Why Failing at Inventory Management
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What is inventory management?
Inventory management deals with inventory planning and control, and seeks to answer two basic but critical questions:
When to place your next Order -This question is related to the concept of the reorder point .This is a system whereby any regularly used material is re-ordered when the inventory drops to a certain level. This level is usually a function of the lead time, daily demand, and safety stock.
How Much you should Order - The quantity to be ordered is determined through the Economic Order Quantity.(Determines the optimum order quantity that a company should hold in its inventory given a set cost of production, demand rate and other variable costs).
The full equation is as follows:
EOQ = Square root of 2SD/PI
where:
S = Setup costs
D = Demand rate
P = Production cost
I = Interest rate (considered an opportunity cost, so the risk-free rate can be used)
The costs of failing to plan for when and how much to order can indeed be significant to your business. Therefore, the cost savings that accrue from improved practices in inventory management are substantial . Effective management and control are crucial because mismanagement of inventory is a threat to the viability or existence of your company. Effective management of inventory also influences the financial strength and competitive position of your business, because as research shows, the approach taken in Inventory management directly affects working capital, production and customer service.
However, while the critical role of inventories to a firm’s survival is well recognizedin theory, many SME’s have been found not to be driven by recommended practices for managing inventory. When formulating their business strategies, many SME’s do not generally treat inventory management as a critical or strategic activity.
The Strategic case for SME’s
While the management of inventory has been defined in several different ways, the concept implies the establishment of strategic objectives for positioning inventories as key drivers of the business. Assuch, Inventory Management is the active control program, which allows a firm to manage itsmanufacturing, sales, purchases, distributions and payments.
A well-operated integrated production-inventory system is a decisive success factorunder a variety of conditions. However, concerning performance, many SMEs have a limitedscope, and are often satisfied and limit inventory along procedures like end-of-year stocktaking,disclosing the cost of consumption in the trading and profit and loss accounts.
There are two basic inventory planning systems - (1) the fixed-order quantity model, and (2) fixed-time period model.
The inventory policy of firms employing the Fixed-Order Quantity Model will be to order a standard quantity when the reorder point has been reached regardless of when this occurs. This is event-triggered and depends on the demand for the items. This model is applicable for:
The Fixed-Time Period Model is the other inventory planning system where inventory policy is to order materials or parts at a designated time period regardless of whether the reorder point has been reached. This is time-triggered and involves no physical count of inventory items.
This is applicable under the following conditions:
Less expensive and less critical items
Vendors / buyers can get fresh orders if they make regular / routine visits to customers
Vendors / buyers will combine orders to reduce ordering and transportation costs
Since the system is time triggered, it must have a larger average inventory to protect against stock out during the review period.
In most SMEs, the balance sheet rules even though many benefits can bederived from implementing a perpetual inventory management system. In systems of thistype, all stock items are periodically and randomly checked throughout the year. Given thatmany SMEs lack professional expertise and generally take decisions based on intuitionand elementary management practices , investments in inventory are not alwaysgiven an accurate or appropriate cost.
Inventory management has significance for any enterprise in an inventory intensivemanufacturing industry because effective practices in the management of stock will allowan enterprise to minimize inventory costs and therefore, avoid the dire consequences thatcome with a shortage of material resources. Research has shown that this sequence of eventshas special significance in the context of SMEs and how they manage their stock. Researchers who surveyed a wide range of SME’s in North America found that poor quality forecasts where the main factors contributing to this sequence of events in SME’s. They further observed that a sound Inventory Management system is a decisive factor in a firm’s success.
Another researcher has discussed the linkages between management of inventoryand competitive advantage, bringing into focus the integration of strategic and competitivefactors such as cost, delivery and quality. He argues that reducing the throughput time byfaster value addition to the materials provides a firm with a distinct edge incompetitive environments. However, inventory costs are determined not only by theirlevel of inventory but also by the time the materials spend in the system.
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Inventory Management Practices Inventory Control Management Accounting For Goods In Transit Return from Inventory Management to Home Page
