Chapter 12: Inventory Management
Inventory: An idle material or product, usually in a warehouse or storeroom and
kept for use or sale in the future.
Inventory Management: Planning and controlling the inventories.
Importance of Inventories
Major source of inventories
~30% of its current assets
~90% of its working capital:
INVESTED IN INVENTORIES.
One widely used measure is R.O.I. (Return on Investment):
This is profit AFTER taxes divided by total assets.
Since INVENTORIES likely represent a SIGNIFICANT portion of total assets,
A reduction in INVENTORIES can represent a SIGNIFICANT increase in R.O.I.
Functions (Purpose) of Inventories
1. To wait while being transported.
Raw materials and parts from suppliers, and finished goods from
manufacturers heading to markets need to be transported. Depending on the
method of transportation and the destination itself it could take the freight
months to arrive. Items being transported are called in-transit inventory.
2. To protect against stock outs.
Risk of shortage can be reduced by safety-stock, which are stocks in excess of
average demand to compensate for variability’s in demand and delivery lead-
-if usage rate higher than expected.
-if supplier delivery is delayed.
3. E.O.Q.’s and quantity discounts.
In order to reduce costs organizations purchase materials in bulk even
thought it exceeds their demand. This is then stored for later use.
4. To smooth seasonal demand or production.
For organizations that have seasonal demand they normally build up their
inventories during off-season periods to meet high requirements during peak
5. To decouple operations.
Use inventories as buffers so while a problem is going on production can still
continue temporarily while the problem is being resolved.
6. To hedge against price increases. If a manager feels that the materials they sue to create a product will have a
price increase they will buy a lot of the product needed and store it. This is
called anticipation inventory.
Importance and Objectives of Inventory Management
Under and over stocking of items are 2 major problems than can occur when
inventory management is not done correctly.
- Under-Stocking: results in missed deliveries, lost sales, dissatisfied
customers, and production stoppage.
- Over- Stocking: ties up funds that might be more productive
elsewhere and also ties up storage space.
Inventory management has 2 main concerns:
1. Level of Customer Service (Availability)
2. The Costs of Ordering and Holding Inventories.
Inventory Turnover: The ratio of annual costs of goods to average
inventory investment. The inventory turnover rate indicates how many times
a year the inventory is sold or used.
- The higher the ratio the better, because that implies more efficient use
LO2: Requirements for Effective Inventory Management
Inventory managers are required to perform the following activities:
1. Safely storing and managing inventories.
Things that can freeze e.g. Paint mus