introduction of inventory management selected

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As the cost of logistics increases retailers and manufacturers are looking to inventory

management as a way to control costs. Inventory is a term used to describe unsold goods held for

sale or raw materials awaiting manufacture. These items may be on the shelves of a store, in the

backroom or in a warehouse mile away from the point of sale. In the case of manufacturing, they

are typically kept at the factory. Any goods needed to keep things running beyond the next few

hours are considered inventory.

Inventory management simply means the methods you use to organize, store and replace

inventory, to keep an adequate supply of goods while minimizing costs. Each location where

goods are kept will require different methods of inventory management. Keeping an inventory,

or stock of goods, is a necessity in retail. Customers often prefer to physically touch what they

are considering purchasing, so you must have items on hand. In addition, most customers prefer

to have it now, rather than wait for something to be ordered from a distributor. Every minute that

is spent down because the supply of raw materials was interrupted costs the company unplanned

expenses.

DEFINITIONS OF INVENTORY MANAGEMENT

1. Involves a retailer seeking to acquire and maintain a proper merchandise assortment

while ordering, shipping, handling, and related costs are kept in check.

2. Systems and processes that identify inventory requirements, set targets, provide

replenishment techniques and report actual and projected inventory status.

3. Handles all functions related to the tracking and management of material. This would

include the monitoring of material moved into and out of stockroom locations and thereconciling of the inventory balances. Also may include ABC analysis, lot tracking, cycle

counting support etc.



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Inventory represents one of the most important assets that most businesses possess, because theturnover of inventory represents one of the primary sources of revenue generation and

subsequent earnings for the company's shareholders/owners.

The word 'inventory' can refer to both the total amount of goods and the act of counting them.

Many companies take an inventory of their supplies on a regular basis in order to avoid running

out of popular items. Others take an inventory to insure the number of items ordered matches the

actual number of items counted physically. Shortages or overages after an inventory can indicate

a problem with theft or inaccurate accounting practices.

Possessing a high amount of inventory for long periods of time is not usually good for

a business because of inventory storage, obsolescence and spoilage costs. However,

possessing too little inventory isn't good either, because the business runs the risk of losing out

on potential sales and potential market share as well.

Restaurants and other retail businesses which take frequent inventories may use a 'par' system

based on the results. The inventory itself may reveal 10 apples, 12 oranges and 8 bananas on the

produce shelf, for example. The preferred number of each item is listed on a 'par sheet', a master

list of all the items in the restaurant. If the par sheet calls for 20 apples, 15 oranges and 10

bananas, then the manager knows to place an order for 10 apples, 3 oranges and 2 bananas to

reach the par number. This same principle holds true for any other retail business with a number

of different product lines.



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1. COUNTING CURRENT STOCK

All businesses must know what they have on hand and evaluate stock levels with respect to

current and forecasted demands. You must know what you have in stock to ensure you can meet

the demands of customers and production and to be sure you are ordering enough stock in the

future. Counting is also important because it is the only way you will know if there is a problem

with theft occurring at some point in the supply chain. When you become aware of such

problems you can take steps to eliminate them.

2. CONTROLLING SUPPLY AND DEMAND

Whenever possible, obtain a commitment from a customer for a purchase. In this way, you

ensure that the items you order will not take space in your inventory for long. When this is not

possible, you may be able to share responsibility for the cost of carrying goods with the

salesperson, to ensure that an order placed actually results in a sale. You can also keep a list of

goods that can easily be sold to another party, should a customer cancel. Such goods can be

ordered without prior approval.

Approval procedures should be arranged around several factors. You should set minimum and

maximum quantities which your buyers can order without prior approval. This ensures that you

are maximizing any volume discounts available through your vendors and preventing over-

ordering of stock. It is also important to require pre-approval on goods with a high carrying cost.

3. KEEPING ACCURATE RECORDS

Any time items arrive at or leave a warehouse, accurate paperwork should be kept, itemizing the

goods. When inventory arrives, this is when you will find breakage or loss on the goods you

ordered. Inventory leaving your warehouse must be counted to prevent loss between the

warehouse and the point of sale. Even samples should be recorded, making the salesperson

responsible for the goods until they are returned to the storage facility. Records should be

processed quickly, at least in the same day that the withdrawal of stock occurred.



