- June 24, 2020
- Posted by: matogconsulting
- Category: Business Analysis
MANAGING BUSINESS INVENTORY
By Ayoade Apelegan
WHAT IS INVENTORY MANAGEMENT?
Inventory management is a part of supply chain management that focuses on having the right products in the right quantity for sale, at the right time.
The goal of inventory management is to minimize the cost of holding inventory by helping business owners know when it’s time to replenish products or buy more materials to manufacture them.
For most businesses, inventories constitute the most significant part of current assets. Due to this, a considerable amount of funds is required to be expended on them. It is therefore important to manage inventories efficiently and effectively to eliminate unnecessary investment.
WHAT IS INVENTORY?
This can be defined as the goods and materials a business acquires, produces or manufactures, for manufacturing, selling or exchanging.
TYPES OF INVENTORY
There are 3 main types of inventory namely:
- Raw materials inventory
- Work-In-Process inventory
- Finished goods inventory
Raw materials inventory
Raw materials inventory is the inputs that are converted into finished products through the manufacturing process. They are items/goods that have been purchased to be used up in the process of production. For example, if you run a bakery, flour and yeast which are part of the ingredients used in making bread are part of your inventory.
Work-In-Process inventory is any unfinished good which requires additional work before becoming a finished product. If your business makes and sells dresses, work-in-process inventory would include any unfinished dress on hand that your business has made.
Finished goods inventory
Finished goods inventory includes any finished goods that are ready to be sold.
IMPORTANCE OF INVENTORY MANAGEMENT
For all businesses, inventory management seeks to solve two conflicting problems which are:
Maintaining a large size of inventory for efficient and smooth production and sales operation.
To maintain a minimum investment in inventories to maximize profitability.
An inventory management system also helps to prevent several other mistakes:
Inventory management helps a business save money. For example, if you’re into the selling of a product that has an expiry date, like food, drugs and other consumables, there’s a very real chance it will go bad if it doesn’t get sold in time. Solid inventory management will help avoid spoilage.
Inventory management helps a business to prevent stockout. Stockout is inventory shortfall arising from unexpected demand, ineffective inventory management, production delays or replenishment disruptions.
These are costs incurred when a customer’s demand cannot be met because the stock is not available. It’s the opportunity cost of not having a stock when there is a demand for it. Examples of these costs are loss of goodwill, loss of turnover.
Deadstock is stock that can no longer be sold, not necessarily because it is expired, but it could have gone out of season, out of style, or otherwise become irrelevant. By managing your inventory better, you can avoid dead stock.
Save on storage costs
Warehouse cost is often a variable cost, meaning it fluctuates based on how much product is being stored. When you store too much product at once or end up with a product that’s difficult to sell, your storage costs will go up. Avoiding this will save the business money.
Improvement of cash flow
Not only is good inventory management more cost-efficient, but it also improves cash flow in other ways. Picture this scenario, you have ordered for goods/products that you’ve likely already paid for with cash and you’re going to sell it for cash, but while it’s sitting in your warehouse, it’s not cash.
This is why it’s important to factor inventory into your cash flow management. Inventory directly affects sales (by dictating how much you can sell) and expenses (by dictating what you have to buy), and both of these elements factor heavily into how much cash you have on hand. In short, better inventory management leads to better cash flow management.
When you have a solid inventory system you’ll know exactly how much product you have, and based on sales you can project when you’ll run out and make sure you replace it on time. Not only does this help ensure you don’t lose sales (critical for cash flow), but it also lets you plan for buying more so you can ensure you have enough cash set aside.
Read about Post-Incorporation Requirements
INVENTORY MANAGEMENT TECHNIQUES
Let’s take a look at some inventory-control techniques you may choose to utilize in your warehouse.
Economic Order Quantity
Economic order quantity, or EOQ, is a mathematical model used to calculate the ideal order quantity a business needs to order from a supplier each time that an order is made.
The overall goal of EOQ is to minimize related costs. The formula is used to identify the greatest number of product units to order to minimize buying. The formula also takes the number of units in the delivery of and storing of inventory unit costs. This helps free up tied cash in inventory for most companies. The model is based on the following assumptions
|Demand rate is constant and can be ascertained.|
|There is zero lead-time on orders|
|Stockouts are not allowed|
|The purchase price per unit is constant and hence quantity discounts are not allowed|
|The purchase price is constant|
|Orders arrive instantly|
|The ordering cost per order is known|
|The annual holding cost per item can be determined and is constant|
However, these assumptions are not realistic because demand cannot be easily determined in practice and to avoid stockout, the reasonable stock level must be kept as safety stock.
