Inventory Management: Optimizing Stock Levels and Costs
Inventory Management: A Comprehensive Overview
Procurement
The procurement function is responsible for buying the necessary materials for the company’s activity (production or sales), storing them, and managing different inventories. The production department needs materials (raw materials, spare parts, packaging, etc.) for manufacturing, and the sales department needs products for marketing.
- The procurement function purchases products required by the production and sales departments.
- The supply stores provide a means to store purchased products until the production department needs them.
- An effective inventory management system determines the amount of stock to maintain and ensures it keeps pace with orders.
Stocks: Concept and Typology
- Raw materials: Materials that undergo transformation or processing.
- Semi-manufactured products: Products manufactured by the company, not normally intended for sale until further processing.
- Products in progress: Products currently undergoing transformation.
- Finished products: Products manufactured and ready for final consumption or use by other companies.
- Commodity or stock trading: Materials purchased for resale without transformation.
- Other supplies: Additional elements incorporated into production.
- Byproducts: Waste and recoverable materials.
Functions and Needs of Inventories
- Provides security against supply uncertainty.
- Addresses differences in production and seasonal demand.
- Allows for economies of scale in purchasing materials in large quantities.
- Offers protection against inflation and price variability.
Classification of Inventory Costs
- Ordering costs: Charges for ordering or replenishing stock, including administrative costs.
- Inventory holding costs: Costs of keeping stock in warehouses.
- Administrative: Personnel and administrative system management costs.
- Operating: Personnel costs of storage.
- Physical space: Costs of renting warehouse space.
- Economic: Obsolescence and depreciation costs.
- Financial: Interest paid on capital invested in inventory.
- Stockout costs: Costs incurred when stock runs out, preventing order fulfillment or production.
Determining Stock Levels
A key aspect of inventory management is determining the appropriate stock levels to maintain in warehouses.
- Objective effectiveness: Maintaining sufficient stock for flexible operations and production.
- Objective efficiency: Keeping stock levels fair to avoid excessive resource allocation to storage.
Managing Inventories
- Maximum stock: The largest amount of a material that can be stored.
- Minimum or safety stock: The smallest amount of a material that can be stored.
- Reorder point: The stock level at which a replenishment order should be placed.
The Optimal Order Model (Wilson Model)
This model assumes:
- A constant production or purchase batch size.
- Known and constant product demand.
- Constant and known product price and supply lead time.
- Acquisition cost (CA): The cost of buying a product, where ‘p’ is the purchase price and ‘D’ is the expected demand. Ca = PD. If the company manufactures the product, CA = cf.D
- Order cost (CC): The unit cost of placing an order. If N = D: Q = s then CC. D: Q
- Storage cost (EC): The total cost of maintaining inventory in storage. EC = g. (Q: 2 + Es)
- Reorder point: The stock level at which to place a supply order.
Provisioning
Production, purchasing, sales, and stock management are all interconnected.