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Application of Inventory Management to Increase Company Profits

Inventory Management

Inventory management is a department within a firm that is responsible for managing the company's inventory of items. From obtaining inventory to storing it until it is needed or issued, everything is covered.

Inventory management done correctly will boost the company's performance and accelerate its growth and development. Planning, organizing, actuating, and controlling, or POAC, is the starting point for good inventory management.

We'll go through why inventory management is so vital in this essay. What is the purpose of it? How to put it together. Even in relation to other management, the costs that occur.

Definition of Inventory of Goods

There is a distinction between inventory of goods used by a trade company and inventory of goods used by a manufacturing company.

Trading corporations purchase items and resale them in their original form. Inventories are items bought with the goal of reselling them. A distribution firm for soft drinks and mineral water is an example of a trading company.

Manufacturing corporations purchase items and reshape them in order to sell them.

In general, however, the phrase inventory refers to commodities maintained for resale. Alternatively, it could be utilized to make things for sale. The inventory kept by manufacturing companies is made up of various different sorts.

Why Should Inventory Management Be There?

Inventory is a dormant firm asset (idle). Alternatively, assets that are remaining in storage or that are awaiting usage (sold).

Merchandise inventory is an example of inventory (at a trading company).

There are also many forms of inventory in manufacturing organizations, such as inventory of raw materials (materials), semi-finished goods, and finished goods.

Inventory management is both simple and complex. If the available inventory is enormous, it will result in high costs. Every item that is kept must be paid for.

However, if available inventory is insufficient, production activities will be hampered, and there is a risk of losing sales and customers.

Furthermore, there is uncertainty surrounding order timing, supply from suppliers, and demand. Glassware and perishable/rotten objects, for example, require careful handling.

As a result, inventory management is required so that businesses may decide the appropriate amount of inventory while incurring minimal expenditures while still meeting customer demands.

Inventory Management Function

There are several inventory management functions for the company, including:

  • Assuring the availability of inventory (safety stock).
  • Reducing the risk of inventory delivery delays.
  • lowering the risk of price fluctuations
  • Ordering in bulk can save you money.
  • Purchases should be made in accordance with production schedules.
  • Supply and demand variations should be anticipated.
  • Preparing for unexpected requests.
  • Maintain the amount of inventory that is only available seasonally so that the company has inventory of the goods when the material is not in season.
  • Inventory orders that do not match specifications should be supervised and returned to the supplier.
  • Maintain client commitment so that things can be produced on time and in the desired quality.
  • Calculate the amount of goods to have on hand just in case.

Factors Affecting Inventory

Inventory management considers a number of elements that can have an impact on a company's inventory level, including:

The amount of available funds and the availability of funds owned have a significant impact on the priority of purchasing inventory, determining which things are important to purchase and which can wait.

The lead time is the time it takes for an order to be fulfilled from the moment it is placed to the time it is delivered.

The more frequently something is used, the smaller the available inventory becomes.

Inventory durability, inventory with a short shelf life, such as fruit, meat, and similar items, must be issued, sold, or utilized right away.

Cost of Inventory

cost-of-inventory

You might not believe that simply treating inventory might result in a variety of charges.

In general, inventory expenses are divided into four categories:

  • The price of your order (order costs)
  • Costs of storage (carrying costs) 
  • Costs of setup (set up costs)
  • Out-of-pocket expenses (lack of materials)

a. The price of your order (order costs)

Order costs are expenses incurred as a result of placing an order for goods (inventory).

This cost includes all expenses incurred from the time the initial order is placed (order placement) until the ordered goods are received in the warehouse.

The following are some examples of ordering costs:

Costs of Communication

Costs incurred as a result of the necessity for communication during the fulfillment of a purchase order. For example:

Costs of using the phone Fees for faxing There are stamp and correspondence fees (postage fees) as well as a charge/commission fee (if the communication is made by a third party)

Costs of Shipping

The charges of delivering products from the supplier's location to the buyer's warehouse are known as shipping costs. 

The following items are included in the shipping costs:

  • Costs of transportation or expedition 
  • Costs of loading and unloading 
  • Cost of Insurance for shipments

However, there are situations when this is not the case. The shipping fees are covered by some vendors.

Packing Costs (Packing)

The goal of packaging items is to ensure that they arrive in good condition and that flaws are minimized. Don't even think about the cost of this packing.

Example:

Packing expenses can approach 5% of the price of the items if the goods are huge in bulk, breakable, and in large quantities.

For example, with easily scratched ceramics or furniture, the packing technique might be stacked, beginning with tying rope, packing cardboard, plastic wrap, then putting it in cardboard, and finally packing it around wood.

Costs of Order Processing

Companies occasionally place orders for goods, particularly for items that require a high level of precision and quality, such as teak or rattan furniture.

Buyers frequently send representatives to the supplier's manufacturing facility.

Before the product is shipped to the company, the person dispatched will inspect it for quality.

When there is a considerable distance between the supplier and the company that buys the goods, this is usually done in import-export trading or buying and selling.

Buyers do not want the quality of the items to be compromised or lowered after they have been packaged and shipped at a high cost.

b. Costs of storage (carrying costs

Storage costs are expenses incurred to keep items or materials (raw materials) on hand after they have been ordered.

The cost of storage varies depending on the value of the inventory being stored. The following are some examples of storage costs:

Costs of a Storage Facility

All expenditures spent as a result of the facilities necessary to hold goods are referred to as storage facility costs.

