INVENTORY RELATED BENEFITS AND COSTS

As indicated earlier inventories include stocks of raw materials, semi-manufactured or semi-processed goods or work-in-process and finished products. While trading businesses carry inventories of the merchants they offer for sale, manufacturing businesses carry inventories of all three kinds.

 

Raw materials inventories are maintained so that there remains some flexibility in purchasing and in production scheduling. Inventories of semi-manufactured goods ensure flexibility in production scheduling and utilization of resources, and inventories of finished products endures products scheduling and marketing.

 

By carrying inventories a firm can address to a large extent demand and lead time uncertainties. The principle followed is that of carrying what we call a “buffer”. Inventories can also ease out the flow of production when there are time lags in deliveries. Inventories may also help achieve some economies of scale in purchasing and help tide over the problems of seasonal variations. It follows from the above that there are several advantages to be derived from holding a large inventory, such as economies in production and purchasing and flexibility in operations. However, there are several disadvantages and costs associated with carrying large inventories and that is why we must devote our attention to the question of inventory management.

Inventory Management-2

MOTIVE FOR HOLDING ENVENTORIES 

It is possible to identify three major movies for holding inventories.

• The transaction motive peoples a business to maintain inventories so that there are no bottlenecks in production and/or sales. It is natural for a business to plan inventory investment commensurate with the level of transactions in the business. The business seeks to ensure that on the shop floor production does not get stalled for want of materials, etc., and sales do not suffer on account of not-availability of finished goods.
• The precautionary motive is also at work. Inventories are held so that there is a cushion against unpredictable events. For instance, there may be a sudden and unforeseen spurt in demand for finished goods or there may occur a sudden and unforeseen slump or delay of raw materials or other components needed for production. An enterprise would surely like to have some cushion to tide over such situations.
• Inventories may also be held so that advantage can be taken of price fluctuations. For instance, if the price of a particular raw material in expected to go up rather steeply, an enterprise may decide to hold a larger than necessary stock of this item (acquired prior to escalation).

Inventory Management-1

Today we continue out talk on inventory management. Therefore, return investment can improve if the return on sales improves and/or if the turnover ratio improves. Since, the two major components, of total investment are fixed capital or fixed assets (like, land and buildings, plant and machinery, furniture and fixture, motor vehicles, etc.) and working capital, proper management of working capital so as to avoid unnecessary blockage of funds in this area and to ensure that the optimum level of investment is made will make room for reduction in the investment and thus pave the way for a higher return on investment. (This would happen when the turnover of investment improves as the denominator declines.)

 

MOTIVE FOR HOLDING ENVENTORIES 

It is possible to identify three major movies for holding inventories.

• The transaction motive peoples a business to maintain inventories so that there are no bottlenecks in production and/or sales. It is natural for a business to plan inventory investment commensurate with the level of transactions in the business. The business seeks to ensure that on the shop floor production does not get stalled for want of materials, etc., and sales do not suffer on account of not-availability of finished goods.

INVENTORY MANAGEMENT

NATURE AND IMPORTANCE 

Working capital as net concept, is defined as the difference between current assets and current liabilities. Current assets being those assets that are likely to be converted into liquidity within an year’s time or so and include items like inventories of raw materials, semi-manufactured articles or work-in-process, and finished goods, accounts receivable or dues from customers, hundies or bills receivable, bank balance and cash balance, etc.

 

Current liabilities are in essence short-term liabilities which have to be settles in a year’s time, e.g., accounts payable or amount payable to suppliers of goods and services delivered on credit, bills payable, bank overdraft, etc. Since inventories constitute a major item of current assets, the management of inventories is crucial to successful working capital management. Working capital requirements are influences by inventory holding-the period during which raw materials remain in store, that during which processing takes place and that during which finished goods lie in the warehouse prior to sale. The level of inventory investment affects the total investment in working capital. Thus, operating ratios, such as the ratio of Turnover or sales to Working Capital are affected by it as well.

 

Return on investment can be reviewed as follows:

Return/Investment = (Return/Sales) X (Sales/Investment)