Inventory in views

Inventory or stock refers to the goods and
materials include that a business holds for the
ultimate purpose of resale (or repair). [nb 1]
Inventory management is a science primarily
about specifying the shape and percentage of
stocked goods. It is required at different
locations within a facility or within many
locations of a supply network to precede the
regular and planned course of production and
stock of materials.
The scope of inventory management concerns
the fine lines between replenishment lead
time, carrying costs of inventory, asset
management, inventory forecasting, inventory
valuation, inventory visibility, future inventory
price forecasting, physical inventory, available
physical space for inventory, quality
management, replenishment, returns and
defective goods, and demand forecasting.
Balancing these competing requirements
leads to optimal inventory levels, which is an
ongoing process as the business needs shift
and react to the wider environment.
Inventory management involves a retailer
seeking to acquire and maintain a proper
merchandise assortment while ordering,
shipping, handling, and related costs are kept
in check. It also involves systems and
processes that identify inventory
requirements, set targets, provide
replenishment techniques, report actual and
projected inventory status and handle all
functions related to the tracking and
management of material. This would include
the monitoring of material moved into and out
of stockroom locations and the reconciling of
the inventory balances. It also may include
ABC analysis, lot tracking, cycle counting
support, etc. Management of the inventories,
with the primary objective of determining/
controlling stock levels within the physical
distribution system, functions to balance the
need for product availability against the need
for minimizing stock holding and handling
costs.
Definition
Inventory management is primarily about
specifying the size and placement of stocked
goods. Inventory management is required at
different locations within a facility or within
multiple locations of a supply network to
protect the regular and planned course of
production against the random disturbance of
running out of materials or goods.
The scope of inventory management also
concerns the fine lines between
replenishment lead time, carrying costs of
inventory, asset management, inventory
forecasting, inventory valuation, inventory
visibility, future inventory price forecasting,
physical inventory, available physical space
for inventory, quality management,
replenishment, returns and defective goods
and demand forecasting and also by
replenishment Or can be defined as the left
out stock of any item used in an organization.
Business inventory
Reasons for keeping stock
There are five basic reasons for keeping an
inventory
1. Time - The time lags present in the supply
chain, from supplier to user at every stage,
requires that you maintain certain amounts of
inventory to use in this lead time. However, in
practice, inventory is to be maintained for
consumption during 'variations in lead time'.
Lead time itself can be addressed by ordering
that many days in advance.
2. Seasonal Demand : demands varies
periodically, but producers capacity is fixed.
This can lead to stock accumulation, consider
for example how goods consumed only in
holidays can lead to accumulation of large
stocks on the anticipation of future
consumption.
3. Uncertainty - Inventories are maintained as
buffers to meet uncertainties in demand,
supply and movements of goods.
4. Economies of scale - Ideal condition of
"one unit at a time at a place where a user
needs it, when he needs it" principle tends to
incur lots of costs in terms of logistics. So
bulk buying, movement and storing brings in
economies of scale, thus inventory.
5. Appreciation in Value - In some situations,
some stock gains the required value when it is
kept for some time to allow it reach the
desired standard for consumption, or for
production. For example; beer in the brewing
industry
All these stock reasons can apply to any
owner or product
Also, some authors mentioned several reasons
not to keep high inventory levels: [1]
Obsolescence: due to progress of
technology, the bought inventory for future
use may become obsolete.
Capital Investment
Space Usage
Complicated Inventory Control Systems:higher
number of inventory items complicates the
control and monitoring items.
Special terms used in dealing with
inventory
Stock Keeping Unit (SKU) is a unique
combination of all the components that are
assembled into the purchasable item.
Therefore, any change in the packaging or
product is a new SKU. This level of detailed
specification assists in managing inventory.
Stockout means running out of the inventory
of an SKU. [2]
" New old stock" (sometimes abbreviated
NOS) is a term used in business to refer to
merchandise being offered for sale that was
manufactured long ago but that has never
been used. Such merchandise may not be
produced anymore, and the new old stock
may represent the only market source of a
particular item at the present time.
