Importance of Inventory Management
While walking with a friend along a busy street, we decided to have a refreshing cup of tea. The area was such that we could locate only a way/street side tea stall. We stood there and ordered two cups of tea. The owner, who was at the gas stove nodded at us.
As we waited for the tea, which we needed very badly, we noticed that the owner was searching for something. We noticed that the tea powder jar was empty. He called a boy, his assistant, who would serve the tea, clean the glasses etc. and said “ are thodi chai patti lav” (Hey, get me some tea powder) The boy looked for it but found that even the bigger container was empty. The owner got up and from somewhere pulled a small tin box and said “ aare dekho isme maine chai patti rakhi hai’’ (Hey, look I have kept some tea powder here)
My friend asked the chaiwala “Do you always keep some reserve stock?’’ “Ha sab nahito dhanda kaise chalega?Abhi mai shyamko bazar jake pura dibba chai patti leke aaunga” ( yes sir, how will I function otherwise? I will go to the market in the evening and get a bag full of tea powder) replied the shop owner. In the meantime, the tea was served to us in a thick, non-transparent glass!
We left the place thinking about how even the street tea stall owner knows about keeping emergency stock, a very important facet of inventory management. “Whether you are a small street vendor or a multinational corporate, management of inventory is very important,” my friend said.
Let us understand the what’s and how’s of inventory management.
What Is Inventory And It’s Management
The dictionary meaning of the term inventory is:
“The amount/number of goods and material owned by a company at a particular time, including parts, products being made and finished goods”
In a trading concern, the stock of goods purchased for resale forms the inventory. However, in case of a manufacturing or processing activity, inventory consists of raw material, goods under process, and the finished products.
Maintenance of inventory results in the blocking of funds. This would involve payment of interest on the funds borrowed for holding the inventory and also the opportunity cost for the firm. Besides interest, the cost includes storage, insurance, obsolesce and cost of movement of goods from storage to factory/works.
Inventory and all its components are essential assets of any business organisation and the main objectives of inventory management are:
- Minimise the possibility of disruption in the production schedule for want of or inadequacy of raw material or other spares
- Lessen the capital invested in the inventory
- Obtain the best results by better management of inventory
Factors To Consider
The factors which the entrepreneur should consider while deciding the ideal level of these three components of inventory are:
a) Raw Materials:
- How much will be the average monthly consumption for the projected yearly sales?
- Lead time i.e, the time needed from placing the order until the material reaches the workplace.
- Minimum order and economic order quantity which means that some of the suppliers of material insist on placing minimum order quantity. Also when placing the order the entrepreneur should take into account the transport and other expenses. He may also have to consider the expenses on transportation etc., if repeat orders are placed as against purchasing the material in bulk quantity.
- Seasonality: Some of the agricultural based products/raw materials are available only during the season and hence the adequate quantity stock has to be purchased to take care of the yearly requirement.
- Credit available from the suppliers, cost of holding and the storage capacity are few other factors to be considered.
b) Stocks – in- process, also called goods in process:
How much inventory will remain in the form of “in process stock’’ would largely depend upon the following factors:
- technology used
- processing time needed
- product range
- production capacity of the firm
- number of shifts, etc.
Generally, longer the processing time, higher is the SIP (Stocks In Process) i.e, the quantity of material which would remain as partly finished goods.
c) Finished Goods:
How many finished products should be kept ready is one of the major problems many businesses face. The ideal level will depend upon:
- production capacity
- overall demand
- seasonal demand
- storage space and cost
- firm orders or anticipated order quantity
- buyer profile
- the distribution process i.e, directly to retailers or through dealers and
- perishability of the product, etc.
Few Techniques Used For Inventory Management
i) ABC Analysis:
For having effective control over the inventory, especially raw materials, segregation of items can be done on the basis of value i.e. High, Medium and Low value. Normally high-value items comprise a small portion of the total raw material stock, which helps the entrepreneur to have “Always Better Control or ABC” over the stocks.
ii) Setting Norms For Holding Inventory Level:
The entrepreneur can study the inventory holding position in other firms/units in the same business and the past trend. Based on the analysis he can set norms for inventory holding which are normally expressed as under:
- raw material: as ‘so many months’ consumption
- Stock in process: as ‘so many months’ cost of production
- Finished goods: as ‘so many months’ cost of sales
iii) Just In Time (JIT) :
JIT inventory control system implies that the entrepreneur should maintain a minimal level of inventory and rely on suppliers to provide parts and components ‘just-in-time’,i.e, immediately on demand in order to meet its assembly requirements. JIT is also known as Zero Inventory Production Systems(ZIPS), Zero Inventories(ZIN), and Materials as Needed(MAN).
iv) Two Bins Technique:
This includes two ‘bins’ where in the First Bin there is just enough inventory to last from the date a new order is placed until it is received for inventory. Second Bin- enough to meet current demand over the period of replenishment.
As such, inventory management and control are vital to the survival of any business. If the business does not have a good system for inventory management the entrepreneur will never have a true account as to how the business is doing. We are in a very competitive market and the entrepreneur cannot afford to let inventory excess or shortages become reasons for his downfall.
Mr. Arun Vartak
Mr. Vartak has 34 years of experience as a banker specialised in handling credit processing cells. He has served in many banks including State Bank Of India, Janata Sahakari , Saraswat Bank and various other management institutes.