Inventory Systems: Types and Control

Abstract

An inventory system keeps a record of all the movements (orders, sales and transfers) of a company’s raw material, products and other inventories such as office furniture. By having a proper inventory system, businesses can streamline their orders and sales. Selection of an appropriate inventory system depends on the company’s size and specific requirements. Various costs are involved in different inventory systems. Such costs should be considered during the planning phase (while deciding on the inventory system to choose). Most of the companies invest too much in inventories and as such, it is very crucial for them to keep a tab on their movement.

Considering the fluctuations in prices of various raw materials and products, companies tend to purchase such items at lower price and maintain a stock. Monetary wise this seems to be a good option but since a company’s turnover does not substantiate large investments, it does not seem to be appropriate. On the other hand, petite inventories cannot meet market demands and minimizes sales. Moreover, there is a risk of losing customers due to unavailability of specific items.

Under such circumstances, companies need to calculate future demand and place orders accordingly. Inventory systems can be of great help in this because they provide ready information about the inventories available. Besides, inventory systems also help in exercising a control over the inventories so that shrinkage and pilferage can be minimized. In order to exercise a control on the inventories, it is a must to maintain the requisite inventory control records.

Introduction

Inventory can be described as the reserve of products that are meant for the purpose of sale or use by business organizations. An inventory system keeps the record of all such inventories and furnishes reports that help organizations to maintain the requisite level of stocks. Different aspects of business have different meanings of inventory. Like for example, in a manufacturing unit, inventory would mean the stock of different raw materials and finished goods. In a distribution network, inventory would mean the in-transit stocks (it means that the stocks are being shifted within the system). In the case of retail business, inventory would mean stock minus sale. In the service industry, inventory would mean the supplies required to meet the needs of customers.

The main aim behind exploring the inventory, irrespective of the business aspect, is to ascertain the timeframe and quantity of products to be ordered. Recent years have witnessed a change in the perception of ordering goods/products. Instead of ordering every now and then, organizations prefer ordering for a complete year. In such cases the consideration of ‘time and quantity of goods to be ordered’ changes to the ‘time and goods to be delivered’.

Reasons for Inventory

The foremost reason for maintaining proper inventory system is probably to categorize the system within an organization. It is understood that if all the departments of an organizations work as a single entity, all the functions will be jeopardized. There will be no systematic maintenance of records and the required information at any given point of time will not be available. On the other hand, if each function of an organization has a separate department, the whole system will run smoothly. Organizations can even keep a tab on the expenditure. Like for example, if the management of a frozen food company has ready information about the quantity of a particular variety to be delivered to various locations in a single day, it can arrange to load that quantity in the same truck. Similarly, in the case of production units where different parts of different sizes are made, the parts requiring less time can be used to compensate the time required to make the bigger parts. In this manner, stability in the productivity can be maintained.

Secondly, inventory helps in meeting the fluctuation in demand of products. Organizations can manufacture products according to the demand. This would be possible only if an appropriate inventory system is in place. It might not be economical to produce small quantities to meet specific demands, and as such it is advisable to maintain a stock of products in order to sustain the demand fluctuation.

Thirdly, an appropriate inventory system alleviates the strain on the production department. If proper inventory records are maintained, the production department will have an idea about the units to be produced within the given time-frame. Such information can help the production department to plan and schedule things in advance so that the functioning is smooth. Changing the production set up for different products involves substantial costs. Production cost can also be decreased substantially by producing large quantities if the specific demand is identified.

Fourthly, inventory becomes all the more important when ordered raw material gets delayed from the vendor’s end. Such delays might be due to various reasons that are out of control. Proper inventory and bulk stocks can overcome such situations. Fifthly, the cost factor matters a lot in ordering goods; larger orders can decrease such costs. Finally, it is important to keep a tab on the stock. Like for instance, in the case of in-transit goods, it is crucial to know the stock being moved.

Various Costs of Inventory

Purchase cost: This is the most fundamental kind of inventory cost. Different businesses purchase for different reasons. For instance, a retailer will purchase goods to resell immediately without changing the appearance or contents of products. Some organizations are engaged in purchasing parts of a particular product. Such parts are then assembled to make a single product that is sold in the market. Manufacturing companies buy raw materials to convert them into finished goods and sell in the market (Ingram, 2009). A better way to keep the purchase cost low is to make bulk purchases or bulk purchase contracts. Making bulk purchases will reduce the price of the material being purchased and bulk order contracts will guarantee fixed price for a long-term.

Processing cost: The cost incurred during the processing of purchased material to produce the finished good is the processing cost. Some companies do some processing of the purchased material. Like for instance, a manufacturing company incurs expenses in producing finished goods from the purchased raw material. An assembling unit incurs expenses in assembling the various parts to make a single product (Ingram, 2009).

