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Business Studies Notes 3
rd.
Year
Undergraduate / Graduate Level
SUBJECT: Inventory
Management & Risk
Pooling.
Authors: (Original Study Notes and Lecture Notes prepared by Mr. K.P. Saluja (M.B.A. from Indian Institute of Management Ahmedabad), and by Mr. K. K. Prasad (M.B.A from IGNOU Delhi) These notes are intended to be used by undergraduate students, completing Year 3 Business Degree Courses. These notes will help undergraduates and graduates complete case studies, coursework assignments and pass exams in Business Studies and Economics.
TABLE OF CONTENTS
(1) Inventory Management- definition (2) Types of Inventory management (3) The Benefits of Inventory Management (4) Accounting for Inventory (5) Methods of Inventory Management (6) Benefits of Inventory Management (7) Importance of Inventory management (8) Goal of inventory management (9) Benefits of inventory management (10)Benefits of Holding Inventory (11) Inventory management techniques (12) Risk pooling definition
Inventory Management- definition
Inventory management refers to the process of ordering, storing, using, and selling a company's inventory. This includes the management of raw materials, components, and finished products, as well as warehousing and processing of such items. There are different types of inventory management, each with its pros and cons, depending on a company’s needs. Inventory management is the entire process of managing inventories from raw materials to finished products.
The Benefits of Inventory Management
An organization's stock is perhaps of its most important resource. In retail, manufacturing, food services and other stock concentrated areas, an organization's bits of feedbacks and completed items are the center of its business. A lack of stock when and where it's required can be very detrimental. Simultaneously, stock can be considered a liability (while perhaps not in a accounting sense). An enormous stock conveys the risk of deterioration, robbery, harm, or changes popular. Stock should be guaranteed, and on the off chance that it isn't sold in time it might need to be discarded at leeway costs — or just destroyed. For these reasons, inventory management is important for businesses of any size. Knowing when to restock inventory, what amounts to purchase or produce, what price to pay—as well as when to sell and at what price—can easily become complex decisions. Small businesses will often keep track of stock manually and determine the reorder points and quantities using spread sheet (Excel) formulas. Larger businesses will use specialized enterprise resource planning (ERP) software. The largest corporations use highly customized software as a service (SaaS) applications. Appropriate inventory management techniques fluctuate contingent upon the business. An oil terminal can store a lot of stock for broadened timeframes, permitting it to trust that request will get. While putting away oil is costly and hazardous — a fire in the U.K. in 2005 prompted huge number of pounds in harm and fines — there is no gamble that the stock will ruin or become unpopular. For organizations managing in transitory merchandise or items for which request is very time-touchy — 2021 schedules or quick style things, for instance — sitting on stock isn't a choice, and misinterpreting the timing or amounts of requests can be exorbitant.
For companies with complex supply chains and manufacturing processes, balancing the risks of inventory gluts and shortages is especially difficult. To achieve these balances, firms have developed several methods for inventory management, including just-in-time (JIT) and materials requirement planning (MRP).
Accounting for Inventory
Inventory represents an on-going resource since an organization normally expects to sell its done products inside a short measure of time, ordinarily a year. Stock must be truly counted or estimated before it tends to be placed on a monetary record. Organizations commonly keep up with refined stock administration frameworks fit for following constant stock levels. Stock is represented utilizing one of three techniques: earliest in, earliest out (FIFO) costing; rearward in-first-out (LIFO) costing; or weighted-normal costing. A stock record normally comprises of four separate classes: Raw materials — represent various materials a company purchases for its production process. These materials must undergo significant work before a company can transform them into a finished good ready for sale. Work in process (also known as goods-in-process) — represents raw materials in the process of being transformed into a finished product. Finished goods — are completed products readily available for sale to a company's customers. Merchandise — represents finished goods a company buys from a supplier for future resale.
Methods of Inventory Management
3. Economic Order Quantity (EOQ) This model is utilized in inventory management by computing the quantity of units an organization ought to add to its stock with each bunch request to diminish the complete expenses of its stock while expecting consistent customer demand. The expenses of stock in the model incorporate holding and arrangement costs. The EOQ model tries to guarantee that the perfect proportion of stock is requested per group so an organization doesn't need to make orders too habitually and there is certainly not an overabundance of stock sitting close by. It expects that there is a compromise between stock holding expenses and inventory setup expenses, and all out stock expenses are limited when both setup costs and holding costs are minimized. 4. Days Sales of Inventory (DSI) This financial ratio shows the typical time in days that an organization takes to turn its stock, including merchandise that is a work underway, into deals. DSI is otherwise called the normal time of stock, day’s stock remarkable (DIO), days in stock (DII), days deals in stock or days stock and is deciphered in more than one way. Showing the liquidity of the stock, the figure addresses how long an organization's on-going supply of stock will endure. By and large, a lower DSI is liked as it demonstrates a more limited term to tidy up the stock; however the normal DSI differs starting with one industry then onto the next. Benefits of Inventory Management The two main benefits of inventory management are that it ensures you’re able to fulfil incoming or open orders and raises profits. Inventory management also:
Saves Money Understanding stock trends means you see how much of and where you have something in stock so you’re better able to use the stock you have. This also allows you to keep less stock at each location (store, warehouse), as you’re able to pull from anywhere to fulfil orders — all of this decreases costs tied up in inventory and decreases the amount of stock that goes unsold before it’s obsolete. Improves Cash Flow With proper inventory management, you spend money on inventory that sells, so cash is always moving through the business. Satisfies Customers One element of developing loyal customers is ensuring they receive the items they want without waiting.
