Raw materials and components are items that you use to produce products. Work in progress is your stock of goods that are in the midst of production. They are unfinished. Finished goods are your finished products that are ready to be sold. Consumables are materials you use to run your business, such as office supplies or fuel.
Keeping little or no stock on hand saves you money in storage costs and allows you to always use the most up-to-date components. However, you must have reliable suppliers, and you also run the risk of running out of materials in the midst of production. This also means your costs are related to the latest prices, since every purchase reflects the current price and the purchased inventory is quickly used up. Keeping a lot of stock on hand means you may be able to save money by buying materials in bulk, and you never have to worry about running out of materials. However, you may have to pay for storage, and items may expire or become outdated before you can use them. You also assume a price risk if purchases go down in price versus the price of your inventory (but make gain if prices rise).
Ordering costs include paying for transportation, paying for staff to receive, store and control quality of materials and paying clerical staff to prepare requisitions, place orders and manage the ordering process. Carrying costs include the cost of storage in outside facilities, insurance, taxes, capital costs and the cost of staff to handle the materials. Stock out costs refer to the interruption in production if you run out of materials.
With raw materials, the schedule and reliability of your suppliers drives how much you keep on hand. It’s a good idea to have alternative sources of materials in case of a problem with your supplier. Also, if the price of materials fluctuates you may have to time purchases to take advantage of the best prices. Keeping a stock of works in progress can come in handy if there is a problem with delivery of raw materials that interrupts production. Only keep a supply of finished products on hand if you are producing items in batches or you are in the midst of producing a large order. The level of stock for consumable supplies depends on how you use them, discounts for purchasing in bulk and the reliability of your suppliers. You will also need to know how to properly store your products. For example, some products may need to be stored at a specific temperature, or stored in a way that is easy for employees to pick, pack, and ship them easily.
Lead time is the amount of time you need to replenish the inventory. It is the number of days between when you place an order and when you receive it. The rate of consumption is refers to how much of an item you use in a specified time frame. Suppose, for example, that you run an office and you need to determine the minimum number of reams of printing paper to keep on hand. You know that your supplier can get an order of paper to you within five business days. This is your lead time. Also, you know that the office uses an average of three reams of paper per day. This is your consumption rate. Since you know your lead time is five days, you must never allow your inventory of paper to fall below five days’ worth of paper. If your office uses three reams of paper per day, then a five-day supply would be 15 reams of paper. Your minimum stock level is 15 reams of paper.
Using the above example, it might not be the best practice to always let your supply of paper dwindle to the minimum level before initiating a replacement order. Any number of circumstances could delay the delivery, and you would be left without any paper in the office. To determine a reordering level, you would consider the reliability of your supplier. For example, suppose you know that on a few occasions during the winter months, bad weather delayed your delivery for a few days. Based on your history with this supplier, you decide to reorder when your inventory of paper falls to 10 days’ worth of paper, or 30 reams. The reordering level for paper would be 30 reams.
Some businesses use a the reordering level in a formula to calculate maximum stock levels. This formula is: Maximum Level = Re-ordering Level - Consumption Rate * Lead Time + Economic Order Quantity. Economic order quantity (EOQ) is a calculation used to determine a fixed amount when re-ordering inventory. It is discussed later in this article. For this example, assume the EOQ is 30 reams of paper. Using the above information, the maximum stock level could be calculated with the formula 30−3∗5+30=27∗35=945{\displaystyle 30-35+30=2735=945}. The maximum level for paper would be 945 reams.
Group A consists of expensive items. These items typically represent 10 to 20 percent of total inventory but 50 percent of the value of inventory. You would invest the bulk of your efforts in controlling these items. Group B represents 20 to 30 percent of total inventory and approximately 30 percent of the value of your inventory. These items require moderate inventory control measures. Group C represents 70 to 80 percent of total inventory but only about 20 percent of the value. Routine procedures can be used to control this category.
The formula for EOQ is Q=2AS/I{\displaystyle Q={\sqrt {2AS/I}}}. In the formula, Q = the quantity per order, A = the annual amount needed of the item, S = the cost per order and I = the inventory carrying cost per unit per year in dollars. For example, suppose you sold basketballs. The cost per order is $400, the carrying cost is $10 per unit per year and you have a demand of 20,000 basketballs per year. Q=2∗20,000∗400/10=1,265{\displaystyle Q={\sqrt {220,000400/10}}=1,265} The optimum average order should be 1,265 basketballs. If the annual demand is 20,000, then you will have to place 16 orders in a year (20,000/1,265=15. 8{\displaystyle 20,000/1,265=15. 8}).
Close out any open inventory transactions. Restock all of your overstock, understock, or backstock. Account for all of the received purchase orders and inbound transfers in your system. Put away all items. Close and invoice all completed customer orders.
For the two bin system, determine a buying cycle for items and the amount purchased in each cycle. For example, offices may purchase office supplies weekly or monthly. To begin, purchase enough of the item to last two buying cycles. Divide the items into two bundles. When the first bundle is used up, it’s time to reorder enough for one buying cycle of the item. Materials from the second bundle are used while the materials are being reordered. For the second system, create an index that lists all of the items in inventory and a file of cards for each item. On each card, record an item description. When an item is purchased or reordered, someone records the amount received, the unit price and other information such as an ordering description, a catalog number or the serial number.
The advantages of using inventory management software include decreased carrying cost and ordering costs, increased efficiency of inventory management, better organization and security and information about trends in how materials are used. The disadvantages are that the software can be expensive, and it can be complex to use.
