what is inventory management system?

 An inventory management system is the combination of technology (hardware and

software) and processes and procedures that oversee the monitoring and
maintenance of stocked products, whether those products are company assets, raw
materials and supplies, or finished products ready to be sent to vendors or end consumers.

System? Definition of Inventory Management

Systems, Benefits, Best Practices & More
When most people think of inventory management, they think of retail applications. While retail
operations rely heavily on inventory management, inventory management systems are widely
used in a variety of industries, from manufacturing to utilities, healthcare, education,
government, and more. Inventory management systems streamline and centralize the process for
controlling the flow and maintenance of inventory to ensure that the right amount of inventory is
available at the right time and of the right quality.
Definition of an Inventory Management System
 Inventory Management is an enterprise-wide discipline concerned with the identification and
tracking of Information Services (IS) hardware and software assets. three main areas of
Inventory
 Acquisition.
 Redeployment.
 Termination
 An inventory management system is the combination of technology (hardware and
software) and processes and procedures that oversee the monitoring and maintenance of
stocked products, whether those products are company assets, raw materials and supplies,
or finished products ready to be sent to vendors or end consumers. A complete inventory
management system consists of:

 A system for identifying every inventory item and its associated information, such as
barcode labels or asset tags. 
 Hardware tools for reading barcode labels, such as handheld barcode scanners or
smartphones with barcode scanning apps.
  Inventory management software, which provides a central database and point of reference
for all inventory, coupled with the ability to analyze data, generate reports, forecast future
demand, and more.
 Processes and policies for labeling, documentation, and reporting. This should include an
inventory management technique such as Just in Time, ABC Analysis, First-In First-Out
(FIFO), Stock Review, or another proven methodology.
 People who trained to follow these policies and processes.

SearchERP defines inventory management as “the supervision of non-capitalized assets

(inventory) and stock items.” Inventory management is a component of supply chain
management that oversees the flow of items (products, goods, etc.) as they move from the
manufacturer to the warehouse and then to the point of sale. “A key function of inventory
management is to keep a detailed record of each new or returned product as it enters or leaves a
warehouse or point of sale,” SearchERP explains, which points to the importance of having a
clear and established inventory management system to ensure that the process and
documentation are as streamlined and efficient as possible, as well as to minimize error.
Benefits of Inventory Management Systems
Without an inventory management system, the goods and products that flow through an
organization will inevitably be in disarray. An inventory management system enables a company
to maintain a centralized record of every asset and item in the control of the organization,
providing a single source of truth for the location of every item, vendor and supplier information,
specifications, and the total number of a particular item currently in stock.
Because inventory often consists of movable assets, inventory management systems are critical
for keeping tabs on current stock levels and understanding what items move quickly and which
items are more slow-moving, which in turn enables organizations to determine when it’s time to
reorder with greater accuracy. Overall, a comprehensive inventory management system offers
countless benefits to companies including:

 Improved cash flow

 Better reporting and forecasting capabilities
 Reduction in storage costs (overhead)
 Reduced labor costs
 Reduction in dead stock
 Better organization
 Enhanced transparency
 Improved supplier, vendor, and partner relationships

Challenges of Inventory Management Systems

Inventory management systems can have a dramatic effect on productivity and efficiency when
implemented properly. Most of the challenges associated with inventory management systems
arise from failing to follow best practices or relying on outdated methods, such as manual
documentation and inconsistent storage layouts and processes. In these cases, a complete
inventory management overhaul may be in order to streamline inventory management and add
clarity and consistency to the process company-wide.

A good inventory management system reduces human error by eliminating manual

documentation through the use of barcode labels, barcode scanners, and inventory management
software, reducing costly mistakes such as:

 Having too much slow-moving inventory in stock, taking up valuable storage space and
eating into the company’s bottom line.
 Unexpectedly running out of stock of an essential inventory item, which can delay the
supply chain due to backorders.
 Inaccurate records (wrong part numbers, incorrect inventory counts) that arise from
manual documentation errors.
 Wasted man hours spent tracking down items that are stored in the wrong locations.
Inventory storage that’s not optimized for efficiency (due to poor warehouse or stock
room layouts) can also increase stock picking time, which also increases labor costs.

Best Practices for Inventory Management Systems

Cleary Inventory explains that a good inventory management system can help to enhance
productivity, but only if you set it up with some basic essentials including:

 Location names
 Easy-to-read location labels
 Unique item identification numbers
 Units of measure
 A starting count
 A software solution that effectively monitors and tracks activity
 Clear, company-wide policies and processes
 People who know how to support these policies and processes

Implementing a comprehensive inventory management system can be complex. It’s not merely a
matter of purchasing a good software program; an inventory management system must address
the people, processes, and technologies from end-to-end. Following best practices to set up a
comprehensive, company-wide inventory management system is an investment that will pay for
itself again and again through greater efficiency and a boost to the bottom line.

