Inventory Management: Definition, How It Works, Methods & Examples

What Is Inventory Management?

• Definition: The process of ordering, storing, using, and selling a company's inventory, which includes raw materials, components, and finished products.
• Purpose: Streamline inventories to avoid excess and shortages.
• Methods: Just-in-time management (JIT), materials requirement planning (MRP), economic order quantity (EOQ), and days sales of inventory (DSI).

The Benefits of Inventory Management

• Asset Value: Inventory is crucial in retail, manufacturing, and food services.
• Risks: Large inventories can lead to spoilage, theft, damage, and shifts in demand.
• Strategy: Varies by company size and industry, e.g., oil depots vs. perishable goods businesses.
• Technological Aid: ERP software, SaaS applications, and AI are used for optimization.

Accounting for Inventory

• Current Asset: Inventory is a current asset as it is typically sold within a year.
• Inventory Systems: Track levels in real-time; methods include FIFO, LIFO, and weighted-average costing.
• Inventory Categories:
  1. Raw materials
  2. Work in process
  3. Finished goods
  4. Merchandise

Inventory Management Methods

1. Just-in-Time Management (JIT)

• Origin: Developed in Japan, notably by Toyota.
• Objective: Minimize costs by ordering only what is needed.
• Risks: Vulnerable to demand spikes and supply delays.

2. Materials Requirement Planning (MRP)

• Dependence: Relies on sales forecasting to plan inventory needs.
• Application: Effective in manufacturing sectors like ski production.

3. Economic Order Quantity (EOQ)

• Purpose: Calculate the optimal order quantity to minimize total inventory costs.
• Balance: Manages trade-offs between holding and setup costs.

4. Days Sales of Inventory (DSI)

• Metric: Measures the average time to turn inventory into sales.
• Interpretation: Lower DSI indicates quicker inventory turnover.

Inventory Management Red Flags

• Accounting Changes: Frequent changes may suggest management issues.
• Write-offs: Could indicate inventory obsolescence or competitiveness issues.

Examples and Case Studies

Tim Cook and Apple

• Innovation: Implemented JIT, reducing inventory turnover to five days.

Practical Example

• JIT in Action: Car manufacturers receiving airbags just-in-time for assembly.

Conclusion

• Crucial Role: Inventory management is key to business success.
• Tailored Approach: Depends on business type and product.
• Pros and Cons: No perfect method exists, but strategic management is beneficial.