Typology
1. Buffer/safety stock
2. Reorder level
3. Cycle stock (Used in batch processes, it is
the available inventory, excluding buffer stock)
4. De-coupling (Buffer stock held between
the machines in a single process which
serves as a buffer for the next one allowing
smooth flow of work instead of waiting the
previous or next machine in the same
process)
5. Anticipation stock (Building up extra stock
for periods of increased demand - e.g. ice
cream for summer)
6. Pipeline stock (Goods still in transit or in
the process of distribution - have left the
factory but not arrived at the customer yet)
Average Daily/Weekly usage quantity X Lead
time in days + Safety stock
Inventory examples
While accountants often discuss inventory in
terms of goods for sale, organizations -
manufacturers , service-providers and not-for-
profits - also have inventories (fixtures,
furniture, supplies, etc.) that they do not
intend to sell. Manufacturers', distributors',
and wholesalers' inventory tends to cluster in
warehouses . Retailers' inventory may exist in
a warehouse or in a shop or store accessible
to customers . Inventories not intended for
sale to customers or to clients may be held in
any premises an organization uses. Stock ties
up cash and, if uncontrolled, it will be
impossible to know the actual level of stocks
and therefore impossible to control them.
While the reasons for holding stock were
covered earlier, most manufacturing
organizations usually divide their "goods for
sale" inventory into:
Raw materials - materials and components
scheduled for use in making a product.
Work in process , WIP - materials and
components that have begun their
transformation to finished goods.
Finished goods - goods ready for sale to
customers.
Goods for resale - returned goods that are
salable.
Stocks in transit.
Consignment stocks.
Maintenance supply. [1]
For example:
Manufacturing
A canned food manufacturer's materials
inventory includes the ingredients to form the
foods to be canned, empty cans and their lids
(or coils of steel or aluminum for constructing
those components), labels, and anything else
(solder, glue, etc.) that will form part of a
finished can. The firm's work in process
includes those materials from the time of
release to the work floor until they become
complete and ready for sale to wholesale or
retail customers. This may be vats of
prepared food, filled cans not yet labeled or
sub-assemblies of food components. It may
also include finished cans that are not yet
packaged into cartons or pallets. Its finished
good inventory consists of all the filled and
labeled cans of food in its warehouse that it
has manufactured and wishes to sell to food
distributors (wholesalers), to grocery stores
(retailers), and even perhaps to consumers
through arrangements like factory stores and
outlet centers.
Costs associated with inventory
There are several costs associated with
inventory: [1]
Ordering cost
Setup cost
Holding Cost
Shortage Cost
Principle of inventory
proportionality
Purpose
Inventory proportionality is the goal of
demand-driven inventory management. The
primary optimal outcome is to have the same
number of days' (or hours', etc.) worth of
inventory on hand across all products so that
the time of runout of all products would be
simultaneous. In such a case, there is no
"excess inventory," that is, inventory that
would be left over of another product when
the first product runs out. Excess inventory is
sub-optimal because the money spent to
obtain it could have been utilized better
elsewhere, i.e. to the product that just ran
out.
The secondary goal of inventory
proportionality is inventory minimization. By
integrating accurate demand forecasting with
inventory management, rather than only
looking at past averages, a much more
accurate and optimal outcome is expected.
Integrating demand forecasting into inventory
management in this way also allows for the
prediction of the "can fit" point when
inventory storage is limited on a per-product
basis.
Applications
The technique of inventory proportionality is
most appropriate for inventories that remain
unseen by the consumer, as opposed to "keep
full" systems where a retail consumer would
like to see full shelves of the product they are
buying so as not to think they are buying
something old, unwanted or stale; and
differentiated from the "trigger point" systems
where product is reordered when it hits a
certain level; inventory proportionality is used
effectively by just-in-time manufacturing
processes and retail applications where the
product is hidden from view.