Operation of inventory systems

o Meeting customer demand: Maintaining finished goods inventory allows a company to

immediately fill customer demand for product...
o Protecting against supply shortages and delivery delays: A supply chain is only as strong
as its weakest link, and accessibility to raw materials is sometimes disrupted...
o Separating operations in a process: Inventory of subassemblies or partially processed
raw material is often held in various stages throughout a process...
o Smoothing production requirements and reducing peak period capacity needs:
Businesses that produce nonperishable products and experience seasonal customer
demand often try to build up inventory during slow periods in anticipation of the high-
demand period...
o Taking advantage of quantity discounts: Many suppliers offer discounts based on certain
quantity breaks because large orders tend to reduce total processing and shipping costs
 while also allowing suppliers to take advantage of economies of scale in their own
production processes.

The Purpose of Inventory in Operations

Management
The goods that are available for immediate sale make up just one type of inventory; it’s known
as finished goods inventory (FGI). The other two categories are raw material inventory (RMI),
which are typically items purchased from a supplier and used to create the end product, and work
in process inventory (WIP), or product that’s still going through the production process.

Here are some of the important functions of inventory in successful operations:

 Meeting customer demand: Maintaining finished goods inventory allows a company to

immediately fill customer demand for product. Failing to maintain an adequate supply of
FGI can lead to disappointed potential customers and lost revenue.

 Protecting against supply shortages and delivery delays: A supply chain is only as
strong as its weakest link, and accessibility to raw materials is sometimes disrupted.
That’s why some companies stockpile certain raw materials to protect themselves from
disruptions in the supply chain and avoid idling their plants and other facilities.

 Separating operations in a process: Inventory of subassemblies or partially processed

raw material is often held in various stages throughout a process. Work in process
inventory (or WIP) protects an organization when interruptions or breakdowns occur
within the process. Maintaining WIP allows other operations to continue even when a
failure exists in another part of the process.

 Smoothing production requirements and reducing peak period capacity needs:

Businesses that produce nonperishable products and experience seasonal customer
demand often try to build up inventory during slow periods in anticipation of the high-
demand period. This allows the company to maintain thruput levels during peak periods
and still meet higher customer demand.

 Taking advantage of quantity discounts: Many suppliers offer discounts based on

certain quantity breaks because large orders tend to reduce total processing and shipping
costs while also allowing suppliers to take advantage of economies of scale in their own
production processes.

Inventory is necessary to your business. It supplies your operations processes and meets
customer demand.
Strengths and Weaknesses of Inventory
Management Processes
Auto Dealer Monthly looked at the experiences of two dealers who are working on differing
approaches to their inventory management processes and examined some of the strengths and
weaknesses of each approach thus far. One of the dealers felt it was imperative to enlist the aid
of a technology tool – in this case, vAuto – to help him begin tackling his approach to inventory
management processes, while the other dealership has begun the initial overhaul to its inventory
management processes without the aid of any particular piece of software or inventory
management tool.

Using Technology to Tackle Inventory Management

The problem at Don Wood Automotive in Athens and Logan, Ohio, was not the absence of an
inventory management plan but rather a lack of success with the plan that was in place,
according to Jeff Wood, the dealership’s president. “I had hired somebody who was is charge of
[managing inventory], and the biggest problem was … my four sales managers [were] dictating
pricing to this person … The sales managers didn’t respect his opinion and would challenge him
and change the price,” he explained. “This person didn’t feel empowered to lose money on
vehicles or do what was necessary to sell cars at the market price, so we languished.” He decided
to start making changes to his inventory management processes in January of this year.

Authority and Empowerment

Wood said the fault with his previous inventory management setup did not lay with the person
who oversaw the inventory. “I wouldn’t say the person that I had in charge of it did a poor job; I
would say that I didn’t empower him. I didn’t give him the right tools in order to make sure that
my sales managers respected his opinion … It was just poorly designed on my part. Now they
know if they change a price on a car, they’re in deep trouble,” he said.

Wood has since taken over the task of inventory management himself, which he acknowledged,
“is probably not the most efficient method for businesspeople, but I find that I make more money
by worrying about my used car inventory than any activity in the dealership.”

He decided to enlist the aid of inventory management technology from vAuto to help him get a
handle on inventory management at his stores and said the tool has empowered him to take
charge of numerous aspects of the process. “I have accountability for what my sales managers
are putting in their trades, how long we’ve had them, what price we’re putting them at, how long
did recon take, how long does it take to get pictures, where are the bottlenecks—vAuto has
empowered me to do all those things,” he said.
Measuring and Monitoring
Arguably, one of the biggest reasons for utilizing a piece of technology or software to assist in
inventory management is the ability to more easily monitor the process and measure the results.
Wood reviews all trades every morning and adjusts prices on used cars at designated intervals,
and is also alerted to any issues such as photos not yet being online for a vehicle or too much
being given for a trade.

