Inventory Management

Tepes Ana-Ionela Vîrjoghe Alina Cristina B.A, 8892

INVENTORY MANAGEMENT

Inventory management, or inventory control, is an attempt to balance inventory needs and requirements with the need to minimize costs resulting from obtaining and holding inventory. There are several schools of thought that view inventory and its function differently. These will be addressed later, but first we present a foundation to facilitate the reader's understanding of inventory and its function. In the USA and Canada the term has developed from a list of goods and materials to the goods and materials themselves, especially those held available in stock by a business; and this has become the primary meaning of the term in North American English, equivalent to the term "stock" in British English. In accounting, inventory or stock is considered an asset.

WHAT IS INVENTORY?
Inventory is a quantity or store of goods that is held for some purpose or use (the term may also be used as a verb, meaning to take inventory or to count all goods held in inventory). Inventory may be kept "in-house," meaning on the premises or nearby for immediate use; or it may be held in a distant warehouse or distribution center for future use. With the exception of firms utilizing just-in-time methods, more often than not, the term "inventory" implies a stored quantity of goods that exceeds what is needed for the firm to function at the current time (e.g., within the next few hours).

Inventory management is primarily about specifying the size and placement of stocked goods. Inventory management is required at different locations within a facility or within multiple locations of a supply network to protect the regular and planned course of production against the random disturbance of running out of materials or goods. The scope of inventory management also concerns the fine lines between replenishment lead time, carrying costs of inventory, asset management, inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical inventory, available physical space for inventory, quality management, replenishment, returns and defective goods and demand forecasting. Balancing these competing requirements leads to optimal inventory levels, which is an on-going process as the business needs shift and react to the wider environment. Inventory management involves a retailer seeking to acquire and maintain a proper merchandise assortment while ordering, shipping, handling, and related costs are kept in check. Systems and processes that identify inventory requirements, set targets, provide replenishment techniques and report actual and projected inventory status. Handles all functions related to the tracking and management of material. This would include the monitoring of material moved into and out of stockroom locations and the reconciling of the inventory balances. Also may include ABC analysis, lot tracking, cycle counting support etc. Management of the inventories, with the primary objective of determining/controlling stock levels within the physical distribution function to balance the need for product availability against the need for minimizing stock holding and handling costs.

WHY KEEP INVENTORY?
Why would a firm hold more inventory than is currently necessary to ensure the firm's operation? The following is a list of reasons for maintaining what would appear to be "excess" inventory.

Nissan takes delivery on truck seats as many as 18 times per day.Table 1 January February March April May June Demand 50 50 0 100 200 200 Produce 100 100 100 100 100 100 Month-end inventory 50 100 200 200 100 0 KEEP OPERATIONS RUNNING. A machine or workcenter is often dependent upon the previous operation to provide it with parts to work on. components. If a supplier (an external firm or an internal department or plant) cannot supply the required goods on demand. If work ceases at a workcenter. then each machine can maintain its operations for a limited time. Inventory between successive dependent operations also serves to decouple the dependency of the operations. then the client firm must keep an inventory of the needed goods. That means that a firm that uses steel produced at the mill must place orders at least three months . Tennessee. such as Nissan in Smyrna. hopefully until operations resume the original center. can maintain extremely low levels of inventory. LEAD TIME Lead time is the time that elapses between the placing of an order (either a purchase order or a production order issued to the shop or the factory floor) and actually receiving the goods ordered. A manufacturer must have certain purchased items (raw materials. If a supply of work-in-process inventory is kept between each workcenter. A just-in-time (JIT) manufacturing firm. steel mills may have a lead time of up to three months. Running out of only one item can prevent a manufacturer from completing the production of its finished goods. However. the larger the quantity of goods the firm must carry in inventory. The longer the lead time. or subassemblies) in order to manufacture its product. then all subsequent centers will shut down for lack of work.

Salesmen routinely call purchasing agents shortly before a price increase goes into effect. QUANTITY DISCOUNT. This gives the buyer a chance to purchase material. Inventory can also be used as a hedge against price increases and inflation. CONTROLLING INVENTORY Firms that carry hundreds or even thousands of different part numbers can be faced with the impossible task of monitoring the inventory levels of each part number. ABC analysis is based on Pareto Analysis. this is often called anticipation inventory. Consider the demand forecast and production schedule outlined in Table 1. the use of inventory has allowed the firm to move demand requirements to earlier periods. Notice how the use of inventory has allowed the firm to maintain a steady rate of output (thus avoiding the cost of hiring and training new personnel). while building up inventory in anticipation of an increase in demand. This also frequently results in inventory in excess of what is currently needed to meet demand. HEDGE. Sometimes inventory is used to smooth demand requirements in a market where demand is somewhat erratic. the decision to buy the large quantity is justified. In fact. Often firms are given a price discount when purchasing large quantities of a good. SMOOTHING REQUIREMENTS. many firm's use an ABC approach. thus smoothing the demand. an onhand inventory of three months' steel requirements would be necessary.in advance of their need. if the discount is sufficient to offset the extra holding cost incurred as a result of the excess inventory. at a price that is lower than it would be if the buyer waited until after the price increase occurs. In essence. in excess of current need. In order to keep their operations running in the meantime. . In order to facilitate this. However.

