Effective Management of Inventory (AQA A Level Business): Revision Note

Reasons to hold inventory

• Inventory is everything a business owns today for the purpose of selling tomorrow

  • It is sometimes called stock, and the terms are used interchangeably

• Businesses hold inventory for immediate use in production or to distribute without delay to customers

Types of inventory

Why hold inventory?

• Businesses hold inventory for several reasons, each helping operations run smoothly despite changes in supply or demand

  • To meet unexpected increases in customer demand without delay, avoiding lost sales

  • To protect against delays or disruption from suppliers, so production can continue even if a delivery is late

  • To take advantage of bulk-buying discounts by purchasing larger quantities of materials at once

  • To allow for smooth, continuous production, rather than depending on materials arriving at exactly the right moment

  • To cope with seasonal or cyclical changes in demand, by building up inventory ahead of a known busy period

Example

A supermarket holds extra stock of umbrellas and raincoats ahead of the wetter autumn months, anticipating a rise in demand

The importance of inventory management

• Inventory management means planning and controlling the amount, location and movement of stock a business holds

• Effective inventory management ensures a business holds enough stock to meet demand and avoid disruption, without holding so much that it wastes money or storage space

The value of inventory management

• Reduces the risk of running out of stock, which can lead to lost sales and dissatisfied customers

• Minimises the cost of holding excess stock, including storage, insurance and the risk of stock becoming obsolete or unsellable

• Frees up cash that would otherwise be tied up in unused stock, improving cash flow

• Supports efficient production, ensuring materials are available when needed without unnecessary delays

• Helps a business respond quickly to changes in demand, by giving accurate, up-to-date information on stock levels

Example

A clothing retailer uses inventory management software to track stock levels in real time across all its stores, moving items from quieter branches to busier ones rather than reordering unnecessarily

Implications of poor inventory management

• Problems may arise from holding too much inventory

  • Storage costs (e.g. warehouse rental, security costs) will be higher than necessary 

  • The risk of inventory shrinkage or spoilage is increased 

  • Excess inventory may need to be sold at a lower price, reducing revenue

• Similarly, holding too little inventory is risky

  • A business may run out of inventory, resulting in production stoppages and higher unit costs due to underused capacity

  • A business may not be capable of meeting a sudden increase in demand 

Influences on the amount of inventory held

Level and predictability of demand

• Unpredictable or highly seasonal demand encourages a business to hold more inventory as a buffer

• Stable, predictable demand allows a business to maintain lower stock levels

Example

A fireworks retailer holds very little stock for most of the year but builds up large amounts of inventory ahead of Bonfire Night, when demand rises sharply and unpredictably

Cost of storage

• High storage costs, such as needing refrigerated warehousing, discourage a business from holding large amounts of inventory

Perishability of the product

• Perishable goods, such as fresh food, must be held in smaller quantities to avoid waste

• Non-perishable goods can be stored in bulk for long periods

Example

A bakery holds only a day or two's worth of fresh ingredients, as they spoil quickly, but can store tinned or dried ingredients for much longer

Reliability of suppliers

• Unreliable suppliers encourage a business to hold more inventory

• Dependable suppliers means a business can maintain lower stock levels

Cost of capital tied up in stock

• Holding large amounts of inventory ties up cash that could be used elsewhere, encouraging businesses to minimise stock where possible

Example

A small business with limited cash available holds lower stock levels, as tying up money in inventory would leave less available to pay staff or suppliers

Lead time for reordering

• The lead time is the amount of time that passes from placing an order until inventory is delivered

• A longer wait between placing an order and receiving stock encourages a business to hold more inventory to avoid running out in the meantime

Just in time vs just in case

The just-in-time approach

• The just-in-time (JIT) approach is where raw materials and components are ordered as required and delivered at precisely the time they are to be used in production

• Raw materials and components are ordered from a small number of trusted key suppliers just before they are to be used

  • Close, long-term relationships with these suppliers need to be developed

    • Many businesses using JIT inventory management systems aim to source raw materials and components from local or regional suppliers

    • They must be flexible and reliable

    • They may be required to hold inventory on behalf of a JIT-operating customer

    • They are often in close proximity to their key JIT-operating customer

Evaluating the just-in-time approach

The just-in-case approach

• Just-in-case inventory management involves a business holding a quantity of raw materials, components or finished goods as buffer stock

  • Stock is held in case of shortages so as to provide a competitive edge over rivals unable to meet demand

• The decision to keep buffer stocks is one that businesses have to weigh up very carefully

  • Holding inventory incurs storage and security costs and can increase waste, as stock could be damaged, stolen or become obsolete

  • Failing to hold enough inventory could mean a business is unable to meet demand, potentially missing out on sales revenue

Evaluating the just-in-case approach