What is inventory? 

Inventory can be defined in different ways. But the generic definition is that it is the stock of idle resources in a firm for future use. Now, different organizations can have different types of inventory. In a typical manufacturing organization, the inventory can be raw materials, components, sub-assemblies, semi-finished goods (work in progress), and it can also be finished goods.

Let us look consider the example of a nut-and-bolt manufacturing plant. There has to be a supplier for the manufacturing plant. He provides the raw material. Now this becomes the raw material inventory. Different components will be manufactured in the plant. These components are being manufactured into semi-finished goods and finally into finished goods. All of these are part of the inventory until they are shipped to the distribution centers.

Why do we need inventory? Is it good or bad to have inventory?

Let’s understand why organizations keep inventory. Let’s consider an example of a garment retail store that sells two types of apparel, x and y. You need to identify the quantities of x and y that need to be bought by you. First, you’ll forecast. The forecast will be based on the previous data from the past few years of sales and keeping the current economic situation in mind. Say x and y, and you get 50. But demand is for 60, so you lost the opportunity to make money on these 10 apparels. This is a stock-out situation. You lost the money plus the customers, who will now go to a different shop. But if the actual demand turns out to be 40, then 10 is the excess you have. So you may end up selling it at a lower cost. So the inventory should be optimal.

Two questions that we should ask is: how much to order from the supplier? And when should the order be placed?

What are the types of inventory?

Inventory can be divided into various categories. It helps managers to view inventory as something they can control or regulate basis categories. In general the categories can be:

Cycle stock: Let’s consider the example of a shoe retailer. Cycle stock includes items on the shelf and in the stocking area. It’s called cycle stock because lots are produced in cyclical slots. Because of the economies involved in production and transport (when you produce in bulk, the cost per unit reduces), it’s preferred to produce in batches rather than singles. The process of determining the frequency of an order and what quantity to order is known as lot sizing. There are different analytical models to determine the optimal cycle stock. (Economic order quantity, EOQ) being one of them.

Safety stock: Companies hold safety stock to avoid customer service problems and the hidden costs of unavailable components. It protects against uncertainties in demand, lead time, and supply.

Pipeline stock: Inventory moving from point to point in the materials flow system is a pipeline. For example, material is moving from the supplier to your plant. Within the plant, it may move from operation 1 to 2. From the plant, it may move to the distribution center, and from there to the retailer. This inventory is also known as intransit.
Pipeline inventory = Usage rate X Transport lead time. 
Let’s say the demand of an item is 4 units per day and the lead time to supply is 2 days. Hence, d X L= 8 units

Anticipation stock: As the name suggests, it consists of stock accumulated in advance of the expected peak in sales. For example, AC or fridge manufacturing experiences high demand during the summer (3 months). If they have to spike production in the next 3 months, this will lead to a rise in temporary labor. Manufacturing can stock the anticipation inventory during periods of low demand so that output levels don’t have to be increased during high demand.

Dead stock: It is a part of inventory that is unlikely to be of any use in any part of the supply chain. Items that have become obsolete. Because of changes in design, taste, or production process. These should be disposed of on a periodic basis. (Even though it means incurring a loss.) So important in managing dead stock is that periodically non-moving items are analyzed. And those that are unlikely to be used should be disposed of.

Let’s look at the reasons for maintaining inventory:

  1. Protection against uncertainty: Let’s say you are a manufacturer for a large company. You’ve got a supplier. Let’s say you order 50 units. Shipping in the next 5 days. Considering you need to deliver them to your customer, the supplier promised 50. But at the last moment, he says 45. So you have a deficit of 5 units, which puts a dent in your reputation. However, if you had an inventory of 10 units, you could take 5 from the inventory and meet customer demands. Another case is if the customer orders 10 more at the last moment while the supplier delivers exactly 50. So your inventory of 10 will help fulfill customer demand.
  2. Support a strategic plan: If the demand in your business keeps fluctuating, then you can adopt a strategy to maintain the level of production. When demand is low, inventory will be high, and when demand is high, you can use the excess inventory to meet the demands.
  3. To take advantage of economies of scale.