Concept Of Inventory

  Inventory is defined as a usable resource which is physical and tangible such as material. In this sense, our stock is our inventory, but even then the term inventory is more comprehensive. Though inventory is a usable resource, it is also an idle resource; unless it is managed efficiently and effectively.

  Inventory management boils down to maintaining an adequate supply of something to meet the ­expected demand pattern subject to budgeting considerations. Inventory could be raw materials, work-in-pregress (WIP), finished products or the spare parts and other indirect materials. Effectiveness of the materials and production functions depend to a large extent upon inventory management.

                                                        Annual Demand

Inventory turnover ratio=----------------

                                                         Average Inventory

 Above formula is an index of business performance. Sound management gives a higher inventory turnover ratio.

   Inventories have to be procured, stored and carried for a production system, since a situation when they can be instantaneously available is difficult to assume in Indian setting, Inventor therefore, a necessary evil to stay.

Definition

The term Inventory' originates from the French word “Inventaire” and Latin word “inventariom”, which implies a list of things found.

The term inventory has been defined by several authors. The more popular of them are:

“The term inventory includes materials - raw, in process, finished packaging, spares and others stocked in order to meet an unexpected demand or distribution in the future.”

“it can be used to refer to the stock on hand at a particular time of raw materials, goods-in-process of manufacture, finished products, merchandise purchased for resale, and the like, tangible assets which can be seen, measured and counted…. in connection with financial statements and accounting records, the reference may be to the amount assigned to the stock of goods owned by an enterprise at a particular time”

Importance of Inventory

 Inventories constitute the largest component of current assets in many organizations

• Poor management of inventories therefore may result in business failures

• A stock-out creates an unpleasant situation for the organization.

• In case of a manufacturing organization, the inability to supply item from inventory could bring production process to a halt

• Conversely, if a firm carries excessive inventories, the added carrying cost may represent the difference between profit and loss

• Efficient inventory control, therefore, can significantly contribute to the overall profit-position of the organization

Types of Inventories

1. Production Inventories

Raw materials, parts, and components which enter the firm’s product in the production process are called as production inventories. These may consist of two general types:

a) Special items manufactured to company specifications

b) Standard industrial items purchased “off the shelf”.

2. MRO Inventories

Maintenance, repair, and operating supplies which are consumed in the production process but which do not become part of the product, (e.g., lubricating oil, soap, machine repair parts).

3. In-process inventories

Semi-finished products found at various stages in the production operation.

4. Finished goods Inventories

Completed products ready for shipment.

Inventory Costs

The following four types of costs are considered in calculating inventory size:

1. Holding (or carrying) costs

These relate to those costs which are incurred to carry the inventory items in stock for a period of time. It is expressed as a percentage of rupee value per unit of time. An annual holding cost of 15 per cent means that it will cost Rs. 15 to hold Rs100 of inventory for a year. This broad category includes costs for storage, handling, insurance, pilferage, breakage, obsolescence, depreciation, taxes and the opportunity cost of capital. When items are carried in inventory, the capital is tied up and is not free to be invested in other things — a foregone opportunities for other investments. This is assigned to inventory as an opportunity cost.

2. Set up (or production charge) costs

Production of different products requires procurement of necessary materials, arrangement of specific equipment set-ups, filling of the required papers, charging time and materials and moving out previous stock of materials. It means paperwork costs and to set up production equipment for a run.

When set up costs are heavy, there is an economy in having large runs. Set up time can be reduced by changes in production system and product. Though set up cost is considered fixed, it can be changed by changing the design and management of operations.

Where there no costs in changing from product to product, it would have been possible to produce smaller lots leading to lowering of inventory levels and saving in costs.

3. Ordering costs

These are the cost associated with the placement of an order. This cost remains the same irrespective of the items ordered. These costs include clerical costs of making an order, expediting it, receiving it and so on. Transportation costs are a part of ordering costs. Even if the item is produced within a firm, there are ordering costs. Tracking an order is also a part of the ordering costs.

4. Stock-out costs

There is an economic cost when we run out of stock. If the customer has to wait because of back logging an item for the customer, there is loss of future business. It is an opportunity loss. If the material is not on hand, there can be a lost sale with consequent loss of and future profits.

When the item is depleted, we cannot entertain its order till the stock is replenished. There is a trade-off between carrying cost to satisfy demand and costs resulting from stock out. This is what is known as shortage costs.