What is an Inventory?
Inventory is the stock of any item or resource used in your business. An inventory system is the set of policies and controls that monitor levels of inventory and determine what levels should be maintained, when stock should be replenished, and how large orders should be.
By convention, manufacturing inventory generally refers to items that contribute to or become part of a firm’s product output. Manufacturing inventory is typically classified into raw materials, finished products, component parts, supplies, and work-in-process. In distribution, inventory is classified as in-transit, meaning that it is being moved in the system, and warehouse, which is inventory in a warehouse or distribution centre.
Retail sites carry inventory for immediate sale to customers. In services, inventory generally refers to the tangible goods to be sold and the supplies necessary to administer the service. The basic purpose of inventory analysis, whether in manufacturing, distribution, retail, or services, is to specify (1) when items should be ordered and (2) how large the order should be. Many firms are tending to enter into longer-term relationships with vendors to supply their needs for perhaps the entire year. This changes the “when” and “how many to order” to “when” and “how many to deliver.”
So what is the goal of your inventory?
1: To maintain an independence of operations. A supply of materials at a work centre allows that centre flexibility in operations. For example, because there are costs for making each new production setup, this inventory provides management to reduce the number of configurations. Independence of workstations is desirable on assembly lines as well. The time that it takes to do same operations will naturally vary from one unit to the next. Therefore, it is desirable to have a cushion of several parts within the workstation so that shorter performance times can compensate for longer performance times. This way the average output can be reasonably stable.
2: To meet variation in product demand. If the need for the product is known precisely, it may be possible (though not necessarily economical) to produce the product to exactly meet the demand. Usually, however, demand is not completely known, and a safety or buffer stock must be maintained to absorb variation.
3: To allow flexibility in production scheduling. A stock of inventory relieves the pressure on the production system to get the goods out. This causes longer lead times, which permit production planning for smoother flow and lower-cost operation through larger lot-size production. High setup costs, for example, favour producing a larger number of units once the setup has been made.
4: To take advantage of economic purchase order size. There are costs to place an order: labour, phone calls, typing, postage, and so on. Therefore, the larger each order is, the fewer the orders that need be written. Also, shipping costs favour larger orders, so the more significant the shipment, the lower the per-unit cost.