Inventory Control Techniques for Stock Optimization in Organization

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By: Site Engineer, Staff

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Inventory can be defined as a stock of materials that are used to facilitate production or to satisfy customer demand.

There are three major types of inventory: Raw Materials, Work-in-Process, and Finished Goods.

1. Raw Materials Inventory

This is the stock of parts, ingredients and other basic inputs to a production or service process. For example, the baker’s raw materials inventory includes: flour, yeast, eggs etc., for the bicycle factory, the raw materials inventory includes: chains, handlers, seats, and sprockets.

2. Work-in-Process Inventory

This is the stock of items currently being transformed into a final product or service. For example, Restaurant (a fast food outfit) work-in-process inventory includes the meat pies being assembled, the salad is made and the hamburgers being assembled. A bicycle frame with only the handlebars and seat attached would be work-in-process at a bicycle factory.

3. Finished-Goods Inventory

This is the stock of items that have been produced and are awaiting sale or transit to its customer. At Restaurant, the finished-goods inventory includes the hamburgers waiting on the warmer and the salads in the refrigerated case. Bicycles constitute the finished goods inventory at a bicycle factory.

Organizations that provide services rather than products, such as hospitals, beauty salons, or accounting firms, do not have finished-goods inventory since they are not able to stockpile finished goods. (e.g., kidney operations, haircuts, and audits).

The essence of all inventory control is to have the right goods in the right quantity at the right time and place. Many-valued customers are lost when the organization fails to deliver on time because the right quantity of inventory is not there. This normally leads to profit losses that are not always reflected normal accounting report to the management, because the loss is a hidden cost.

The entrepreneur should, therefore, be interested in determining the inventory turnover, turnover period and minimum inventory. This last issue raised is very important in the life of the organization because at times the storekeepers because of one interest or the other, may overstock a particular item at expense of some other items short stocked.

Techniques for Inventory Control

The techniques for inventory control are:

  1. Perpetual Inventory Methods: The store card is the most used method of control in the small business. This covers raw material and supplies. A typical store card would contain the date for all receipts and issues of materials and a section for new balances. The card would contain what is on order, received on hand, issued, allocated and available. A glance at each card would help the organization to know the level of inventory and help to determine when to place an order for new items.
  2. Physical Inventory Method: The goods are physically counted by the storekeeper and one or two others who will either count or record. Many organizations in developing countries still use this method in taking their inventory. Even though computers in recent times are used by companies for inventory control, for the small businessman, the physical inventory method is still the ideal method and should be used.
  3. Cost of Inventory: The entrepreneur should be very careful here because of the attendant costs associated with any lapse in the cause of controlling cost.

Care should be taken in the areas of:

  • Ordering Cost: This refers to the expenses involved in placing an order (such as paperwork, postage and time)
  • Carrying and Holding Cost: This refers to the expenses associated with keeping an item on hand (such as storage, insurance pilferage breakage).
  • Stock Out Cost: This refers to the economic consequences of running out of stock. The stock out costs includes the loss of customer goodwill and possibly sales because an item requested by the customer is not available.

Economic Order Quantity (EOQ)

This is an inventory control method developed to minimize ordering plus holding cost while avoiding stockout costs.

Re-order Point (ROP)

This is the inventory level at which a new order should be placed. The significance of inventory in organizations is numerous and appreciative. It helps deal with uncertainties in supply and demand. For example, having extra raw materials inventory may include shortages and hold up a production process. Having extra finished goods inventory makes it possible to serve customers better. The inventory also facilitates more economic purchases, since materials are sometimes less expensive when purchased in large amounts at one time.

Finally, inventory may be a useful means of dealing with anticipated changes in demand or supply, such as seasonal fluctuations or an expected shortage.

Break-Even Point (BEP) Analysis

The break-even point analysis is profit planning and control technique that is often used in some organizations. The break-even point is a point at which the company’s sales revenue is equal to its cost of production. The company will lose money if sales are less than the amount spent and make a profit if sales are greater than this amount.

At the break-even point, it is necessary to classify cost into variable and fixed costs. Variable costs are costs that vary or change in direct relation to production.

Fixed costs on other hand are costs that will remain constant at least in the short range, regardless of the volume of operations. Example: depreciation on the plant, property insurance, rent expenses, machinery, premises equipment and general administrative expenses (e.g. salary).

Computing Break-Even Point (BEP)

Break-Even Point (BEP) will be computed by the company by identifying three cost revenue components thus:

  • Total fixed cost
  • Variable cost per unit
  • Selling price per unit

Break-even point control is the best control measure as it helps the organizations to monitor cost increases and decreases.

AUDITS

This is another very important control system. Audits are not limited to financial statements. Large corporations have internal auditors who give information on company operations and reports. Their principal task is to ensure that the company’s control systems function as expected and give timely information on the deviation and suggest corrective actions.

The internal auditor ensures that the various operating divisions observe the policies and procedures prescribed by management.

The internal auditor goes beyond what an external auditor does by evaluating non-quantitative areas of managerial performance. This type of audit is often referred to as a management audit.

Management audit also examines the company’s position in such areas as market trends, political and social factors influencing the industry and technological and economic factors.

Management audit takes place every two to three year.

Some organizations are very detailed in the exercise that they even examine:

  • Demand for their products or service
  • Stage in product life cycle
  • Cost structure vis-à-vis other companies’ unique cost advantages
  • Competitive conditions in the industry
  • Market position – the strength of the company in a major market
  • Special competitive considerations such as relative financial strength and the overall ability of company management.

 

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