Inventory Management Terms that Everyone Should Know
Inventory Management is an essential function within most businesses. The purpose of inventory management is to develop strategies that will achieve an optimal inventory investment. A company can maximise its rate of return and minimise its liquidity and business risk by optimally managing inventory.
Inventory management involves a comparison between the costs associated with keeping inventory versus the benefits of holding stock. Successful inventory management minimises inventory, lowers cost and improves profitability. An optimal inventory level can be based on consideration of the incremental cost-effectiveness of the opportunity cost of carrying the higher inventory balances.
So here are some critical inventory management terms everyone should know:
ABC analysis: also called Pareto analysis or the rule of 80/20, is a way of categorizing inventory items into different types depending on value and use.
B2B: business-to-business dealings, where one business buys materials from another business.
B2C: business-to-customer dealings, where a final customer buys from a business.
Backorder: occurs when a customer demand cannot be met from stock, but the customer waits for the item to come into stock.
Bill of materials: an ordered list of all the materials needed to make a product, and the order in which the materials are used.
Causal forecast: a method that uses a known (possibly cause and effect) relation-ship to forecast the value of one variable from known values of another.
Co-managed inventory: where an organisation and a third party jointly manage stocks.
Consumables: stocks of materials needed to support operations, but which do not form part of the final product, such as oil, paper, cleaners, etc.
Cycle service level: the probability of meeting all demand in a stock cycle.
Cycle stock: normal stock used during operations.
Demand: the amount of materials wanted by customers.
Distribution centres: locations in the supply chain for performing logistic activities, often including stocks and warehousing.
Economic order quantity: the order size that minimises costs for a simple inventory system.
Exponential smoothing: a widely used method of projective forecasting, where: New Forecast = α × latest demand +(1 − α ) × previous forecast.
FIFO: first-in-first-out convention for valuing stock.
Finished goods: items that are ready to be moved to a customer.
Forecast: assessment of what will happen in the future.
Forecast error: the difference between the actual value and the forecast value.
Holding cost: cost of holding a unit of an item in stock for a unit time.
Inventory: is a list of the items held in stock (often taken as being the stock itself).
Just-in-time: an approach that organizes operations to occur at exactly the time they are needed.
Lead time: the total time between ordering materials and having them delivered and available for use.
Lead time demand: demand for an item during its lead time.
Lean strategy: a business strategy that aims at doing every operation using the least possible resource – people, space, stock, equipment, time, etc.
Linear regression: a method of finding the line of best fit through a set of data, which can be used for causal forecasting.
Material: anything that is kept in stock.
Min-max system: a hybrid method (between fixed order quantity and periodic review) for setting the size of orders.
Newsboy problem: a standard problem of finding the best order size for a single stock cycle, with uncertain demand.
Projective forecast: a forecast that projects historical patterns into the future.
Reorder cost: cost associated with each order for materials placed with suppliers.
Reorder level: the stock level at which it is time to place another order for materials (generally the lead time demand plus safety stock minus any stock on order).
Replenishment: putting materials into stock to replace units that have been used.
Replenishment rate: the (finite) rate at which materials are added to the stock.
Safety stock: a reserve of materials that is not normally needed, but is held to cover unexpected circumstances.
Seasonal stock: the stock that is used to maintain stable operations through seasonal variations in demand.
Sensitivity: the rate at which a forecast responds to changes in demand.
Service level: a measure of the proportion of customer demand met from stock (or some equivalent measure).
Shortage: occurs when customer demand cannot be met from stock (resulting in backorders or lost sales).
Simulation: uses a dynamic model to duplicate the continuous operation of a system over time.
SKU: stock keeping unit (an alternative name for an item).
Smoothing constant: a value used to set the sensitivity of a forecasting method.
Supply chain: the series of activities and organizations that a product moves through between initial suppliers and final customers.
Supply chain management: the function responsible for the flow of materials into organizations, through their operations, and then on to customers.
Target stock level: determines the order size for a periodic review method (with order size equal to target stock level minus current stock minus amount already on order).
Valid minimum: an EOQ that corresponds to a point on the valid total cost curve when costs are discounted.
Valid total cost curve: the stepped curve that connects valid sections of a family of cost curves when there are price discounts.