Concept Of Inventories
Inventory denotes “stock of goods”. Various authors have defined this word in their own way. In terms of accounting, the word may be used to refer to the stock of finished goods only, while in a manufacturing concern this may include work in process, stores, raw materials, etc. International Accounting Standard Committee (I.A.S.C) defines inventories as “Tangible property
1) Held for sale in the ordinary course of business,
2) In the process of production for such sale, or
3) To be consumed in the process of production of goods or services for sale”.
Reasons/Need of Holding Inventory
There are three main purposes for the need of holding inventories:
1) Transaction Motive: Every firm needs to maintain a certain level of inventories to meet its daily requirements related to production and sales. In order to meet these requirements, a firm maintains an inventory of raw materials and finished goods. Maintaining of transaction motive makes the production process smoother.
2) Precautionary Motive: A company may face raw material shortage on account of natural causes, strikes, or other unforeseen circumstances. Such a shortage of raw material may interrupt the production process. In order to avoid such circumstances, a company needs to maintain a proper inventory level.
3) Speculative Motive: A company may maintain inventory to grab various opportunities for making profits such as a sudden increase in prices. Such motives are speculative in nature and may help the firm in earning extra profit
Types of Inventories
The various kinds of inventory are as follow:
Seasonal inventory is made to meet the anticipated instability in demand. The company usually makes use of seasonal inventory at the time of low demand and keep the stock for the period of high demand as they will not be able to manufacture at the time of high demand. The manager takes decision of whether to produce the seasonal inventory or not, the amount to be produced, etc. In case, the company is able to quickly change the rate of production system at a very low cost then the company will not require seasonal inventory as the production system can change to a high demand period without incurring a high cost. But if the changing production rate is costly (e.g., when workers must be hired or fired), then the company should be knowledgeable enough to ensure the continuous flow of production and store its inventory at the time of low demand. Hence, the primary problem faced by the supply chain manager while defining the quantity of seasonal inventory is to compare the carrying cost of additional inventory against the cost of having a more flexible production rate.
The decoupling of inventories refers to separating or disengaging the different parts of production system. It can be easily seen that each and every machinery and person have their own working capacity. For example, a portion of the final product is manufactured from a machine and the remaining portion of the product will be made next. The inventories in between the machine are held for separating the work on the machines. If these types of inventories are not present then the different machines and men cannot work together on an ongoing basis. The reason for holding these inventories is that if any machine stops then the production on others does not stop.
The cycle inventories are stored because the purchases are made in lots on a regular basis instead of buying the exact number at a particular time. Naturally, when all the purchases are done at the time when the product is demanded then there will be no cycle inventories. Although the company does the purchases in lots because if the purchases are done regularly and in small numbers, the cost incurred will be too large.
Pipeline inventories come into picture when transportation time is required in moving a substantial amount of resources. Pipeline inventories are also known as transit or movement inventories. For example, when petrol is moved from the oilfield to the city by train, then the petrol which is in shipment will not provide any kind of service to the customers for any purpose.
These stocks are maintained to provide safety if there is any type of uncertainties in demand and supply. The organization usually knows the average demand for various items that they may require. But, the actual demand may be more than the average demand. To overcome such type of situation, the inventories can be stored if there is an increase in the average anticipated demand. In the same way, the average delivery time must be known. The delivery time or lead time refers to the time in-between placing the order and having the goods in stock ready for use. Although there may be some uncertain events that may lead to an increase in average delivery time. So extra stocks should be stored for encountering the demand at the time when delivery is delayed. These inventories are stored for meeting the average demand and also for safeguarding at the time of variation in demand and lead-time.