Inventory Management

By: Floyd D. Hedrick
Library of Congress, Washington, D.C.
Frank C. Barnes, P.E., Ph.D.
University of North Carolina at Charlotte
Edward W. Davis
University of Virginia, Charlottesville
D. Clay Whybark
Indiana University, Bloomington
Murray Krieger
TBD
Editor: Jeannette Budding, Communications Manager
National Association of Purchasing Management

This publication is a merger of former SBA publications, “Purchasing for
Owners of Small Plants,” “Buying for Retail Stores” and “Inventory
Management.”

While we consider the contents of this publication to be of general merit
its sponsorship by the U.S. Small Business Administration does not
necessarily constitute an endorsement of the views and opinions of the
authors or the products or services of the companies with which they are
affiliated.

All SBA programs are provided to the public on a non-discriminatory basis.

INTRODUCTION

“Inventory” to many small business owners is one of the more visible
and tangible aspects of doing business. Raw materials, goods in
process and finished goods all represent various forms of inventory.
Each type represents money tied up until the inventory leaves the
company as purchased products. Likewise, merchandise stocks in a
retail store contribute to profits only when their sale puts money
into the cash register.

In a literal sense, inventory refers to stocks of anything necessary
to do business. These stocks represent a large portion of the business
investment and must be well managed in order to maximize profits.
In fact, many small businesses cannot absorb the types of losses
arising from poor inventory management. Unless inventories are con-
trolled, they are unreliable, inefficient and costly.

SUCCESSFUL INVENTORY MANAGEMENT

Successful inventory management involves balancing the costs of inventory
with the benefits of inventory. Many small business owners fail to
appreciate fully the true costs of carrying inventory, which include not
only direct costs of storage, insurance and taxes, but also the cost of
money tied up in inventory. This fine line between keeping too much
inventory and not enough is not the manager’s only concern. Others
include:

* Maintaining a wide assortment of stock–but not spreading the
rapidly moving ones too thin;
* Increasing inventory turnover–but not sacrificing the service
level;
* Keeping stock low–but not sacrificing service or performance.
* Obtaining lower prices by making volume purchases–but not ending up
with slow-moving inventory;
and
* Having an adequate inventory on hand–but not getting caught with
obsolete items.

The degree of success in addressing these concerns is easier to gauge for
some than for others. For example, computing the inventory turnover ratio
is a simple measure of managerial performance. This value gives a
rough guideline by which managers can set goals and evaluate performance,
but it must be realized that the turnover rate varies with the function of
inventory, the type of business and how the ratio is calculated (whether
on sales or cost of goods sold). Average inventory turnover ratios for
individual industries can be obtained from trade associations.

THE PURCHASING PLAN

One of the most important aspects of inventory control is to have the items
in stock at the moment they are needed. This includes going into the
market to buy the goods early enough to ensure delivery at the proper
time. Thus, buying requires advance planning to determine inventory needs
for each time period and then making the commitments without
procrastination.

For retailers, planning ahead is very crucial. Since they offer new items
for sale months before the actual calendar date for the beginning of the
new season, it is imperative that buying plans be formulated early enough
to allow for intelligent buying without any last minute panic purchases.
The main reason for this early offering for sale of new items is that the
retailer regards the calendar date for the beginning of the new season as
the merchandise date for the end of the old season. For example, many
retailers view March 21 as the end of the spring season, June 21 as the end
of summer and December 21 as the end of winter.

Part of your purchasing plan must include accounting for the depletion of
the inventory. Before a decision can be made as to the level of inventory
to order, you must determine how long the inventory you have in stock
will last. For instance, a retail firm must formulate a plan to ensure
the sale of the greatest number of units. Likewise, a manufacturing
business must formulate a plan to ensure enough inventory is on hand for
production of a finished product.

In summary, the purchasing plan details:

* When commitments should be placed;
* When the first delivery should be received;
* When the inventory should be peaked;
* When reorders should no longer be placed; and
* When the item should no longer be in stock.

Well planned purchases affect the price, delivery and availability of
products for sale.

CONTROLLING YOUR INVENTORY

To maintain an in-stock position of wanted items and to dispose of unwanted
items, it is necessary to establish adequate controls over inventory on
order and inventory in stock. There are several proven methods for
inventory control. They are listed below, from simplest to most complex.

* Visual control enables the manager to examine the inventory visually
to determine if additional inventory is required. In very small
businesses where this method is used, records may not be needed at
all or only for slow moving or expensive items.
* Tickler control enables the manager to physically count a small
portion of the inventory each day so that each segment of the
inventory is counted every so many days on a regular basis.
* Click sheet control enables the manager to record the item as it
is used on a sheet of paper. Such information is then used for
reorder purposes.
* Stub Control (used by retailers) enables the manager to retain a
portion of the price ticket when the item is sold. The manager can
then use the stub to record the item that was sold.