4. MANAGING EMPLOYEES

Buyers are the employees who make stock purchases for your company. Reward systems shouldbe set in place that encourage high levels of customer service and return on investment for the

product lines the buyer manages.

Warehouse employees should be educated on the costs of improper inventory management. Be

sure they understand that the lower your profit margin, the more sales must be generated to make

up for the lost goods. Incentive programs can help employees keep this in perspective. When

they see a difference in their paychecks from poor inventory management, they are more likely

to take precautions to prevent shrinkage.

Each stock item in your warehouse or back room should have its own procedures for

replenishing the supply. Find the best suppliers and storage location for each and record this

information in official procedures that can easily be accessed by your employees.

Inventory management should be a part of your overall strategic business plan. As the business

climate evolves towards a green economy, businesses are looking for ways to leverage this trend

as part of the “big picture”. This can mean reevaluating your supply chain and choosing products

that are environmentally sound. It can also mean putting in place recycling procedures for

packaging or other materials. In this way, inventory management is more than a means to control

costs; it becomes a way to promote your business.



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Inventory consists of the goods and materials that a retail business holds for sale or a

manufacturer keeps in raw materials for production. Inventory control is a means for maintaining

the right level of supply and reducing loss to goods or materials before they become a finished

product or are sold to the consumer.

Inventory control is one of the greatest factors in a company’s success or failure. This part of the

supply chain has a great impact on the company’s ability to manufacture goods for sale or to

deliver customer satisfaction on orders of finished products. Proper inventory control will

balance the customer’s need to secure products quickly with the business need to control

warehousing costs. To manage inventory effectively, a business must have a firm understanding

of demand, and cost of inventory

UNCERTAINTY IN DEMAND

Methods to control inventory can depend on the kinds of demand a business experiences.

Derived demand, or the demand of raw materials for production and manufacture, can be met

through calculations in manufacturing output, balanced with demand forecasts for a given

product.

Independent demand comes from consumer demand, making it more susceptible to market

fluctuations and seasonal changes. By coordinating the supply chain businesses can reduce

uncertainty in this area.

Inventory costs are controlled through different models that will apply to varying products. Items

that are in continuous supply benefit from the Economic Order Quantity model (EOQ). Products

available for a limited period are best suited to News Vendor models.



INVENTORY COSTS

There are three main types of cost in inventory. There are the costs to carry standard inventoriesand safety stock. Ordering and setup costs come into play as well. Finally, there are shortfall

costs. A good inventory control system will balance carrying costs against shortfall costs.

SAFETY STOCK

Safety stock is comprised of the goods needed to be kept on hand to satisfy consumer demand.

Because demand is constantly in flux, optimizing the Safety Stock levels is a challenge.

However, demand fluctuations do not wholly dictate a company’s ability to keep the right supplyon hand most of the time. Companies can use statistical calculations to determine probabilities in

demand.

ORDERING COSTS

Ordering costs have to do with placing orders, receiving and stowage. Transportation and invoice

processing are also included. Information technology has proven itself useful in reducing these

costs in many industries. If the business is in manufacturing, then to production setup costs areconsidered instead.

THE COST OF SHORTFALLS

Stockout or shortfall costs represent lost sales due to lack of supply for consumers. Sales

departments prefer these numbers be kept low so that an ample stock will always be kept.

Logistics managers prefer to err on the side of caution to reduce warehousing costs.

Shortfall costs are avoided by keeping an ample safety stock on hand. This practice also

increases customer satisfaction. However, this must be balanced with the cost to carry goods.

The best way to manage stockout is to determine the acceptable level of customer service for the

business. One can then balance the need for high satisfaction with the need to reduce inventory

costs. Customer satisfaction must always be considered ahead of storage costs.