One early example of inventory proportionality
used in a retail application in the United
States was for motor fuel. Motor fuel (e.g.
gasoline) is generally stored in underground
storage tanks. The motorists do not know
whether they are buying gasoline off the top
or bottom of the tank, nor need they care.
Additionally, these storage tanks have a
maximum capacity and cannot be overfilled.
Finally, the product is expensive. Inventory
proportionality is used to balance the
inventories of the different grades of motor
fuel, each stored in dedicated tanks, in
proportion to the sales of each grade. Excess
inventory is not seen or valued by the
consumer, so it is simply cash sunk (literally)
into the ground. Inventory proportionality
minimizes the amount of excess inventory
carried in underground storage tanks. This
application for motor fuel was first developed
and implemented by Petrolsoft Corporation in
1990 for Chevron Products Company. Most
major oil companies use such systems today.
[3]
Roots
The use of inventory proportionality in the
United States is thought to have been inspired
by Japanese just-in-time parts inventory
management made famous by Toyota Motors
in the 1980s. [4]
High-level inventory
management
It seems that around 1880[5] there was a
change in manufacturing practice from
companies with relatively homogeneous lines
of products to horizontally integrated
companies with unprecedented diversity in
processes and products. Those companies
(especially in metalworking) attempted to
achieve success through economies of scope
- the gains of jointly producing two or more
products in one facility. The managers now
needed information on the effect of product-
mix decisions on overall profits and therefore
needed accurate product-cost information. A
variety of attempts to achieve this were
unsuccessful due to the huge overhead of the
information processing of the time. However,
the burgeoning need for financial reporting
after 1900 created unavoidable pressure for
financial accounting of stock and the
management need to cost manage products
became overshadowed. In particular, it was
the need for audited accounts that sealed the
fate of managerial cost accounting. The
dominance of financial reporting accounting
over management accounting remains to this
day with few exceptions, and the financial
reporting definitions of 'cost' have distorted
effective management 'cost' accounting since
that time. This is particularly true of
inventory.
Hence, high-level financial inventory has these
two basic formulas, which relate to the
accounting period:
1. Cost of Beginning Inventory at the start of
the period + inventory purchases within the
period + cost of production within the period =
cost of goods available
2. Cost of goods available − cost of ending
inventory at the end of the period = cost of
goods sold
The benefit of these formulas is that the first
absorbs all overheads of production and raw
material costs into a value of inventory for
reporting. The second formula then creates
the new start point for the next period and
gives a figure to be subtracted from the sales
price to determine some form of sales-margin
figure.
Manufacturing management is more interested
in inventory turnover ratio or average days to
sell inventory since it tells them something
about relative inventory levels.
Inventory turnover ratio (also known as
inventory turns ) = cost of goods sold /
Average Inventory = Cost of Goods Sold /
((Beginning Inventory + Ending Inventory) /
2)
and its inverse
Average Days to Sell Inventory = Number
of Days a Year / Inventory Turnover Ratio =
365 days a year / Inventory Turnover Ratio
This ratio estimates how many times the
inventory turns over a year. This number tells
how much cash/goods are tied up waiting for
the process and is a critical measure of
process reliability and effectiveness. So a
factory with two inventory turns has six
months stock on hand, which is generally not
a good figure (depending upon the industry),
whereas a factory that moves from six turns
to twelve turns has probably improved
effectiveness by 100%. This improvement will
have some negative results in the financial
reporting, since the 'value' now stored in the
factory as inventory is reduced.
While these accounting measures of inventory
are very useful because of their simplicity,
they are also fraught with the danger of their
own assumptions. There are, in fact, so many
things that can vary hidden under this
appearance of simplicity that a variety of
'adjusting' assumptions may be used. These
include:
Specific Identification
Lower of cost or market
Weighted Average Cost
Moving-Average Cost
FIFO and LIFO.
