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You are here8. Inventory Fundamentals

8. Inventory Fundamentals


By Anonymous - Posted on 11 February 2012

Inventories are materials and supplies that a business or institution carry either for sale or to provide inputs or supplies to the production process. All businesses and institutions require inventories. Often they are a substantial part of total assets.

Financially, inventories are very important to manufacturing companies. On the balance sheet, they usually represent from 20% to 60% of total assets. As inventories are used, their value is converted into cash, which improves cash flow and return on investment. There is a cost of carrying inventories, which increases operating costs and decreases profits.

Inventory ties up capital, requires handling, uses storage space, deteriorates, sometimes becomes obsolete, requires insurance, incurs taxes, can be stolen or gets lost. Inventory must be considered at each of the planning levels with production planning concerned
with overall inventory, master planning with end items and materials requirements planning with components parts and raw material.

The primary function of inventory is buffering and decoupling. It serves as a shock absorber between customer demand and the manufacturer’s production capability, between input materials required for an operation and the output of the preceding operation, between the manufacturing process and the supplier of raw materials. It essentially – decouples – demand from the immediate dependence on the source of
supply.

Aggregate inventory management
Aggregate inventory management deals with managing inventories according to their classification (raw material, WIP and finished goods) and the function they perform rather than at the individual item level. It is financially oriented and is concerned with the costs and benefits of carrying the different classifications of inventories. As such, aggregate inventory management involves:
- Flow and kinds of inventory needed,
- Supply and demand patterns,
- Functions that inventories perform,
- Objectives of inventory management,
- Cost associated with inventories.

Item inventory management
Management must establish decision rules about inventory items so the staff responsible for inventory control can do their job effectively. These rules include the following:
- Which individual inventory items are most important,
- How individual items are to be controlled,
- How much to order at one time,
- When to place an order.

Some factors influencing inventory management decisions are:
- Types of inventory based on the flow of material,
- Supply and demand patterns,
- Functions performed by inventory,
- Objectives of inventory management,
- Inventory costs.

Reasons for Carrying Inventory

  1. To meet the customer (internal & external) demand at the right time
  2. To avoid lost sales due to stock outs
  3. Economy of scale in production, purchase and logistics
  4. To protect against the rising prices of the material in the market

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