Inventory analysis definition
/What is Inventory Analysis?
Inventory analysis is the examination of inventory to determine the optimum amount to keep on hand. Traditionally, this has been done by balancing the costs of ordering and holding inventory (known as the economic order quantity). However, considerably more inventory analysis must be conducted to account for additional factors, including the following:
Just-in-time ordering. A business may have a just-in-time system, which is designed to minimize the amount of inventory on hand. In this situation, suppliers are likely to be close by and able to deliver small quantities with great frequency. If so, the amount of inventory kept on hand may represent only a few hours of usage. However, this presents the risk of a complete production shutdown if there is a delayed delivery. Consequently, many organizations strive to maintain a modest amount of safety stock to act as a buffer.
Order fulfillment philosophy. If management wants to reduce the turnaround time on orders placed by customers, it may be necessary to store large amounts of finished goods inventory near the shipping area, in every possible product configuration. This can be a real concern when a business maintains large numbers of stock keeping units, since the related inventory investment can be astronomically high. Conversely, rapid order fulfillment is easier when the range of product options is strictly confined to a small number of items.
Inventory obsolescence. If a company manufactures goods that are only relevant in the marketplace for a short period of time (such as consumer electronics), it will need to maintain tight control over the amount of inventory kept on hand. This is also a concern when the inventory can spoil in a few days, as is the case with food inventory in a restaurant.
Cash availability. If an entity has little excess cash, it will have little to invest in inventory, and so is forced to keep inventory levels lower than may be optimal. This could involve accepting stockout conditions, where customers must wait for extended periods before goods are delivered to them. An extreme scenario is that the company maintains no inventory at all, and instead only places orders for inventory from suppliers after it has received payment from customers.
Customer service levels. If a business wants to compete based on high levels of customer service, then it will likely need to maintain a significantly higher investment in inventory, so that the goods customers want are always in stock. A high level of customer service can correspond to a substantially higher investment in inventory.
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In short, inventory analysis involves more than the use of a single calculation to determine inventory levels. Instead, a number of factors involving company strategy, production systems, financing, and the requirements of the marketplace must all be examined to arrive at the optimal inventory level.
Advantages of Inventory Analysis
There are multiple advantages associated with inventory analysis. One of the key ones is a significant reduction in lost sales. This is because the analysis indicates the quantities of goods to keep on hand for goods that are most likely to sell. Another advantage is a reduction in the amount of working capital needed to support a firm’s inventory investment, since the investment in inventory items with low turnover levels is reduced. A third advantage is increased customer loyalty, since the inventory items that customers actually want to purchase are being kept in stock. A fourth advantage is a reduction in inventory obsolescence charges, since inventory levels are being reduced for those inventory items that are not being used.