Chapter 24
Inventory management
Importance of Managing Inventory
• Improves operational efficiency
• Balances holding costs and the cost of running out
• Reduces waste and avoids interruptions.
• Ensures smooth production and customer satisfaction
Why Businesses Hold Inventory
Manufacturing firms hold three main types:
[Link] Materials & Components
Inputs from suppliers.
Enable immediate production increases.
[Link] in Progress (WIP)
Semi-finished goods.
Levels depend on production time and method.
3. Finished Goods
Completed items ready for sale.
Support demand surges and seasonal peaks.
Importance of Effective Inventory Management
If inventory is not well managed:
Risk of insufficient inventory.
Increased out-of-date or obsolete stock.
Higher wastage due to poor storage.
High storage and opportunity costs.
Poor supply purchasing leading to late or oversized
deliveries.
Costs of Holding Inventory
1. Opportunity Cost
Capital tied up in inventory cannot be used elsewhere.
Increases when interest rates are high.
2. Storage Costs
Warehousing.
Special conditions (e.g., refrigeration).
Security, handling, insurance.
Interest on borrowed funds.
3. Wastage & Obsolescence
Slow-moving or outdated goods lose value.
Risk of damage while stored.
Benefits of Holding Inventory
1. Reduced Risk of Lost Sales
Immediate availability improves customer service.
2. Continuous Production
Avoids shutdowns due to shortages.
3. Avoids Special Orders
Prevents costly emergency deliveries.
4. Economies of Scale
Larger orders reduce unit and transport costs.
Optimum Inventory Level
Minimum point of total inventory cost.
Too much inventory → higher storage and capital costs.
Too little inventory → stockouts and production delays.
Optimum Order Size
Objectives of the purchasing manager:
Smooth production.
Timely supply.
Suitable quality.
Low ordering and storage cost.
Large Orders:
Advantages: low admin costs, fewer interruptions.
Disadvantages: high storage cost, tied-up capital, risk of
obsolescence.
Economic Order Quantity (EOQ)
EOQ identifies the most cost-efficient order size.
Factors affecting EOQ:
Rate of demand.
Storage/holding cost.
Ordering cost.
Lead time.
Availability of bulk discounts.
Inventory Control Charts
Purpose
Visual tools used to track stock levels, delivery timings, and
reorder decisions. Help managers respond quickly to changes in
demand and maintain efficient operations.
Key Components of an Inventory Control Chart
Buffer Inventories
Minimum stock level held for safety.
Protects against demand changes and supplier delays.
Higher uncertainty requires higher buffer levels.
Maximum Inventory Level
Highest stock a business chooses or can hold.
Based on storage limits and financial constraints.
Often equals EOQ plus buffer stock.
Re-order Quantity
Amount ordered each time stock reaches the re-order level.
Influenced by the EOQ.
Lead Time
Time between placing an order and receiving it.
Longer or unreliable lead times require higher re-order levels.
Re-order Level
Stock level at which a new order is triggered.
Determined by usage rate and lead time.
Often automated in modern systems.
Using Inventory Control Charts
Real stock levels vary due to changing demand.
Charts help managers analyse unusual patterns.
Support adjustments to order size and timing.
Improve forecasting and planning.
Importance of Supply Chain Management
Ensures smooth flow of materials from suppliers to customers
while minimising cost and time.
How It Improves Efficiency
Better supplier communication
Reduced delivery time
Faster product development
Increased production speed
Lower waste
Benefits
Improved customer service
Lower operating costs
Higher profitability
Just-in-Time (JIT) Inventory Management
Definition
A method that aims to hold zero buffer stock. Materials arrive
just before they are used and finished goods leave immediately.
JIT
Minimal or no inventory
Frequent deliveries
Requires accurate forecasts and reliable suppliers
Focus on waste reduction and efficiency
JIC
High buffer inventory
Protects against delays and demand changes
Higher storage costs
Advantages of JIT Disadvantages of JIT
Lower working capital Vulnerable to supply disruptions
Reduced storage costs Higher delivery and admin costs
Less wastage and obsolescence Loss of bulk buying discounts
Faster response to demand High dependency on suppliers
More flexible and efficient workforce
Advantages and Disadvantages of JIC
Advantages Disadvantages
Low risk of stockouts High capital tied up
Less need for precise forecasting High storage and insurance
Bulk discount benefits costs
Risk of outdated or obsolete
stock
Conditions Required for JIT Success
Strong supplier relationships
Multi-skilled employees
Flexible machinery
Accurate demand forecasts
Advanced IT systems
Strong labour relations
High-quality standards
Evaluation of JIT
Suits lean production and many modern industries
Not ideal where production stoppages are costly
Small firms may lack required technology
Inflation may make buying in bulk more economical
Service firms often need buffer stock