CH.
24 INVENTORY MANAGEMENT
Inventory
Materials needed for the production of gids and services.
Types:
1. Raw materials
Purchased from outside suppliers
2. Work in progress
Work in progress is any product which is not yet converted
into finished goods.
Depends on time period of production and production
method used.
3. Finished goods
Good ready to be sold to consumers
Inventory management
Without effective inventory management, there maybe many
problems.
o Insufficient inventories to meet unforeseen changes in
demand
o Out-of-date inventories maybe held
o Wastage due to incorrect storage conditions
o High storage and opportunity costs if extra inventory is held
o Poor management may lead to delayed deliveries, ignoring
discounts, etc
Inventory holding costs
1. Opportunity cost – working capital tied up in inventory could be
used elsewhere. Higher interest rates, higher the opportunity cost of
holding inventory.
2. Storage cost – inventories must be held in appropriate, safe
conditions to avoid wastage. Higher inventory, higher the storage
costs
3. Risk of wastage and obsolescence – if inventories are kept unused,
they may become obsolete, lowering the value of such inventories
and increasing the business’s expenses
Costs of not holding inventories
1. Lost sales – business may not be able to supply all customers,
leading to loss of sales and revenue
2. Idle production resources – if raw material inventories run out,
expensive equipment and workers will be left idle, leading to loss of
output and wasted resources.
3. Special orders could be expensive – urgent orders given to suppliers
may lead to extra delivery, administration costs
4. Small order quantities – higher average costs as the company will
not benefit from economies of scale
Optimum order size
Operations manager must ensure they have enough stocks to allow
for smooth production.
Operations managers usually order their inventories on the basis of
the Economic Order Quantity (EOQ)
EOQ is the optimum inventory level where the costs incurred are
minimum (both re-ordering costs and stock-holding costs)
The reorder costs decrease as
the order size increases,
showing a downward sloping
graph.
Whereas, the stock-holding
costs increase as the order
size rises, showing an
upward sloping graph.
The Economic Order
Quantity is shown where the
stock-holding costs and re-
order costs curves intersect.
Inventory control graphs
Inventory-control graphs record the buffer inventories, maximum
inventory.
They help in determining the right order time and quantity.
Buffer inventory – minimum inventory held to deal with delays in
delivery and unforeseen demand changes
Maximum inventory level – the maximum quantity of inventory
the company can hold, space and financial terms
Reorder quantity – the number of units ordered each time
Lead time – time taken for the supplier to deliver the raw
materials
Reorder stock level – the level of inventory which will trigger a new
order
The maximum inventory is 60000 units. The buffer inventory level is
10000 units and the reorder level is 20000 units. The reorder quantity is
50000 units (60000-10000)
Just in time (JIT) inventory control
It is an inventory control system which avoids the need to hold
inventories. They arrive just as and when required
Requirements for JIT
Excellent relations with supplier
Flexible and multiskilled production staff
Flexible equipment and machinery
Accurate demand forecasts
Latest IT technology
Excellent employee-employer relations
Quality must be priority
Advantages and disadvantages
JIT evaluation
JIT requires employees to be accountable for their performance and
suppliers to be reliable
JIT may be unsuitable when:
o Costs of halting production exceed inventory holding costs
o Expensive IT systems cannot justify potential cost savings
o Global inflation makes holding inventories cheaper