Inventory Turn is a financial accounting tool
for evaluating inventory and it is not
necessarily a management tool. Inventory
management should be forward looking. The
methodology applied is based on historical
cost of goods sold. The ratio may not be able
to reflect the usability of future production
demand, as well as customer demand.
Business models, including Just in Time (JIT)
Inventory, Vendor Managed Inventory (VMI)
and Customer Managed Inventory (CMI),
attempt to minimize on-hand inventory and
increase inventory turns. VMI and CMI have
gained considerable attention due to the
success of third-party vendors who offer
added expertise and knowledge that
organizations may not possess.
Accounting for inventory
Each country has its own rules about
accounting for inventory that fit with their
financial-reporting rules.
For example, organizations in the U.S. define
inventory to suit their needs within US
Generally Accepted Accounting Practices
(GAAP), the rules defined by the Financial
Accounting Standards Board (FASB) (and
others) and enforced by the U.S. Securities
and Exchange Commission (SEC) and other
federal and state agencies. Other countries
often have similar arrangements but with their
own accounting standards and national
agencies instead.
It is intentional that financial accounting uses
standards that allow the public to compare
firms' performance, cost accounting functions
internally to an organization and potentially
with much greater flexibility. A discussion of
inventory from standard and Theory of
Constraints -based ( throughput ) cost
accounting perspective follows some
examples and a discussion of inventory from a
financial accounting perspective.
The internal costing/valuation of inventory
can be complex. Whereas in the past most
enterprises ran simple, one-process factories,
such enterprises are quite probably in the
minority in the 21st century. Where 'one
process' factories exist, there is a market for
the goods created, which establishes an
independent market value for the good.
Today, with multistage-process companies,
there is much inventory that would once have
been finished goods which is now held as
'work in process' (WIP). This needs to be
valued in the accounts, but the valuation is a
management decision since there is no
market for the partially finished product. This
somewhat arbitrary 'valuation' of WIP
combined with the allocation of overheads to
it has led to some unintended and undesirable
results.
Financial accounting
An organization's inventory can appear a
mixed blessing, since it counts as an asset on
the balance sheet , but it also ties up money
that could serve for other purposes and
requires additional expense for its protection.
Inventory may also cause significant tax
expenses, depending on particular countries'
laws regarding depreciation of inventory, as in
Thor Power Tool Company v. Commissioner.
Inventory appears as a current asset on an
organization's balance sheet because the
organization can, in principle, turn it into cash
by selling it. Some organizations hold larger
inventories than their operations require in
order to inflate their apparent asset value and
their perceived profitability.
In addition to the money tied up by acquiring
inventory, inventory also brings associated
costs for warehouse space, for utilities, and
for insurance to cover staff to handle and
protect it from fire and other disasters,
obsolescence, shrinkage (theft and errors),
and others. Such holding costs can mount up:
between a third and a half of its acquisition
value per year.
Businesses that stock too little inventory
cannot take advantage of large orders from
customers if they cannot deliver. The
conflicting objectives of cost control and
customer service often pit an organization's
financial and operating managers against its
sales and marketing departments.
Salespeople, in particular, often receive sales-
commission payments, so unavailable goods
may reduce their potential personal income.
This conflict can be minimised by reducing
production time to being near or less than
customers' expected delivery time. This effort,
known as " Lean production" will significantly
reduce working capital tied up in inventory
and reduce manufacturing costs (See the
Toyota Production System).
Role of inventory accounting
By helping the organization to make better
decisions, the accountants can help the public
sector to change in a very positive way that
delivers increased value for the taxpayer’s
investment. It can also help to incentive's
progress and to ensure that reforms are
sustainable and effective in the long term, by
ensuring that success is appropriately
recognized in both the formal and informal
reward systems of the organization.
To say that they have a key role to play is an
understatement. Finance is connected to
most, if not all, of the key business processes
within the organization. It should be steering
the stewardship and accountability systems
that ensure that the organization is
conducting its business in an appropriate,
ethical manner. It is critical that these
foundations are firmly laid. So often they are
the litmus test by which public confidence in
the institution is either won or lost.