effort and money) to dedicate to each item. From an inventory perspective it can restated thusly: approximately 20 percent of all inventory items represent 80 percent of inventory costs. A item may be counted monthly. B items quarterly. The top 20 percent of the firm's most costly items are termed "A" items (this should approximately represent 80 percent of total inventory costs). then the B items. Certainly. moving on to other sections upon completion.also known as the "80/20" rule. Cycle counting is used instead of the traditional "once-a-year" inventory count where firms shut down for a short period of time and physically count all inventory assets in an attempt to reconcile any possible discrepancies in their inventory records. it has to be the correct 20 percent. The percentages may vary with each firm. Another control method related to the ABC concept is cycle counting. but B items usually represent about 30 percent of the total inventory items and 15 percent of the costs. The firm may also choose to count all the A items. In addition the required accuracy of inventory records may vary according to classification. By classifying each inventory item as an A. In other words. and finally the C items. a firm can control 80 percent of its inventory costs by monitoring and controlling 20 percent of its inventory. Usually this means that the firm monitors A items very closely but can check on B and C items on a periodic basis (for example. But. The 80/20 comes from Pareto's finding that 20 percent of the populace possessed 80 percent of the wealth. until the entire facility is counted. When cycle counting is used the firm is continually taking a physical count but not of total inventory. . B or C the firm can determine the resources (time. monthly for B items and quarterly for C items). Therefore. with "B" items falling in between A and C items. with A items requiring the most accurate record keeping. A firm may physically count a certain section of the plant or warehouse. Items that are extremely inexpensive or have low demand are termed "C" items. Then the process starts all over again. and C items yearly. C items generally constitute 50 percent of all inventory items but only around 5 percent of the costs. the counting frequency will vary with the classification of each item.

and water. lighting. can be expressed as H ( Q /2). . pilferage (theft). Inventory in excess of current demand frequently means that its holder must provide a place for its storage when not in use. Now. how do we balance this supply with its costs? First let's look at what kind of costs we are talking about. average inventory is expressed as Q /2. A storage facility requires personnel to move the inventory when needed and to keep track of what is stored and where it is stored. Average inventory can be computed by dividing the amount of goods that are ordered every time an order is placed ( Q ) by two. Thus. are the costs that result from maintaining the inventory. There are three types of costs that together constitute total inventory costs: holding costs. This could range from a small storage area near the production line to a huge warehouse or distribution center. also called carrying costs. inventory management is an attempt to maintain an adequate supply of goods while minimizing inventory costs.BALANCING INVENTORY AND COSTS As stated earlier. and opportunity costs occur from the lost use of the funds that were spent on the inventory. Holding costs. then. obsolescence. Also. cooling. If the firm can determine the cost of holding one unit of inventory for one year ( H ) it can determine its annual holding cost by multiplying the cost of holding one unit by the average inventory held for a one-year period. All of these things add cost to holding or carrying inventory. The firm must pay taxes on the inventory. and shrinkage are problems. forklifts may be necessary to move it around. Storage facilities also require heating. and purchasing costs. set-up costs. Annual holding cost. We saw a variety of reasons companies hold inventory and these reasons dictate what is deemed to be an adequate supply of inventory. HOLDING COSTS. If the inventory is heavy or bulky.

long-distance telephone bills. the firm will obviously place 10 orders per year ( D / Q ). office space. Hence. it can determine its annual setup/order cost by multiplying the cost of one set-up by the number of set-ups made or orders placed annually. that will have to be scrapped (a cost). rather than a set-up cost. Set-up costs are the costs incurred from getting a machine ready to produce the desired good. there is considerable cost involved in set-up. Then the technician has to calibrate the machine and probably will run a number of parts. PURCHASING COST. another cost) and brings it to the machine in question. As one can see. in order to get the machine correctly calibrated and running. In a manufacturing setting this would require the use of a skilled technician (a cost) who disassembles the tooling that is currently in use on the machine. administrative and secretarial support. The technician then takes the currently needed tooling from the tool room (where it has been maintained. The disassembled tooling is then taken to a tool room or tool shop for maintenance or possible repair (another cost). Also. is incurred. and computer systems and support. Suppose a firm has an annual demand ( D ) of 1. Ordering costs include the purchasing agent's salary and travel/entertainment budget. copiers and office supplies. If the firm purchases the part or raw material.000 units. Purchasing cost is simply the cost of the purchased item itself. some firms include the cost of shipping the purchased goods in the order cost. If the firm orders 100 units ( Q ) every time it places and order. forms and documents. All the while the machine has been idle and not producing any parts (opportunity cost). the firm can determine its annual purchasing cost by . If the firm can determine the cost of one set-up ( S ) or one order.SET-UP COSTS. If the firm purchases a part that goes into its finished product. There the technician has to assemble the tooling on the machine in the manner required for the good to be produced (this is known as a "set-up"). then an order cost. annual set-up/order cost can be expressed as S ( D / Q ).

