Chapter 22: inventory management.
Stock (inventory) :materials and goods required to allow for the production and supply of products to
Why all businesses hold stock.
Manufacturing business will hold stocks in three distinct forms
1. Raw materials and components – these are held in stock until they are used. These stocks can
be drawn upon at any time and allow the firm to meet increases in demand by increasing the
rate of production quickly.
2. Work in progress – the production will be converting raw materials and components into
finished goods. During this process there will be ‘work in progress’ and for some firms this will
be the main form of stocks held. The value of stocks held in this form depends not only on the
length of time needed to complete production used.
3. Finished goods – these are held in stock until sold and despatched to the customer. These
stocks can be displayed to potential customers and increase the chances of sales. They are also
held to cope with sudden, unpredicted increases in demand so that customers can be satisfied
Without effective stock management several serious problems can arise for firms:
There might be insufficient stocks to meet unforeseen changes in demand.
Out-of-date stocks might be held if an appropriate stock-rotation system is not used.
Stock wastage might occur due to mishandling or incorrect storage conditions.
Very high stock levels may result in excessive storage costs and a high opportunity cost for the
capital tied up.
Poor management of the stock-purchasing function can result in late deliveries, low discounts
from suppliers or too large a delivery for the warehouse to cope with.
In analysing stock-management systems it is essential to be aware of the costs of holding stocks and the
costs of running out of stocks.
Stock- holding costs.
1. Opportunity cost – capital tied up in stocks could be used to other uses such as, to pay off loans,
buy new equipment, left in bank to earn interest etc. the higher level of stocks and the more
capital used to finance them, then the greater the opportunity cost will be. During periods of
high interest rates, the opportunity cost of stock holding increases.
2. Storage cost – stocks have to be held in warehouses, some require special conditions such as
refrigeration, also staff will be needed to guard and transport the stocks and insurance of stocks is recommended. If finance has to be borrowed to buy the stocks, then this will incur interest
charges. Lower stock levels are likely to reduce these costs significantly.
3. Risk of wastage and obsolescence – if stocks are not used or sold as rapidly as expected, then
they probably deteriorate or become out-dated. Goods often become damaged whilst held in
storage or being moved.
Costs of not holding enough stocks.
This occurs when a business can is not able to operate the JIT system. However there are risks to holding
low stock levels, these have financial costs for the firm. These costs are often called ‘stock-out’ costs:
1. Lost sales- if a firm is unable to supply customers form stock, then sales could be lost to other
firms, this could lead to future losses too. Also in purchasing contracts between businesses,
there may be a penalty-payment if stock is late.
2. Idle production resources – if stocks of resources run out, production will have to stop. This will
leave expensive equipment idle and labour with nothing to do.
3. Special orders could be expensive
4. Small order quantities - keeping low stock levels may mean onl