Page 239 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 11: Inventory Management

(c) Sale lag: Once goods have been sold, they normally do not create cash immediately. Notes
Most sales occur in credit and accounts receivable is created. The firm has to wait to
collect receivables. This lag also represents a cost to the firm.
4. Circulating activity: Inventories get rotated with other current assets. They get converted
into cash and then invested again in inventory to continue the operating cycle.

11.1.1 The Purpose of Inventories

The specific benefit that accrue from holding inventories can be identified as follows:
1. Avoiding lost sales: In most cases, a firm must be prepared to deliver goods on demand
without goods on hand which are ready to be sold, most firms would lose business. Shelf
stock refers to items that are stored by the firm and sold with little or no modifications to
custome An automobile is an item of shelf stock even though customers may specify
minor variations, the basic item leaves a factory and is sold as a standard item. The same
situation exists for many items of heavy machinery, consumer products and high industrial
goods.
2. Getting quantity discounts: Due to bulk purchases many suppliers will reduce the price of
suppliers and component parts or may offer discounts.

3. Reducing orders costs: By reducing the number of orders, the administration costs for
raising purchase orders, acceptance and inspection note gets reduced.

4. Achieving efficient production runs: Frequent setups produce high start up costs, longer
runs involve lower costs.

Inventories provide a ‘buffer’ between purchasing, producing and marketing goods. Raw
materials and other inventory items can be purchased at appropriate times and in proper
amounts to take advantage of economic conditions and price incentives. The manufacturing
process can occur in sufficiently long production runs and with pre-planned schedules to
achieve efficiency and economies.
5. Reducing risk of production shortages: Manufacturing from produced goods with hundred
or even thousands of components. One of them, however, small it may be, is to be in stock
if the production is to be continued for a longer spell.
6. In-process inventory provides flexibility in production scheduling so that an efficient
schedule and high utilization of capacity may be attained within in process inventory; a
bottleneck at any stage in the production process renders idle the machines and facilities
at subsequent stages.
7. Finished goods inventory enables a firm to double its production programme and
marketing activities so that desirable results can be achieved on both the fronts. If finished
goods inventory is available, the marketing department can meet the needs of customer
promptly, irrespective of the quantity and composition of goods flowing out of the
production time currently.
11.1.2 Types of Inventory

Four types of inventories may be identified:
1. Raw material inventory: This consists of basic materials that have not been committed to
production in a manufacturing firm. Raw materials that are purchased from time-to-time

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