CYCLICAL COUNTING

Many companies prefer to count inventory on a cyclical basis to avoid the need for shuttingdown operations while stock is counted. This means that a particular section of the warehouse or

plant is counted physically at particular times, rather than counting all inventory at once. While

this method may be less accurate than counting the whole, it is much more cost effective.

Cyclical counting is preferred because it allows for operations to continue while inventory is

taken. If not for this practice, a business would have to shut down while counts were taken, often

requiring the hire of a third party or use of overtime employees. Cyclical counting usually

utilizes the ABC rule, but there are other variations of this method that can be used. The ABC

rule specifies that tracking 20 percent of inventory will control 80 percent of the cost to store the

goods. Therefore, businesses concentrate more on the top 20 percent and counter other goods

less frequently. Items are categorized based on three levels:

• A Category: Top valued 20 percent of goods, whether by economic or demand value

• B Category: Midrange value items

• C Category: Cheaper items, rarely in demand

Warehouse staff can now schedule counting of inventories based on these categories. The “A”

category is counted on a regular basis while “B” and “C” categories are counted only once a

month or once a quarter.



FLOW MANAGEMENT

Manufacturers are less likely to use cyclical counting and often rely on flow management, byanalyzing cycle times in the manufacturing process. This involves calculating lead times for raw

materials and the manufacture time in which the materials are used to create the product. By

analyzing the time cycle, manufacturers learn when the optimal ordering times are for raw

materials.

SPECIAL CONCERNS FOR RETAIL

Retail businesses have a greater risk of loss to goods than other businesses. They suffer fromshrinkage due to employee and third party theft on a regular basis. Because of this, hiring

practices play an important role in inventory control for these businesses. By screening potential

employees for criminal records and drug use, retailers are able to reduce shrinkage.



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Warehouses are full of boxes and boxes of stock. These boxes are full of items that must betracked using some system or method in order to keep up with them. One of the best ways to

keep up with stock is to assign it a Stock Keeping Unit (SKU). An SKU is a number or code that

is used to identify individual products and services which can be purchased.

An SKU is a stock number used by businesses and merchants that allows them to track inventory

and services from point of distribution to point of sale. SKU is a type of data management

system. Each individual item or package is given a code either by the distributor or the business

owner. There is an SKU code applied to every product, item, or other forms of goods that can be

purchased by a customer.

SKU are not necessarily assigned to just physical products. They also are used to identify

services and fees. As some companies provide services, they use SKU’s for billing. As an

example, if a computer store repairs a customer’s computer; they use an SKU to determine what

services were completed in order to fill out a bill for services rendered. All SKU tracking varies

from business to business and according to regions and corporate data systems. SKU also varies

from other product tracking systems due to manufacturer regulations or even government

regulations.

HOW DOES SKU FUNCTION?



SKU’s are typically printed as a barcode on a label somewhere on the product. This makes it

easy and quick to find the products information by scanning it with a barcode reader.

Every item and variant item has its own SKU. This means that slightly different models have

different tracking codes which make it easier to keep up with the items. The first part of a SKU

may contain the code for that type of product while the second part of the code may represent the

color or style. Not only is the SKU given to an item, the same number is also used on the

packaging. So if a box contains 12 widgets that all have the same SKU, then the box will also

have the same SKU code.

Retail stores generally track the individual items through their store while warehouses track the

boxes. While pretty self-explanatory in a store, this can get tricky when ordering items online or

through catalogs. Since the SKU represents the number of units in the item, you should read

carefully to make sure you are ordering the desired quantity. In some cases, a quantity of 1 may

mean one box full of a dozen separate products. The problem arises when you only need one

product, not a dozen.

SKU can also be used to determine how many sales occur at each separate location or where the

inventory is stored. SKU can be used to track products through the supply chain as well as to use

for inspecting sales data. SKU can tell if certain products sell better than other products. Another

benefit of using SKU is with seasonal products that need to be updated every year. Some SKU’s

contain the year somewhere in the code. If product from the following year is going to be used in

a new year, then the year in the code can be changed. This is useful for products that do not

change from year to year.

Luckily for distributors, there have been advances in computer software and systems that makethe task of giving a product an SKU much easier. This new technology has made the task easier

and more convenient , not to mention more accurate because it is free from human error.