Minimum Order Quantity
On the supplier side, the minimum order quantity (MOQ) is the smallest amount of stock a supplier is willing to sell. If retailers are unable to purchase the MOQ of a product, the supplier would refuse to sell. For example, inventory items that cost more to produce typically have a smaller MOQ as opposed to cheaper items that are easier and more cost-effective to make.
With the ABC method of inventory control, we are made to understand that some items of inventory cost more than others to hold.
The ABC method divides an inventory into 3 categories.
Category A inventory item serves as the most valuable products that contribute the most to overall profit.
Category B inventory items are the products that fall somewhere in between the most and least valuable.
Category C inventory items are those whose holding costs are low and insignificant. Holding excessive amounts of these inventory items would not affect costs significantly.
Just-in-time inventory management
The principle of JIT is that producing items for inventory is wasteful because inventory adds no value, and holding inventory is an expense for which there is no benefit.
JIT inventory management implies that:
There should be no inventory of finished goods: items should be produced just in time to meet customer orders, and not before
There should be no inventory of purchased materials and components: purchases should be delivered by external suppliers just in time for when they are needed in the production
Safety stock inventory
Safety stock inventory management is the ordering of inventory beyond expected demand. This technique is employed to prevent stockouts typically caused by inaccurate forecasting or unforeseen changes in customer demand.
FIFO and LIFO
LIFO and FIFO are methods to determine the cost of inventory.
FIFO, or First in, First out, assumes the older inventory is sold first. FIFO is a great way to keep inventory fresh.
LIFO, or Last-in, First-out, assumes the newer inventory is typically sold first.
LIFO helps prevent inventory from going bad.
The best way to apply FIFO in a storeroom or warehouse is to add new items from the back so the older products are at the front. This way, the older products get taken out of the warehouse first.
Batch tracking is a quality control inventory management technique wherein users can group and monitor a set of stock with similar traits.
This method helps to track the expiration of inventory or trace defective items back to their original batch.
Consignment inventory is a business deal when a consigner (vendor or wholesaler) agrees to give a consignee (retailer) their goods without the consignee paying for the inventory upfront. The consigner offering the inventory still owns the goods and the consignee pays for them only when they sell.
Perpetual inventory management
Perpetual inventory management is simply counting inventory as soon as it arrives. It’s the most basic inventory management technique and can be recorded manually on pen and paper or a spreadsheet.
This is an inventory management method where a store doesn’t keep any of the products it sells in stock.
The way this works is when a store makes a sale, rather than picking it from their inventory, they purchase the item from a third party and have it shipped to the consumer. The seller never sees our touches the product itself.
Lean is a broad set of management practices that can be applied to any business practice. Its goal is to improve efficiency by eliminating waste and any non-value-adding activities from daily business.
Six Sigma refers to a quality management improvement process used by large scale manufacturers. It is a highly disciplined approach to improving manufacturing processes, products and design.
Lean Six Sigma
Lean Six Sigma enhances the tools of Six Sigma but instead focuses more on increasing word standardization and the flow of business.
Demand forecasting is based on historical sales data to formulate an estimate of the expected forecast of customer demand.
Essentially, it’s an estimate of the goods and services a company expects customers to purchase in the future. Fine-tuning your forecasting and accurate forecasting is vital. Your projected sales calculations should be based on factors such as historical sales figures, market trends, predicted growth and the economy, promotions, marketing efforts, etc.
Cross-docking is an inventory management technique whereby an incoming truck unloads materials directly into outbound trucks to create a JIT shipping process. There is little or no storage in between deliveries and as such, no cost is incurred on warehousing.
Bulk shipments is a cost-efficient method of shipping when you palletize inventory to ship more at once.
Use cloud-based inventory management software
Using software with real-time sales analytics. Such software connects directly to your point of sale, so your stock levels are automatically adjusted every time you make a sale. You can receive daily stock alert emails so you always know which items are low or out of stock so you can order more in time.
Reduce equipment repair times
Essential machinery isn’t always in working order, so it’s important to manage those assets. A broken piece of machinery can be costly and take a significant amount of time to repair. Monitoring your machinery and its parts is crucial to understanding its life cycle, so you can be prepared before issues arise.
It’s important to ensure that all your products look great and are working well. It could be as simple as having employees do a quick examination during stock audits that includes a checklist for signs of damage and correct product labelling.
Inventory is the biggest asset to your company, so to save money and make money, you need to protect that asset and nurture it in the right direction. Without implementing inventory management techniques, you’ll never get ahead.
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