000 Finally. the point at which they are equal) would indicate the lowest total inventory cost.800 − 306. For example. Therefore. In order to minimize total inventory cost. we subtract the total cost of Q from Q to determine the savings: $306.000)($150)/$10= 600 And we calculate total costs at the EOQ of 600: Q = $10(600/2) + $150(12. we should order the quantity ( Q ) that corresponds to the point where the two values are equal.000) = $306. Hence. First. the firm will order Q every time it places an order. If we set the two costs equal and solve for Q we get: H ( Q /2) = S ( D / Q ) Q = 2 DS / H The quantity Q is known as the economic order quantity (EOQ). We might assume this means that purchasing cost is not relevant to our order decision and .000 units (at a purchase price of $25 each).000/1000) + $25(12.000) = $306. every time we place an order. a firm with an annual demand of 12.000/600) + $25(12.800 Then we calculate EOQ: EOQ = 2(12.multiplying the cost of one purchased unit ( P ) by the number of finished products demanded in a year ( D ). we determine the total costs without using the EOQ method: Q = $10(1000/2) + $150(12. the savings is still $800. purchasing cost is expressed as PD. Now total inventory cost can be expressed as: Total = Holding cost + Set-up/Order cost + Purchasing cost or Total = H ( Q /2) + S ( D / Q ) + PD If holding costs and set-up costs were plotted as lines on a graph. the point at which they intersect (that is.000 = $800 Notice that if you remove purchasing cost from the equation. annual holding cost of $10 per unit and an order cost of $150 per order (with orders placed once a month) could save $800 annually by utilizing the EOQ. if we want to minimize total inventory cost.

EOQ is an example of the fixed-order-quantity model since the same quantity is ordered every time an order is placed. If you were to walk into an office supply store and ask to buy 22 paper clips. Constant demand (demand is stable through-out the year). and part-period balancing. OTHER LOT-SIZING TECHNIQUES There are a number of other lot-sizing techniques available in addition to EOQ. FIXED-ORDER-QUANTITY MODEL. Constant costs (no price increases or inflation). fixed-order-interval model. You were captive to the . the demand for steering wheels would be derived from the demand for automobiles (dependent demand) but the demand for purses is not derived from anything else. While these assumptions would seem to make EOQ irrelevant for use in a realistic situation. the firm must determine whether the savings of the quantity discount are sufficient to offset the loss of the savings resulting from the use of the EOQ. purses have independent demand. A firm might also use a fixed-order quantity when it is captive to packaging situations. the single-period model. chances are you would walk out with 100 paper clips. it is relevant for items that have independent demand. If a quantity discount is available. It must be noted that this is true only as long as no quantity discount exists. Deterministic demand (demand is known with certainty). These include the fixed-order quantity. There are a number of assumptions that must be made with the use of the EOQ. For example.can be eliminated from the equation. No quantity discounts. These include: • • • • • Only one product is involved. This means that the demand for the item is not derived from the demand for something else (usually a parent item for which the unit in question is a component).

This model tries to balance the cost of lost customer goodwill and opportunity cost that is incurred from not having enough inventory. It works the same way for other purchasing situations. The lot size is dependent upon how much inventory is needed from the time of order until the next order must be placed (order cycle). A supplier may package their goods in certain quantities so that their customers must buy that quantity or a multiple of that quantity. FIXED-ORDER-INTERVAL MODEL.e. and items with a limited life. they come 100 to a box and you cannot purchase a partial box. or point at which an order should be placed. The single-period model is used in ordering perishables. utilizing one of the above techniques. the reorder point. If safety stock is necessary it would be added to the reorder point quantity. biweekly.. When a proper lot size has been determined. with the cost of having excess inventory left at the end of a period. SINGLE-PERIOD MODEL. such as food and flowers. i. PART-PERIOD BALANCING. Part-period balancing attempts to select the number of periods covered by the inventory order that will make total carrying costs as close as possible to the set-up/order cost. .packaging requirements of paper clips. Unsold or unused goods are not typically carried over from one period to another and there may even be some disposal costs involved. or monthly. This system requires periodic checks of inventory levels and is used by many retail firms such as drug stores and small grocery stores. such as newspapers. The fixed-order-interval model is used when orders have to be placed at fixed time intervals such as weekly. can be determined by the rate of demand and the lead time.

to insure there is continuity between functions: . and new manufacturing technology. an order would be placed whenever the inventory level for that good reached 250 units. an inventory item with a demand of 100 per month. new opportunities due to worldwide marketing. global sourcing of materials. a two-month lead time and a desired safety stock of two weeks would have reorder point of 250.Reorder point = Expected demand during lead time + Safety stock Thus. Companies that store inventory must have a management system to track the materials and products in the organization.Sales & Operations Planning . In other words.Production & Material Planning Inventory Management and Inventory Control must be designed to meet the dictates of the marketplace and support the company's strategic plan. Inventory management is a method to meet the needs of the organization while keeping the costs of storing materials to a minimum. Reorder point = 100/month × 2 months + 2 weeks' safety stock = 250 Inventory Management Inventory Control Must tie together the following objectives.Company Strategic Goals . The many changes in market demand. The . means many companies need to change their Inventory Management approach and change the process for Inventory Control.Sales Forecasting .

new opportunities due to worldwide marketing. such as purchasing. and communicate with customers. accounting and production. Inventory Management and Inventory Control must be designed to meet the dictates of the marketplace and support the company's strategic plan. The Inventory Management system and the Inventory Control Process provides information to efficiently manage the flow of materials. Despite the many changes that companies go through. The many changes in market demand. they provide the information to Managers who make more accurate and timely decisions to manage their operations. and new manufacturing technology. Each of the areas above will . Inventory Management and the activities of Inventory Control do not make decisions or manage operations. but the underlying principles for accomplishing good Inventory Management and Inventory activities have not changed. planning. the basic principles of Inventory Management and Inventory Control remain the same. and what requirements are placed on it due to market demands. means many companies need to change their Inventory Management approach and change the process for Inventory Control. global sourcing of materials. effectively utilize people and equipment. coordinate internal activities. The basic building blocks for the Inventory Management system and Inventory Control activities are: Sales Forecasting or Demand Management Sales and Operations Planning Production Planning Material Requirements Planning Inventory Reduction The emphases on each area will vary depending on the company and how it operates. Some of the new approaches and techniques are wrapped in new terminology.management system the company uses impacts several departments within the organization.