As a business grows, it may find a need for a more sophisticated and
technical form of inventory control. Today, the use of computer systems to
control inventory is far more feasible for small business than ever
before, both through the widespread existence of computer service
organizations and the decreasing cost of small-sized computers. Often the
justification for such a computer-based system is enhanced by the fact that
company accounting and billing procedures can also be handled on the
computer.

* Point-of-sale terminals relay information on each item used or sold.
The manager receives information printouts at regular intervals for
review and action.
* Off-line point-of-sale terminals relay information directly to the
supplier’s computer who uses the information to ship additional
items automatically to the buyer/inventory manager.

The final method for inventory control is done by an outside agency. A
manufacturer’s representative visits the large retailer on a scheduled
basis, takes the stock count and writes the reorder. Unwanted merchandise
is removed from stock and returned to the manufacturer through a
predetermined, authorized procedure.

A principal goal for many of the methods described above is to determine
the minimum possible annual cost of ordering and stocking each item. Two
major control values are used: 1) the order quantity, that is, the size and
frequency of orders; and 2) the reorder point, that is, the minimum stock
level at which additional quantities are ordered. The Economic Order
Quantity (EOQ) formula is one widely used method of computing the minimum
annual cost for ordering and stocking each item. The EOQ computation takes
into account the cost of placing an order, the annual sales rate, the unit
cost, and the cost of carrying inventory. Many books on management
practices describe the EOQ model in detail.

DEVELOPMENTS IN INVENTORY MANAGEMENT

In recent years, two approaches have had a major impact on inventory
management: Material Requirements Planning (MRP) and Just-In-Time (JIT and
Kanban). Their application is primarily within manufacturing but
suppliers might find new requirements placed on them and sometimes buyers
of manufactured items will experience a difference in delivery.

Material Requirements Planning is basically an information system in which
sales are converted directly into loads on the facility by sub-unit and
time period. Materials are scheduled more closely, thereby reducing
inventories, and delivery times become shorter and more predictable. Its
primary use is with products composed of many components. MRP systems are
practical for smaller firms. The computer system is only one part of the
total project which is usually long-term, taking one to three years to
develop.

Just-In-Time inventory management is an approach which works to eliminate
inventories rather than optimize them. The inventory of raw materials and
work-in-process falls to that needed in a single day. This is accomplished
by reducing set-up times and lead times so that small lots may be ordered.
Suppliers may have to make several deliveries a day or move close to the
user plants to support this plan.

TIPS FOR BETTER INVENTORY MANAGEMENT

What to do at time of delivery:

* Verify count–Make sure you are receiving as many cartons as are
listed on the delivery receipt.
* Carefully examine each carton for visible damage–If damage is
visible, note it on the delivery receipt and have the driver sign
your copy.
* After delivery, immediately open all cartons and inspect for
merchandise damage.

Steps to take when damage is discovered:

* Retain damaged items–All damaged materials must be held at the
point received.
* Call carrier to report damage and request inspection.
* Confirm call in writing–This is not mandatory but it is one way
to protect yourself.

Steps to take when carrier makes inspection of damaged items:

* Have all damaged items in the receiving area–Make certain the
damaged items have not moved from the receiving area prior to
inspection by carrier.
* After carrier/inspector prepares damage report, carefully read
before signing.

Steps to be taken after inspection has been made:

* Retain damaged materials–Damaged materials should not be used or
disposed of without permission by the carrier.
* Do not return damaged items to shipper without written authorization
from shipper/supplier.

SPECIAL TIPS FOR MANUFACTURERS

If you are in the business of bidding, specifications play a very important
role. In writing specifications, the following elements should be
considered.

* Do not request features or quality that are not necessary for the
items’ intended use.
* Include full descriptions of any testing to be performed.
* Include procedures for adding optional items.
* Describe the quality of the items in clear terms.

The following actions can help save money when you are stocking inventory:

* Substitution of less costly materials without impairing required
quality;
* Improvement in quality or changes in specifications that would lead
to savings in process time or other operating savings;
* Developing new sources of supply;
* Greater use of bulk shipments;
* Quantity savings due to large volume, through consideration of
economic order quantity;
* A reduction in unit prices due to negotiations;
* Initiating make-or-buy studies;
* Application of new purchasing techniques;
* Using competition along with price, service and delivery when
making the purchase selection decision.

* * *
APPENDIX: Information Resources

U.S. Small Business Administration (SBA)

The SBA offers an extensive selection of information on most
business management topics, from how to start a business to
exporting your products.

This information is listed in “The Small Business Directory”. For
a free copy contact your nearest SBA office.

