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This web site is designed to help navigate
you through the mountain loads of information about inventory
management.
The purpose of holding inventories is to allow the firm to separate the processes of purchasing, manufacturing, and marketing of its primary products. The goal is to achieve efficiencies in areas where costs are involved and to achieve sales at competitive prices in the marketplace. Within this broad statement of purpose, we can identify specific benefits that accrue from holding inventories. 1. Avoiding Lost Sales: Without goods on hand, which are ready to be sold, most firms would lose business. Some customers are willing to wait particularly when an item must be made to order or is not widely available from competitors. In most cases, however, a firm must be prepared to deliver goods on demand. Shelf stock refers to items that are stored by the firm and sold with little or no modification to customers. An automobile is an item of shelf stock. Even though customers may specify minor variations, the basic item leaves a factory and is sold as a standard item. The same situation exists for many items of heavy machinery, consumer products, and light industrial goods. 2. Gaining Quantity Discounts: In return for making bulk purchases, many suppliers will reduce the price of supplies and component parts. The willingness to place large orders may allow the firm to achieve discounts on regular prices. These discounts will reduce the cost of goods sold and increase the profits earned on a sale. 3. Reducing Order Costs: Each time a firm places an order, it incurs certain expenses. Forms have to be completed, approvals have to be obtained, and goods that arrive must be accepted, inspected, and counted. Later, an invoice must be processed and payment made. Each of these costs will vary with the number of orders placed. By placing fewer orders, the firm will pay less to process each order. 4. Achieving Efficient Production Runs: Each time a firm sets up workers and machines to produce an item, startup costs are incurred. These are then absorbed as production begins. The longer the run, the smaller the costs to begin producing the goods. As an example, suppose it costs $12,000 to move machinery and begin an assembly line to produce electronic printers. If 1,200 printers are produced in a single three-day run, the cost of absorbing the startup expenses is $10 per unit (12,000/1,200). If the run could be doubled to 2,400 units, the absorption cost would drop to $5 per unit (12,000/2,400). Frequent setups produce high startup costs; longer runs involve lower costs. These benefits arise because inventories provide a "buffer" between purchasing, producing, and marketing goods. Raw materials and other inventory items can be purchased at appropriate times and in proper amounts to take advantage of economic conditions and price incentives. The manufacturing process can occur in sufficiently long production runs and with pre-planned schedules to achieve efficiency and economies. The sales force can respond to customer needs and demands based on existing finished products. To allow each area to function effectively, inventory separates the three functional areas and facilitates the interaction among them. Reducing Risk of Production Shortages:
Manufacturing firms frequently produce goods with hundreds or even
thousands of components. If any of these are missing, the entire
production operation can be halted, with consequent heavy expenses. To
avoid starting a production run and then discovering the shortage of a
vital raw material or other component, the firm can maintain larger than
needed inventories.
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