An inaccurate inventory can cause delays in the materials necessary to build products. Meet Customer Demand o The inventory management system ensures the company has the materials available to build product to meet customer demand. Purchasing o The inventory management system provides trigger points for material purchases. Excessive amounts of inventory tie up company funds and can result in waste. Inaccuracies in the inventory quantities may result in ordering delays or over ordering materials for production. Vendor lead times are a factor in determining the quantity necessary to trigger a purchase. An inventory management system ensures the smooth flow of materials to production when it is needed to create products for customers. which may delay production and delivery times for customers. A lean inventory is flexible and can respond faster to material changes. Production Planning o The production planning department relies on accurate inventory quantities to schedule builds or production runs. Defects found in materials may cause excessive waste when large amounts of inventory are in stock. The purchasing department orders materials when the quantity reaches a specific amount. A leaner inventory also reduces the space needed to store materials. Inaccuracies in the system can result in shortages of materials or products. For example.need to be addressed in some form or another to have a successful program of Inventory Management and Inventory Control. . changes in production or material specifications can cause an abundance of materials held in stock to become obsolete. The planning department schedules production to meet the demands of customer orders. Reduce Costs o An accurate inventory management system prevents delays in purchases or over ordering materials for production. Accurate quantities in the system allow the company to build the product within the time frame the customer demands as well. Keeping only what is necessary on hand reduces the company's investment in materials until there is customer demand.

Just-in-time (JIT) is a philosophy that advocates the lowest possible levels of inventory. even though one hears the term "zero inventory" used. a necessity for a complex item with dependent demand. Theory of constraints (TOC) is a philosophy which emphasizes that all management actions should center around the firm's constraints. MRP and MRP II are computer-based resource management systems designed for items that have dependent demand. allow discrete ordering (ordering only what is currently needed). JUST-IN-TIME (JIT). In this way inventory levels can be kept at a very low level. it advocates that there be some . THEORY OF CONSTRAINTS (TOC). as such. MRP AND MRP II. JIT espouses that firms need only keep inventory in the right quantity at the right time with the right quality. While it agrees with JIT that inventory should be at the lowest level possible in most instances. MRP and MRP II look at order quantities period by period and. The ideal lot size for JIT is one.OTHER SCHOOLS OF THOUGHT IN INVENTORY MANAGEMENT There are a number of techniques and philosophies that view inventory management from different perspectives.

g. Finally. firms now have to deal with post-consumer items such as scrap. or outright "I changed my mind" responses from customers. THE FUTURE OF INVENTORY MANAGEMENT The advent. and any number of items that require repair. finished goods. of environmental management has added a new dimension to inventory management-reverse supply chain logistics. or color. work-in-process. Instead of managing one's inventory to maximize profit and minimize cost for the individual firm. Environmental management has expanded the number of inventory types that firms have to coordinate. or secondary use in another product. through altruism or legislation. finish. and MRO goods. supply chain management has had a considerable impact on inventory management. Retailers have the same type problems dealing with inventory that has been returned due to defective material or manufacture.. today's firm has to make inventory decisions that benefit the entire supply chain. Business inventory The reasons for keeping stock There are three basic reasons for keeping an inventory: . reuse. In addition to raw materials. the slowest machine) and before finished goods.buffer inventory around any capacity constraint (e. reusable or recyclable containers. recycling. poor fit. returned goods.

This level of detailed specification assists in managing inventory.Ideal condition of "one unit at a time at a place where a user needs it. Therefore. supply and movements of goods. This stock can be eliminated by tools like SMED. This stock is then used while that changeover is happening. Special terms used in dealing with inventory • Stock Keeping Unit (SKU) is a unique combination of all the components that are assembled into the purchasable item. • Stockout means running out of the inventory of an SKU. not just within a facility or plant. when he needs it" principle tends to incur lots of costs in terms of logistics.Inventories are maintained as buffers to meet uncertainties in demand. Some plants have centralized stock holding across sub-processes. it is often the work practice to hold all these stocks mixed together before or after the sub-process to which they relate. which makes the situation even more acute. Where these stocks contain the same or similar items. any change in the packaging or product is a new SKU. • Buffer stock is held in individual workstations against the possibility that the upstream workstation may be a little delayed in long setup or change over time. which is due to a particular cause and should be a particular individual's responsibility with inevitable consequences.The time lags present in the supply chain. 3. requires that you maintain certain amounts of inventory to use in this "lead time. Economies of scale . Because they are mixed up together there is no visual reminder to operators of the adjacent sub-processes or line management of the stock.1. All these stock reasons can apply to any owner or product stage. movement and storing brings in economies of scale. Uncertainty . This 'reduces' costs. These classifications apply along the whole Supply chain. thus inventory." 2. Time . So bulk buying. from supplier to user at every stage. .