“If they put too much money in the trade, day one when I go to put the description in and
determine the market price for this vehicle, I know they’ve put too much money in it,” he said.
He can then address the issue with the appropriate individual. “Anytime there’s a car that’s not
appraised correctly, they’ll definitely get a call from me that morning.”

Being able to monitor numerous aspects of his inventory management across multiple rooftops
also saves Wood some time when it comes to handling inventory matters at different stores. “I
can see their appraisals … I see if they’re under-appraising cars based on how many trades to
appraisals they get. I just see the health of their inventory, I see their inventory mix; if they need
something, I see all that from vAuto and I don’t really have to have the one-on-one
[conversations].”

However, while conversations about some issues are unnecessary thanks to the information
available to him through the program, Wood must still make certain to regularly communicate
with his sales managers. “We talk about what they’ve sold, because sometimes the feedback on
what they’ve sold doesn’t come back to me quickly enough. It may take a few days for it to pull
out of vAuto when they sell something.” Wood  is able to observe what is in inventory, days
supply and how competitively each vehicle is priced by category in relation to what’s in his
market area, allowing him to adjust his pricing strategy on each vehicle as needed.

Once he sets a price on a vehicle, it stays at that price for its first 20 days on the lot; after the
twentieth day he’ll make the first price reduction on it. “From there, I’ll reduce the prices based
on market days supply and how competitive we are,” he said, and added that the vAuto tool will
remind him daily of any vehicles that haven’t been adjusted in the last seven days.

Effect on Days Supply and Inventory Acquisition

Having a tool that allows him to monitor market inventory trends and more easily adjust pricing
has allowed Wood to make better decisions on what to carry in inventory and to move that
inventory more quickly. “I want to maintain a 45-day supply in almost all categories unless it’s
something we don’t do well in,” he said. He said vAuto’s strategy tool allows him to see what
vehicles he has sold in which categories over the past 45 days and observe trends. “I watch that
strategy [tool] all the time; it’s telling me where I need to back off and [where to] be aggressive.”

Effect on Gross
One thing Wood admitted he has not been entirely fond of since changing his inventory
management process is a lower gross per unit. Periodically and regularly reducing the prices on
aging inventory has been necessary in order to move the units, but of course this often means
accepting a “significantly” lower gross per unit. However, he added that this has started to shift a
little for him as he’s acquired fresh inventory. Since he is paying closer attention to which cars
move the best in his market, he is able to focus on acquiring the correct inventory to achieve a
quicker sale; the more quickly a car sells, the fewer price reductions it undergoes and the closer
Wood stays to the initial margin he set for the vehicle.

Even in the cases of vehicles that have undergone price reductions in order to sell, he said the
perceived negative of lower grosses was far outweighed by other benefits. “What I do like is the
fact that we’re turning a lot more inventory and we’re making a lot more in finance and
insurance,” he said. “I, as a company, am more profitable with that method than I was with
higher grosses and less volume … [We have] more business in fixed [and] we’re focused more
on our F&I processes.”

Lessons Learned
One thing Wood has learned since the beginning of the year is that accountability is important,
and an inventory management tool is only as useful as a dealer makes it.

“I don’t know how many people have told me that vAuto doesn’t work or vAuto does work. I’ve
heard it on both sides,” he said, and added that he thinks of it like a hammer. One person could
use a hammer correctly and have no problems at all, while another person could be using it
improperly yet conclude that the nail isn’t driving in very well because the hammer itself is
somehow defective. “It’s whether or not you embrace and use the tool,” he said. In his case,
effectively implementing the tool means he is “pricing cars consistently … [and] repricing them
every seven days, keeping it market-competitive and not trying to hold out for a big gross when
it isn’t there … I’m not selling any cars at auction. I’m retailing every car at wholesale prices
after 60 days and getting F&I profits from that, and trades.”

Working Without an Inventory Management Tool

At McKaig Chevrolet Buick in Gladewater, Texas, the situation was one that is likely pretty
common amongst dealers when it comes to inventory management process—they simply didn’t
have a set plan in place. “I think it’s pretty accurate to say we didn’t have a formalized process
and it was just being done on the fly,” said Mark Abernathy, president and partner at McKaig.
Further complicating matters was the fact that the store also needed to focus on having the right
inventory for special finance.

Inventory Turn
The initial emphasis at McKaig, Abernathy said, has been on improving inventory turn. “I come
from a manufacturing background, so turnover or days in inventory has always been a key to me
and we had kind of let that go,” he said. Adding to the problem was the fact that the dealership
was “keeping everything [that was traded in] and thinking we could retail it without really taking
into consideration the carrying cost of inventory.”