Importance of Inventory management
One of the most important resources of an organization is its stock. In different businesses, for example, retail, food administrations, and assembling, an absence of stock can make negative impacts. Besides being an obligation, stock can likewise be viewed as a risk. It tends to be inclined to robbery, harm, and decay. Having a huge stock can likewise prompt a decrease in deals. No matter what the size of your organization, having a legitimate stock administration framework is vital for any business. It can assist you with monitoring every one of your provisions and decide the specific costs. It can likewise assist you with overseeing unexpected changes popular without forfeiting client experience or item quality. This is particularly significant for brands hoping to turn into a more customer-centric organization.
Manage seasonal items throughout the year Deal with sudden demand or market changes Ensure maximum resource efficiency Improve sales strategies using real-life data
Benefits of Holding Inventory
Holding inventories is useful to a firm in the processes of purchasing, producing, and selling. Companies that do not hold adequate inventories of raw materials and finished goods may lose customers or suffer from delays in supplying goods as per their orders. The following are the benefits of holding adequate inventories:
1. Customer Service: A company with sufficient reserves of stock will not lose customers and will supply goods within a reasonable time. Therefore, holding inventory can have positive externalities regarding customer service. 2. Discounts: Large purchases of raw materials and finished goods are likely to lead to greater discounts than would otherwise be the case with smaller purchases. 3. Lower Ordering Costs: When companies purchase raw materials and finished goods in large quantities, they reduce the ordering cost in terms of preparing new orders, checking and validating receipts, and communicating with suppliers. 4. Lower Setup Costs: Maintaining an adequate inventory is useful for a company because it will benefit the production setup cost, which further results in a lower per-unit cost of output.
5. Continuous Production Schedule: Adequate inventory is useful for the production schedule because it ensures that production can continue at all times, thereby ensuring customer demand is met. 6. Employment Stability: Adequate inventory is useful for employment stability as it coordinates production and distribution. When adequate inventory is not kept, it is a possibility that production will suffer and employment stability will be in danger. 7. Reasonable Return on Capital Employed: When inventories are excessive, the company has deployed its funds in a way that won't generate a return. The company's liquidity will suffer and, thus, an adequate inventory should be maintained.
Inventory management techniques
Without precise inventory data, settling on choices that influence your business can be extremely challenging. There are two fundamental strategies for monitoring stock: occasional and interminable. The fundamental difference between these is the way frequently information is refreshed. Despite how frequently you track stock, you might need to utilize one of the accompanying stock management techniques: ABC Analysis ABC (Always Better Control) Analysis is inventory management that separates various items into three categories based on pricing and is separated into groups A, B, or C. The A category is usually the most expensive one. The items in the B category are relatively cheaper compared to the A category. And the C category has the cheapest products of all three. EOQ Model
inventory that is required for production usually justifies the low inventory for those parts.
Risk pooling definition
The pooling of risk is principal to the concept of insurance. A health care coverage risk pool is a group of people whose clinical expenses are consolidated to work out charges. Pooling risks Together permits the greater expenses of the less beneficial to be counterbalanced by the generally lower expenses of the solid, either in an arrangement by and large or inside an exceptional rating classification. As a general rule, the bigger the risk pool, the more unsurprising and stable the expenses can be. Risk pooling is a statistical concept where variability is reduced through aggregation. This means that the demand variability for your product is reduced when you add more customers into your customer pool. Adding more suppliers, similarly, reduces supplier variability. An unreliable supplier has highly variable delivery times and is unable to offer consistent lead-time estimates when you place an order. This type of supplier causes problems because you aren’t able to give your customers consistent service. Risk pooling is having 50 suppliers and being better off. Why would you be better off with 50 suppliers versus one? Because with the aggregation – the adding together of suppliers – the odds are good that at least one vendor will have good delivery times, accurate lead-time estimates, and consistent service. To use an example that’s not technically related to inventory: if the dots on the face of a die represent a supplier’s delivery time in weeks, tossing fifty dice
instead of one or two would increase the odds that at least one of the dice will land with a specific number facing up. The same is true with respect to unpredictable customers. You are better off having a pool of 50 variable customers than having only one variable customer. The idea is that while the demand of some of these 50 customers will be low for the month, the demand of some of the others will be high for the month, and the low demand will be offset by the high demand. The greater the pool of customers, the less variability they exhibit as a group over a period of time – the variability smooth’s out as the number of customer’s increases. Risk pooling can be used in a wide variety of inventory control decisions. For example: the problem of choosing between separate warehouses that independently service their local areas versus one that is centralized and services all areas is easily resolved by thinking of the problem in terms of risk pooling. How? Because local warehouses deal with a small pool of local customers, the demand variability is high and therefore will require you to have more safety stock. A single, centralized warehouse deals with a larger customer pool, meaning less demand variability and requiring a smaller safety stock. Other factors, such as freight costs, must be taken into consideration when making this decision, of course, but all things being equal might make risk pooling helpful in swaying your decision in one direction or the other.
References
Marcos Antonio Mendoza, "Reinsurance as Governance: Governmental Risk Management Pools as a Case Study in the Governance Role Played by Reinsurance Institutions", "Operations and Supply Chain Management: The Core", Third Edition, F. Robert Jacobs and Richard B. Chase, p 346 Maynard's Industrial Engineering Handbook, Fifth Edition, Kjell B. Landin (ed.), McGraw-Hill 2001, p G.