) that they do not intend to sell. Such merchandise may not be produced anymore. it is the available inventory.. it will be impossible to know the actual level of stocks and therefore impossible to control them.materials and components scheduled for use in making a product. most manufacturing organizations usually divide their "goods for sale" inventory into: • Raw materials . De-coupling (Buffer stock that is held by both the supplier and the user) 4. distributors'.have left the factory but not arrived at the customer yet) Inventory examples While accountants often discuss inventory in terms of goods for sale. ice cream for summer) 5.g. Anticipation stock (Building up extra stock for periods of increased demand . . and wholesalers' inventory tends to cluster in warehouses. Manufacturers'. organizations manufacturers. . Inventories not intended for sale to customers or to clients may be held in any premises an organization uses. and the new old stock may represent the only market source of a particular item at the present time. Buffer/safety stock 2. Pipeline stock (Goods still in transit or in the process of distribution .e. Typology 1. While the reasons for holding stock were covered earlier.also have inventories (fixtures. service-providers and not-for-profits . Retailers' inventory may exist in a warehouse or in a shop or store accessible to customers.• "New old stock" (sometimes abbreviated NOS) is a term used in business to refer to merchandise being offered for sale that was manufactured long ago but that has never been used.. if uncontrolled. Stock ties up cash and. furniture. excluding buffer stock) 3. supplies. Cycle stock (Used in batch processes.

and even perhaps to consumers through arrangements like factory stores and outlet centers. to grocery stores (retailers). a company may wish to install a complex inventory system.returned goods that are salable. A case study of k-curve benefits to one company shows a successful implementation. A more sophisticated method takes these two techniques further.. but unless there is a good understanding of the role of inventory and its parameters.goods ready for sale to customers. filled cans not yet labeled or sub-assemblies of food components. • • For example: Manufacturing A canned food manufacturer's materials inventory includes the ingredients to form the foods to be canned. .) that will form part of a finished can. the system cannot bring the necessary benefits to the organisation in isolation. and an effective business process to support that. Goods for resale . WIP . .• Work in process. glue. Finished goods . and anything else (solder. labels. It may also include finished cans that are not yet packaged into cartons or pallets. Examples of case studies are very revealing. combining certain aspects of each to create The K Curve Methodology. Typical Inventory Management techniques include Pareto Curve ABC Classification and Economic Order Quantity Management. and consistently show that the improvement of inventory management has two parts: the capability of the organisation to manage inventory..materials and components that have begun their transformation to finished goods. and the way in which it chooses to do so. This may be vats of prepared food. The firm's work in process includes those materials from the time of release to the work floor until they become complete and ready for sale to wholesale or retail customers. For example. empty cans and their lids (or coils of steel or aluminum for constructing those components). Its finished good inventory consists of all the filled and labeled cans of food in its warehouse that it has manufactured and wishes to sell to food distributors (wholesalers).

etc. a much more accurate and optimal outcome. By integrating accurate demand forecasting with inventory management. Accurate demand forecasting also allows the desired inventory proportions to be dynamic by determining expected sales out into the future. this allows for inventory to be in proportion to expected short-term sales or consumption rather than to past averages. and thereby closer to achieving the primary goal. The primary optimal outcome is to have the same number of days' (or hours'. Integrating demand forecasting into inventory management in this way also allows for the prediction of the "can fit" point when inventory storage is limited on a per-product basis. Many of the big MRP/and ERP systems do not offer the necessary inventory planning tools within their integrated planning applications. replenishment inventories can be scheduled to arrive just in time to replenish the product destined to run out first. Excess inventory is sub-optimal because the money spent to obtain it could have been utilized better elsewhere. while at the same time balancing out the inventory supply of all products to make their inventories more proportional. Reduction and elimination of these inventory 'wait' states is a key concept in Lean. There are well-proven processes and techniques to assist in inventory planning and strategy. there is no "excess inventory." that is. as well as the complexity of the supply chain. The secondary goal of inventory proportionality is inventory minimization. . Principle of inventory proportionality Purpose Inventory proportionality is the goal of demand-driven inventory management. Too big an inventory reduction too quickly can cause a business to be anorexic. i. inventory that would be left over of another product when the first product runs out. to the product that just ran out.Unnecessary inventory adds enormously to the working capital tied up in the business.) worth of inventory on hand across all products so that the time of runout of all products would be simultaneous.e. both at the business overview and part number level. In such a case.

The motorists do not know whether they are buying gasoline off the top or bottom of the tank. nor need they care. and differentiated from the "trigger point" systems where product is reordered when it hits a certain level. so it is simply cash sunk (literally) into the ground. One early example of inventory proportionality used in a retail application in the United States is for motor fuel. Roots The use of inventory proportionality in the United States is thought to have been inspired by Japanese just-in-time parts inventory management made famous by Toyota Motors in the 1980s.Applications The technique of inventory proportionality is most appropriate for inventories that remain unseen by the consumer. the product is expensive. each stored in dedicated tanks. Finally. gasoline) is generally stored in underground storage tanks. This application for motor fuel was first developed and implemented by Petrolsoft Corporation in 1990 for Chevron Products Company. . Inventory proportionality minimizes the amount of excess inventory carried in underground storage tanks. Most major oil companies use such systems today. unwanted or stale.g. Additionally. inventory proportionality is used effectively by just-in-time manufacturing processes and retail applications where the product is hidden from view. As opposed to "keep full" systems where a retail consumer would like to see full shelves of the product they are buying so as not to think they are buying something old. in proportion to the sales of each grade. these storage tanks have a maximum capacity and cannot be overfilled. Inventory proportionality is used to balance the inventories of the different grades of motor fuel. Motor fuel (e. Excess inventory is not seen or valued by the consumer.

