What is Inventory ?
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.
Objectives of Inventory
Many different organizational units have an interest in the creation and control of inventories. These objectives often conflict and must be resolved through negotiation and consideration of the overall benefits to the company. Some of the major objectives that underlie the use of inventories are:
Customer Service : Customer Service is the ability of a company to satisfy the needs of the customer. Inventory helps achieve this in several ways, including delivering in a timely manner, buffering against uncertainty, and providing variety to meet individual customer needs.
Delivering in a Timely Manner : The need to provide quick delivery of goods to users is a primary objective for holding inventories. This is especially true in terms of consumer goods. When a retailer runs short of a particular product, immediate replenishment from a distribution center is needed. The retailer is unwilling to wait for raw materials to be procured and the goods to be manufactured and then delivered over long distances. In the same way, when a distribution center needs replenishment of some products, quick delivery from an upstream distribution center or the factory is demanded. Other goods, notably industrial products, often do not call for immediate shipment. Still, the ability to deliver when promised is a service objective for every company. Competition also plays a major role in the need for customer service, because the ability
to deliver in a timely fashion often determines which producer or distributor will survive.
Buffering against Uncertainty : Inventories are often held because either the demand for goods or the replenishment of goods is subject to uncertainty. Anticipated demand for products is often forecasted in various ways. Forecasting is an inexact science, however, and it always includes some normal deviations that represent uncertainty. Inventories allow delivery even when demand exceeds those that were expected. Sometimes there is also uncertainty regarding supply; that is, how quickly can goods be replenished? Transportation, quality problems, excessive scrap, and supplier lead times are often factors contributing to uncertainty for which inventory can compensate.
Providing Variety : Not only is there uncertainty regarding the timing of demand for goods, but there is also uncertainty regarding exactly what will be demanded. This is often the case where goods are available with various options, colors, or packaging. Inventories in a variety of configurations are therefore needed to adequately fulfill customer demands.
Efficiency : There are many instances when inventories are held due to cost efficiencies in procurement and production and for balancing demand to production rate strategies.
In Purchasing : In many cases, goods are purchased in larger quantities than are immediately needed in order to achieve efficiency in purchasing or transport. For example, it is less costly per unit of material to ship goods in full truck, FCL (full container load) or full railcar loads than to ship smaller quantities and break bulk lots. Quantity discounts may also be available when goods are purchased in large quantities and larger purchasing lots results in lower ordering costs per unit. When large quantities of goods are delivered in this way, the result is higher inventory levels
In Production : From the production standpoint, long production runs of a single product are usually much more efficient than short runs. Things are only produced when the equipment is running. When the equipment is being set up for production of a certain part or product, it is nonproductive. The performance of factory managers is often measured by the amount of product they produce, which acts as an incentive for longer production runs. Long production runs lower the setup costs per item as setup costs, which are fixed, get absorbed over a larger number and lowers the average cost per unit. It is most important in cases of bottleneck resources where time lost on setups leads directly to lost throughput and lost capacity. Inventory allows operations with different production rates to operate independently and more economically. Inventory is used to level production runs for catering seasonal demand products where demand is non-uniform throughout the year. Level production runs allow manufacturing to continually produce an amount equal to the average demand. This leads to several cost efficiencies, as costs of changing production levels are avoided,
peak installed capacity is not required, overtime, hiring and firing costs and subcontracting costs are reduced. However, this leads to building up of anticipation inventory for peak periods.
Investment : Inventories are expensive to hold. They tie up funds in a company that could be more profitable if used elsewhere. Often it is necessary to borrow money from outside sources to pay for inventories. Carrying inventory is justified when benefits exceed the costs of carrying that inventory. Therefore, it is an objective of financial and other-senior level managers to keep inventory level as low as possible.
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.
Objectives of Inventory
Many different organizational units have an interest in the creation and control of inventories. These objectives often conflict and must be resolved through negotiation and consideration of the overall benefits to the company. Some of the major objectives that underlie the use of inventories are:
Customer Service : Customer Service is the ability of a company to satisfy the needs of the customer. Inventory helps achieve this in several ways, including delivering in a timely manner, buffering against uncertainty, and providing variety to meet individual customer needs.
Delivering in a Timely Manner : The need to provide quick delivery of goods to users is a primary objective for holding inventories. This is especially true in terms of consumer goods. When a retailer runs short of a particular product, immediate replenishment from a distribution center is needed. The retailer is unwilling to wait for raw materials to be procured and the goods to be manufactured and then delivered over long distances. In the same way, when a distribution center needs replenishment of some products, quick delivery from an upstream distribution center or the factory is demanded. Other goods, notably industrial products, often do not call for immediate shipment. Still, the ability to deliver when promised is a service objective for every company. Competition also plays a major role in the need for customer service, because the ability
to deliver in a timely fashion often determines which producer or distributor will survive.
Buffering against Uncertainty : Inventories are often held because either the demand for goods or the replenishment of goods is subject to uncertainty. Anticipated demand for products is often forecasted in various ways. Forecasting is an inexact science, however, and it always includes some normal deviations that represent uncertainty. Inventories allow delivery even when demand exceeds those that were expected. Sometimes there is also uncertainty regarding supply; that is, how quickly can goods be replenished? Transportation, quality problems, excessive scrap, and supplier lead times are often factors contributing to uncertainty for which inventory can compensate.
Providing Variety : Not only is there uncertainty regarding the timing of demand for goods, but there is also uncertainty regarding exactly what will be demanded. This is often the case where goods are available with various options, colors, or packaging. Inventories in a variety of configurations are therefore needed to adequately fulfill customer demands.
Efficiency : There are many instances when inventories are held due to cost efficiencies in procurement and production and for balancing demand to production rate strategies.
In Purchasing : In many cases, goods are purchased in larger quantities than are immediately needed in order to achieve efficiency in purchasing or transport. For example, it is less costly per unit of material to ship goods in full truck, FCL (full container load) or full railcar loads than to ship smaller quantities and break bulk lots. Quantity discounts may also be available when goods are purchased in large quantities and larger purchasing lots results in lower ordering costs per unit. When large quantities of goods are delivered in this way, the result is higher inventory levels
In Production : From the production standpoint, long production runs of a single product are usually much more efficient than short runs. Things are only produced when the equipment is running. When the equipment is being set up for production of a certain part or product, it is nonproductive. The performance of factory managers is often measured by the amount of product they produce, which acts as an incentive for longer production runs. Long production runs lower the setup costs per item as setup costs, which are fixed, get absorbed over a larger number and lowers the average cost per unit. It is most important in cases of bottleneck resources where time lost on setups leads directly to lost throughput and lost capacity. Inventory allows operations with different production rates to operate independently and more economically. Inventory is used to level production runs for catering seasonal demand products where demand is non-uniform throughout the year. Level production runs allow manufacturing to continually produce an amount equal to the average demand. This leads to several cost efficiencies, as costs of changing production levels are avoided,
peak installed capacity is not required, overtime, hiring and firing costs and subcontracting costs are reduced. However, this leads to building up of anticipation inventory for peak periods.
Investment : Inventories are expensive to hold. They tie up funds in a company that could be more profitable if used elsewhere. Often it is necessary to borrow money from outside sources to pay for inventories. Carrying inventory is justified when benefits exceed the costs of carrying that inventory. Therefore, it is an objective of financial and other-senior level managers to keep inventory level as low as possible.