I. What is inventory?
Most of us are accustomed to keeping inventory for use in our personal lives, but often we don’t think about it. For example, most families have some stocks of food and drinks, so that they don’t have to go out to the shops before every meal. Holding a variety of food ingredients in stock in the kitchen cupboard or freezer gives us the ability to respond quickly (with speed) in preparing a meal whenever unexpected guests arrive. It also allows us the flexibility to choose a range of menu options without having to go to the time and trouble of purchasing further ingredients. We may purchase some items because we have found something of exceptional quality, but intend to save it for a special occasion. Many people buy multiple packs to achieve lower costs for a wide range of goods. In general, our inventory planning protects us from critical stock-outs; so this approach gives a level of dependability of supplies.
II. Why is inventory necessary?
No matter what is being stored as inventory, or where it is positioned in the operation, it will be there because there is a difference in the timing or rate of supply and demand. If the supply of any item occurred exactly when it was demanded, the item would never be stored. When the rate of supply exceeds the rate of demand, inventory increases; when the rate of demand exceeds the rate of supply, inventory decreases. So if an operation can match supply and demand rates, it will also succeed in reducing its inventory levels.
III. Inventory costs
1. Cost of placing the order: Every time that anorder is placed to replenish stock, a number of transactions are needed which incur costs to the company.
2. Price discount costs: In many industrie ssuppliers offer discounts on the normal purchase price for large quantities; alternatively they might impose extra costs for small orders.
3. Stock-out costs: If we misjudge the order-quantity decision and our inventory runs out of stock, there will be costs to us incurred by failing to supply our customers.
4. Working capital costs: Soon after we receive are plenishment order, the supplier will demand payment for their goods. Eventually, when (or after) we supply our own customers, we in turn will receive payment.
5. Storage costs: These are the costs associated with physically storing the goods. Renting, heating and lighting the warehouse, as well as insuring the inventory, can be expensive, especially when special conditions are required such as low temperature or high security.
6. Obsolescence costs: When we order large quantities, this usually results in stocked items spending a long time stored in inventory. Then there is a risk that the items might either become obsolete (in the case of a change in fashion, for example) or deteriorate with age (in the case of most foodstuffs, for example).
7. Operating inefficiency costs: According to lean synchronization philosophies, highinventory levels prevent us seeing the full extent of problems within the operation.
IV. Summary:
Inventory helps increase customer service levels, but inventory itself increases costs for the company.