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Look at any large successful retailer today and you will be astounded at the sheer numbers

involved. Wal-Mart alone carries items manufactured in over 70 countries. The logistics of

managing such an inventory is astounding. Other discount retailers like Wal-Mart are able to

maintain low prices by using inventory management systems and sharing the information with

store managers.

The goal of inventory management systems is to ensure there is always enough supply to meet

demand while keeping as little stock as possible. Selling out of a product causes damaged

customer relations and lost sales. Large retailers can offset these problems by offering low costs

to consumers, who will keep coming back even when a store is sometimes out of stock on items

they regularly buy. Smaller businesses will have less success with this strategy as they are simply

not capable of securing the same bulk discounts on goods that larger retailers benefit from.

TRACKING IN INVENTORY MANAGEMENT

Inventory is managed primarily through tracking. Systems are put in place that monitor sales,

available supply, demand and market forecasts. Businesses must be able to communicate quickly

and efficiently with suppliers and central offices to keep up with the every changing demand and

availability of goods.

THE HUMAN ELEMENT



A good system does not make purchasing decisions directly, but allows employees to make good

decisions based on information provided by the system. Such systems provide information such

as demand forecasting, and warehouse supply information. Other benefits to a inventory

management system allow for strategic planning, providing sales forecasts and procurement

information on raw materials and finished goods. Some retailers avoid the need to manage

inventory altogether by employing vendors to do the work. Product vendors visit a retail

location, stocking and placing products. Store managers and vendors share information to

maximize sales. This reciprocal arrangement is often ideal for both parties in that the retailer has

no duty to track inventory and the vendor receives important feedback to use in marketing and

product development.

Bar Codes and Scanners

Most businesses manage inventory through the use of bar codes and laser scanners. The barcodes

represent a product identification that a computer recognizes when scanning the code. In this

way, companies can count items as they come into the warehouse, are shipped off to the retailer

and finally sold to a customer. This allows the retailer to know how much has come into the

store, how much has been sold, and by extension, how much should remain on the shelves. Thistells retailers which items are selling well and also alerts them when products need to be

reordered.

THE TRADE OFF

Maintaining a backup supply of goods ensures you can always provide items to customers when

they are desired, resulting in high customer satisfaction. Time is saved as well. Lags can occur at

every point along the supply chain. Safety stock compensates for these delays be preventingdisruptions in the flow of products from warehouse to retailer. As demand fluctuates, they can be

sure a supply remains on hand. There are also cost savings in buying large lots, so businesses are

well served to purchase extra inventory to keep as safety stock.

UPCOMING TECHNOLOGIES IN INVENTORY MANAGEMENT



In coming years, expect to see more automation in respect to product tracking through the use of

RFID (radio frequency identification). This method uses a microchip to transmit the information

about a product to a data collection source. Because radio waves travel in all directions, there is

no need for a specific scanning point. This means a business can receive information about each

item in a large shipment without ever opening the container. This will allow for greater

flexibility in order consolidation and shipping for resellers. The method can also give specific

location information to a store manager, allowing better theft protection for high-ticket items.

Businesses can run into problems with RFID signals, which can interfere with each other and

create inaccurate readings. Still, RFID is generally becoming accepted as superior to bar codes.

Such devices allow for more efficiency, more compact storage of merchandise, and swifter

movement of inventories through the business. All this drives down costs for everyone, both

business and consumer alike. Heavy reliance on technology has its share of headaches. There are

problems with computer crashes and software failures that can severely disrupt a company’s

ability to do business. Many large discount retailers are caught off guard by unpredicted surges

in sales because they rely too heavily on inventory management systems instead of keeping

safety stock. This results in lost sales.

INVENTORY ACCOUNTING

It is also important to look at the role of inventory management systems in inventory accounting.