An important first step in the inventory management process was the decision to set a goal of
having their inventory turn in at least 45 days. “I think ours had gone well over 60,” he recalled.
“Our ultimate goal is to turn our used car inventory every 30 days. I’d like to get 12 turns a
year.” He said they have hit the 45-day turn goal a few times so far, “but it’s more about
consistency than hitting it once or twice … and while we’ve made a lot of progress, we still don’t
have that month-to-month consistency.” He said once they’ve established a consistent pattern of
turning vehicles within 45 days, they will focus on the next goal of a 30-day turn.

Segmenting Inventory
To tackle their inventory turn goals, Abernathy said they have begun segmenting their inventory
in the hopes that it will allow them to discern inventory trends and make better decisions on what
vehicles to carry. “We’re trying to break our inventory back out into classes or segments so we
can track turnover among individual segments or classes as well as overall,” he said. “We’re
further along with that process in our new inventory than we are used. We developed some
spreadsheets that show our inventory, what’s on the ground, and not only by Chevy cars, Chevy
trucks and Buicks, but we’ve also developed a cross-section so that we look at the different
competitive segments like subcompacts, compacts, small cars, that type of thing,” he explained.
“Now we’re looking at our turns by segment and not just what our overall average is.”

When Do You Need an Inventory Management Tool?

Abernathy said that as soon as they iron out the process of looking at their new inventory by
segment, they will work on applying it to their used vehicle inventory. However, he believed that
to effectively apply the same process to their used inventory, something more would be required.
“We’re going to need an additional software tool to do that, probably, so we’ve got all the
information,” he said.

He commented that the dealership has in the past used some technology tools such as vAuto and
AAX to help with inventory management but had “kind of gotten away from that.” The problem
was not with the tools themselves, which he believes are able to provide a great deal of useful
information, but rather with utilization of the tools. “We weren’t utilizing them and so the ROI
wasn’t there. I don’t think it was the technology; I think it was our utilization and not fully
optimizing.”

This seems to be part of the reason that Abernathy is focused on revising their processes before
adding any technology to the mix. “We’re going back to the basics,” he said. “You’ve got to
have a written plan or a process that’s formalized. There has to be someone accountable for the
execution of that process, and you have to measure the results and then act on those results to
improve the process and/or the execution of the process, and we didn’t really … have any of that
in place, or if it was in place, it broke down.”

For now, he said dealership management is evaluating a number of different technology tools to
see which might best meet their needs. “[We are] looking at the NADA mobile application. I
think we’re looking at Red Bumper. We’re looking at Bidzpin, which looks particularly
appealing to me because of the focus on the special finance units and how much information you
can get very quickly through that tool.”

Accountability
As Abernathy pointed out, appointing someone to oversee those efforts who can be held
accountable for the results is just as important as having set processes in place for managing
inventory. Abernathy has been working with his brother Kent, the dealer-operator for McKaig, to
get inventory management on track and said they will decide together on the best people to
oversee processes and hold accountable for the results. He said, “[My role] is probably more
putting processes in place, and he and I agree on who we’re going to hold accountable for the
processes.”
 
As it stands now, he said they have a special finance manager at McKaig who is becoming more
and more involved with the inventory. “Then our general sales manager is … more responsible
for what we would call our regular inventory business, prime [and] near-prime,” he stated. “After
we measure the results, we’ll go over them with the manager  … to see how we can improve the
results. What do we need to do? Do we need to further improve the process, or is it merely an
execution problem?”

Changing the Approach to Sourcing

As a result of their efforts to classify their inventory according to certain segments, Abernathy
said they are able to look at trade-ins with a more critical eye and are trying to broaden their
sources for acquiring inventory. “We historically have always gotten the lion’s share, I’d say 90-
plus percent, of our used cars through trades,” he said. “We are starting to look [more] at

A Better Approach for Special Finance?

Although Abernathy said McKaig is “just in the beginning stages on setting up our inventory
plan,” the practice of segmenting their used car inventory into categories seems to be making it a
little easier to determine which kinds of vehicles tend to work well for subprime deals. “We’re
really just going back to the basics and separating out what we think are prime or near-prime
merchandise and having kind of a separate inventory for special finance,” he said. “We’re doing
things like keeping up with our credit apps and tiering them so that we know the different
categories and what percent comes in [that fits] the different categories so that we can then match
up our inventory.”.

The idea of accepting lower grosses in favor of moving more units seemed to be something he
could entertain temporarily but not as a long-term strategy. “At this time we’re probably wanting
the sales,” he said. “As far as high-volume, low gross, I don’t know that we really have
approached that philosophically. We would like to obviously maximize grosses and we feel like
that there are some high grosses that are going to average out lower-gross sales.” However, he
added, “We’re going to be evolving over time because we want to grow out volume and our
gross.”

Objectives Of Inventory Management

The main objective of inventory management is to maintain inventory at appropriate level to
avoid excessive or shortage of inventory because both the cases are undesirable for business.

