Inventory management is one of the most critical components of supply chain and logistics management because it implements policies and procedures that promote efficient supply chain operations. Inventory management entails prudent planning that ensures adequate amount of stock of the right quality is available whenever needed.
Inventory includes raw materials and components used in production, work in progress or partly finished merchandise, finished goods and other materials used in the business. Inventory management helps to enhance operational efficiency, customer service, and minimizes inventory and distribution cost (Emmett, 2005, p. 3).
The main aim of this study is to explore the significance of inventory management in supply chain and logistic management. The study will also examine a number of methods used in inventory valuation.
Inventory carries with it a number of costs and these include its money value, the space it consumes, labors used in receiving and dispatching stocks, damage/ deterioration/ obsolescence and theft (Emmett, 2005, p. 4).
These costs can be classified as handling cost and holding costs, ordering or acquisition costs, cost of expediting the purchased stocks, and so on. Holding costs includes costs tied up in inventory, storage costs, and handling costs (Muller, 2002, p. 3).
Inventory management helps to control the amount of stocks needed at a given time and therefore is very significant in capacity planning and production scheduling. Proper inventory management also cushions an organization against externalities such as fluctuation in demand, unreliability of supply, fluctuation in prices, order costs, and discounts.
When setting up inventory control and management system, a company must consider the ideal inventory level. Inventory should be maintained at an ideal level and availed in a timely manner or else it will have adverse effects on efficiency of production.
However, the ideal inventory level is influenced by a number of factors such as the amount of capital or finance available, customer demand and projected sales, patterns of historical sales, industry average, supply level, storage space, and the quantity discount (Emmett, 2005, p. 4; Waters, 2003, p. 5).
In determining the ideal level of inventory, amount of capital available should be considered as well as the financial charges on the cash flow. Obviously, the amount of capital a business has determines the amount of inventory to be purchased.
However, access to capital will be insignificant if the cash flow needs are unpredictable. Such kind of scenario requires special capital reserve to meet unexpected demand. Consumer demand must be predicted so that adequate amount of inventory can be acquired to meet this demand.
Historical sales pattern helps in determining the frequently used stocks or stocks required at a particular period of the year. Ideal stock levels also depend on the available space for more stocks, quantity discount offered by the suppliers, inventory carrying costs (such as cost of storage, handling and transportation) and the quantity of goods available in the market (Muller, 2002, p. 3; Viale, 1996, p.3).
Accurate inventories within any organization enable the firm to increase its economic advantages by leveraging economy of scale through a number of suppliers. This helps to minimize the risk of stocking excess inventory of products that are non-durable or depreciates very first.
Adequate supply of inventory to meet consumer demand is very crucial in terms of increasing sales and consumer services. Total lack of enough inventories usually results to loss of customers to the competitors. An excellent inventory system (whether manual or automated) must identify sales trends and ensure that there is enough supply to meet consumer demand.
Accurate inventories (based on the historical pattern of sales) help the company to specialize in the production of products that are in high demand at a particular period or in anticipated time. This protects the business from unreliable consumer demand. The historical pattern of demand and supply provides a clear picture of order cycle thus minimizes errors in handling inventory (Simchi-Levi, Kaminsky & Simchi-Levi, 2008, p. 8).
Maintaining excessive inventory means that too much money is tied up in stocks and therefore little or no money is available for other business operations. This has serious effects on the level business liquidity and the cash flow. Under such circumstance, the business is not able to meet unexpected obligations.
Excess inventory also results in extra costs of handling and storage. Costs associated with carrying inventory often represent one of the highest dollar figures for a logistics company because it reflect the total quantity of inventories stored as well as other cost components such as shipping, maintenance, and personnel to manage to inventory (Emmett, 2005, p. 4; Waters, 2003, p. 5).
There are three predominant methods of accounting for inventory namely FIFO, LIFO and the average cost method. FIFO refers to First in First Out. This method of inventory valuation presumes that the first stocks purchased are the first to be consumed or sold in spite of the actual time factor.
This valuation method is directly linked to the actual flow of goods in stock. Some experts support this valuation method because stocks of good are sold at a higher price than the buying price (Emmett, 2005, p. 5).
FIFO, on the other hand, refers to First- in First-Out. This method of inventory valuation postulates that the most recently purchased stocks are either to be utilized or sold irrespective of the time factor. Given the fact that stocks have just been bought thus more expensive than those bought in the past, this method is the most suitable because the cost matches the profit.
Lastly, the Average Cost Method of valuing inventory establishes the value of inventory and cost of sales by computing the average unit cost of all the goods available for sale at a specific period of time. This method of valuation suggests that the closing inventory is made up of all the stocks available for sale (Emmett, 2005, p. 5).
Although reducing the level of inventory in the business is risky affair, the ideal level of inventory is very vital in business operations. First, it reduces the amount of money tied up in stock and therefore enhances the cash flow/ liquidity of the business. It also reduces ordering/ acquisition cost and handling costs.
These costs include transportation costs, cost of loading and unloading, storage costs, and maintenance costs among others. However, the business will also miss out on a number of benefits associated with high levels of inventories such as quantity discounts offered on the goods purchased, protection from the fluctuations of supplies and maximum utilization of the warehouse capacity (Muller, 2002, p. 3).
As note above, inventory management is a critical component of supply chain and logistics management because it facilitates the implementation of policies and procedures that promote efficient supply chain operations. It is worthy to note that efficient and effective management of inventories can significantly improve overall profit margins of business organizations as well as allow firms to invest in other critical areas that promise high returns.
In addition, effective management of inventories increases profitability of the business organizations by minimizing ordering costs and handling costs as well as satisfying the producer/ consumer demand (Simchi-Levi, Kaminsky & Simchi-Levi, 2008, p. 8). Moreover, accurate inventories within any business operation enable the firm to increase its economic advantages by leveraging economy of scale through a number of suppliers.
This helps to minimize the risk of stocking excess inventory of products that are non durable or depreciates very first. Finally, efficient management of inventories ensures that no capital is wasted in maintaining low demand or obsolete inventory (Emmett, 2005, p. 3).
Emmett, S. (2005). Excellence in Warehouse Management: How to Minimize Costs and Maximize Value. London: John Wiley & Sons Ltd.
Muller, M. (2002). Essentials of Inventory Management. New York. AMACOM Books. Web.
Simchi-Levi, D., Kaminsky, P., & Simchi-Levi, E. (Eds.). (2008). Designing and Managing the Supply Chain Concepts, Strategies, and Case Studies. New York, NY: McGraw-Hill Irwin.
Viale, D. (1996). Inventory Management : From Warehouse to Distribution Center. California. Course Technology Crisp. Web.
Waters, D. (2003). Global Logistics and Distribution Planning. Web.