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Inventory management is an integral part of any supply chain. Depending on the company’s approach and nature of business, ways of inventory management may change. This article discusses the importance of inventory management in logistics and types of inventory management. Let’s begin with what inventory management is.
What is inventory management in logistics?
Inventory is procured raw materials needed for production as well as finished products that are available for sale. Managing this inventory means storing, using and selling the inventory. The scope of inventory management is from procurement to distribution. Now, why is it important to manage inventory efficiently? Inventory management can have a direct impact on your business. For example, with efficient inventory management practices, you can track and forecast demand.
The role of efficient inventory management can be explained through the following basic scenarios:
- Overstocking: Overstocking of finished goods or raw materials does not only occupy space but also money. Inventory is considered a current asset and overstocking mean investment into the stock that may not sell at all or may take longer time to sell. In such cases, the business may have to discard the existing stock, which lead to losses. Raw material or finished goods, in either case, overstocking is a loss for any company.
- Running out of stock: As much as overstocking is harmful to the business, running out of stock results in loss of business. In case of raw materials run out of stock, production stops, which is a costly affair. If finished products run out of stock, the company occurs losses.
In order to improve such scenarios, it is important to manage inventory efficiently.
Role of inventory management in logistics
The role of inventory management is to:
Bring accuracy in procurement and order fulfilment: Efficient inventory management should improve the accuracy of procurement as well as order fulfilment. This also leads to customer satisfaction as they receive timely deliveries of their orders.
Improve inventory planning: Efficient inventory management helps to forecast demand which improves inventory planning.
Improve warehouse organising: Good inventory management practice helps in organising warehouses and fulfilment centres. Optimised way of using a warehouse translates into cost savings for any company.
Improve profits: Cost savings done with the help of inventory management can help your business improve profits.
Types of inventory management
Different types of inventory management styles can have pros and cons depending on nature of your business. You can choose the one that suits you the best.
Just in time (JIT)
Just in time approach is a manufacturing model approach where goods are produced only to meet demand. There is no room for surplus. This method aims at reducing waste of any kind and brings efficiency. Just in time manufacturing means inventory also has to be managed in the same way. It means that just only the required amount of raw material is procured just when the production is to begin. This saves space and reduces cost. Also, the stock of finished goods does not pile up as production quantity is only to meet existing demand.
Although the JIT can be advantageous on various parameters such as cost, efficiency, etc. It is especially suitable for businesses, which usually experience fluctuating demand as the inventory is procured and managed to match the current demand. However, it can be risky if there is a sudden surge or dip in demand. It can be difficult for the procurement team to source raw materials quickly.
Materials requirement planning (MRP)
This inventory management system is dependent on the sales forecast. Basis the previously available data, sales for the coming months are forecasted. The quantity of production depends on the forecast. Accordingly, raw materials are procured. For example, the sales team of steel wire ropes may project 20% higher demand. As a result, the inventory management and procurement team will have to source the raw material depending on the projected sales. Moreover, warehousing also needs to be planned according to the projected production.
The flip side of this method inaccuracy in projections can lead to higher or lower inventory. In other words, this approach is suitable for businesses when you can forecast demand. For example, air conditioner manufacturers usually can forecast higher demand during summer while low demand in winter. This can be backed by the previous years’ sales. Hence MRP inventory management approach can be applied here. On the other hand, demand for steel remains fluctuating and it is difficult to forecast. Therefore, it may not be feasible for the industry to adopt MRP.
Economic order quantity (EOQ)
It is a calculation-based method. It aims at calculating the right quantity of units the company should add to its inventory with each batch to optimise the cost of inventory management cost. Many times, suppliers offer discounts on bulk orders, and it is easy to fall prey to these offers. ECQ helps inventory managers to calculate the right quantity and eliminate overspending.
ECQ is a data-driven approach that helps in reordering the right quantity, eliminating waste and minimising storage costs. On the flip side, ECQ assumes constant demand. Therefore, if you are in a business where demand fluctuates often, ECQ may not be the right approach for your business.
Days sales of inventory (DSI)
This method is known by many names such as days inventory outstanding (DIO), average age of inventory, days in inventory (DII), etc. Here, a business calculates the days for which the current inventory would last. In other words, the turnaround time or days required to liquidate current inventory. And as an inventory manager, you might need to maintain a certain DSI.
The formula for calculating DSI: Days Sales in Inventory (DSI) = (Average Inventory ÷ Cost of Goods Sold) × 365 Days.
Usually, short DSI is preferred. Short DSI means that sales and product strategy is effective. Longer DSI may indicate that the business requires a change in strategy.
Conclusion: key takeaways
- The role of inventory management is important for any business.
- You need to select the right inventory management type for your business considering business activities, sector your business is operational in, and so on.
- Inventory management can be improved with the help of inventory management solutions.