Businesses who do not keep safety stock have fewer assets on the books, limiting cash flow in

the business. The big retailers who rely heavily on technology to manage inventory justify the

lost sales with the savings in taxes. The level of reliance on technology in inventory management

systems depends on the business. It is notable that this methodology is not widely used. While

larger retailers have trended towards reducing or eliminating safety stock, other businesses have

not adopted this model. They instead rely more on traditional methods of inventory management

which include keeping a buffer stock on hand. This allows such companies to leverage the buffer

stock as an asset in securing loans to increase cash flow.



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Inventory accounting is the method by which a business determines the value of assets both for

financial statements and tax purposes. Inventory is comprised of fixed assets that are intended for

sale or being used in production. The value of your inventory is determined by taking the value

of the beginning inventory, adding the net cost of purchases, and then subtracting the cost of

goods sold. This results in the ending inventory value. Retailers and manufacturers cannot

expense the cost of goods sold until those goods have actually been sold. Until then, those items

are counted as assets on the balance sheet.

COMMON INVENTORY VALUATION METHODS

The methods a company uses to value the costs of inventory have a direct effect on the business

balance sheets, income statements and cash flows. Three methods are widely used to value such

costs. They are First-In, First-Out (FIFO), Last-In First-Out (LIFO) and Average Cost. Inventory

can be calculated based on the lesser of cost or market value. It can be applied to each item, each

category or on a total basis.

FIFO

FIFO operates under the assumption that the first product that is put into inventory is also the

first sold. An example of this in action can be made when we assume that a widget seller

acquires 200 units on Monday for $1.00 per unit. The next day, he spots a good deal and gets 500

more for $.75 per unit. When valuing inventory under the FIFO method, the sale of 300 units on

Wednesday would create a cost of goods sold of $275. That is, 200 units at $1.00 each and 100

units at $.75 each. In this way, the first 200 units on the income statement were valued higher.

The remaining 400 widgets would be valued at $.75 each on the balance sheet in ending

inventory.

LIFO



LIFO assumes instead that the last unit to reach inventory is the first sold. Using the same

example, the income statement and balance sheet would instead show a cost of goods sold of

$225 for the 300 units sold. The ending inventory on the balance sheet would be valued at $350

in assets. When this method is used on older inventories, the company’s balance sheet can be

greatly skewed. Consider the company that carries a large quantity of merchandise over a period

of 10 years. This accounting method is now using 10-year-old information to value its assets.

WEIGHTED AVERAGE

Average Cost works out a weighted average for the cost of goods sold. It takes an average cost

for all units available for sale during the accounting period and uses that as a basis for the cost of

goods sold. To site our example again, we would calculate the cost of goods sold at [(200 x $1) +

(500 x $.75)]/700, or $.821 each. The remaining 400 units would also be valued at this rate on

the balance sheet in ending inventory.

SPECIFIC IDENTIFICATION

A less commonly used, but important method to valuation is called specific identification. This

method is used for high-end items that are more easily tracked. In some cases, this method can

be used for more common items, but less value is realized from this accounting method is such

cases. This is because powerful and detailed tracking software is required to employ specific

identification on large numbers of goods.

INFLATIONARY EFFECTS ON VALUATION



No matter how you look at it, you are still coming up with 700 widgets that cost you a total of

$575. This would all be well and good if the value of money remained static. However, market

conditions change causing inflationary changes. When this happens, your accounting method can

have a strong impact on how healthy the business looks on income statements and balance

sheets. The affects cash flow when businesses seek credit to pay for ongoing operations.

RISING PRICES

When prices are rising, using FIFO will show a greater value on the balance sheet, thereby

increasing tax liabilities but also improving credit scores and the ability to borrow cash for

ongoing operations. Older inventory is being used to determine the cost of goods sold and newer

inventory is being used to report assets. LIFO decreases the value on the income statement, but

can reduce the level of depreciation you are able to take on assets. This is good for taxes but bad

for borrowing. Industries most likely to adopt LIFO are department stores and food retailers. The

method is rarely used in defense or retail apparel.