. and the financial reporting definitions of 'cost' have distorted effective management 'cost' accounting since that time. However. Those companies (especially in metalworking) attempted to achieve success through economies of scope . Manufacturing management is more interested in inventory turnover ratio or average days to sell inventory since it tells them something about relative inventory levels. The second formula then creates the new start point for the next period and gives a figure to be subtracted from the sales price to determine some form of sales-margin figure. The managers now needed information on the effect of product-mix decisions on overall profits and therefore needed accurate product-cost information.High-level inventory management It seems that around 1880 there was a change in manufacturing practice from companies with relatively homogeneous lines of products to vertically integrated companies with unprecedented diversity in processes and products. which relate to the accounting period: 1. In particular. Cost of goods available − cost of ending inventory at the end of the period = cost of goods sold The benefit of these formulae is that the first absorbs all overheads of production and raw material costs into a value of inventory for reporting. the burgeoning need for financial reporting after 1900 created unavoidable pressure for financial accounting of stock and the management need to cost manage products became overshadowed. Cost of Beginning Inventory at the start of the period + inventory purchases within the period + cost of production within the period = cost of goods available 2. high-level financial inventory has these two basic formulas. it was the need for audited accounts that sealed the fate of managerial cost accounting. The dominance of financial reporting accounting over management accounting remains to this day with few exceptions. A variety of attempts to achieve this were unsuccessful due to the huge overhead of the information processing of the time. Hence.the gains of jointly producing two or more products in one facility. This is particularly true of inventory.

The ratio may not be able to reflect the usability of future production demand. which is generally not a good figure (depending upon the industry). Inventory management should be forward looking. whereas a factory that moves from six turns to twelve turns has probably improved effectiveness by 100%. Inventory Turn is a financial accounting tool for evaluating inventory and it is not necessarily a management tool.Inventory turnover ratio (also known as inventory turns) = cost of goods sold / Average Inventory = Cost of Goods Sold / ((Beginning Inventory + Ending Inventory) / 2) and its inverse Average Days to Sell Inventory = Number of Days a Year / Inventory Turnover Ratio = 365 days a year / Inventory Turnover Ratio This ratio estimates how many times the inventory turns over a year. So a factory with two inventory turns has six months stock on hand. so many things that can vary hidden under this appearance of simplicity that a variety of 'adjusting' assumptions may be used. they are also fraught with the danger of their own assumptions. While these accounting measures of inventory are very useful because of their simplicity. as well as customer demand. This improvement will have some negative results in the financial reporting. The methodology applied is based on historical cost of goods sold. There are. in fact. . since the 'value' now stored in the factory as inventory is reduced. These include: • • • • Specific Identification Weighted Average Cost Moving-Average Cost FIFO and LIFO. This number tells how much cash/goods are tied up waiting for the process and is a critical measure of process reliability and effectiveness.

attempt to minimize on-hand inventory and increase inventory turns. such enterprises are quite probably in the minority in the 21st century. with multistage-process companies. For example. Today. define inventory to suit their needs within US Generally Accepted Accounting Practices (GAAP). Each country has its own rules about accounting for inventory that fit with their financialreporting rules. including Just in Time (JIT) Inventory. VMI and CMI have gained considerable attention due to the success of third-party vendors who offer added expertise and knowledge that organizations may not possess. the rules defined by the Financial Accounting Standards Board (FASB) (and others) and enforced by the U. but the valuation is a management decision since there is no market for the partially finished product. there is much inventory that would once have been finished goods which is now held as 'work in process' (WIP). which establishes an independent market value for the good. This somewhat arbitrary 'valuation' of WIP combined with the allocation of overheads to it has led to some unintended and undesirable results.S.S.Business models. . Where 'one process' factories exist. cost accounting functions internally to an organization and potentially with much greater flexibility. Other countries often have similar arrangements but with their own GAAP and national agencies instead. This needs to be valued in the accounts. there is a market for the goods created. It is intentional that financial accounting uses standards that allow the public to compare firms' performance. organizations in the U. A discussion of inventory from standard and Theory of Constraints-based (throughput) cost accounting perspective follows some examples and a discussion of inventory from a financial accounting perspective. The internal costing/valuation of inventory can be complex. Securities and Exchange Commission (SEC) and other federal and state agencies. Whereas in the past most enterprises ran simple. one-process factories. Vendor Managed Inventory (VMI) and Customer Managed Inventory (CMI).

Role of inventory accounting By helping the organization to make better decisions.Financial accounting An organization's inventory can appear a mixed blessing. in principle. turn it into cash by selling it. as in Thor Power Tool Company v. and for insurance to cover staff to handle and protect it from fire and other disasters. The conflicting objectives of cost control and customer service often pit an organization's financial and operating managers against its sales and marketing departments. Such holding costs can mount up: between a third and a half of its acquisition value per year. Salespeople. known as "Lean production" will significantly reduce working capital tied up in inventory and reduce manufacturing costs (See the Toyota Production System). This effort. This conflict can be minimised by reducing production time to being near or less than customers' expected delivery time. inventory also brings associated costs for warehouse space. Commissioner. in particular. Inventory appears as a current asset on an organization's balance sheet because the organization can. Some organizations hold larger inventories than their operations require in order to inflate their apparent asset value and their perceived profitability. obsolescence. Businesses that stock too little inventory cannot take advantage of large orders from customers if they cannot deliver. depending on particular countries' laws regarding depreciation of inventory. but it also ties up money that could serve for other purposes and requires additional expense for its protection. for utilities. shrinkage (theft and errors). In addition to the money tied up by acquiring inventory. so unavailable goods may reduce their potential personal income. Inventory may also cause significant tax expenses. often receive sales-commission payments. the accountants can help the public sector to change in a very positive way that delivers increased value for the taxpayer’s . since it counts as an asset on the balance sheet. and others.

