3 min read
25 May 2021

Inventory management is an important function in your business. Lack of competent management can lead to stoppage of production in a manufacturing unit and lost sales in a trading company. So, take a look at the finer details of inventory and inventory management and finance to ensure your business achieves steady growth.

What is inventory

Inventory is an accounting term that encompasses the idle stock of items such as goods and property or buildings, which contain economic value. These goods may be held in various forms such as work-in-progress, finished goods or raw materials. Any stocks held for speculative purposes also forms part of the inventory.

Types of inventory or stock

Here’s an in-depth look at the types of inventory.

  • Raw material: This is the stock of materials that a manufacturing company holds, which is to be used in the manufacturing process. Any materials that are in transit to your manufacturing unit are included in this type of inventory.
  • Work-in-progress inventory: This includes the stocks that are partly converted in the production process but are yet to be completely converted to attain the maximum value in a manufacturing company.
    Work-in-progress inventory is usually in various stages of manufacture, awaiting further processing.
  • Finished goods inventory: These are goods that have been through the entire manufacturing process; however, these good are yet to be sold. This inventory includes the goods that are in transit to dealers.
  • Packing material: Among the various types of inventory, packing material fulfils the packaging needs for products in a manufacturing or warehousing unit. As packaging can be both primary and secondary, the inventory is also maintained accordingly. Primary packaging renders the product usable while secondary packaging makes it transportable.
  • MRO Goods Inventory: Maintenance, repair and operating supplies (MRO) are supporting items that help in smooth production, manufacturing and operational flow of an enterprise. Also known as consumables, MRO goods help complete the maintenance and repair of machineries utilised in the production process. The inventory of MRO goods can include nuts and bolts, bearing, lubricating oil, office supplies, etc.

A proper implementation of inventory management system ensures the MRO inventory is stocked up at all times for successful support function

Types of inventory by function

Here’s another way to consider your inventory by its utility.

  • Input Inventory: In a manufacturing unit, this includes the raw materials required in the production process along with consumables such as fuel, stationary, maintenance and spares for machinery and packing materials.
  • Process Inventory: All materials held in the process of making the final product including semi-finished products on the shop floor, at quality control and at packing form part of the process inventory. Even the rejects and defects and production waste and scrap are included in process inventory.
  • Output inventory: All finished goods, either on the factory floor or at the distribution centre, are included in this type. Even goods in transit, sales return and repaired stocks and sales promotion samples are included in output inventory.

Additional Read: Inventory management techniques

How to Calculate and Maintain the Right Amount of Stock

Now that you have a clear idea of what forms inventory, it is necessary to calculate the right amount of inventory you need to stock. However, before you understand the calculation, you need to understand the importance of maintaining the right quantity of inventory. If you stock too less, you will be unable to fulfil orders. If you stock too much inventory, it will become a financial burden on you and deplete your working capital.

So, it is best to consider the previous months’ sales as a benchmark when placing future orders for inventory. Also, you will need to consider the previous year’s sales as demand for some items may be seasonal or related to upcoming festivals. So, a mix of previous months’ sales data and the previous years’ sales data will provide you a clear understanding of the level of inventory you need to stock for the future months.

How to tackle the dilemma about ‘right price’ of inventory

Vendors are always offering better prices or discounts when you buy inventory in larger quantities. However, does pocketing 5% savings to pick up 20% additional inventory make business sense? Manufacturers offer discounts on larger purchases as an incentive to encourage you to sell more and also because they are able to pass on savings with increase in production. However, as a trader you need to weigh the cost of additional inventory. After all, the inventory also has a carrying cost.

This is the cost associated with holding the stock instead of keeping the money in the bank earning interest. Use the Economic Order Quantity [EOQ] formula to help you know the units of inventory you can stock that minimises your cost of storage and ordering.

The EOQ is calculated as follows

Square root of two times your fixed costs X Demand in units per year / the carrying cost per unit. For example, let’s say your fixed costs are 100, demand per year is 1000 units and the carrying cost per unit is 2 then the EOQ is 316 units.

This means that you can safely order 316 units when your inventory is nil and your demand is constant.

When should you place a new order for inventory?