FALLING PRICES

When prices are falling, the effect on FIFO and LIFO values is reversed. FIFO produces a lower

income statement and higher balance sheet. LIFO produces a higher income statement and a

lower balance sheet. In either case, Average costs falls somewhere between, while specific

identification will give the most accurate and reliable results. It is important to understand that

LIFO is only used widely in the United States. This valuation method is disallowed under

International Financial Reporting Standards. When firms adopt LIFO, it is for the tax advantages

during periods of high inflation. Once adopted however, switch back to FIFO during a period of

market growth can be painful. The switch will create an artificially lower net income.

MAKING THE COMMITMENT



The problem with committing to either FIFO or LIFO is found in tax filing. Once a company

uses one or the other on its tax filing, it must use the same method when reporting to

shareholders. So using one method to a company’s benefit on taxes can harm earnings per share.

In either case, the company’s financial statements must disclose the method used. It must also

disclose the LIFO reserve, or the difference in value between what the inventory would have

been worth under FIFO accounting. The method a company chooses does not necessarily have to

reflect the actual flow of goods. The method chosen will be used for tax and accounting benefits

and will rarely be based in reality.

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Distressed inventory is comprised of those goods or materials that have spoiled, become ruined,

or are otherwise impossible to sell on the standard market. It can also be items in good condition



that have remained on the shelf too long, taking up valuable resources that could be used towards

more profitable merchandise. Sometimes distressed inventory comes about due to overstock;

other times, demand simply dries up. Distressed inventory is a serious threat to the livelihood of

any business.

THE COST OF DISTRESSED INVENTORY

For many businesses, the cost to buy goods for sale or manufacture eclipses even the cost of

labor. When inventory levels are allowed to grow beyond sales forecasts, margins are reduced

because excess stock must be sold at discounted rates, resulting in lower margins. Stagnant

inventory is a source of money a business cannot access when it may be most needed. This slowsdown a company’s ability to maneuver in a competitive market. The money would be put to

better use in purchasing the next high-margin product of the day.

Beyond tying up dollars, unsold inventory declines in value over time, creating a double

jeopardy. Not only is the business losing profits it could be securing, it is also losing monetary

value on the product itself. This makes it harder to sell, forcing deeper discounts and lower

margins. This is especially damaging if the inventory was purchased with a loan. Now it is also

costing to company money in interest fees.

PRODUCT LIFE CYCLES

Every product stocked by a company has a life cycle. There will be increasing demand until a

peak is reached and then the demand will subside. These trends may run along seasonal lines or

simply be a one-time fad event. Once demand begins to ebb, huge mark downs are needed to

keep sales going. The value of the merchandise can go down as much as 50% annually while it

sits on the shelves taking up the space of cash that could be used to grow the business.

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Overstocking comes from several sources, most of which are forces from within the company.

This means the business can control overstocking through proper management. Market forces are

only the cause of overstocking in a small percentage of cases.

INTERNAL CAUSES OF OVERSTOCKING

Various managers are encouraged to maximize inventory investments to paint a rosier picture on

balance sheets. In addition, buyers look at the cost per unit, rather than paying attention to the

bulk of the inventory. The more they buy, the cheaper they get it, making them look good at

review time. Operations managers like to over-buy so that the production line will not come to a

stall because the supply of a part has been depleted. Salesmen are ever-optimistic and will over-buy in anticipation of gains in sales and fears of running out of stock just when a big sale is being

closed. The various motivations of these workers are well-intentioned, but they lose sight of the

effects over-buying has on the company’s bottom line.

TRYING NEW ITEMS

Market forces can also contribute to over stocking and dead inventory. The biggest culprit is

often a new product that the business tries in an effort to find new sources of profit. Too often

wholesalers try out new items based on a vendor’s recommendations without getting any

assurances about what will happen to items that do not sell. When agreeing to try a new product,

wholesalers should negotiate terms for the vendor to take back unsold merchandise at or near

cost, within a specific time frame. A good target date is six to nine months after the wholesaler

receives shipment of the stock.

Another way to reduce the risk of dead inventory on new products is to search the market for

smaller quantities of the item that can be tested to see how the sales will be. Even if the cost per

unit is higher, the reduction in dead inventory will be well worth the extra cost.

