Inventory Management Definition

Inventory Management pertains to the formulation and administration of plans and policies in order to satisfactorily meet the manufacturing and merchandising requirements and minimize the cost-related inventories (Waters, 2003). It aims to attain an inventory level that that reconciles turnover and profit which eventually results to investment returns. The inventory size is related to the frequency and the size of the purchase order. When purchases are made less but in larger volume, higher level inventory causes less ordering cost but greater handling cost.

On the other hand, when purchases are made more often but in smaller volume, lower level inventory leads to higher ordering costs but less handling costs. Thus, the management of the firm should determine the extent of inventory level the firm must carry through evaluation of the customer demand and the cost along with the production needs. Inventory Composition There are three basic categories of Inventory: Raw Materials, Work in Progress, and Finished Products (Muller, 2003). Raw Materials are the collections of items necessary for the firm’s production process while work in progress is created in every stage of the production process.

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The work in progress inventory commences from the time that the raw materials are received upon the production stage to the stage where goods are completely ready to be sold. On the other hand, the finished product inventory is done after the production process. Meanwhile, the composition of the inventory categories mentioned earlier depends on different factors (Relph and Peter, 2003). As such, the raw material inventory is shaped by the season sales, suppliers, availability of technology, and the plan and schedule of production.

Next in line, the working process inventory is largely affected by the intricacies of the production process and the number of finished products. As well, the inventory of finished products depends on market forces like consumer expectations. Inventory Analysis Inventories have financial aspects that are characterized as: part of the firm’s current assets and possibly converted into cash in a year period; the firm’s current least liquid assets; and are prone to time lags from the purchase of the raw materials to the inventory of the finished products (Hugos, 2003).

In line with these, as the firm gains high variation on production and sales processes, the difficulty in liquidating its inventories increases except if these are sold discounted or lower than their actual values. In inventory analysis, current ratio, quick ratio or acid test, and inventory turnover ratio are employed to ensure the adequacy of inventory level (Wild, 2004). The current ratio evaluates the firm’s ability to meet short-term obligations and reflects the company’s liquidity. Technically, the ratio of current assets to current liabilities corresponds to current ratio.

The low value of current ratio denotes the inability of the firm to meet liabilities and cash flow difficulties. On the other hand, a high current ratio may reflect the firm’s high risk inventory or mismanagement of its assets. Also, the high current ratio value may signify the firm’s inappropriate cash reinvestments. Similar to current ratio is the quick ratio or acid test. It is a comparison of the firm’s current asset and current liabilities. Nevertheless, the inventory turnover ratio determines the extent of inventory replacement over a time period.

Since the turnover of inventories directly affects the liquidity of the firm, the inventory turnover ratio is an important measure. This is calculated by dividing the cost of sold products to the average inventory. Inventory Management Techniques The Usage-Value Analysis Techniques or ABC System classifies inventory items into A, B, and C classes depending on their usage value (Waters, 2003). The degrees of control variation are adopted with the strictest control for class-A items. On the other hand, the Economic Order Quantity or EOQ pertains to the order size which reduces the ordering and carrying costs (Waters, 2003).

This also refers to the manufacturing firm’s economic lot size or optimum production run along with the set up and carrying cost. This model shows the required quantity of inventories at hand during order placement in order to minimize the total inventory costs. Nonetheless, the just-in-time inventory system, popularized in Japan, is intended to minimize the firm’s inventory level through the smooth coordination between the ordering and the receiving inventory in every stage of the production process (Waters, 2003). References Hugos, M.

H. (2003). Essential of Supply Chain Management. Hoboken, New Jersey: John Wiley and Sons. Muller, M. (2003). Essentials of Inventory Management. New York: Amacom Books. Relph, G. and Peter, B. (2003). Overage Inventory: How Does It Occur and Why Is It Important? International Journal of Production Economics 81–82 (1): 163–171. Waters, C. D. J. (2003). Inventory Control and Management. Hoboken, New Jersey: John Wiley and Sons. Wild, A. (2004). Improving Inventory Record Accuracy: Getting Your Stock Information Right. Boston, MA: Elsevier.

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