Distribution cost: Inventory goods have to be transported a couple of times before they reach the targeted consumer or seller. Such transportation involves expenses that are termed as distribution costs. It seldom happens that goods are sent directly from the vendor’s facility to the consumer or seller (except in the case of trading goods). Companies buy from the vendors and before sending goods to their consumers or sellers, these goods are kept at a centralized warehouse for future distribution. Transporting goods from one place to another involves transportation costs.

Holding cost: Storing goods, irrespective of the place, involves a couple of expenses such as labor cost, electricity, maintenance, etc. Such costs are termed as holding costs. A smart way to avoid holding costs is to order material delivery only when the material is actually required. This will help in having more free space in the warehouse facility and the employees will also be available for some other work (Ingram, 2009).

Shrinkage/Pilferage: Goods stored in warehouses are prone to shrinkage and pilferage. It is possible that some goods are returned by the customers due to being damaged or of low quality; this is called shrinkage. Another risk is the goods being stolen from the warehouse; this is called pilferage. Both shrinkage and pilferage involve costs.

Different Kinds of Inventory Systems

It is important for businesses, whether small shops or conglomerates, to maintain proper inventory system. Several companies invest a lot in their inventories and as such, it is crucial for them to keep a track of all inventories. The system to be followed depends on the specific need. For instance, a street vendor can keep inventory of his stock in a small pocket book. A small shopkeeper can keep inventory of his stock in a ledger or a computer. A retail departmental store follows a different system that deducts the goods sold from the inventory as soon the billing is done. So, the nature of business decides the kind of inventory system to be used in a manner that the ultimate aim of keeping a track of the inventory is achieved. This paper will discuss the various kinds of inventory systems being used by businesses. First, let us understand the two main systems i.e. the ‘perpetual inventory system’ and the ‘periodic inventory system’.

Perpetual inventory system

In this kind of inventory system, the inventory gets updated immediately and automatically. The immediate feature of this inventory system gives it the name of ‘perpetual’. As soon as any “order is placed or received, that data immediately is entered into the system to update the quantity and inventory availability right away” (Jagath, 2012a, p. 1). Unlike the periodic inventory system, perpetual inventory system requires continuous updating of data. With increased use of computers, this system has achieved momentum. Since the data is entered immediately and continuously, the available reports at any given point of time are up to date and precise.

This particular inventory system has made it easy for procurement managers to view the latest inventory position and order goods according to the requirement. Likewise any other system, the perpetual inventory system also has its own drawbacks. One of the main drawbacks is that a lot of data has to be entered on a daily basis and if by any chance employees work without the system, it becomes very cumbersome and costly to reset the whole system. In spite of the fact that this inventory system gives perfect results, it is imperative to have a manual check of the stock every now and then. This means that the manual inventory system hasn’t lost ground.

Periodic inventory system

This inventory system requires updating of data once in a while (say quarterly, half yearly or after festive seasons. Unlike the perpetual inventory system, in the periodic inventory system the data needs to be updated at certain intervals of time (period). This gives it the name ‘periodic inventory system’. The data in this kind of inventory system is not up to date and procurement managers cannot rely on it to order goods. A plus point with this inventory system is that it does not incur any costs once it is set up. Moreover, the installation cost of this inventory system is also less. Standard programs like Microsoft Excel are enough to comply with its requirements. Reports are generated annually and as such, instant results are difficult to get. This inventory system is apt for small businesses only that finalize their accounts on a yearly basis (Jagath, 2012b).

In addition to the perpetual and periodic inventory systems, there are other inventory systems also, which businesses adopt, depending on their requirement. Following is a description of such inventory systems:

The intuitive inventory system

This is a very simple inventory system in which the procurement manager views the inventory and decides on ordering any particular product or not. This kind of inventory system needs forecasting knowledge about the demand of goods. Due to excessive human involvement, this system has become out dated and is not used anymore, except for a few small business owners.

The reserve inventory system

In this kind of inventory, some surplus stock is maintained. This surplus stock is used only when the current stock is exhausted. New orders are placed when such surplus stocks are opened.

The computer inventory system

This is a sophisticated inventory system where “the system uses perpetual inventory records to automatically trigger inventory orders when inventory falls below a certain level” (Uman, 2010, p. 1).

Manual inventory system

This inventory system is good for small businesses where a simple spreadsheet is used to enter the inventories and can be referred anytime. The business owner counts the available inventory and enters the quantity in the spreadsheet. The next week’s expected requirement is also entered in this spreadsheet. Using appropriate formulae, the requirement for a particular week can be generated. This is also a very cost-effective inventory system but is not advisable for large businesses.