WHAT TO DO ABOUT DEAD INVENTORY



Distressed or “dead” inventory is a problem for any company in the distribution business. While

sooner or later every company must deal with this problem, any business caught in a cycle of

over-buying must take measure to break the trend. This means ridding the business of distressed

inventory, freeing up cash to purchase goods that will sell quickly and monitoring stock more

closely in the future. Managers must be level-headed and sober in assessing the steps needed to

liquidate the inventory.

MARK DOWNS

The most popular method for ridding the business of distressed inventory is to mark the goods

down for quick sale. It is common for businesses to keep a regular practice of scheduled mark downs as long as particular products remain in inventory. Managers must be merciless in

discounting merchandise to make it move quickly. While marking items down as much as 75%

can be painful, the cost of keeping the goods is even more so.

RETURNS

In some cases, the company can communicate with distributors to request that they take back

excess inventory. Proposals should be structured in a way that benefits the distributor, such as

offering the merchandise in exchange for other merchandise that may sell better.

In some cases, the company can communicate with distributors to request that they take back

excess inventory. Proposals should be structured in a way that benefits the distributor, such as

offering the merchandise in exchange for other merchandise that may sell better.

CHARITABLE DONATIONS



If all else fails, charitable donations are always an option. If goods have been drastically reduced

and still remain on the shelves, a charitable donation allows the business to write the donation off

on taxes.

MONITORING STOCK

Close monitoring of inventory levels is needed to keep them at healthy limits. Cycle counting

should be done to maintain control of stock on a regular basis. This allows the business to spot

problems before they cause serious financial concerns. In addition, strong inventory manage-

ment systems should be kept in place that base purchase decisions on market forecasts and

stock levels, not on the influence of salespeople or operations managers.

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Inventory credit is the business practice of using a company’s stock or inventory as collateral for

a loan. Ost banks, especially in today’s economy, are reluctant to issue unsecured loans, even to

established companies with good credit. But inventory represents a company’s physical assets

and has cash value if liquidated.

The concept of inventory credit started in ancient Rome with agriculture and merchant goods.

One common product that uses inventory credit for financing and can be found in any grocery

store is parmesan cheese from Italy. Inventory credit is also used for agricultural businesses in

Latin American and Africa, manufacturing, and automobile dealers with a lot of money tied into

their inventory.

HOW INVENTORY CREDIT WORKS

Before you can get a loan using inventory credit, you need a few things. Your business needs to

have a good credit rating. This means it needs to be current with all bills and no outstanding

accounts. The second thing needed to make a list, along with estimated value, of the inventory to

be used. You also need to have a business plan worked out to pitch to the bank for the loan.

Inventory values can fluctuate depending on the economy and the particular industry of the

company. To make sure they do not lose money should inventory values plummet, banks usually

only lend up to 60 percent of the total value of the inventory being used. Plus, physical inventory

can be liquidated but you would not get the full value for it.

The bank will inspect any inventory before they approve a loan. They will want to know exactly

what they are loaning the money for and what kind of condition the collateral is in. If the loan is

approved, the bank has the right to inspect the inventory at any time.

When inventory is sold, it is up to the owner to keep track of it. A portion of the profits will need

to go towards paying off the loan. Banks tend to frown on companies that borrow money based

on inventory credit and then sell the inventory without paying off the loan.

In agriculture, inventory credit works a little different. The produce that is used for the loan has

to be stored in a reliable and bonded warehouse by a third party. In agriculture, inventory credit



is used for imported produce, produce ready to be exported, and domestic products. The

warehouse owner that stores the produce has to ensure that it remains in good condition and is

secure. The agricultural company that borrows the money is charged a fee for the storage of the

produce and to insure it against damage. This inventory credit process is used widely in Africa

and parts of Asia

WHEN SHOULD INVENTORY CREDIT BE USED?

Inventory credit is not a practical means of financing for every business. It largely depends on

the type of industry you are in as well as the current state of the economy. Businesses that should

not use inventory credit are those will a low turnover rate for their inventory. This means that if your inventory sits there for a long time and cash flow from it is slow, you would be better off

finding an alternative means of financing. Otherwise, you may have a difficult time paying back

the loan. This is also true for inventory that is out of date, expired, or obsolete.