,To keep inventory at sufficiently high level to perform production and sales activities
smoothly,To ensure that the supply of raw material & finished goods will remain continuous, To
minimize carrying cost of inventory, To keep investment in inventory at optimum level and To reduce
the losses of theft, obsolescence & wastage .
ess Stock is a term used in inventory management, and is often called a number of different
things; overstock, stock surplus, excessive stock, or excess inventory. No matter what you call it,
one thing that remains constant is the threat excess stock represents to your company’s bottom
line.

Companies that carry excess stock levels in their inventory typically find that the issue was
caused by poor management of demand forecasting and replenishment or not properly tracking
the life-cycle stages of a product.

Excessive stock levels come with many different cost considerations that organizations should be
concerned about. First off, there is lost revenue associated with products being in inventory with
little market demand. There are company dollars tied up in capital that is directly linked to the
original purchase of the goods and there are associated costs to storing the inventory, sometimes
referred to as “carrying costs”.

Carrying costs add up quickly across a number of different factors including, rent or mortgage
payments, equipment costs, labor cost, utilities, insurance and interest that accrues on stock that
has not been sold.

Excess stock is best classified as a declining stage of the product life cycle, which is represented
in the graph below. There is typically demand for the product, but it is beginning to phase out
and organizations that do not actively monitor the demand stages of all their individually stocked
items run the risk of getting stuck with a large quantity of excess stock due to poor reorder or
replenishment practices.

what are the consequences of over investment & under investment in

inventory?

Both over investment and under investment in inventory is undesirable as both have
consequences.

Following are the consequences of over investment:

- Unnecessary blockage of funds in inventory

- Excessive storage is required to store the inventory.

- Excessive insurance cost.

- Risk of liquidity: Value of the inventory reduces due to the long holding period as the
inventories once purchased are difficult to dispose off at the same value.

Following are the consequences of under investment:

 - Under investment in the inventory may cause frequent interruptions in production process.

- Insufficient stock of finished goods may create problems in meeting customers’ demands and
they may shift to the competitors.

Basic Financial Management

 Forms of Business Organization
 Financial Statements
 Interpretation of Financial Statements
 Funds Flow and Cash Flow Statement
 Capitalization
 Long Term and Medium Term Finance
 Capital Structure
 Capital Market
 Capital Rationing
 Working Capital Management
 Cash Management
 Management of Receivables

 Management of Inventory
 Dividends
 Finance interview
 Accounting interview
 Basic accounting interview
 Taxation interview

Inventory carrying cost: what it is and how to

calculate it
Inventory carrying cost, also known as inventory holding cost, is the cost
associated with holding inventory or stock in storage or a warehouse, in
order to fulfill sales orders.
Why is it important for you to have an accurate view of your carrying costs at all times?

1. It is critical in figuring out how much profit you can make on current inventory.

2. It can help you determine if production should be increased or decreased, in order to maintain
the current or desired balance between income and expenses.
3. Carrying costs are typically 20 - 30 percent of your inventory value. This is a significant
percentage, making it an essential cost factor to account for. 

Don’t be intimidated by this seemingly complicated formula! We’ve broken down the formula,
and there are just four important cost components you need to understand:

1. Capital costs

Capital costs refer to the costs incurred for carrying inventory. Examples include money spent on
acquiring goods, interest paid on a purchase, interest lost when cash turns into inventory, as well
as the opportunity cost of purchasing inventory. Capital cost usually makes up the largest portion
of the total carrying cost.

2. Storage costs

Storage costs are expenses incurred to help keep your inventory safely organized in a particular
place like your warehouse. It can be separated into two components: fixed costs and variable
costs.

Fixed costs include rent or mortgage costs of the storage space, while variable costs are
manpower costs, costs of handling materials and utilities expenses associated with the space.

3. Service costs

Service costs are incurred to protect your inventory from issues such as theft or workplace
accidents, to ensure that government regulations are met and to keep your inventory well
managed. Examples include insurance payments, taxes on inventory, as well as the costs of using
an inventory management software system to keep track of inventory levels.

4. Costs of inventory risk

Carrying inventory presents a certain level of risk, and this risk translates into a cost component.
This cost component is made up of a few factors. The first factor is the risk of shrinkage, which
refers to any inventory loss that occurs after a good is purchased, and before it is sold to your
customer. Shrinkage may occur to due to damages in transit, administrative errors or theft by
employees.

weaking the design of your storage space

Start by making improvements to the design of your storage space. Do not underestimate the
value that good design brings — a design modification of your storage area can be a highly
effective measure in creating additional space to reduce carrying costs. Consider making changes
such as narrowing the aisle used for equipment handling, installing a mezzanine floor, altering
the layout of your storage space or making a switch to adopt more appropriate storage modes.
Negotiating long-term customer contracts

Having long-term contracts in place does not only mean that you’ve secured a sustainable source
of revenue; it could also mean that you’re in a better position to allocate a larger portion of your
inventory costs to your customers. Negotiate these contracts to ensure that they cover a portion
of your inventory carrying costs. You could lay down terms that specify the duration that
inventory remains in your storage complex, or impose carrying charges for storing inventory for
extended periods of time.

