actual demand with the result of having less inventories and lower logistic costs.

Hennes & Mauritz (H&M) AB, a new clothing retailer situated in Sweden is famous for its cheap but chic fashion. While other vendors are struggling, H&M sees the economic slowdown as a chance to enlarge, go into new markets and to put in new brands. In September 2008, H&M was all set to go into Japan, known as one of the world’s most competitive fashion markets. It was to open another store in Japan in November and a third one was to be launched soon. In Japan, H&M decided to enter into a  collaboration  of design with designer Rei Kawakubo, who was the creator of well-established  fashion brand, Comme des Garçons. Last year, H&M got into China and has established itself in 30 more countries with more 1,600 stores worldwide. As a result of effective vendor management inventory skills, it was able to establish in other countries. This has come as a result of planning which is essential in VMI, knowing the demand, improved quality of production. As a result they H&M increased its inventory annual turns and reduced material obsolescence and hence a considerable increase in assets. It was able to improve its customer services and responsiveness through scheduling forecasting of the fluctuations.

VMI has some benefits to the supplier and the customer. VMI ensures that the company operation of production is not interfered with by shortage of material. Secondly, they make sure that the distributor is not caught short on products. Moreover it helps in ensuring that the customers and the suppliers do not have more inventories that are necessary to meet the needs of the customers. VMI also improve the planning processes that are beneficial to the business. Some of the pros and cons of VMI to the supplier include: bullwhipping effect reduction, lowering reliance to forecasting, it reduces the order of modifications and simplifies production plan. To the customers, it assists in reduction of stock, reduces financial cost, simplify the purchase process and increases sales. To both the customers and the suppliers, VMI helps in reducing the data entry errors, improves the speed of the process, reduces stocks level and it improves the service level.

VMI plays a major role in cost management. In this case, the supplier holds stock on site or near the buyer. By doing this, the customer is given instant access and the power to get stock while they pay for only what they have sold. This increases the stock turnover and reduces investments in the stock. The supplier is mandated to replenish the stock in many VMI business partnerships. This also comprises of stock ordering, logistics and freight management and counting and stocking the stock. By doing this, the expenses are handled by the supplier and hence they are responsible for regulation of the prices to the customers. Another  benefit of VMI is that they distinguish variations of demands and errors of forecasting between the downstream and the upstream chain supply associates. This type of decoupling assists in reducing the levels of stock and the linked stock maintenance costs.

One thought on “Inventory Management Techniques

  1. The inventory management process begins as soon as one has started production and ordered raw materials, semi-finished products or any other thing from a supplier. If you are a retailer, then this process begins as soon you have placed your first order with the wholesaler.

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