SBA has offices throughout the country. Consult the U.S.
Government section in your telephone directory for the office
nearest you. SBA offers a number of programs and services,
including training and educational programs, counseling services,
financial programs and contract assistance. Ask about

– Service Corps of Retired Executives (SCORE), a national
organization sponsored by SBA of over 13,000 volunteer business
executives who provide free counseling, workshops and seminars
to prospective and existing small business people.

– Small Business Development Centers (SBDCs), sponsored by the SBA
in partnership with state and local governments, the educational
community and the private sector. They provide assistance,
counseling and training to prospective and existing business
people.

– Small Business Institutes (SBIs), organized through SBA on more
than 500 college campuses nationwide. The institutes provide
counseling by students and faculty to small business clients.

For more information about SBA business development programs and
services call the SBA Small Business Answer Desk at 1-800-8-ASK-SBA
(827-5722).

Other U.S. Government Resources
Many publications on business management and other related topics
are available from the Government Printing Office (GPO). GPO
bookstores are located in 24 major cities and are listed in the
Yellow Pages under the “bookstore” heading. You can request a
“Subject Bibliography” by writing to Government Printing Office,
Superintendent of Documents, Washington, DC 20402-9328.

Many federal agencies offer publications of interest to small
businesses. There is a nominal fee for some, but most are free.
Below is a selected list of government agencies that provide
publications and other services targeted to small businesses. To
get their publications, contact the regional offices listed in
the telephone directory or write to the addresses below:

– Consumer Information Center (CIC), P.O. Box 100 Pueblo, CO 81002
The CIC offers a consumer information catalog of federal
publications.

– Consumer Product Safety Commission (CPSC)
Publications Request
Washington, DC 20207
The CPSC offers guidelines for product safety requirements.

– U.S. Department of Agriculture (USDA)
12th Street and Independence Avenue, SW
Washington, DC 20250
The USDA offers publications on selling to the USDA.
Publications and programs on entrepreneurship are also available
through county extension offices nationwide.

– U.S. Department of Commerce (DOC)
Office of Business Liaison
14th Street and Constitution Avenue, NW
Room 5898C
Washington, DC 20230
DOC’s Business Assistance Center provides listings of
business opportunities available in the federal government. This
service also will refer businesses to different programs and
services in the DOC and other federal agencies.

– U.S. Department of Health and Human Services (HHS)
Public Health Service
Alcohol, Drug Abuse and Mental Health Administration
5600 Fishers Lane
Rockville, MD 20857
Drug Free Workplace Helpline: 1-800-843-4971. Provides
information on Employee Assistance Programs.
National Institute for Drug Abuse Hotline:
1-800-662-4357. Provides information on preventing substance
abuse in the workplace.
The National Clearinghouse for Alcohol and Drug Information:
1-800-729-6686 toll-free. Provides pamphlets and resource
materials on substance abuse.

– U.S. Department of Labor (DOL)
Employment Standards Administration
200 Constitution Avenue, NW
Washington, DC 20210
The DOL offers publications on compliance with labor laws.

– U.S. Department of Treasury
Internal Revenue Service (IRS)
P.O. Box 25866
Richmond, VA 23260
1-800-424-3676
The IRS offers information on tax requirements for small
businesses.

– U.S. Environmental Protection Agency (EPA)
Small Business Ombudsman
401 M Street, SW (A-149C)
Washington, DC 20460
1-800-368-5888 except DC and VA
703-557-1938 in DC and VA
The EPA offers more than 100 publications designed to help small
businesses understand how they can comply with EPA regulations.

– U.S. Food and Drug Administration (FDA)
FDA Center for Food Safety and Applied Nutrition
200 Charles Street, SW
Washington, DC 20402
The FDA offers information on packaging and labeling
requirements for food and food-related products.

For More Information
A librarian can help you locate the specific information you need
in reference books. Most libraries have a variety of directories,
indexes and encyclopedias that cover many business topics. They
also have other resources, such as

– Trade association information
Ask the librarian to show you a directory of trade associations.

Associations provide a valuable network of resources to their
members through publications and services such as newsletters,
conferences and seminars.

– Books
Many guidebooks, textbooks and manuals on small business are
published annually. To find the names of books not in your local
library check “Books In Print”, a directory of books currently
available from publishers.

– Magazine and newspaper articles
Business and professional magazines provide information that is
more current than that found in books and textbooks. There are
a number of indexes to help you find specific articles in
periodicals.

In addition to books and magazines, many libraries offer free
workshops, lend skill-building tapes and have catalogues and
brochures describing continuing education opportunities.

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SMB Reviews
SMB Reviews 473 posts

SMBReviews is committed to providing small and mid-sized business owners with the information and resources they need to select the best service or product for their company.

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