Finance should also be providing the
information, analysis and advice to enable the
organizations’ service managers to operate
effectively. This goes beyond the traditional
preoccupation with budgets – how much have
we spent so far, how much do we have left to
spend? It is about helping the organization to
better understand its own performance. That
means making the connections and
understanding the relationships between given
inputs – the resources brought to bear – and
the outputs and outcomes that they achieve.
It is also about understanding and actively
managing risks within the organization and its
activities.
FIFO vs. LIFO accounting
Main article: FIFO and LIFO accounting
When a merchant buys goods from inventory,
the value of the inventory account is reduced
by the cost of goods sold (COGS). This is
simple where the CoG has not varied across
those held in stock; but where it has, then an
agreed method must be derived to evaluate it.
For commodity items that one cannot track
individually, accountants must choose a
method that fits the nature of the sale. Two
popular methods that normally exist are: FIFO
and LIFO accounting (first in - first out, last in
- first out). FIFO regards the first unit that
arrived in inventory as the first one sold. LIFO
considers the last unit arriving in inventory as
the first one sold. Which method an
accountant selects can have a significant
effect on net income and book value and, in
turn, on taxation. Using LIFO accounting for
inventory, a company generally reports lower
net income and lower book value, due to the
effects of inflation. This generally results in
lower taxation. Due to LIFO's potential to
skew inventory value, UK GAAP and IAS have
effectively banned LIFO inventory accounting.
Standard cost accounting
Main article: Standard cost accounting
Standard cost accounting uses ratios called
efficiencies that compare the labour and
materials actually used to produce a good
with those that the same goods would have
required under "standard" conditions. As long
as actual and standard conditions are similar,
few problems arise. Unfortunately, standard
cost accounting methods developed about 100
years ago, when labor comprised the most
important cost in manufactured goods.
Standard methods continue to emphasize
labor efficiency even though that resource
now constitutes a (very) small part of cost in
most cases.
Standard cost accounting can hurt managers,
workers, and firms in several ways. For
example, a policy decision to increase
inventory can harm a manufacturing
manager's performance evaluation . Increasing
inventory requires increased production, which
means that processes must operate at higher
rates. When (not if) something goes wrong,
the process takes longer and uses more than
the standard labor time. The manager appears
responsible for the excess, even though s/he
has no control over the production
requirement or the problem.
In adverse economic times, firms use the
same efficiencies to downsize, rightsize, or
otherwise reduce their labor force. Workers
laid off under those circumstances have even
less control over excess inventory and cost
efficiencies than their managers.
Many financial and cost accountants have
agreed for many years on the desirability of
replacing standard cost accounting. They
have not, however, found a successor.
Theory of constraints cost accounting
Eliyahu M. Goldratt developed the Theory of
Constraints in part to address the cost-
accounting problems in what he calls the
"cost world." He offers a substitute, called
throughput accounting , that uses throughput
(money for goods sold to customers) in place
of output (goods produced that may sell or
may boost inventory) and considers labor as a
fixed rather than as a variable cost. He
defines inventory simply as everything the
organization owns that it plans to sell,
including buildings, machinery, and many other
things in addition to the categories listed
here. Throughput accounting recognizes only
one class of variable costs: the truly variable
costs, like materials and components, which
vary directly with the quantity produced
Finished goods inventories remain balance-
sheet assets, but labor-efficiency ratios no
longer evaluate managers and workers.
Instead of an incentive to reduce labor cost,
throughput accounting focuses attention on
the relationships between throughput (revenue
or income) on one hand and controllable
operating expenses and changes in inventory
on the other.
National accounts
Inventories also play an important role in
national accounts and the analysis of the
business cycle. Some short-term
macroeconomic fluctuations are attributed to
the inventory cycle.
