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Inventory Management

What is Inventory?

Inventory is a set of materials or final products kept 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, the Possibility of inventory getting expired, and 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. At the 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.

The more the downstream partner maintains the inventory, the 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.

Thus, having different replenishment strategies with different levels throughout the supply chain is a pitfall of echelon inventory. This is due to the lack of understanding of the impact of one’s strategy on other levels of the supply chain. A single echelon network has access to the immediate upstream partner and to the immediate downstream partner. Thus, a multiple echelon network focus on the demand of partners in the supply chain other than the immediate upstream ad downstream partner enabling an optimised inventory management system.

Below are some of the negative impacts of pitfalls of echelon inventory:

  • Create redundant safety stocks due to excess inventory throughout the network.
  • Suppliers become incapable of providing inventories due to unrealistic inventory orders. Sometimes, this could affect the quality of materials when the supplier tries to meet the demand.
  • Unsatisfied customers due to lack of product availability with fewer safety stocks.
  • Demand for scarce resources becomes higher with predicted high demand leading to a price increase of items.

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 has hidden problems. Some hidden problems are:

  • Maybe high inventory requires due to a breakdown of a machine or 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 100% accurate forecasting. Thus, proper forecasting can reduce the inventory level.
  • Unreliable suppliers also lead to a high level of inventory. By recognising the reason for inventory as the unreliable suppliers can find new reliable suppliers. This will reduce the inventory level.

So, inventory management can identify hidden problems like the 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


EOQ = Economic Order Quantity

Co     = Ordering Cost (Per order)

Ch    = Holding Cost (Per unit per year)

D     =  Demand per Year

Products have Direct Demand and Indirect Demands. What is it?

The demand arises for the end product calls as the direct demand. So, these products with direct demand will not go through a production process again and readily available for use. The demand for the material or product which will use to produce another product calls as indirect inventory.

 What is Total Cost in Inventory

The total cost in Inventory is the carrying cost and ordering cost involved with it. It is important to find the best or the minimum total cost for the Inventory when ordering

What is the Re-Order Point?

The level of inventory we have in the stock at the time of placing an order is the reorder point.

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