Objectives and Techniques of Inventory Management
Inventory is an important item of current Assets which also form an important element of firm’s working capital. The capable finance manager will follow proper balance of inventories needed for production schedule and this ultimately suits the interests of its valued customers. The management of inventories faces the following two basic problems.
(a) Management of sufficient size of inventories needed for production and distribution.
(b) Maintaining minimum Investment in inventories to check unnecessarily locking up of capital.
Objectives of Inventory Management
Technically the following are the objectives of inventory management:
(i) Adequate investment in inventories is desirable for smooth production and sale.
(ii) Maintaining optimum level of supply of inventory will work as rain-coat during short-supply of Raw Materials.
(iii) Adequate stock of inventory of finished goods is helpful for smooth sales.
(iv) Advantages of carrying costs. Purchases of large stock of inventories will also get the advantages of carrying costs.
(v) To avoid fear of wastage and obsolescence. Inventory management is helpful for checking the fear of wastage stock remained idle for long time, effect of bad weather and change of fashion.
(vi) Useful in Emergencies. Proper and adequate inventory will work as rain-coat in periods of short supply.
Techniques of Inventory Management
The following are the important techniques of inventories management:
(i) Minimum stock Level
(ii) Maximum stock Level
(iii) Re-order stock Level
(iv) Danger Level.
(i) Minimum Stock Level
This represents the minimum quantity of stock that should be held at all time, stock level is normally not allowed to face below this level. This level of stock is a buffer stock for use during emergencies. Fall in stock level below Minimum Level will indicate potential danger to the business. Thus, extra efforts have to be taken to expedite the supply.
Minimum Stock Level is:
Re-order level – (Normal Consumption x Normal re-order Period)
The following factors are to be considered in fixing the minimum level
(a) Nature of items of materials.
(b) Minimum time required for delivery.
(c) Rate of consumption of materials.
(a) Stock-out costs which includes loss of contribution margin, loss of etc.
(ii) Maximum Level
Maximum Level indicates the maximum quantity of an item of material. It is the level above which stocks are not allowed to rise, Maximum Level is calculated as:
(Re-order Level + Re-order Quantity) – (Minimum Consumption x Minimum Re-order Period)
In maximum stock level, the factors to be considered are:
(a) Maximum Requirement of the stock for production at any point of time.
(b) Storage space available.
(c) Storage and Insurance Costs.
(d) Availability of funds.
(e) Price advantage arising out of bulk purchases.
(f) Economic order quantity also affects the maximum level.
(g) Government restrictions on import.
(h) Possibility of price fluctuation.
(iii) Danger Level
This level is fixed usually below the minimum level. Emergent purchase actions are initiated if stock falls below danger level.
(iv) Re-order Quantity (EOQ). It refers to the quantity to be purchased in a single purchase order. It is nothing but economic order quantity.
Lead time. This the period of time between ordering and replenishment.
Usage. It represents the consumption pattern.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.