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Inventory is the most essential and important asset owned by any entity. Inventory is critical for both manufacturers and retailers generally maintaining 3 types of inventories viz raw materials, work in progress and finished goods.

In this article we cover the following topics:

  1. Importance of Inventory Management
  2. Inventory Management Concerns
  3. Disclosure of Inventory in the Financial Statement
  4. Case Study for Inventory Management

1. Importance of Inventory Management

Inventory Management involves activities which allow an entity to have a better control over various inventory items from the time goods are received to the point of sale.

This inventory management is more critical for the manufacturers or retailers dealing with perishable stock which has a short expiry period.

Listed below are some of the important benefits to an entity from a good inventory management:

I. Stock Out

One of the important advantages of inventory management is that an entity will not face stock out issues. It plays a vital role in the smooth functioning of an entity’s business by ensuring production process is not paused due to insufficient raw materials or sales is not affected due to insufficient finished goods.

When demand for the products increases suddenly due to market conditions, such close monitoring of the inventories will help the entity to gear up for increasing the purchase and production process thereby retaining the customer orders.

II. Minimum Stock

Having a good inventory management is essential for an entity to avoid overstocking of goods. If the inventory is not managed well, an entity might end up having excess stock which has to be stored & handled until it is moved out of the warehouse. Such overstocking will add to the company’s cost and also there are huge chances that it might turn into obsolete inventory.

The longer the stock is stored in the warehouse, the greater is the chance for it to become obsolete and the entity might end up writing off such obsolete inventory. Inventory management allows an entity to maintain minimum stock per the requirement and thereby avoiding the overstocking issues.

III. Working Capital

Generally, inventory is an expensive asset possessed by an entity and major part of its working capital is blocked. If an entity’s inventory is well managed, it will help in cost saving and ensure minimum cash is blocked in the process.

For example, an entity spends Rs.1000 on the raw material purchase and processes the same for conversion into finished goods. It expects that the finished goods will be sold for a higher price including the entity’s margin. But if the finished good is not sold for a long time and the product is stored in the warehouse, then the entity’s working capital is blocked to this extent.

So inventory management is not about just dealing with the receipt and issue of raw materials or finished goods, it is also about managing an entity’ working capital by having minimum cash tied in operations.

2. Inventory Management Concerns

Some of the common issues w.r.t inventory management is:

i. Lack of having good control systems

ii. Failure to use the management tools as required

iii. Not following the steps per the set process

iv. Proper transportation structure

v. Lack of visibility in the supply chain

vi. Lack of knowledge of the responsible staff in handling the inventories

vii. Not segregating the stock per required categorization

viii. Failure to secure the stock against risk (fire, theft etc)

Inventory management problem is not just in the inventory only; it is also about addressing the root causes for the inventory which will enable the above issues are handled smoothly.

Leading organizations have managed to establish means of reducing these issues through superior inventory management and training.

3. Disclosure of Inventory in the Financial Statement

For companies having various categories of inventories, it is suggested that the inventories are reported separately category-wise for better disclosure purpose and analysis.

Where the inventories represent a substantial part of entities asset structure, this kind of disclosure give better investor perspective than reporting as a single line:

inventory management

Example of Reorder Point

Let’s see a simple example of how to reorder point is used in inventory management.

Assume the following:

Entity’s daily usage of inventory units: 30 units/day; Order lead time: 20 days and Safety stock: 240 units. Safety stock is calculated assuming 8 days’ supply at the current daily usage rate.

Let us calculate the reorder point with these factors:

Reorder point = (Daily usage rate) x (lead time days) + Safety stock units = 30 x 20 + 240 = 840 units.

Therefore, an entity should replenish with an order when the current inventory level falls to 840 units.

4. Case Study for Inventory Management

Company A is a manufacturing entity with suppliers’ world-over delivering parts for the company’s products. They had multiple buyers who were responsible for tracking the parts required for each product from the manufacturing stage through delivery.

The company was unable to maintain a master list of all inventories with all required information and was experiencing ineffective inventory management.

Solution to this situation would be:

company A should develop a custom database driven inventory application. That will provide a lot of benefits to the company like:

1. Enable multiple buyers to easily track, manage the deliveries from any location.

2. The automated system will provide the company with accurate and efficient data to collect, process, record and manage the inventory.

3. The company will be able to take more informed decisions and this will drive the productivity better, reduce cost and increase the margins.

4. It also eliminates the manual process with multiple registers and trackers.

5. The occurrence of errors will be reduced to a greater extent

6. The time involved in the process will be reduced and thereby utilizing the staff time on improvements

When the application is updated on a timely basis about the movement of goods and other such required details, this will eliminate the inefficiencies in the inventory management which company A is currently facing.

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