Businesses that would benefit from an inventory credit loan would be those who have a high

turnover rate for their inventory. If business is good and your company is moving a lot of

inventory product but you still need more money in order to keep up with demand, then you

should check out an inventory credit loan.

EECCOONNOOMMIICC OORRDDEERR QQUUAANNTTIITTYY



Economic Order Quantity is the calculating method used to determine the best level of inventory

for production while being the most cost effective for holding and ordering. EOQ, as it is

referred to, has been around since the rise of modern manufacturing processes back in the early

20th century. The first model for calculating EOQ was designed in 1913 by F.W. Harris.

What EOQ basically does is determine the best point where the costs for inventory holding and

ordering are at the lowest. This helps to determine the number of units of stock to order to re-

supply inventory without spending too much money on overstock.

HOW DOES EOQ WORK?

EOQ is not used in every type of business and industry. Most companies that deal with large

volumes of stock use a form of EOQ. It is common in manufacturing where the ordering of stock

is constant and repetitive. EOQ is primarily used for purchase-to-stock distributors and make-to-

stock manufacturers. These are businesses that have multiple orders, release dates for their

products, and have to plan for their components.

Another type of business that uses EOQ are those that have maintenance, repair, and operating

inventory (or MRO). Businesses that have a steady demand for stock are the most suitable for

EOQ applications but some seasonal items can benefit from the method, too.

HOW TO CALCULATE EOQ



Economic Order Quantity must be calculated using a mathematical equation. By using a set of

numbers for production, demand, and a few other variables, a company’s inventory costs can be

minimizes. Here is the equation for EOQ:

The sub-components that make up the equation are as follows:

Annual Usage – This part is pretty self-explanatory. Based on units, a company simply enters

the predicted annual usage amount.

Order Cost –This component is the sum of the fixed costs that occur every time an item is

ordered. They are not associated with the quantity ordered, only with the actual physical act

required to process the order. Also known as purchase cost or set up cost.

Carrying Cost – This part is the financial costs of carrying and storing inventory at or near the

business. The amount is mostly made up of the costs associated with physically storing the

inventory and the financial investment for the inventory. It is also referred to as holding cost.

As long as the data used for the calculations is accurate, this formula is a good method for

determining EOQ. Miscalculations such as exaggerated costs are common mistakes. If a

company only uses the data from purchasing and receiving, or from product storage and

handling, the calculations will yield very high numbers. Sometimes the goals of a company donot meet the product of the EOQ calculations. When this happens, company leaders and

executives usually ignore the EOQ calculations. The EOQ formula is not absolute and can be

modified slightly from its original form. It can be used to determine many things such as

production levels and lengths of time between orders.

IMPLEMENTING EOQ



There are two main methods to implement EOQ in a business. It is assumed before you do that

the data for costs have already been gathered. The first method is to use a spreadsheet and

manually enter the quantity one at a time onto the inventory sheet. While simple, this can be very

time-consuming. It also works best for companies that deal with smaller amounts of inventory.

If the company in question has a large inventory, say more than several thousand units, then you

will have to use the EOQ software along with your existing inventory system. This method will

calculate it at a much quicker rate and save money on manpower and resources.

The second method you can use is to download company data to a spreadsheet. Once the

calculations are finished, you can upload them to your inventory system manually or with a batchprogram. Either way will work.

To make sure that the EOQ you are using for your company is running efficiently, there are some

things you can do. The first is to run a test on the model. This should be done before the EOQ

model is finalized to make sure it is accurate and no glitches are involved. The best way to test it

is to run the method on a sample batch of items. Afterwards, manually check the results to make

sure they match the model’s final numbers.

Adjust the EOQ formula if needed. By running tests, you can determine how the method will

work on inventory storage and ordering costs. Try to look at a long term plan if possible. Small

changes may not be readily apparent with the model and may only become noticeable over time.

To reach the best inventory level, the EOQ model may need to be slightly adjusted.

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