25-08-2017, 09:32 PM
Nature of inventory and its role in working capital- purpose of inventory, types and costs of inventory
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INVENTORY MANAGEMENT
The word inventory has been derived from the French word ‘Inventaire’, and the Latin word ‘Inventariom’, which means a list of the things found. American Institute of Accountants has defined inventory as the aggregate of those items of tangible personal property which (a) are held for sale in the ordinary course of business, (b) are in the process of production for such sales, or © are to be currently consumed in the production of goods or services to be available for sale.
The word inventory refers to the stockpile of the products a firm is offering for sales and the components that make up the product.
Inventory----
In very exceptional cases, like inflation and scarcity, a company may gain on account of holding inventories. Moreover, a company may enjoy the benefit of discounts in case of bulk purchases.
Dangers of Inadequate inventories: Maintaining an inadequate level of inventories may also not be desirable which may have far reaching affects like:
1. Production holds-up.
2. Failure to honor delivery deadlines.
ROLE IN WORKING CAPITAL
Level of Liquidity: Inventories are viewed as a source of near-all cash. For most products, this description is accurate. At the same time, most firms hold some slow-moving items that may not be sold for a long time. With economic slowdowns or changes in the market for goods, the prospects for sale of entire product lines may be diminished. In these cases, the liquidity aspects of inventories become highly important to the manager of working capital. At a minimum, the analyst must recognize that inventories are the least liquid of current assets. For firms with highly uncertain operating environments, the analyst must discount the liquidity value of inventories significantly.
PURPOSE OF INVENTORIES
(a) Ensure a continuous supply of raw materials to facilitate uninterrupted production.
(b) Maintain sufficient stocks of raw materials in periods of short supply and anticipated price rise.
© Maintain sufficient finished goods inventory for smooth sales operations and efficient customer service.
(d) Minimize ordering and carrying costs.
(e) Always be conscious of lead time i.e. time gap between placing the order and receiving the materials.
(f) Ensure cost-benefit analysis.
TYPES OF INVENTORIES
Inventory of materials occurs at various stages and departments of an organization. A manufacturing organization holds inventory of raw materials and consumables required for production. It also holds inventory of semi-finished goods at various stages in the plant with various departments. Finished goods inventory is held at plant, FG Stores, distribution centers etc. Further both raw materials and finished goods, those that are in transit at various locations also form a part of inventory depending upon who owns the inventory at the particular juncture. Finished goods inventory is held by the organization at various stocking points or with dealers and stockists until it reaches the market and end customers.
COSTS OF INVENTORY
These two above costs together are called Total Stocking Cost. If you plot the order quantity vs. the TSC, you will see the graph declining gradually until a certain point after which with every increase in quantity the TSC will proportionately show an increase.
This functional analysis and cost implications form the basis of determining the Inventory Procurement decision by answering the two basic fundamental questions - How Much to Order and When to Order.
How much to order is determined by arriving at the Economic Order Quantity or EOQ.