Entrepreneurial Finance: Fundamentals of Financial Planning and Management for Small Business

CHAPTER 12 INVENTORY MANAGEMENT AND CONTROL

12.1 What is Inventory?

Inventory refers to all items related to the firm's inputs and output, which would be stocked up. It includes three types:

1. Raw material for production
2. Work-in-process or any partially produced items, which are out of the intermediate phase of production
3. Final product that is ready to be sold

Usually, market demand for a product would play a direct and significant role in the estimation of the level of the third type of inventory, the final product. Once this part has been estimated, it should become clear to estimate the required levels of the raw material, and intermediate products that are required to produce and maintain the inventory level of the final product. Inventory is a significant and expensive part of the firm's total investment. Its value could reach to half or more of the value of all assets. This monetary significance is one reason why inventory planning and control is crucial for most businesses. The other reason is its paradoxical role in the general business planning. On the one hand, inventory level needs to be enough to smoothly satisfy market demand and avoid any stockouts and backorders, as well as avoid any potential dissatisfaction by customers who could be lost to competition. On the other hand, any financial manager would like to keep the cost of inventory down by minimizing its level and freeing up funds for other purposes. Furthermore, another kind of contradiction involving inventory ...