What Is Inventory Management?Inventory management refers to the process of ordering, storing, using, and selling a company's inventory. This includes the management of raw materials, components, and finished products, as well as warehousing and processing of such items. Show Key Takeaways
Inventory ManagementUnderstanding Inventory ManagementA company's inventory is one of its most valuable assets. In retail, manufacturing, food services, and other inventory-intensive sectors, a company's inputs and finished products are the core of its business. A shortage of inventory when and where it's needed can be extremely detrimental. At the same time, inventory can be thought of as a liability (if not in an accounting sense). A large inventory carries the risk of spoilage, theft, damage, or shifts in demand. Inventory must be insured, and if it is not sold in time it may have to be disposed of at clearance prices—or simply destroyed. For these reasons, inventory management is important for businesses of any size. Knowing when to restock inventory, what amounts to purchase or produce, what price to pay—as well as when to sell and at what price—can easily become complex decisions. Small businesses will often keep track of stock manually and determine the reorder points and quantities using spreadsheet (Excel) formulas. Larger businesses will use specialized enterprise resource planning (ERP) software. The largest corporations use highly customized software as a service (SaaS) applications. Appropriate inventory management strategies vary depending on the industry. An oil depot is able to store large amounts of inventory for extended periods of time, allowing it to wait for demand to pick up. While storing oil is expensive and risky—a fire in the UK in 2005 led to millions of pounds in damage and fines—there is no risk that the inventory will spoil or go out of style. For businesses dealing in perishable goods or products for which demand is extremely time-sensitive—2021 calendars or fast-fashion items, for example—sitting on inventory is not an option, and misjudging the timing or quantities of orders can be costly. For companies with complex supply chains and manufacturing processes, balancing the risks of inventory gluts and shortages is especially difficult. To achieve these balances, firms have developed several methods for inventory management, including just-in-time (JIT) and materials requirement planning (MRP). Some firms like financial services firms do not have physical inventory and so must rely on service process management. Accounting for InventoryInventory represents a current asset since a company typically intends to sell its finished goods within a short amount of time, typically a year. Inventory has to be physically counted or measured before it can be put on a balance sheet. Companies typically maintain sophisticated inventory management systems capable of tracking real-time inventory levels. Inventory is accounted for using one of three methods: first-in-first-out (FIFO) costing; last-in-first-out (LIFO) costing; or weighted-average costing. An inventory account typically consists of four separate categories:
Inventory Management MethodsDepending on the type of business or product being analyzed, a company will use various inventory management methods. Some of these management methods include just-in-time (JIT) manufacturing, materials requirement planning (MRP), economic order quantity (EOQ), and days sales of inventory (DSI).
There are other methods to analyze inventory. If a company frequently switches its method of inventory accounting without reasonable justification, it is likely its management is trying to paint a brighter picture of its business than what is true. The SEC requires public companies to disclose LIFO reserve that can make inventories under LIFO costing comparable to FIFO costing. Frequent inventory write-offs can indicate a company's issues with selling its finished goods or inventory obsolescence. This can also raise red flags with a company's ability to stay competitive and manufacture products that appeal to consumers going forward. What are the 4 types of inventory?While there are many types of inventory, the four major ones are raw materials and components, work in progress, finished goods and maintenance, repair and operating supplies.
What is lead time in inventory?Lead time in inventory management is how long it takes to restock between the time of the order to when it's received. This impacts how much inventory a company needs to warehouse in order to maintain the production cycle they've decided upon.
How does inventory help satisfying guest needs?Inventory management helps you maintain customer satisfaction when it comes to product returns. When product is returned because it is damaged or dead on arrival, and it is still under warranty, you can arrange with the manufacturer to do an instant swap of the product to keep the customer happy.
How does lead time affect inventory levels?Lead time directly affects your total inventory levels. The longer your lead time the more stock you will need to hold in your inventory. Longer lead times make deliveries more unpredictable and force a company to rely heavily on demand forecasts to make orders.
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