Inventory Management

Written by True Tamplin, BSc, CEPF®

Updated on July 22, 2022

Inventory Management: Definition

Inventory management is the process of fixing the minimum and maximum limits of an inventory and determining the size of inventory to be maintained.

Inventory management encompasses considerations relating to issue prices, norms of receipts and inspections, determining the economic order quantity (EOQ), providing proper store facilities, and keeping an effective check on obsolescence.

Inventories are the goods that will be sold in the future in the normal course of business operations.

Coverage of Inventories

Inventories consist of:

  • Raw Materials: These are the basic materials used for production
  • Work-in-Progress: These are raw materials that have been applied in the production process but that have not been finished
  • Finished Stock: These are the final products available for sales made out of raw materials

Benefits of Holding Inventory

Holding inventories is useful to a firm in the processes of purchasing, producing, and selling. Companies that do not hold adequate inventories of raw materials and finished goods may lose customers or suffer from delays in supplying goods as per their orders.

The following are the benefits of holding adequate inventories:

1. Customer Service: A company with sufficient reserves of stock will not lose customers and will supply goods within a reasonable time. Therefore, holding inventory can have positive externalities regarding customer service.

2. Discounts: Large purchases of raw materials and finished goods are likely to lead to greater discounts than would otherwise be the case with smaller purchases.

3. Lower Ordering Costs: When companies purchase raw materials and finished goods in large quantities, they reduce the ordering cost in terms of preparing new orders, checking and validating receipts, and communicating with suppliers.

4. Lower Setup Costs: Maintaining an adequate inventory is useful for a company because it will benefit the production setup cost, which further results in a lower per-unit cost of output.

5. Continuous Production Schedule: Adequate inventory is useful for the production schedule because it ensures that production can continue at all times, thereby ensuring customer demand is met.

6. Employment Stability: Adequate inventory is useful for employment stability as it coordinates production and distribution. When adequate inventory is not kept, it is a possibility that production will suffer and employment stability will be in danger.

7. Reasonable Return On Capital Employed: When inventories are excessive, the company has deployed its funds in a way that won’t generate a return. The company’s liquidity will suffer and, thus, an adequate inventory should be maintained.

Inventory Management FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.