Negotiating terms in vendor agreements

Negotiation does not end with customer contracts — you should also review and discuss the
terms in vendor agreements. When vendors hold on to your inventory, costs associated with
damage, theft and handling are borne by them. Avoid stipulating unfair terms that make the
contract a one-sided agreement. Instead, adopt a balanced approach by splitting carrying costs
between you and your vendors.  

Giving different inventory management techniques and systems a go

Consider adopting online inventory management techniques that minimize carrying costs, such
as selling on consignment, drop shipping or backordering for some of your products. Rather than
rely on excel spreadsheets (manually tracking each and every transaction will quickly turn into a
nightmare), utilize inventory control software that will provide valuable information, such as
accurate demand forecasts and reorder points, to help reduce your carrying costs.

Inventory Control: Forms and Models of

Inventory Management – Explained!
Inventories refer to those products or goods a firm is manufacturing for sale and components that
make up the product.

The forms of inventories existing in a manufacturing enterprise can be classified into three
categories:

(i) Raw Materials:

These are those goods which have been purchased and stored for future productions. These are
the goods which have not yet been committed to production at all.

(ii) Work-in-Progress:

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These are the goods which have been committed to production but the finished goods have not
yet been produced. In other words, work-in-progress inventories refer to ‘semi-manufactured
products.’

(iii) Finished Goods:

These are the goods after production process is complete. Say, these are the final products of the
production process ready for sale. In case of wholesaler or retailer, inventories are generally
referred to as ‘merchandise inventories.’ Some firms also maintain the fourth type of inventories
called ‘supplies.’ Examples of supplies are office and plant cleaning materials, oil, fuel, light
bulbs and the like.

Needless to mention, maintaining the required size of inventory is necessary for the smooth and
effective functioning of production activity. Holding required inventories provides certain
advantages to the entrepreneur. For example, it helps in avoiding losses of sales, reducing
ordering costs, and achieving efficient production run.

However, against these benefits are some costs as well associated with inventories? It is said that
every noble acquisition is attended with risk; he who fears to encounter the one must not expect
to obtain the other. This is true of inventories also.

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There are broadly two costs involved in holding inventories:

(i) Ordering Costs:

These include costs which are associated with placing of orders to purchase raw materials and
components. Clerical and administrative salaries, rent for the space occupied, postage, telegrams,
bills, stationery, etc. are the examples of ordering costs. The more the orders, the more will be
the ordering costs and vice versa.

(ii) Carrying Costs:

These include costs involved in holding or carrying inventories like insurance charges for
covering risks, rent for the floor space occupied, wages of labourers, wastages, obsolescence, or
deterioration, thefts, pilferages, etc. These also include ‘opportunity costs.’ This simply means
had the money blocked in inventories been invested elsewhere in the business, it would have
earned a certain return. Hence, the loss of such return may be considered as an ‘opportunity
costs.’

Models of Inventory Management:

While it is very necessary to maintain the optimum level of inventory, it is not so easy as well.
Nonetheless, some models or methods have been developed in the recent past for determining
the optimum level of inventories to be maintained in the enterprise.
ADVERTISEMENTS:

Inventories refer to those products or goods a firm is manufacturing for sale and components that
make up the product.

The forms of inventories existing in a manufacturing enterprise can be classified into three
categories:

(i) Raw Materials:

These are those goods which have been purchased and stored for future productions. These are
the goods which have not yet been committed to production at all.

(ii) Work-in-Progress:

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These are the goods which have been committed to production but the finished goods have not
yet been produced. In other words, work-in-progress inventories refer to ‘semi-manufactured

(iii) Finished Goods:

These are the goods after production process is complete. Say, these are the final products of the
production process ready for sale. In case of wholesaler or retailer, inventories are generally
referred to as ‘merchandise inventories.’ Some firms also maintain the fourth type of inventories
called ‘supplies.’ Examples of supplies are office and plant cleaning materials, oil, fuel, light
bulbs and the like.

Needless to mention, maintaining the required size of inventory is necessary for the smooth and
effective functioning of production activity. Holding required inventories provides certain
advantages to the entrepreneur. For example, it helps in avoiding losses of sales, reducing
ordering costs, and achieving efficient production run.

However, against these benefits are some costs as well associated with inventories? It is said that
every noble acquisition is attended with risk; he who fears to encounter the one must not expect
to obtain the other. This is true of inventories also.

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There are broadly two costs involved in holding inventories:

(i) Ordering Costs:

These include costs which are associated with placing of orders to purchase raw materials and
components. Clerical and administrative salaries, rent for the space occupied, postage, telegrams,
bills, stationery, etc. are the examples of ordering costs. The more the orders, the more will be
the ordering costs and vice versa.