first out. Using LIFO accounting for inventory. This goes beyond the traditional preoccupation with budgets – how much have we spent so far. on taxation. due to the effects of . a company generally reports lower net income and lower book value. Which method an accountant selects can have a significant effect on net income and book value and. Finance should also be providing the information. That means making the connections and understanding the relationships between given inputs – the resources brought to bear – and the outputs and outcomes that they achieve. So often they are the litmus test by which public confidence in the institution is either won or lost. if not all. analysis and advice to enable the organizations’ service managers to operate effectively. For commodity items that one cannot track individually. by ensuring that success is appropriately recognized in both the formal and informal reward systems of the organization. To say that they have a key role to play is an understatement. FIFO regards the first unit that arrived in inventory as the first one sold. FIFO vs. ethical manner. of the key business processes within the organization. This is simple where the CoG has not varied across those held in stock. but where it has. LIFO accounting When a merchant buys goods from inventory. It is also about understanding and actively managing risks within the organization and its activities. accountants must choose a method that fits the nature of the sale. It should be steering the stewardship and accountability systems that ensure that the organization is conducting its business in an appropriate. LIFO considers the last unit arriving in inventory as the first one sold. Two popular methods that normally exist are: FIFO and LIFO accounting (first in . It can also help to incentivise progress and to ensure that reforms are sustainable and effective in the long term. last in . how much do we have left to spend? It is about helping the organization to better understand its own performance.first out). then an agreed method must be derived to evaluate it. Finance is connected to most. the value of the inventory account is reduced by the cost of goods sold (COGS). in turn. It is critical that these foundations are firmly laid.investment.

firms use the same efficiencies to downsize. Due to LIFO's potential to skew inventory value." He offers a substitute. or otherwise reduce their labor force. UK GAAP and IAS have effectively banned LIFO inventory accounting. the process takes longer and uses more than the standard labor time. a policy decision to increase inventory can harm a manufacturing manager's performance evaluation. and firms in several ways. This generally results in lower taxation. Standard cost accounting Standard cost accounting uses ratios called efficiencies that compare the labour and materials actually used to produce a good with those that the same goods would have required under "standard" conditions. Unfortunately. As long as similar actual and standard conditions obtain. Workers laid off under those circumstances have even less control over excess inventory and cost efficiencies than their managers. Standard methods continue to emphasize labor efficiency even though that resource now constitutes a (very) small part of cost in most cases. Many financial and cost accountants have agreed for many years on the desirability of replacing standard cost accounting. few problems arise. Theory of constraints cost accounting Eliyahu M. even though s/he has no control over the production requirement or the problem. which means that processes must operate at higher rates. Goldratt developed the Theory of Constraints in part to address the costaccounting problems in what he calls the "cost world. found a successor. workers. called throughput accounting. The manager appears responsible for the excess. Standard cost accounting can hurt managers. rightsize. In adverse economic times. When (not if) something goes wrong. when labor comprised the most important cost in manufactured goods. that uses throughput (money for goods sold to customers) in place of . For example. Increasing inventory requires increased production. standard cost accounting methods developed about 100 years ago.inflation. however. They have not.

like materials and components. It also includes computer or consumer-electronic equipment that is obsolete or discontinued and whose manufacturer is unable to support it. This is one of the biggest inventory write-offs in business history. distressed inventory is inventory whose potential to be sold at a normal cost has passed or will soon pass. Those relationships direct attention to the constraints or bottlenecks that prevent the system from producing more throughput. Instead of an incentive to reduce labor cost. Throughput accounting recognizes only one class of variable costs: the truly variable costs. Distressed inventory Also known as distressed or expired stock. clothing that is defective or out of fashion. . or have reached a date in advance of expiry at which the planned market will no longer purchase them (e. and many other things in addition to the categories listed here. 3 months left to expiry). including buildings. but labor-efficiency ratios no longer evaluate managers and workers. He defines inventory simply as everything the organization owns that it plans to sell. Finished goods inventories remain balance-sheet assets. Cisco wrote off inventory worth US $2. One current example of distressed inventory is the VHS format In 2001.g. and old newspapers or magazines. rather than to people .output (goods produced that may sell or may boost inventory) and considers labor as a fixed rather than as a variable cost. machinery. In certain industries it could also mean that the stock is or will soon be impossible to sell. which vary directly with the quantity produced.25 billion due to duplicate orders. Examples of distressed inventory include products that have reached their expiry date.who have little or no control over their situations. throughput accounting focuses attention on the relationships between throughput (revenue or income) on one hand and controllable operating expenses and changes in inventory on the other.

