Inventory Facts

Inventory management is the process of reducinginventory costs while remaining responsive to customer demands. Through proper control a store is able to meet it's customers demands at reasonable costs to itself. A retail store's inventory may represent it's largest investment. To protect this investment a store must have control over it. If this investment is poorly cared for the store may not profit. To many stores what may be of great importance is the impact inventory value can have on it's taxes. If inventory is stated to high to much income tax is paid, if it is valued to low not enough income tax is paid(Jones p455).

To begin our discussion on inventory managment we will look at those costs that affect inventory the most. The cost that many people think of first is the acquisition cost. The aquisition cost is the cost of buying the inventory. Other costs to consider are the carrying cost for inventory items, the ordering costs, and the stockout costs. The carrying cost is the cost of holding a good in inventory, while ordering costs are the cost of ordering a good to be placed in inventory. The last cost called stockout cost is the cost of lost sales when a good is no longer available in inventory.

While the above costs are a main concern for inventory management other activities affect inventory. The amount set aside in budgeting for the purchase of inventory can have widespread effects. Budgeting for inventory may affect the number of times that inventory can be replaced, the quality of the merchandise bought and the amount. Once inventory is in place, the need to protect it becomes a major concern. Insurance is an absolute must if the store has any wish to recover any value if the inventory is lost or damaged.

To find the value of inventory you may use one of four methods. The first is the specific cost, in this method each units cost is used to determine the total value of the inventory. The second method is the weighted average. For this process the average cost of goods in inventory is used to compute the current value by multipling the cost with the inventory level. The third method is First In, First Out. This method assumes goods first entering inventory are the first sold. To determine the value you use the latest unit costs per order quantity working your way towards the beginning of the period until all the goods in inventory are valued. The final method is Last In, First Out. This method assumes that the last goods into inventory are the first sold. To find the value of inventory you follow the same procedure as FIFO except you use the beginning costs and work towards the end of the period.

So far we have talked about the money side of inventory management so lets take a look at the physical side. The physical side is concerned with the actual control over items. This control may be in the form of controlled access to storage areas, giving limited authority over inventory movement, or conducting a physical count of all items in inventory periodically. A actual physical count must be done at least once a year if not more often due to perishable or seasonal items. For items that require more care, inventory may be checked at six month, three month or monthly periods(Wingate p156). To conduct an inventory the store may use an inventory sheet which lists the goods classification, number in stock and location(Wingate p157). By keeping accurate counts of what is in inventory a store not only can reduce value losses, it can deter theft of property. this can be done due to the accurate counts which help the store detect missing items easily and promptly. These records are also useful in case of a robbery for reporting to insurance.

All of the before mentioned problems have their effects on inventory. It is now time to introduce the two biggest issues: how much to order and when to order. To solve these two problems there are several methods that can be used.

The first method is to use a fixed order quantity system. In this systems orders are placed as fixed quantities with varied preiods of reordering. A two bin system is an example of this method. In the two bin system two bins are filled in an inventory, one large bin and one small bin. A predetermined amount is used to fill both bins at the start of the inventory. Goods are taken from the larger bin to satisfy customer demands until it is emptied. At yhe point when the larger bin is emptied a order is placed that will refill the bins to their established levels. While waiting for this redorder to be delivered the small bin is used to satisfy customer demands. While the two bin system may make it easier to determine when to reorder it is not very well adapted for telling how much should be ordered. That answer must come from the business's sales forecasting which will be discussed later.

To determine a order quantity two formulas may be used giving the Economic Order Quantity(EOQ). The EOQ is the order quantity that minimizes the stocking cost of an item(Gaither p377). The basic EOQ formula is EOQ= the square root of ((2*D*S) divided by C)(Gaither p381). In the formula D is the annual demand, S the average cost of completing a order, and C the cost of carrying a unit in inventory(Gaither p381). The basic is based on four assumptions:

1. Annual demand, carrying cost and ordering cost can be estimated.
2. Inventory level is divided by 2, no safety stock, items are used uniformaly and gone by next resupply and orders received all at once.
3. Stockout, customer responsivenessand other costs not considered.
4. No quantity discounts. (Gaither p381).

The second formula is used for quantity discounts. The discount EOQ formula is EOQ= the square root of (((2*D*S) divided by C)*[p divided by (p-d)](Gaither p386). In this formula p is the rate of supply and d is the rate of use(Gaither p386). The second formula is based on the following assumptions:

1. Annual demand, carrying costs and ordering costs can be estimated.
2. No safety stock items are used and supplied uniformly, orders are received gradually and are gone by next receipt of items.
3. Stockout, customer responsiveness and other costs not considered.
4. Quantity discounts do exsit. (Gaither p386).

To determine the ordering point for this system you must first know your demand and how long it takes to receive a order. Demand is simply how many items you can sell in a period. Lead time is used to describe the time period between sending a order and receiving it. The demand during the period it takes to receive a order is called the expected demand duruing lead time (Gaither p390). The other important factor during this time is the store's safety stock. Safety stock is a quantity of goods held to meet unexpected demand or a short in supplies(Gaither p378). To find a order point add the demand during lead time to the safety stock. When inventory reaches this level it is time to reorder.

Another method is to use the fixed order period system. In this system inventory levels are set at predetermined levels. At fixed times throughout the inventory cycle orders are placed to return inventory to its predetermined levels.

The last method is the Just In Time(JIT) system. In this system orders are placed so that new inventory is received as the last of the old inventory is depleted. This system requires constant attention to inventory levels so that stockouts do not occur.

With a good reordering system the store may be able to utilize quantity discounts on goods or use wholesale buying to lower its costs of inventory resupply.

Ordering quantities of goods does little to help a store grow and profit alone. To accomplish the ability to meet customer demands a store must do forecasting. Typically forecasting can be broken into two types: Qualitative and Quantitative. Quantitative forecasting is the examination of past data to determine future sales by using numerical data and statistical models. Forecasting can be done by comparing the previous year's sales and estimating this year's sales. Forecasting may be done through the tracking of trends to find out what is selling. Another example of this type of forecasting is the use of linear regression analysis.

In qualitative forecasting the forecasting is done by asking people what they think about a certain product. An example would be a survey of customer opinions or sales staff. Gaither points to several factors to look for in forecasting. These factors are cost, accuracy, data available, time span, nature of items, and interference of outside factors. There are many computer based software packages that will run forecasting models in the market today. These may be of great help in reducing the costs and time spent on forecasting.

By using a good inventory control system a retail store may be able to avoid or remove many of the headaches the affect their competitors. With a good inventory system a store can reduce shrinkage, waste and costs. Inventory control together with good forecasting of future demands can lead to a successful business.

I hope you have found this section useful in understanding inventory control. More information may be obtained through the links located on the background page.