Inventory Management: 6 Common Business Uses of Inventory
Inventories exist because its items must be on hand to perform a process such as fulfilling customer orders or manufacturing a batch of products. One way to gain a better appreciation for why inventory is such a necessity to businesses everywhere is to examine its different uses. Here are six of them:
1. Safety or Buffer Inventory
Safety or buffer inventory is the amount of inventory that is held back from the production floor and is used to fill customer orders, replace inventory that has been damaged or lost, and reduce the number of times that a product needs to be ordered. Safety inventory provides a buffer against uncertainty. There is often the uncertainty of demand for one’s products. Without safety inventory, there would be lots of missed opportunities when unexpected demand spikes aren’t fulfilled because of insufficient stock. Supply uncertainties are another reason for maintaining safety inventory. A supplier might fail to deliver on time because of any number of reasons. For example, the transport of the goods might get delayed because of weather problems or a traffic accident. Buffer inventory is calculated using the formula: Buffer inventory = (Order Quantity × 0.9) – (WIP + Reservation). This formula shows that the buffer inventory is the amount of product that is held back from the production floor (Order Quantity) and is used to fill customer orders, replace inventory that has been damaged or lost, and reduce the number of times that a product needs to be ordered.
2. Raw Materials Inventory
If you are a manufacturer or practice delayed differentiation to minimise your safety stock of finished goods, you would have a raw materials inventory. The raw materials could be subassemblies, sub-components, or possibly elemental things like minerals, metals, and wood. It’s the ‘stuff’ required to make your finished product. This allows you to assemble or manufacture your goods without the delay of acquiring your raw materials.
3. Anticipation Inventory
When a business anticipates an event that will require more inventory than usual, it acquires anticipation inventory. For example, a business may anticipate increased demand because a competitor will go out of business and will build up inventory for that event. Inventory may be increased because a supplier is going out of business or because the supplier plans to increase its prices in the future. Anticipation inventory is normally held in an inventory account, such as Inventory, and may be held in either finished goods or raw materials.
4. Cycle Inventory
Cycle inventory covers normal demand. It’s ordered from suppliers in batches, the size of which is determined by factors such as supplier lead times, bulk pricing, shipping costs, and order processing costs. When the batch is used up and gets replaced again, it has ‘turned over’. Businesses seek to maximise inventory turnover while minimising the associated costs. Cycle inventory does not include safety inventory which covers “abnormal” demand or supply problems.
5. Finished Goods Inventory
Finished goods inventory is the product you keep on hand so that you can immediately respond to customer orders without the delays of ordering or manufacturing the goods requested in the order. Its purpose is to maintain good customer satisfaction levels.
6. Decoupling Inventory
Finished goods are often produced by the flow of materials through a chain of operations or manufacturing centres. Each operation processes the material in some way before the material proceeds to the next operation centre. Decoupling inventory allows the operation centres to work independently of each other. In this way, temporary bottlenecks don’t affect downstream operations.
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The original article appeared in MicroChannel Australia’s blog
Tags: Inventory Management