then the replenishment order is filled from stock on hand. used with Parmesan cheese in Italy. A precondition for such credit is that banks must be confident that the stored product will be available if they need to call on the collateral. Single-Level Inventory Policies Inventory policies specify decision rules with respect to the point in time when a replenishment of the inventory should be initiated. If the supplying node is a production segment of the same company. archaeological evidence suggests that it was practiced in Ancient Rome. If the supplying node is an inventory node located upstream in the supply network (an inventory node of the same company or an external supplier). This is not a new concept. then the replenishment order is filled after the flow time of a production order at the production node. this implies the existence of a reliable network of certified warehouses. It is. Obtaining finance against stocks of a wide range of products held in a bonded warehouse is common in much of the world. or inventory. as well as to the replenishment quantity that should be ordered from the supplying node in the supply network. Where banks may be reluctant to accept traditional collateral. Inventory credit on the basis of stored agricultural produce is widely used in Latin American countries and in some Asian countries. for example. possibly after an inventory-related waiting time. as collateral to raise finance. The possibility of sudden falls in commodity prices means that they are usually reluctant to lend more than about 60% of the value of the inventory at the time of the loan.Inventory credit Inventory credit refers to the use of stock. . Banks also face problems in valuing the inventory. inventory credit is a potentially important way of overcoming financing constraints. for example in developing countries where land title may be lacking.

deterministic methods of constructing a production schedule are too costly or unavailable. If the source is an external supplier.according to an ABC classification. then the replenishment lead time is equal to the customer order waiting time provided by the supplier. The inventory is supplied from a "source" which fulfills orders for the considered product after a certain replenishment lead time. the utilization of the production stage being one of them. The application of inventory policies is also proposed for B and C products. In all mentioned cases it is clear that the replenishment lead time may be subject to random variations. This is usually the case for spare parts or retail goods. If the source is a production segment or rather production stage of the same company. then the replenishment lead time is a function of the flow time of a production order and depends on numerous factors. in cases when capacity oriented. If the source is another inventory node of the company. Multi-Level Inventory Systems . plus an additional time required for material handling and transportation.Inventory policies must be applied when no sufficient planning data are available that could be used to construct a deterministic production schedule based on the predicted development of the future demand. then the order is a demand observed by this inventory node and the replenishment lead time depends on the inventory available on hand as well as on the time required for material handling and transportation processes.

node located upstream) and multiple regional warehouses (retailer. The central warehouse sends replenishment orders to an external supplier who delivers after a fixed delivery lead time (which is the replenishment lead time of the central warehouse). Echelon stock policies use inventory information from all nodes located downstream in the supply network which are linked to the focused inventory node. nodes located downstream) serving random demands. we consider: . Therefore the replenishment lead time seen by the customer node is the customer order waiting time provided by the supplier node. e. • Central Control – Echelon Stock Policies. An installation stock policy uses only inventory data with respect to the local inventory node. the downstream node is the customer of the upstream node. Reducing the customer's replenishment lead time reduces the required safety stock. In this case the replenishment decisions are made for each inventory node in isolation. The reason is: In a multi-level supply network. In the case studied most often. i. Reducing the customer order waiting time is possible by increasing the supplier's safety stock. The inventory node located upstream (central warehouse) has several options to use the data that are available after an inventory review: • Local Control – Installation Stock Policies.Compared to single-level inventory systems. multi-level supply networks are much more complicated. a two-stage inventory system is considered with one central warehouse (wholesaler. To put it the other way round. The majority of approaches to the analysis of supply networks consider system structures which include solely inventory nodes. an upstream node is the supplier of a downstream node. without considering the states of the other nodes in the supply network. According to the different types of system structures which can be further differentiated with respect to the number of levels.

We are your source for inventory management information. A complete Inventory Management Control system contains the following components: . retail or product line will help to create revenue for your company. payment receipts and can print bar coded labels.• Convergent systems • Divergent systems • Generally structured systems In a convergent system each node of the supply network has at most one successor (downstream node). An inventory management software system configured to your warehouse. receiving lists. In a divergent system each node has at most one predecessor node (upstream node) but may have multiple successor nodes. Inventory management software Inventory management software helps create invoices. The Inventory Management will control operating costs and provide better understanding. This type of system structure is often used for modeling the valueadding process of an end product in a supply network consisting of several tiers of suppliers and the different production stages within a factory. Finally. purchase orders. The most popular system of this kind is the ”OneWarehouse-N-Retailer” distribution system. This system structure is the most complicated one and the structure that is most often found in practice. inventory management software and tools. at least if the value-adding processes are modeled in detail. in a generally structured system there are no restrictions with respect to the number of predecessors and successors that a node may have.

With NetSuite. you gain an in-depth. manufacturing. and purchasing capabilities that will provide you with integrated supply chain management and control across your entire organization.• • • • • • • • Inventory Management Definition Inventory Management Terms Inventory Management Purposes Definition and Objectives for Inventory Management Organizational Hierarchy of Inventory Management Inventory Management Planning Inventory Management Controls for Inventory Determining Inventory Management Stock Levels Total Visibility and Control of Your Supply Chain NetSuite inventory management software offers a complete set of inventory management. you'll be able to better manage inventory levels and costs—and better meet fulfillment expectations. NetSuite delivers an end-to-end procure-to-pay process that truly creates competitive advantage. With NetSuite. Self-service capabilities for partners. inventory and procurement indicators. improving customer service. real-time view into key supplier. . vendors and customers allow you to share supply and demand information—improving collaboration throughout the entire supply chain.

costs and fulfillment measures and trends Manage margins with a clear view into inventory costs. supply. turn rates and inventory profitability Eliminate manual inventory management processes and improve vendor satisfaction with a seamless procure-to-pay process Significantly improve your relationships with suppliers.Benefits • Get complete real-time visibility into demand. helping drive and maintain superior customer service levels • • • • . vendors and partners by providing self service and real-time visibility Effectively and efficiently meet customer demand.

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