Inventory Planning and Management

Chapter 5

• Inventories include all tangible items held for sale or consumption in the normal course of business for which the company holds title where they may be located.

• In other words Inventory is the stock of items held to meet future demand.

• A company needs to maintain a level of inventory where investment is minimum but at the same time chances of stock out is also minimum.

• When a company achieves this objective, it is called Inventory Management.

Inventory costs are a constant concern of most business marketers for two reasons.

• For two reasons– They are the second largest cost in distribution

– They can add as much as 40% in extra cost per year to the value of goods being stored.

A business house can have various types of Inventories. In general any company does have

five types of Inventories.

• 1. Cycle stock• 2. In transit stock• 3. Safety Stock• 4. Speculative Stock• 5. Dead Stock

Cycle stock

• Cycle stock is Inventory required to meet basic demand under conditions of certainty. It is also known as Transition Inventory.

• This is the Inventory currently under going transformation and functions as a vehicle for profit generation.

• It can either be in the form of work in progress or in the form finished goods.

In Transit Stock

• Refers to goods undergoing movement between fixed stock points such as warehouses.

• The concept of in transit stock is important because of funds can be tide up while goods are being transported.

Safety Stock

• Safety stock also known as buffer Inventory. This inventory is held over and above cycle stock level to cushion against and anticipated shortages of supply or uncertainties of demands.

• Safety stock levels are calculated on the basis of equating marginal savings of preventing stock outs to marginal carrying cost of additional inventory.

Speculative Stock

• Speculative Stock is inventory in excess of normal requirements that is held in anticipation of price increase.

• The objective of holding Speculative Stock is to increase profitability on the basis of the change of value of the goods while they being stored

Dead Stock

• Dead stock is inventory for which no demand has been registered for a specified period of time.

Reasons for holding inventory

• Catering to the needs of customer during sales fluctuations and other related problems.

• To provide assurance on availability• To store in advance expecting movement in sales.• Flexible raw material scheduling.• To suit variations in production scheduling• To take advantage of favourable raw material

price.• To manufacture material in economic run sizes.

Adverse effects of inventories

– Over depending on inventory can prohibit meaningful feed back on the quality of the product service bundle. With large inventories, there is usually a long delay between the creation if an item and its use.

– Large inventories hide operational problems that might be solved if they were discovered. When a worker finds a non confirming item and inventory provides an immediate replacement, the worker has very little interest to communicate the fact that a defective item was created .

– There is a financial cost to carrying excessive inventory. It includes the lost opportunity to invest the money tied up in the inventory, as well as the rental cost for the space used to house the inventory.

continuation– There is risk of damage of goods held in inventory. Larger the

inventory ,the more likely items are to be handled before shipment. Often warehouse workers have to move larger inventory just to find a specific item. Each time an item is handled it undergoes the risk of damage.

– Large inventories are associated with a risk of product

obsolescence and losses due to depreciation.

Technological advances and product innovations cannot be adopted while pre existing inventories appear on the balance sheet.

The costs associated with inventory

It can be broadly classified into four categories

• Procurement costs.• Inventory carrying costs• Out of stock costs• Over stock costs.

Procurement costs

• Procurement costs include

• Cost of order processing through accounting and purchase department

• Cost of placing order includes cost of transmitting the order to supplier.

• Cost of transportation comes in to picture when transportation charges are not included in purchased goods.

• Cost of material handling includes processing of the order at the receiving dock

Inventory carrying costs• Inventory carrying costs are the costs associated with holding the

inventory for a period of time .It is a major component of total distribution costs.

They include

• Capital costs ( actual capital tied up in the form of inventories)

• Insurance and taxation costs (The premium paid to the insurance depends upon the level of inventories)

• Storage costs (The costs incurred under storage like rent of the ware house, store man, wages, depreciation of the material handling equipment, heating and water expenses etc. )

Out of stock costs

• These costs are divided into two main categories. A) Lost sales cost.

• These costs occur when a customer faced with an out of stock situation with draw his order for the product.. Cost could have become profit had there been a sale and loss because it has a bearing on future sales as well. if more substitutes are available in the market higher is the cost. The lost sale costs are generally intangible but significant .Usually they are estimated on the basis of personal perceptions of the executives.

Continuation

B) Back-order costs

• In this case customer waits for his order to be filled even if there is delay. They have to be processed along with regular distribution process which may make the company to incur clerical and sales cost. These costs are tangible and simple to measure.

• If a company runs out of raw material and whole of production process is shut down then the costs out of such breakdown are out of stock costs.

Over stock costs.

• Such sort of costs come into existence when the company is left with some stock on hand even after the demand for the product is terminated.

A slightly different approach that divides the overall costs of stock into four separate components.

1. Unit cost (The price for an item charged by the supplier)2. Re-order cost (The cost of placing repeat order for an item)3. Holding cost (The cost of holding one unit of an item in stock

for a unit period of time. For example Air-India holding a spare engine in stock for a year)

4. Shortage cost (Occurs when an item is needed, it cannot be supplied from stock. Shortages can lead disruptions in production, re-scheduling, re-maintenance, laying of employees, loss of existing customers and future sales. Many in-tangible factors such as goodwill also form a part of shortage cost. )

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