08/ 03/ 2007
by Charles R. McConnell
Many production supervisors worry about the possibility of running short of parts or materials needed to meet production schedules. Likewise, sales representatives are sometimes haunted by the possibility of having insufficient finished goods available to satisfy current orders. Often, your business can overcome such fears of shortages by keeping generous supplies of everything on hand.
In addition to raw materials, component parts and finished goods, inventory can also include work in process and other necessities, such as packaging materials and operating supplies. Parts and materials inventory and finished goods inventory are equally important. Not having enough inventory can lead to costly disruptions; having too much inventory can mean precious dollars tied up often to the extent of strangling cash flow. Too little inventory triggers shortages leading to lost output and, thus, lost revenue. Financial problems associated with inventory have sometimes led to business failure; a company having significant value tied up in inventory can appear healthy "on paper," but lack operating cash.
For some companies, inventory control can be one of the most complex and far-reaching business activities, yet, too often, it receives close attention only when shortages interfere with production or sales. The time to pay attention, however, is not when disruption of production or sales occur, but rather when signs of trouble emerge. Indications of inventory management problems include:
- Inordinately high numbers of back-orders
- Increases in inventory quantities occurring while back orders do not decrease
- Increasing rates of order cancellations or customer turnover
- Uneven production and equipment downtime because of material shortages
- Special, uneconomical production runs to meet immediate demands
- Gradual loss of space available for storage
- Inventory write-offs
The principal objectives of inventory control are to: maintain investment in inventory at a reasonable level; safeguard the company's assets; and balance production and inventory costs with inventory carrying costs. In pursuit of these objectives, an effective inventory control program will:
- Maintain inventory investment at the lowest practical level
- Ensure adequate materials and supplies moving in and products moving out
- Identify slow-moving or obsolete items
- Reduce loss from damage, waste and pilferage
- Ensure that actual quantities match recorded amounts
- Highlight conditions of over- or under-stock
To control inventory, it's necessary to: determine what items to carry and when and by how much to replenish them; purchase, store and issue material; keep records of all transactions and be able to verify quantities at all times; and identify and dispose of slow-moving and obsolete items.
The greatest inventory concern is always the concern for incoming materials and supplies, and perhaps, the simplest and most effective way of controlling such inventory is by applying the ABC inventory method, which focuses attention on items in proportion to their importance. It works as follows:
- "A" items, usually the smallest percentage of all items, are costlier, accounting for the largest portion of inventory cost. These require the most attention; run-outs and overstock are both costly.
- "B" items are of average importance, not high-dollar but of sufficient value to require control.
- "C" items frequently account for more than half of all stock. These are low-cost items, parts and supplies, comprising what is often referred to as "bin stock." Keeping plenty of these on hand costs less than the effort required for close monitoring.
The key to controlling parts and materials inventory is determining how much to order at any given time. The process can sometimes become complex, involving calculation of a number referred to as the "economic order quantity" (EOQ). This overview is far too brief to delve into the mathematics of determining the EOQ. It's possible, however, to arrive at a reasonably accurate EOQ using a formula applied either manually or by computer, and there are also available aids such as EOQ slide rules, charts and relatively simple tables. For any particular item, all of these means take into account: unit cost; total annual cost; inventory carrying cost; ordering cost; and expected annual usage. If reliable purchasing and usage records are available, these factors can usually be approximated from historical information.
Always stocking more than enough of what might be needed at any time may foster feelings of security for those who are wary of run-outs or shortages. However, the costs of carrying inventory—the time value of money tied up in inventory, plus the value of occupied space—can mount up to a damaging extent, tying up precious resources that can't readily be tapped for operating purposes.
To control inventory is to remove real and potential obstacles to a company's financial health. More than a few businesses have discovered that improvements in inventory handling can generate savings that fall directly to the bottom line.
