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What is 'Inventory Management'

Inventory management refers to the process of ordering, storing and using a company's inventory: raw materials, components and finished products.

BREAKING DOWN 'Inventory Management'

A company's inventory is one of its most valuable assets. In retail, manufacturing, food service and other inventory-intensive sectors, a company's inputs and finished products are the core of its business, and a shortage of inventory when and where it's needed can be extremely detrimental. At the same time, inventory can be thought of as a liability (if not in an accounting sense). A large inventory carries the risk of spoilage, theft, damage, or shifts in demand. Inventory must be insured, and if it is not sold in time it may have to be disposed of at clearance prices – or simply destroyed.

For these reasons, inventory management is important for businesses of any size. Knowing when to restock certain items, what amounts to purchase or produce, what price to pay – as well as when to sell and at what price – can easily become complex decisions. Small businesses will often keep track of stock manually and determine reorder points and quantities using Excel formulas. Larger businesses will use specialized enterprise resource planning (ERP) software. The largest corporations use highly customized software as a service (SaaS) applications.

Appropriate inventory management strategies vary depending on the industry. An oil depot is able to store large amounts of inventory for extended periods of time, allowing it to wait for demand to pick up. While storing oil is expensive and risky – a fire in the UK in 2005 led to millions of pounds in damage and fines – there is no risk that the inventory will spoil or go out of style. For businesses dealing in perishable goods or products for which demand is extremely time-sensitive – 2017 calendars or fast-fashion items, for example – sitting on inventory is not an option, and misjudging the timing or quantities of orders can be costly.

For companies with complex supply chains and manufacturing processes, balancing the risks of inventory gluts and shortages is especially difficult. To achieve these balances, firms have developed two major methods for inventory management: just-in-time and materials requirement planning.

Just-in-Time

Just-in-time (JIT) manufacturing originated in Japan in the 1960s and 1970s; Toyota Motor Corp. (TM) contributed the most to its development. The method allows companies to save significant amounts of money and reduce waste by keeping only the inventory they need to produce and sell products. This approach reduces storage and insurance costs, as well as the cost of liquidating or discarding excess inventory.

JIT inventory management can be risky. If demand unexpectedly spikes, the manufacturer may not be able to source the inventory it needs to meet that demand, damaging its reputation with customers and driving business towards competitors. Even the smallest delays can be problematic; if a key input does not arrive "just in time," a bottleneck can result.

Materials Requirement Planning

The materials requirement planning (MRP) inventory management method is sales-forecast dependent, meaning that manufacturers must have accurate sales records to enable accurate planning of inventory needs and to communicate those needs with materials suppliers in a timely manner. For example, a ski manufacturer using an MRP inventory system might ensure that materials such as plastic, fiberglass, wood and aluminum are in stock based on forecasted orders. Inability to accurately forecast sales and plan inventory acquisitions results in a manufacturer's inability to fulfill orders.

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