4.5 - Managing Inventory
Types of stock and associated costs
Stock refers to the materials and products held by a business at various stages of production and distribution. Managing stock effectively is essential to balance availability with cost efficiency.
Categories of stock in a business
- Raw materials - Basic components used to manufacture products.
- Work-in-progress - Items that are partially completed during the manufacturing process.
- Finished goods - Completed products ready for sale to customers.
Businesses aim to keep stock levels as low as possible to reduce costs.
Costs of holding stock
Holding stock incurs various expenses that can impact a business's profitability.
Main costs associated with stock holdings
- Storage expenses - Includes rent for warehouse facilities, along with utilities like heating, lighting, refrigeration, and security measures to protect the stock.
- Wastage expenses - Arise from discarding damaged or obsolete items; the longer stock is held, the higher the risk of physical deterioration or items becoming outdated.
- Opportunity costs - Represent the lost potential from tying up capital in stock that could be invested elsewhere, making the funds unproductive while held in inventory.
Principles of stock control and production methods
Stock control involves monitoring and adjusting inventory levels to ensure they are neither too high nor too low. This helps businesses avoid shortages or excesses, with maximum stock levels influenced by factors like available storage space, production techniques, and the financial implications of tied-up capital.
How production methods influence stock requirements
- Flow production - Involves continuous manufacturing, requiring substantial stocks of raw materials.
- Batch production - Produces items in groups, often resulting in significant holdings of work-in-progress.
- Job production - Focuses on custom-made items, typically leading to minimal or no stocks of finished goods since products are made to order.
- Cell production - Organises workers into teams for flexible output, commonly using just-in-time (JIT) approaches to keep stock levels low.
Buffer stock and lead time
Buffer stock acts as a safety net in inventory management, ensuring a business does not run out of essential items during unexpected demand spikes or supply delays. Lead time, the duration from placing an order to receiving it, directly affects how much buffer stock is required.
Factors determining buffer stock levels
- Storage constraints - Limited warehouse space restricts how much buffer can be held.
- Product characteristics - Perishable items require smaller buffers to avoid spoilage, while non-perishable goods allow for larger holdings.
- Usage patterns - High daily or weekly consumption rates demand more substantial buffers.
- Lead time variations - Extended lead times increase the need for buffers to handle any rises in demand during waiting periods.
Calculations for inventory management and control charts
Effective inventory management relies on key calculations to determine when and how much to order, helping to maintain optimal stock levels. Inventory control charts visually represent these elements over time, plotting lines for buffer stock, re-order levels, maximum stock, and lead times to aid managers in monitoring and decision-making.
Formula for re-order level
Where:
- Lead time (in days) = Time taken for ordered goods to arrive
- Average daily usage = Typical amount of stock used per day
- Buffer stock level = Minimum safety stock to prevent shortages
Additional inventory terms
- Re-order quantity - The specific amount of stock ordered from suppliers each time a purchase is made.
- Maximum stock level - The highest amount of inventory a business aims to hold.
Features of inventory control charts
- Buffer stock line - A horizontal line showing the minimum safety level.
- Re-order level line - Indicates when new orders should be placed to avoid dipping below buffer.
- Maximum stock line - Marks the upper limit for holdings.
- Lead time representation - Shown as the gap between ordering and delivery, helping to predict stock fluctuations.
Worked example - Calculating re-order level
A retail business maintains a buffer stock of 500 units for a popular item. The lead time from suppliers is 7 days, and the average daily usage is 150 units. Calculate the re-order level.
Step 1: Identify the values
- Lead time = 7 days
- Average daily usage = 150 units
- Buffer stock level = 500 units
Step 2: Apply the formula