(ii) Carrying Costs:

These include costs involved in holding or carrying inventories like insurance charges for
covering risks, rent for the floor space occupied, wages of labourers, wastages, obsolescence, or
deterioration, thefts, pilferages, etc. These also include ‘opportunity costs.’ This simply means
had the money blocked in inventories been invested elsewhere in the business, it would have
earned a certain return. Hence, the loss of such return may be considered as an ‘opportunity
costs.’

Models of Inventory Management:

While it is very necessary to maintain the optimum level of inventory, it is not so easy as well.
Nonetheless, some models or methods have been developed in the recent past for determining
the optimum level of inventories to be maintained in the enterprise.

ADVERTISEMENTS:

All models are classified into two major types:

(i) Deterministic Models, and

(ii) Probabilistic Models.

In brief, the deterministic models are built on the assumption that there is no uncertainty
associated with demand and replenishment of inventories. On the contrary, the probabilistic
models take cognizance of the fact that there is always some degree of uncertainty associated
with the demand pattern and lead time of inventories.

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Usually, the following three deterministic models are in use:

1. Economic Ordering Quantity (EOQ) Model,

2. ABC Analysis,

3. Inventory Turnover Ratio,

ADVERTISEMENTS:

Let us discuss these one by one.

1. Economic Ordering Quantity (EOQ) Model:

One of the important decisions to be taken by a firm in inventory management is how much
inventory to buy at a time.

This is called ‘Economic Ordering Quantity (EOQ). EOQ also gives solutions to other
problems like:

(i) How frequently to buy?

(ii) When to buy?

(iii) What should be the reserve stock?

Assumptions:

Like other economic models, EOQ Model is also based on certain assumptions:

1. That the firm knows with certainty how much items of particular inventories will be used or
demanded for within a specific period of time.

2. That the use of inventories or sales made by the firm remains constant or unchanged
throughout the period.

3. That the moment inventories reach to the zero level, the order of the replenishment of
inventory is placed without delay.

The above assumptions are also called as lim

inventory Model & Types

Inventory also referred as stocks are basically the goods and raw materials that any business
would hold and are ready or will be ready for sale.

Inventory Model

Inventory model is a mathematical model that helps business in determining the optimum level
of inventories that should be maintained in a production process, managing frequency of
ordering, deciding on quantity of goods or raw materials to be stored, tracking flow of supply of
raw materials and goods to provide uninterrupted service to customers without any delay in
delivery.
ADVERTISEMENTS:

Inventories refer to those products or goods a firm is manufacturing for sale and components that
make up the product.

The forms of inventories existing in a manufacturing enterprise can be classified into three
categories:

(i) Raw Materials:

These are those goods which have been purchased and stored for future productions. These are
the goods which have not yet been committed to production at all.

(ii) Work-in-Progress:

ADVERTISEMENTS:

These are the goods which have been committed to production but the finished goods have not
yet been produced. In other words, work-in-progress inventories refer to ‘semi-manufactured
products.’

(iii) Finished Goods:

These are the goods after production process is complete. Say, these are the final products of the
production process ready for sale. In case of wholesaler or retailer, inventories are generally
referred to as ‘merchandise inventories.’ Some firms also maintain the fourth type of inventories
called ‘supplies.’ Examples of supplies are office and plant cleaning materials, oil, fuel, light
bulbs and the like.

Needless to mention, maintaining the required size of inventory is necessary for the smooth and
effective functioning of production activity. Holding required inventories provides certain
advantages to the entrepreneur. For example, it helps in avoiding losses of sales, reducing or

usually, the following three deterministic models are in use:

1. Economic Ordering Quantity (EOQ) Model,

2. ABC Analysis,

3. Inventory Turnover Ratio,

dering costs, and achieving efficient production run.

However, against these benefits are some costs as well associated with inventories? It is said that
every noble acquisition is attended with risk; he who fears to encounter the one must not expect
to obtain the other. This is true of inventories also.
ADVERTISEMENTS:

There are broadly two costs involved in holding inventories:

(i) Ordering Costs:

These include costs which are associated with placing of orders to purchase raw materials and
components. Clerical and administrative salaries, rent for the space occupied, postage, telegrams,
bills, stationery, etc. are the examples of ordering costs. The more the orders, the more will be
the ordering costs and vice versa.

(ii) Carrying Costs:

These include costs involved in holding or carrying inventories like insurance charges for
covering risks, rent for the floor space occupied, wages of labourers, wastages, obsolescence, or
deterioration, thefts, pilferages, etc. These also include ‘opportunity costs.’ This simply means
had the money blocked in inventories been invested elsewhere in the business, it would have
earned a certain return. Hence, the loss of such return may be considered as an ‘opportunity
costs.’

