Inventory methods: Which are the best and how to choose?

Raw material inventories are a crucial stage in supply chains: These serve as inputs to a particular stage of the production process, as inventories of finished products serve to meet the needs or demands of customers. Because these inventories often represent a considerable investment of financial resources, the decisions on the quantities of inventories are quite important. Inventory models and the description of inventory systems are the main criteria for this decision making.

Keeping an inventory for its sale or future use is a common practice in the business world. The relevant question, then, is how a company decides its inventory policy, essentially about when, how much, and how it is replenished. To answer this question, it is key to know some of the best inventory systems.

Inventory models are usually classified depending on the type of demand of items. This demand may be whether deterministic or probabilistic. The first one is the type of demand for articles in which the future period is precisely known, generally, companies that work on demand, such as Amazon. The probabilistic demand is one in which although the future period of demand for an article is not known; it is possible to establish a probability distribution to its eventual sale. Any article may be classified into one of these two categories.

To this extent, before knowing how to make an inventory, it is important to know both the type of demand for your products as well as their nature. Products can be perishable or durable, for example, and this is also a determining factor when choosing an inventory method. Moreover, any inventory model must include three elements. The first one is the costs: How much does it cost in terms of money, space, energy, and resources? The second is, again, the demand: How much is planned to be sold, and when is the inventoried merchandise planned to be sold? The third one is the time of anticipation: The period that goes from the moment a production order to the moment when the production begins or the purchase is received.

Read also: An Effective Approach for Implementing Just-In-Time Inventory, by David Kiger

One of the most popular inventory methods is the ABC classification system. In this system, a level of existence control is set to classify products to reduce control times, energy expenditure, and inventory management costs. The time and costs that companies invest in the control of each and every one of their products and merchandise are unimaginable. This is the main justification for this classification system. Now, products are organized according to their importance and value in three ways. The first one corresponds to the type of products that, due to their high cost, high investment in inventory, and the level of contribution to profits, require constant and careful control of their stocks (jewelry, for example.)

tea-box-package_logistics_inventory_supply chain
Image courtesy of Breakingpic at Pexels.com

The second one relates to the type of products that are less costly and less important, and, therefore, require less strict control (e.g. building materials.) The third one is related to low-cost products, with low investment and little importance for the production process (scrap and recyclable material, for example,) and which, consequently, need an almost nonexistent level of control.

Unit price classification is another widely used method for inventories. It’s simple, but it requires constant monitoring. To do this, you need to know the average unit price of each item during the months of analysis. Then, you must average the values of all articles. After this, you order them from highest to lowest. In this way, you may know how many items you must take for each zone: Just multiply your percentages by the number of articles. It is simple and safe.

Classification by total value is another way of doing things. Here you will have to take into account the total value of the whole inventory and you will have to set a level or percentage of importance for each classification level. The procedures are simple too. First, you must average the total values, and, based on this, order the inventory items in descending price (in three fundamental categories,) and thus establish the control policies and periodicity of the orders.

Finally, another method which is widely used by several organizations is classification by use and value. In this inventory method, by only using historical data you take into account the use or consumption of each article with its corresponding cost. Here it is also necessary to set a level or percentage of importance for each classification level. The normal procedure begins with knowing the consumption of each product for the same unit of time, as well as the cost of each unit of product (this will allow establishing the control policies and periodicity in the orders.) Then, the inventory items are sorted in descending order based on the value of the inventory consumed in three categories.

I hope this information is useful for your business. See you next time!

Recommended: The Role of Inventory in Supply Chain Management

* Featured Image courtesy of Moto “Club4AG” Miwa at Flickr.com

 

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