Barcode inventory system

Owing to its accuracy, barcode is used by several inventory systems. Majority of the departmental stores use the barcode inventory system. When a barcode of any product is read at the sale counter, the details are automatically sent to the main inventory system where the statistics are maintained. Barcodes and ‘radio frequency identification’ are also used in warehouses very effectively.

First in first out inventory system

This inventory system is also known as the FIFO system. The name itself suggests the method to be adopted. It means that those inventories that have been entered first will sold first. For instance, if 20 bicycles were bought for $200 on December 20, and 10 bicycles of the same model were bought for $210 on December 31, the FIFO system will guide that the bicycles bought on December 20 will be put up for sale first.

Last in first out inventory system

This system is also known as the LIFO system. Again, the name itself suggests the method to be adopted. This system is exactly opposite to the FIFO system. For instance, if 20 bicycles were bought for $200 on December 20, and 10 bicycles of the same model were bought for $210 on December 31, the LIFO system will guide that the bicycles bought on December 31 will be put up for sale first.

Average cost inventory system

In this particular inventory system, the costs of similar inventories are added and divided by the number of inventories. The resultant will be the average cost of this kind of inventory. This calculation has to be made frequently so that the price swing can be taken care of. The average cost inventory system is best applicable to businesses that don’t have business on a daily basis; for instance, a machine manufacturer.

Inventory Control Records

It is imperative for companies to maintain ‘inventory control records’ in order to make assessments pertaining to buying and selling. Some businesses keep a tab on their inventories by doing frequent manual checks, while others utilize the ‘dollar inventory record’ to have an idea of their stocks (in dollars). Businesses where there are several inventories (such as a departmental store), the dollar inventory record system proves to be more beneficial rather than the manual method. Nonetheless, businesses using the dollar inventory record system have to check their inventories manually at regular intervals. Following is a description of inventory control records generally used by businesses.

‘Perpetual inventory control records’

This record system is used by businesses that have large (in size) inventories. It is easy to make a manual head count for such inventories. A card is maintained for each product or a cluster of similar products. Every time a product is sold, corresponding deduction is made from the card. Frequent counting is done to tally the actual number with the entry on the card.

‘Out-of stock sheets’

These are also known as the ‘want sheets’. By way of such sheets, the buyer is informed about the need to reorder items.

‘Open-to-buy records’

These records avert placing of orders in excess to what is actually needed. These records also assist in maintaining the budget. “They provide a running account of the dollar amount that may be bought without departing significantly from the pre-established inventory levels. An open-to-buy record is related to the inventory budget” (Score, 2002, p. 4).

‘Purchase order files’

These files keep details of the ordered material and its expected delivery date. In order to have an easy method of making the entries, copies of all the purchase orders are gathered and corresponding entries are made. Any specific notes can be written against the purchase orders.

‘Supplier files’

These are the files that have details about the suppliers. Price negotiations and delivery terms can be discussed. “Extra copies of purchase orders can be used to create these files, organized alphabetically by supplier, and can provide a fast way to determine how much business is done with each vendor” (Score, 2002, p. 4).

‘Returned goods files’

These files furnish the details of items that have been sent back to the suppliers. Amount of the items, dates and cause of return are mentioned in these files. “This information is used in controlling debits, credits and quality issues” (Score, 2002, p. 4).

‘Price Books’

These books provide details of the “purchase prices, selling prices, market-downs, and markups. It is important to keep this record completely up to date in order to be able to access the latest price and profit information on materials purchased for resale” (Score, 2002, p. 4).

Controlling Inventory

Likewise maintaining inventory system, controlling inventory is also of equal importance. Various steps are involved in exercising a systematic control over the inventory. The initial step is inventory planning in which the inventory system to be used is decided. Care is taken to select an inventory system that is appropriate to the business. Second step involves establishing order cycles. This step becomes easy if future demand and market trends are identified. The third step is to set the inventory levels. It needs great expertise and forecasting knowledge to set such levels. The fourth step requires a sharp eye on the inventories. Non-moving inventories should be disposed off at the earliest. The final step requires proper follow up of the inventories. Frequent checks should be conducted to identify the dead stock.

Conclusion

Considering the increase in business and variety of products that companies deal in, it has become imperative for them to use appropriate inventory systems. Companies have to choose from the various inventory systems, depending on their size and specific requirement. The intention behind maintaining proper inventory is to have an idea about the timeframe and quantity of products to be ordered. While selecting an inventory system, the various costs involved should also be considered. It is also very important to maintain proper inventory records. Finally, companies should exercise control over their inventories in order to avoid wastages.

References

Ingram, D. (2009). Types of inventory costs. Web.

Jagath. (2012a). Types of inventory systems: the perpetual inventory system. Web

Jagath. (2012b). Types of inventory systems: the periodic inventory system. Web.

Score. (2002). Inventory control. Web.

Uman. (2010). Inventory control systems. Web.