Techniques of Inventory Management – Classification
The forms of inventories existing in a manufacturing enterprise can be classified into three categories:
(i) Raw Materials:
These are those goods which have been purchased and stored for future productions. These are the goods which have not yet been committed to production at all.
These are the goods which have been committed to production but the finished goods have not yet been produced. In other words, work-in-progress inventories refer to ‘semi-manufactured products.’
(iii) Finished Goods:
These are the goods after production process is complete. Say, these are final products of the production process ready for sale. In case of a wholesaler or retailer, inventories are generally referred to as ‘merchandise inventory’.
Some firms also maintain a fourth kind of inventory, namely, supplies. Examples of supplies are office and plant cleaning materials, oil, fuel, light bulbs and the like. These items are necessary for production process. In practice, these supplies form a small part of total inventory involving small investment. Therefore, a highly sophisticated technique of inventory management is not needed for these.
The size of above mentioned three types of inventories to be maintained will vary from one business firm to another depending upon the varying nature of their businesses. For example, while a manufacturing firm will have all three types of inventories, a retailer or a wholesaler business, due to its distinct nature of business, will have only finished goods as its inventories. In case of them, there will be, therefore, no inventories of raw materials as well as work-in- progress.
These are broadly classified into three categories:
- Material Costs:
These include costs which are associated with placing of orders to purchase raw materials and components. Clerical and administrative salaries, rent for the space occupied, postage, telegrams, bills, stationery, etc. are the examples of ordering costs. The more the orders, the more will be the ordering costs and vice versa.
- Carrying Costs:
These include costs involved in holding or carrying inventories like insurance charges for covering risks, rent for the floor space occupied, wages to laborers, wastages, obsolescence or deterioration, thefts, pilferages, etc. These also include opportunity costs. This means had the money blocked in inventories been invested elsewhere in the business, it would have earned a certain return. Hence, the loss of such return may be considered as an ‘opportunity cost’.
The above facts underline the need for inventory management, i.e., to decide the optimum volume of inventories in the firm/enterprise during the period.