Models of Inventory Management:

While it is very necessary to maintain the optimum level of inventory, it is not so easy as well.
Nonetheless, some models or methods have been developed in the recent past for determining
the optimum level of inventories to be maintained in the enterprise.

ADVERTISEMENTS:

This is called ‘Economic Ordering Quantity (EOQ). EOQ also gives solutions to other
problems like:

(i) How frequently to buy?

(ii) When to buy?

(iii) What should be the reserve stock?

Assumptions:

Like other economic models, EOQ Model is also based on certain assumptions:

1. That the firm knows with certainty how much items of particular inventories will be used or
demanded for within a specific period of time.

2. That the use of inventories or sales made by the firm remains constant or unchanged
throughout the period.
3. That the moment inventories reach to the zero level, the order of the replenishment of
inventory is placed without delay.

The above assumptions are also called as limitations of the EOQ Model.

Determination of EOQ:

EOQ Model is based on Baumol’s cash management model. How much to buy at a time, or
say, how much will be EOQ is to be decided on the basis of the two costs:

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(i) Ordering Costs, and

(ii) Carrying Costs.

These are just discussed. Hence are not repeated again. The above two costs are inversely
associated. If holding inventory cost increases, ordering cost decreases and vice versa. A balance
is, therefore, struck between the two opposing costs and economic ordering quantity is
determined at a level for which the aggregate of two costs is the minimum.

The various components of ordering costs and carrying costs are shown in the following Table
27.3:

ADVERTISEMENTS:

Table 27.3: Components of Ordering Costs and Carrying Costs:

Ordering Costs Carrying Costs

Requisitioning Warehousing
Order Placing Handling
Transportation Administrative
Storing Insurance
Administrative Deterioration and Obsolesce
EOQ can be determined by applying the following commonly used formula:

Q = 2UxP/S

Where:

Q = Economic Ordering Quantity (EOQ)

U = Quantity purchased in a year or month

P = Cost of placing an order

S = Annual or monthly cost of storage of one unit known as ‘carrying cost.’

Let us illustrate this with an imaginary example:

Let us assume the following data for a firm:

Annual requirements 800 units

Ordering Cost (per order) Rs. 50

Carrying Cost (per unit) Rs. 100

Now, using the EOQ formula, EOQ quantity will be as follows:

EOQ = 2 x 800 x 50/2

= 80,000/2

= 40,000

= 200 Units

2. ABC Analysis:

This is also called ‘Selective Inventory Control.’ The ABC analysis of selective inventory is
based on the logic that in any large number, we usually have ‘significant few’ and ‘insignificant
many.’ This holds true in case of inventories also. A firm maintaining several types of
inventories does not need to exercise the same degree of control on all the items.

The firm adopts selective approach to control investments in various types of inventories. This
selective approach is called the ABC Analysis. The items with highest value are classified as ‘A
Items’. The items with relatively low value as ‘B Items’ and the items least valuable are
classified as ‘C Items.’ Since the ABC analysis concentrates on important items, hence, it is also
known as ‘Control by Importance and Exception (CIE).’

The composition of these items in terms of quantity and value is lopsided. In a study conducted
sometimes ago, the shares of various items, viz. A, B and C in total number and value of an
automobile company were found as follows:

Items % of Numbers % of Value

A 9 57
B 10 18
C 81 25
Total 100 100
In case of ABC Analysis, stringent control is imposed on ‘A Items’ maintaining bare minimum
necessary level of inventories of these. While ‘B Items’ will be kept under reasonable control, ‘C
Items’ will be under simple control.

The FSN analysis classifying goods into Fast-Moving, Slow-Moving, and Non-Moving and
VED analysis classifying goods into Vital, Essential, and Desirable are similar to ABC Analysis
in principle.

3. Inventory Turnover Ratio:

Inventory can also be managed by using accounting ratios like Inventory Turnover Ratio.
Inventory ratio establishes relationship between average inventory and cost of inventory
consumed or sold during the particular period.

This is calculated with the help of the following formula:

Cost of Good Consumed or Sold during the year/Average Inventory during the year.

A comparison of current year’s inventory ratio with those of previous years will unfold the
following points relating to inventories:

Fast-Moving Items:

This is indicated by a high inventory ratio. This also means that such items of inventory enjoy
high demand. Obviously, in order to have smooth production, adequate inventories of these items
should be maintained. Otherwise, both production and sales will be adversely affected through
uninterrupted supply of these items.

Slow-Moving Items:

That some items are slowly moving is indicated by a low turnover ratio. These items are,
therefore, needed to be maintained at a minimum level.

Dormant or Obsolete Items:

These refer to items having no demand. These should be disposed of as early as possible to curb
further losses caused by them

Definition
Inventory Management is an enterprise-wide discipline concerned with the identification and
tracking of Information Services (IS) hardware and software assets. three main areas of Inventory
 Acquisition.
 Redeployment.
 Termination.