Efficient Inventory Management: Strategies and Optimization
Inventories and Management
Procurement Function
The procurement function is to buy the materials needed for the company’s activity (production and/or sale) and store them while starting every process of production or marketing.
The overall objective of the procurement function is to provide the production department with the necessary materials (raw materials, spare parts, packaging…) for the manufacture and sales of the products you sell, and organize the different stocks generated in this process. Usually, this process is responsible for purchasing or procurement.
The procurement function is composed of three fundamental aspects: purchasing, warehousing, and inventory management.
First, it is in charge of making purchases of products needed by the production and sales departments (depending on whether the company is producing or commercial). It has to take into account the price, quality, delivery time, payment terms, service, etc. This involves optimal selection of suppliers to maximize these variables, which determine the purchases.
Second, the supply function implies the availability of warehouses to store the purchased products needed by the production department. Once the product is manufactured, it also must be stored while the sales department sells to their customers. For all this, we need a physical space to organize and conveniently store bought or manufactured products, i.e., an organizational system for classifying and managing stocks.
Third, it is necessary to develop an inventory management system that aims to determine the amount of inventory to be maintained and the pace of orders to meet the needs of the enterprise for production and marketing.
Therefore, the supply function is a period of time, as there is a set of activities that have a chronological order. Thus, we consider the procurement cycle as the period between the completion of purchase and the time the products are delivered to customers.
This cycle is different in the case of a producer or a commercial enterprise.
The cycle of a producer is:
The production company begins with the purchase of materials needed for production, which, while not in use, remain in the warehouse (stock). Once products have been manufactured for sale, they are also in the store while not sold (stocks). That is, in the warehouse, movements are generated in four ways: input procurement, production output, input manufactured product, and output product for sale.
In the case of a commercial enterprise, the supply cycle means fewer movements because the activity of the company is marketing and distributing a product, i.e., a trading activity without transformation. The cycle is reduced to two strokes: entries for purchases and sales outlets.
Service companies that are not commercial also belong to this group, as they must have some stock in their warehouses, materials needed to perform the service they offer.
Stocks: Concept and Types
Stocks are all materials that a company has deposited in its warehouses and perform a series of specific functions within procurement management. Stocks are also known as stocks or inventories; the two terms can be considered synonyms.
According to the characteristics of the company, you can identify different types of stocks in terms of their usefulness or their position in the procurement cycle:
– Raw materials: Those intended to be part of the products through processing or preparation.
– Semi-finished: Products manufactured by the company and usually not for sale until they are the subject of another development, incorporation, or further processing.
– Finished products: Products manufactured by the company and for final consumption or use as they lead to other companies.
– Merchandise or stock trading: Materials purchased by the company and intended for subsequent sale or marketing without transformation.
– Other supplies: Elements include, for example, fuel, spare parts, packaging, containers, and office supplies.
– By-products (secondary or ancillary to the main manufacturing), waste (obtained at the same time as the products can be used, sold, or unusable), and recyclable materials (reused after production).
Inventory Management
Stocks can be considered stored resources used to satisfy a number of economic and operational needs of the company.
Inventories, meanwhile, provide flexibility to the operations of the company and facilitate supply management.
The company needs to have resources stored for many reasons:
– To avoid a breakdown of stocks, i.e., not running out of products if there is an unexpected increase in demand, as this could cause some customers to leave for the competition.
– Because there may be differences in the rates of production and distribution when demand depends on the time of year. For example, a company that makes coats will have demand in the winter months, so during the spring and summer, it increases manufacturing stocks.
– To obtain large discounts on the purchase of materials in large quantities. Seizing this opportunity helps to reduce product costs.
In general, stocks of the company can better harmonize the rhythms of purchasing, production, and sales, softening the differences. In this way, they can take better advantage of business opportunities and reduce the negative impact of threats (inflation, unexpected increase in demand, failure to delivery time, etc.).
The company dedicates a portion of its resources to maintain a certain level of inventory since their management raises a number of economically relevant costs.
Classification of Inventory Costs
The costs of inventory management can be classified into three groups:
– Order costs: Costs incurred by ordering, including the administrative costs of managing and placing orders to suppliers.
– Purchase costs: The price of the product we buy from the supplier.
– Costs of maintaining inventory: Costs that the company has to maintain a specific level of stocks in its warehouses. These costs include:
– Administrative: Administrative personnel costs and system management and administration.
– Operations: Warehouse personnel costs, equipment, and safe handling of stocks against various risks.
– Physical space: Costs of rent, depreciation, taxes, building insurance, heating, ventilation, and refrigeration equipment…
– Economic: Obsolescence and depreciation costs of inventories.
– Financial: Cost of interest paid on the financing of the capital invested in maintaining stocks. If the stock is self-financing, the firm incurs an opportunity cost.
– Cost breakdown of stocks: Costs that the company has when it runs out of stock, i.e., when you cannot deal with a customer’s order for lack of product or cannot produce for lack of raw materials or other stock needed for production.
Inventory Management
To achieve optimal supply management, it is very important to establish what you want to determine with this management system, which orders are to be performed to maintain optimal stock levels, when, and with what management and planning system.
To study the elements that characterize inventory management, consider the following indicators:
– Stock up: The greater amount of stocks of a material that can be maintained in the warehouse, in relation to the abundant storage costs that must be endured.
– Minimum stock or security: The smaller amount of stocks of a material that can be maintained in the warehouse under which the risk of rupture of stocks is very high.
– Point of order: Stock level at which it is ordered to replenish the stock. When the order is made, consider the time it takes to serve the provider (time of supply) not to be below the safety stock.
Inventory management must adopt specific criteria to determine the maximum stock and safety stock, since it is normally very complex to set optimal inventory levels. With the available data, you can determine the point of order, which is useful in determining when to place an order to the supplier or a production order to the production department.