Types of inventory | Inventory management | periodic | perpetual | Inventory System

Inventories

In this chapter, the concept of inventory is discussed which is central to materials management function.

The definition of inventory and various types of inventories – raw materials, finished goods, in-process inventory, MRO inventory, etc. – are outlined. The inventory-related cost parameters are listed along with methods of estimating these. Other situational parameters like demand and lead times also need to be estimated.

What Is Inventory?

Inventory or stock (in common terms) is considered to be the central theme in managing materials. Inventory is the term for the goods available for sale and raw materials used to produce goods available for sale. Inventory means a physical stock of goods kept in store to meet the anticipated demand.

It is necessary to have physical stock in the system to take care of the anticipated demand because non availability of materials when needed will lead to delays in production or projects or services delivered. However, keeping inventory is not free because there are opportunity costs of “carrying” or “holding” inventory in the organization. 

Types of Inventories

Employing the generic definition of inventory, a large spectrum of situations can be structured as inventory management problems. These include the following:

(a) Raw materials inventory as input to manufacturing system. (b) Bought-out-parts (BOP) inventory which directly go to the assembly of product as it is. (c) Work-in-progress (WIP) or work-in-process inventory or pipeline inventory. (d) Finished goods inventory for supporting the distribution to the customers. (e) Maintenance, repair, and operating (MRO) supplies. These include spare parts, indirect materials, and all other sundry items required for production/service systems.

It may be noted that the basic definition of inventory being a “usable but idle resource” remains valid irrespective of the type of inventory being managed.

Why Do We Need Inventories?

From the resource management point of view, we should not have inventories as these constitute the idle resources. However, if we did not have inventories, there will be shortages, production delays, and project delays. Some of the reasons for having inventories in the production/service system are as follows:

Time lag between placing orders and getting supplies at the point of consumption – Whenever we place a replenishment order, there is a time lag between placing the order and getting the materials at the point of use. This is called “replenishment lead time.”

Just-in-Time or Zero-Inventory Essentials

Just-in-time (JIT) is one of the most talked about topics in materials planning primarily due to its tremendous success in the context of Japanese companies.

JIT or zero-inventory system is an idealized concept of inventory management wherein we are able to supply whatever material is required, wherever required, and whenever required just in time with 100 % supply assurances without keeping any inventory on hand. Obviously, from the resource management point of view, nothing can be better than this, as there are no inventories, no shortages, and no replenishment orders placed. However, this concept necessitates that the suppliers (vendors) are local and are 100 % dependable; orders splitting with small orders without additional transportation costs is feasible, i.e., frequent deliveries are economically viable, and the requirements are firmly known. The success of JIT can be visualized. In uncertain demand and supply environment, JIT is not feasible. Thus, inventory management in uncertain supply environment is JIC type in which minimization of the total expected system cost becomes an important objective.

Periodic and Perpetual Inventory Systems

 

There are two methods of handling inventories

·          the periodic inventory system, and

·          the perpetual inventory system

 

With the periodic inventory system, the firm calculates its Cost of Goods Sold at the end of the year. The firm takes its beginning inventory, and adds its purchases for the period. This gives the firm all the goods that pass through the firm for the period (the goods available for sale). The firm then takes a physical inventory. This gives the firm what is left at the end of the period. The ending inventory is then subtracted from the available goods figure to get the cost of goods sold.

Two disadvantages of the periodic method are:

 This method does not give the firm much information on the theft or spoilage of goods. (Everything not present is assumed to be sold.)

  Unless a physical inventory is taken, the firm does not know what its cost of goods sold is during the period (as opposed to the end of the period).

An advantage of the periodic method is that it is a easy system to maintain.

With the perpetual inventory system, the firm keeps track of its cost of goods sold on a continual basis. Thus, at any given time, the firm can estimate its current inventory levels. At the end of the period, a physical inventory is taken. Any discrepancy with the estimated inventory level and the actual inventory level is then attributed to theft and spoilage.

An advantage of the perpetual system is that it provides information about theft and you have a Cost of Goods Sold figure whenever needed. A disadvantage of the perpetual system used to be that it was very expensive to maintain this type of system. With the use of computers and scanners, the marginal cost to implement a perpetual system may be minimal.

Systems Differences Between Periodic and Perpetual Inventory

 

		Periodic			Perpetual
a. Purchase inventory on credit:
D.	Purchases		D.	Merchandise Inventory
	Cr.	Accounts Payable		Cr.	Accounts Payable
b. Transportation Costs on purchases:
D.	Freight In		D.	Freight In
	Cr.	Accounts Payable		Cr.	Accounts Payable
c. Purchases Returns and Allowances:
D.	Accounts Payable		D.	Accounts Payable
	Cr.	Purchases Ret & Allow.		Cr.	Merchandise Inventory
d. Payments on Accounts Payable:
D.	Accounts Payable		D.	Accounts Payable
	Cr.	Cash		Cr.	Cash
e. Sale of Merchandise on Credit:
D.	Accounts Receivable		D.	Accounts Receivable
	Cr.	Sales		Cr.	Sales
			D.   Cost of Goods Sold
				Cr.	Merchandise Inventory
f. Payment of Delivery Costs
D.	Freight Out Expense		D.	Freight Out Expense
	Cr.	Cash		Cr.	Cash
g. Return of Merchandise Sold:
D.  Sales Returns and Allowances			D.	Sales Returns and Allowances
	Cr.	Accounts Receivable		Cr.	Accounts Receivable
			D.	Merchandise Inventory
				Cr.  Cost of Goods Sold
f. Receipts on Accounts Receivable:
D.	Cash		D.	Cash
	Cr.	Accounts Receivable		Cr.	Accounts Receivable