Inventory management or control is defined as the management of redundant resources that will have economic value tomorrow and usable but idle resources that have economic value today. Inventory can take the form of finished goods sitting on shelves, work in process and raw material. Making sure the right level of all types of inventory is available when needed is vital since both inventory shortage and excess inventory are costly.
Choose reliable suppliers. When assessing suppliers, do not focus solely on cost. Consider the quality of the materials, delivery time and dependability. Separate each type of inventory such as finished goods, work in process and raw material.
Calculate the annual dollar spent on each type of inventory by multiplying the unit cost times the expected future annual sales. Rank each type of inventory from high to low based on annual dollars spent.
Classify the inventory into three categories of A, B or C based on the top 20 percent, the next 30 percent and the last 50 percent valuation. Label the inventory with A, B and C classification tags. Items in the A category should be given more rigorous attention in inventory planning.
Determine appropriate order quantity by the Economic Order Quantity (EOQ) model. EOQ equals the square root of 2DO divided by C; where C=carrying cost per unit (cost of holding inventory such as warehousing cost and insurance); O=ordering cost per order (e.g. purchase order release, receipt, inspection and shelving); D= demand for the inventory item. For example, ABC Inc. records show that it needs 400 units of item abc per month (D). Cost of placing each order is $20 and carrying cost amounts to $6. The economic order quantity for ABC Inc. will be 52.
Calculate the reorder point for each item of inventory by multiplying average daily (or weekly) sales by the lead time in days (or weeks) and adding safety stock to this. Safety stock is intended to prevent inventory shortages in case of lead time variation. Expensive A items should have little safety stock, B items can have more safety stock and C items if required can have the highest level of safety stock.
A good inventory control system has four characteristics: keeps inventory at the optimum level, orders goods in the most economical quantities, speeds up merchandise turnover and reduces chances of stock-outs.
- Schaum's Outline of Financial Management; Jae K Shim, Joel G. Siegel; 2007
- Cost & Management Accounting: An Introduction; N. Mohd. Jamal, N. H. Mastor, M. Mohamed Saat, M. F. Ahmad & D. Fariha
- Masao Nakamura, Sadao Sakakibara and Roger Schroeder. "Adoption of Just-in-Time Manufacturing Methods at U.S.- and Japanese-Owned Plants: Some Empirical Evidence," pages 230-231. IEEE Transactions on Engineering Management, 1988.
- Electronic Code of Federal Regulations. "Regulation S-X, 17 CFR Part 210: Sec. 210.5-02 Balance sheets." Accessed Aug. 1, 2020.
- A good inventory control system has four characteristics: keeps inventory at the optimum level, orders goods in the most economical quantities, speeds up merchandise turnover and reduces chances of stock-outs.
Alfred Sarkissian holds a master’s degree in industrial management. With experience in business and public policy, he has covered intellectual property rights, industrial policy and technology policy for various publications.