management involves balancing the costs of inventory
with the benefits of inventory. Many small business
owners fail to appreciate fully the true costs of
carrying inventory, which include not only direct costs
of storage, insurance and taxes, but also the cost of
money tied up in inventory. This fine line between
keeping too much inventory and not enough is not the
manager's only concern. Others include:
- Maintaining a wide
assortment of stock -- but not spreading the rapidly
moving ones too thin;
inventory turnover -- but not sacrificing the
- Keeping stock low
-- but not sacrificing service or performance.
- Obtaining lower
prices by making volume purchases -- but not ending
up with slow-moving inventory; and
- Having an adequate
inventory on hand -- but not getting caught with
The degree of success
in addressing these concerns is easier to gauge for some
than for others. For example, computing the inventory
turnover ratio is a simple measure of managerial
performance. This value gives a rough guideline by which
managers can set goals and evaluate performance, but it
must be realized that the turnover rate varies with the
function of inventory, the type of business and how the
ratio is calculated (whether on sales or cost of goods
sold). Average inventory turnover ratios for individual
industries can be obtained from trade associations.
One of the most
important aspects of inventory control is to have the
items in stock at the moment they are needed. This
includes going into the market to buy the goods early
enough to ensure delivery at the proper time. Thus,
buying requires advance planning to determine inventory
needs for each time period and then making the
commitments without procrastination.
For retailers, planning
ahead is very crucial. Since they offer new items for
sale months before the actual calendar date for the
beginning of the new season, it is imperative that
buying plans be formulated early enough to allow for
intelligent buying without any last minute panic
purchases. The main reason for this early offering for
sale of new items is that the retailer regards the
calendar date for the beginning of the new season as the
merchandise date for the end of the old season. For
example, many retailers view March 21 as the end of the
spring season, June 21 as the end of summer and December
21 as the end of winter.
Part of your purchasing
plan must include accounting for the depletion of the
inventory. Before a decision can be made as to the level
of inventory to order, you must determine how long the
inventory you have in stock will last.
For instance, a retail
firm must formulate a plan to ensure the sale of the
greatest number of units. Likewise, a manufacturing
business must formulate a plan to ensure enough
inventory is on hand for production of a finished
- In summary, the
purchasing plan details:
- When commitments
should be placed;
- When the first
delivery should be received;
- When the inventory
should be peaked;
- When reorders
should no longer be placed; and
- When the item
should no longer be in stock.
Well planned purchases
affect the price, delivery and availability of products
To maintain an in-stock
position of wanted items and to dispose of unwanted
items, it is necessary to establish adequate controls
over inventory on order and inventory in stock. There
are several proven methods for inventory control. They
are listed below, from simplest to most complex.
- Visual control enables the manager to examine the inventory
visually to determine if additional inventory is
required. In very small businesses where this method
is used, records may not be needed at all or only
for slow moving or expensive items.
control enables the manager to physically count
a small portion of the inventory each day so that
each segment of the inventory is counted every so
many days on a regular basis.
- Click sheet
control enables the manager to record the item
as it is used on a sheet of paper. Such information
is then used for reorder purposes.
- Stub control (used by retailers) enables the manager to retain a
portion of the price ticket when the item is sold.
The manager can then use the stub to record the item
that was sold.
As a business grows, it
may find a need for a more sophisticated and technical
form of inventory control. Today, the use of computer
systems to control inventory is far more feasible for
small business than ever before, both through the
widespread existence of computer service organizations
and the decreasing cost of small-sized computers. Often
the justification for such a computer-based system is
enhanced by the fact that company accounting and billing
procedures can also be handled on the computer.
terminals relay information on each item used
or sold. The manager receives information printouts
at regular intervals for review and action.
point-of-sale terminals relay information
directly to the supplier's computer who uses the
information to ship additional items automatically
to the buyer/inventory manager.
The final method for
inventory control is done by an outside agency. A
manufacturer's representative visits the large retailer
on a scheduled basis, takes the stock count and writes
the reorder. Unwanted merchandise is removed from stock
and returned to the manufacturer through a
predetermined, authorized procedure.
A principal goal for
many of the methods described above is to determine the
minimum possible annual cost of ordering and stocking
each item. Two major control values are used: 1) the
order quantity, that is, the size and frequency of
orders; and 2) the reorder point, that is, the minimum
stock level at which additional quantities are ordered.
The Economic Order Quantity (EOQ) formula is one widely
used method of computing the minimum annual cost for
ordering and stocking each item. The EOQ computation
takes into account the cost of placing an order, the
annual sales rate, the unit cost, and the cost of
carrying inventory. Many books on management practices
describe the EOQ model in detail.
In recent years, two
approaches have had a major impact on inventory
management: Material Requirements Planning (MRP) and
Just-In-Time (JIT and Kanban). Their application is
primarily within manufacturing but suppliers might find
new requirements placed on them and sometimes buyers of
manufactured items will experience a difference in
requirements planning is basically an information
system in which sales are converted directly into loads
on the facility by sub-unit and time period. Materials
are scheduled more closely, thereby reducing
inventories, and delivery times become shorter and more
predictable. Its primary use is with products composed
of many components. MRP systems are practical for
smaller firms. The computer system is only one part of
the total project which is usually long-term, taking one
to three years to develop.
Just-in-time inventory management is an approach which works to
eliminate inventories rather than optimize them. The
inventory of raw materials and work-in-process falls to
that needed in a single day. This is accomplished by
reducing set-up times and lead times so that small lots
may be ordered. Suppliers may have to make several
deliveries a day or move close to the user plants to
support this plan.
TIPS FOR BETTER
At time of
- Verify count --
Make sure you are receiving as many cartons as are
listed on the delivery receipt.
- Carefully examine
each carton for visible damage -- If damage is
visible, note it on the delivery receipt and have
the driver sign your copy.
immediately open all cartons and inspect for merchandise
When damage is
- Retain damaged
items -- All damaged materials must be held at the
- Call carrier to
report damage and request inspection.
- Confirm call in
writing--This is not mandatory but it is one way to
inspection of damaged items
- Have all damaged
items in the receiving area -- Make certain the
damaged items have not moved from the receiving area
prior to inspection by carrier.
carrier/inspector prepares damage report, carefully
read before signing.
- Keep damaged
materials -- Damaged materials should not be used or
disposed of without permission by the carrier.
- Do not return
damaged items without written authorization from
If you are in the
business of bidding, specifications play a very
important role. In writing specifications, the following
elements should be considered.
- Do not request
features or quality that are not necessary for the
items' intended use.
- Include full
descriptions of any testing to be performed.
- Include procedures
for adding optional items.
- Describe the
quality of the items in clear terms.
The following actions
can help save money when you are stocking inventory:
- Substitution of
less costly materials without impairing required
- Improvement in
quality or changes in specifications that would lead
to savings in process time or other operating
- Developing new
sources of supply;
- Greater use of
- Quantity savings
due to large volume, through consideration of
economic order quantity;
- A reduction in
unit prices due to negotiations;
- Application of new
- Using competition
along with price, service and delivery when making
the purchase selection decision.