Distressed inventory
Also known as distressed or expired stock,
distressed inventory is inventory whose
potential to be sold at a normal cost has
passed or will soon pass. In certain industries
it could also mean that the stock is or will
soon be impossible to sell. Examples of
distressed inventory include products that
have reached their expiry date, or have
reached a date in advance of expiry at which
the planned market will no longer purchase
them (e.g. 3 months left to expiry), clothing
that is defective or out of fashion , music that
is no longer popular and old newspapers or
magazines. It also includes computer or
consumer-electronic equipment that is
obsolete or discontinued and whose
manufacturer is unable to support it. One
current example of distressed inventory is the
VHS format. [6] In 2001, Cisco wrote off
inventory worth US $2.25 billion due to
duplicate orders. [7] This is one of the biggest
inventory write-offs in business history.
Stock Rotation
Stock Rotation is the practice of changing the
way inventory is displayed on a regular basis.
This is most commonly used in hospitality and
retail - particularity where food products are
sold. For example, in the case of
supermarkets that a customer frequents on a
regular basis, the customer may know exactly
what they want and where it is. This results in
many customers going straight to the product
they seek and do not look at other items on
sale. To discourage this practice, stores will
rotate the location of stock to encourage
customers to look through the entire store.
This is in hopes the customer will pick up
items they would not normally see. [8]
Inventory credit
Inventory credit refers to the use of stock, or
inventory, as collateral to raise finance. Where
banks may be reluctant to accept traditional
collateral, for example in developing countries
where land title may be lacking, inventory
credit is a potentially important way of
overcoming financing constraints. This is not
a new concept; archaeological evidence
suggests that it was practiced in Ancient
Rome. Obtaining finance against stocks of a
wide range of products held in a bonded
warehouse is common in much of the world.
It is, for example, used with Parmesan cheese
in Italy. [9] Inventory credit on the basis of
stored agricultural produce is widely used in
Latin American countries and in some Asian
countries. [10] A precondition for such credit is
that banks must be confident that the stored
product will be available if they need to call
on the collateral; this implies the existence of
a reliable network of certified warehouses. [11]
Banks also face problems in valuing the
inventory. The possibility of sudden falls in
commodity prices means that they are usually
reluctant to lend more than about 60% of the
value of the inventory at the time of the loan.
Journal
International Journal of Inventory Research
See also
Cash conversion cycle
Consignment stock
Cost of goods sold
Economic order quantity
Inventory investment
Inventory management software
Operations research
Pinch point (economics)
Service level
Spare part
Stock management
Notes
1. ^ The word inventory is commonly used in
American English and in business accounting.
In the rest of the English-speaking world,
stock is more commonly used, although
inventory is recognised as a synonym.
References
1. ^ a b c Malakooti, Behnam (2013).
Operations and Production Systems with
Multiple Objectives . John Wiley & Sons.
ISBN 978-1-118-58537-5 .
2. ^ http://www.specialinvestor.com/
terms/1072.html
3. ^ aspenONE Supply & Distribution for
Refining & Marketing
4. ^ http://www.bsu.edu/web/scfrazier2/jit/
mainpage.htm
5. ^ Relevance Lost, Johnson and Kaplan,
Harvard Business School Press, 1987, p126
6. ^ R. S. SAXENA (1 December 2009).
INVENTORY MANAGEMENT: Controlling in a
Fluctuating Demand Environment . Global
India Publications. pp. 24–.
ISBN 978-93-8022-821-1 . Retrieved 7 April
2012.
7. ^ Armony, Mor. "The Impact of Duplicate
Orders on Demand Estimation and Capacity
Investment" .
8. ^ Lee, Perlitz (2012). Retail Services .
Australia: McGraw HIll. p. 440.
ISBN 9781743070741 .
9. ^ "Who moved my Parmigiano?" .
italiannotebook.com .
10. ^ Coulter, Jonathan; Shepherd, Andrew W.
(1995). "Inventory Credit – An approach to
developing agricultural markets" . fao.org .
Rome.
11. ^ CTA and EAGC. "Structured grain
trading systems in Africa" (PDF). CTA.
Retrieved 27 February 2014.