Inventory Management

What is Inventory?

Inventory is a set of materials or final products keep aside for future use or until a demand arises. Inventory has few compositions as raw materials, work in progress, finished goods, and supplies. Supplies include the requirements for maintenance or overhaul. Inventory is anything that can be stocked. Inventory management is important for overall cost management.

Keeping inventory is a cost to the organization. Storage spaces requirement, the block of cash flow, Possibility of inventory getting expired, the threat of getting damaged are some risks involved with the inventory.

Why We Need Inventory?

Inventory is crucial for the survival of some companies. Yet keeping inventory involves advantages as well as disadvantages. Below are some reasons for a company to keep inventory.

  • To meet the seasonal demand
  • Gain economies of scale while purchasing materials
  • High lead time
  • To decouple the operation
  • For a smooth production
  • Unexpected market changes

What is Echelon Inventory?

The echelon inventory is the inventory level between the final customer and any stage up to the manufacturer. This means the inventory level maintain by a particular level in the supply chain and the total inventory available between the considered level and the customer.  Below example will be helpful to understand the concept.

Consider a wholesaler sells to 2 distributors and two distributors sell to five retailers each. In wholesaler’s level inventory with the wholesaler and the inventory with 2 distributors and 10 retailers will be the echelon inventory. At the distributor’s level, five retailer’s inventory and the distributor’s inventory become the echelon inventory.

More the downstream partner maintain the inventory, lesser the inventory required to maintain by the upstream partner. Having inventories at every level of the supply chain will help everyone in the supply chain to release the burden of keeping a high level of inventories.

What is Inventory Management?

The process of taking measurements to reduce the total cost of inventory comes under inventory management.  This is much required as inventory have hidden problems. Some hidden problems are:

  • May be high inventory requires due to a breakdown of a machine or due to poor maintenance. Replacing the machine can reduce the inventory level.
  • Due to the higher percentage of defects need to keep inventory. Placing a quality check may be able to reduce the inventory level.
  • The inaccurate forecast also leads to inventory. Generally, it is not possible to do a 100% accurate forecasting. Thus, proper forecasting can reduce the inventory level.
  • Unreliable suppliers also lead to the high level of inventories. By recognising the reason for inventory as the unreliable suppliers can find new reliable suppliers. This will reduce the inventory level.

So, with inventory management can identify the hidden problems like above and eliminate them to reduce the inventory level. A proper inventory management system address two aspects namely planning and controlling. With this, can identify the suitable inventory level, order level and replenished stocks. Proper inventory management supports the company’s warehousing policies too.

What are the Cost Components of Inventory?

Carrying Cost

  • Storage Cost
  • Insurance Cost
  • Taxes

Ordering Cost

  • Tendering Cost
  • Order Placing Cost
  • Inspection Cost
  • Quality Checking Cost

Stock-Out Cost

  • Loss of Sale
  • Reputation

Impact of Over Stocking

  • High carrying cost
  • Cash flow get stuck (Difficult to liquidate)
  • Product get expired/ outdated
  • Physical damage to goods
  • Opportunity cost

Impact on Under Stocking

  • Resource idling
  • Loss of goodwill
  • Production gets interrupted
  • Loss of customers
  • Unnecessary pressure on employees

Economic Order Quantity (EOQ)

EOQ is the amount of inventory a company should place as the order under normal conditions which has the minimum total inventory cost. EOQ speaks on the holding cost and the order placing cost.

Daily Logistic Inventory Management

EOQ calculation formula is as below

Daily Logistic EOQ 1


EOQ = Economic Order Quantity

Co     = Ordering Cost (Per order)

Ch    = Holding Cost (Per unit per year)

D     =  Demand per Year

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