While the EOQ helps you to determine the inventory you need to hold, you will want to place your next order to arrive at your warehouse just in time. You don’t want to be burdened with the hassle of finding extra space for new stock and neither do you want to turn away business because you don’t have the inventory. To calculate your re-order point, you will need to know the following:

  • The time it takes for your items to be ready for dispatch
  • Packaging time
  • Shipping time

Now, use the following formula.
Re-order point = (lead time X average daily use/sale) + safety stock

Safety stock is the inventory you would ideally hold in case in case of unexpected delays in receiving fresh stocks. Here is a formula to help you calculate the safety stock number.

Safety stock = (maximum daily usage X maximum lead time {in days}) – (average daily usage X average lead time in days).

This method will help you to cover the difference between extreme situations and everyday production, leaving your business with enough inventory in case of a rainy day.

Additional Read: Inventory management tools

Problems caused by inefficient inventory management

Ultimately, good inventory management helps you save money and improve your cash flow while inefficient management costs you. Here are the 3 most common problems you may face when your inventory management is not up to par.

  • Dead stock or spoilage: When you or your managers don’t have a keen eye on inventory, you may have stock in your possession that cannot be sold. Called dead stock, this stock may be something that is no longer in use or out of fashion. Similarly, if you have inventory that has a certain shelf life and is not maintained will or used by the expiry date, then you will have spoilage.
  • Increased cost of storage: You may use a large warehouse or chain of warehouses or a storage space that is conducive for your particular stock. If you don’t keep an eye on fast-moving inventory and stock up on slow-moving inventory, you will be paying for the rent and utilities of this storage facility needlessly.

So, bear in mind that inventory management forms a part of cash flow management, as inventory has an effect on both your expenses and sales. Thus, good inventory management is the key to keeping your business revenues high.

How to Manage Your Inventory Better?

Inventory management presents numerous challenges and as a business owner you need to understand that inventory is actually money. It is an investment that you are holding until it is either used for production or sold at a profit. Here are some management techniques to overcome challenges to manage inventory efficiently.

  • Identify a responsible person who you can depend on to track the inventory your business is holding and to maintain records efficiently. If you have a large unit, you can also look to outsourcing your inventory management to a third party for greater efficiency.
  • Use the formula mentioned earlier to determine your re-order levels to ensure you are not losing any production time or sales. Accurately forecasting your inventory needs will help you maintain production output and efficacy.
  • While every business will have items that are essential to production or are the main items traded, there will be ancillary items as well that are required in smaller numbers in production but are critical in the process. Ensure you keep track of such items as well when planning your inventory.
  • Follow a standardized system when you liquidate inventory. To ensure you do not accumulate old inventory and use the FIFO or First In First Out method of using your oldest inventory first.
  • Understand that carrying inventory as stock has a cost. There is finance cost and your capital is locked in as well. Further, there are associated costs to inventory, such as insurance, security and the cost of people managing inventory. Holding inventory therefore increases your costs. You need to time your inventory purchases to ensure there is no production stoppage while ensuring that inventory is not building up in your warehouse.
  • Regular inventory checks and audits will help you to keep a regular tab on inventory levels and help identify any old stocks that have been forgotten about. Inventory audit will include spot checks, checking of physical inventory and tracking the cycle of inventory.
  • Set the minimum quantity for regular, contingency and high-utility inventory and be alerted when the current inventory reaches the re-order point. You can use inventory management software for this purpose.

These methods will help you manage your inventory better and thus ensure your business bottom line improves. Since inventory is a key component of your business cycle, maintaining may require additional finance.

Additional Read: How to Convert Slow-Moving and Excess Inventory into Cash?

How to finance your business’ inventory

Whether it is for purchasing inventory management software, have a team or head in place at your warehouse, or doing audits, you can finance all your needs by taking a working capital loan. Typically, working capital finance for SMEs is given collateral-free for tenors ranging from 12 months to 60 months.

You can avail a Working Capital Loan up to Rs. 80 lakh from Bajaj Finserv and enjoy easy online application, fast approval and quick disbursal of funds, and a nominal interest to make the loan more affordable. The special Flexi Loan feature of the loan is perfectly suited to help you manage your dynamic working capital needs. With this facility, you can borrow from your sanctioned amount as per your needs and pay only the amount used as interest, thus giving you full control and flexibility on your inventory finance. Moreover, you can get instant finance with pre-approved offers with which you can get money in bank with 1-step verification. Effective inventory management can boost the success and growth of your business.

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