The inventory may be defined as the physical stock of good, units or economic resources that are stored or reserved for smooth, efficient and effective functioning of business. Many companies have wide-ranging inventories, consisting of many small items such as paper pads, pencils, and paper clips, and fewer big items such as trucks, machines, and computers.
A particular company's inventory is related to the business in which it is engaged. Without inventories customer would have to wait until their orders were filled from a source or were produced. In general, however, customer will not like to wait for long period of time. Another reason for maintaining inventory is the price fluctuation of some raw material, (may be seasonal), it would be profitable for a buyer to procure a sufficient quantity of raw material at lower price and use it whenever needed. Some researchers also argue that maintaining inventories on display attracts more customers resulting increase in sale and profits.
Just as inventory is the stock of any item or resource used in an organization, an inventory system or management is the set of policies and controls that monitor levels of inventory and determine what levels should be maintained, when stock should be replenished, and how large orders should be.
Reasons for Holding Inventories
Inventories serve a number of important functions in various companies. Among the major reasons for holding inventories are mentioned below
To satisfy expected demand Companies use anticipation stock (buffer stock) to satisfy expected demand, and it is particularly important for products that exhibit marked seasonal demand but are produced at uniform rates
To protect against stock outs. Manufacturers use safety stock to protect against uncertainties in either the demand or supply of an item. Delayed deliveries and unexpected increases in demand increase the risk of shortages. Safety stock provides insurance that the company can meet anticipated customer demand without backlogging orders; the plant can invest in safety stocks at several points. Raw materials and component parts
can have safety stocks within the manufacturing plant. Finished goods can have safety stocks throughout the materials flow (at the plant, field warehouses, distribution centers, wholesalers, and retailers).
To take advantage of economic order cycles. Companies use cycle stock to produce (or buy) in quantities larger than their immediate needs. Because of the cost involved in setting up a machine, companies usually find producing in large quantities economical. Similarly, to minimize purchasing costs companies often buy in quantities that exceed their immediate requirements. In both cases, periodic orders, or order cycles, produce more economical overall production costs. The quantity produced is called the economic lot size. The quantity ordered is called the economic order quantity
To maintain independence of operations. The successive stages in the production and distribution system require a buffer of inventories between them so that they can maintain their independence of operations, for example, the raw materials inventory buffers the manufacturer from problems with a supplier. Similarly, the finished goods inventory buffers factory operations from problems in the distribution system.
To allow for smooth and flexible production operations. A production-distribution system needs flexibility and a smooth flow of material, but production cannot be instantaneous so work-in-process inventory relieve pressure on the production system. Similarly, manufacturers use in-transit or pipeline inventory to offset distribution delays. Both work-in-process inventories and pipeline inventories are part of a broader classification, called movement inventories.
To guard against price increases. Manufactures sometimes use large purchase, or large production runs, to achieve savings when they expect price increases for raw materials or component parts.