The following are some examples of storage facility costs:

  • The expense of renting a warehouse (if you rent and do not have your own warehouse)
  • The cost of lighting Costs of managing air temperature and humidity to keep commodities durable, such as fruit and vegetables, meat, or other foodstuffs that require precise temperature settings.
  • All of the aforementioned costs add up to electricity prices.

Cost of Insurance 

Insurance Costs are expenses incurred to reduce the danger of unfavorable events occurring in stored inventory, such as fire, flood, or collapse due to an earthquake or other major force.

With insurance, at the very least, the disaster-affected items do not result in major material losses.

Costs of Security

Insurance does not always cover damages caused by a security breach in keeping firm inventory, such as theft, robbery, or vandalism.

To avoid this, the corporation will have to pay for things like cctv, security guard salaries, fence construction, and other costs related to safeguarding goods.

Costs of Obsolescence

Inventory maintained for too long becomes outmoded or loses value when a company's revenues drop and inventory turnover becomes very slow.

Clothing and clothing supplies, for example, can become obsolete due to shifting fashion trends after a few months. Clothing that is regarded out of style or whose model has become obsolete makes it more difficult to resale.

Smartphones, for example, are examples of technological items. Every month, new, more sophisticated items with more comprehensive capabilities render older stock obsolete or "outdated," making reselling more difficult.

Costs of Inventory Depreciation

Depreciation can occur in the company's inventory as well as fixed assets.

When it comes to fruit, for example, the longer it is stored, the less weight it has (per kg/per gram). 

For example, if you have oranges that only last a few days, the weight of the oranges will drop the longer they are held because they are not sold. Because the fruit is evaluated in weight per kilogram, the value is likewise reduced.

Another example is the reduction in the number of residences available to developers.

Houses are supplies for developers whose business is selling houses.

Although the price of the land may rise, the actual structure of the house would undoubtedly depreciate.

Is it the paint, the frames, the doors, or other decorations? In the end, the developer was responsible for the unsold house's repairs.

Costs of Price Reduction

The cost of price reductions is frequently incurred when the price of goods is volatile (fluctuating).

When buying rice, for example, the price per kilogram is IDR 12,000. The rice is then stored in a warehouse for a period of time because it has not been sold or because it is intentionally not to be sold.

When it was sold, however, it was discovered that the market price of rice had dropped, and the rice was only worth IDR 11,500 per kg.

There was a difference of IDR 500 per kg in losses.

This loss is an unavoidable cost of price reduction.

Physical Calculation and Report Consolidation Costs

It turns out that just physically calculating inventory stock costs a lot of money. If the inventory is simply in one small warehouse, a big calculating cost is unlikely (wages).

However, if the quantity of inventory products is in the tens of thousands, a large warehouse size is required.

That's a different matter; obviously, more personnel are required. the higher the price.

Costs of Inventory Handling

Each form of inventory necessitates a distinct approach. If the inventory is more difficult to handle, such as fragile products or perishable goods like fruit and wet food, the cost will be higher.

Glassware is more expensive than iron or nails.

Glassware necessitates specific treatment, such as how to pack products, place goods, arrange goods in the warehouse, hoist goods, place goods on pedestals, and other special treatments that incur additional expenditures.

Costs of Setting Up a Warehouse

This cost is obvious: the warehouse must be secured. Personnel must be in charge of overseeing and regulating the flow of items into and out of the warehouse. There is a foreman on the job. There are also his men.

Cost of Damage to Goods

When items are housed in a warehouse, they can be damaged at any time. Damage can occur as a result of improper lifting, stacking, and other factors.

Capital Costs (Cost of Capital)

The cost of capital is a cost that is computed based on the opportunity cost of not using funds for inventory for more profitable (investment) activities.

Inventory that is stored owing to excess output is usually kept in the warehouse. If a corporation just buys inventory when it is needed (buys less), no inventory is stored, and storage costs are avoided.

The money spent on supplies and storage should be put toward more productive endeavors.

c. Preparation Costs (Set up Cost)

When a corporation creates its own items or requires inventory resources, preparation costs (set up costs) emerge.

The following are some examples of setup costs:

  • The cost of non-operational machines
  • Costs of direct labor preparation
  • Costs of correspondence
  • Preparation costs for equipment and materials
  • Costs of scheduling

d. Out-of-pocket expenses (lack of materials)

Shortage expenses emerge when inventory materials are not available when they are needed.

For example, suppose a company receives an order, but when it comes time to make it, it turns out that there are no raw materials accessible, preventing the company from fulfilling the order request.

The following are some of the expenses (opportunities) associated with a shortage of inventory:

Sales Decrease

  • Sales that were advertised as "deals" may be canceled if the company is unable to fulfill them.
  • There are opportunities lost as a result of inventory management failures, and this is one type of loss.
  • Customers Are Leaving
  • Customers may leave and go to other companies due to disappointment and inability to be handled, in addition to losing sales.

Fees for Special Orders

Companies will sometimes insist on producing orders even if raw material inventories are low or out of stock in order to preserve customer satisfaction.

Companies have a variety of choices for continuing to produce goods.

To begin, the firm outsources its work to other related firms.

By "passing" this task, there is a danger of product quality differences and higher prices than if the goods were created in-house.

Second, the corporation purchases raw materials at greater prices than usual. It could be to a long-term supplier or to a new source who offers a better raw material price and faster delivery (of course adding more costs).

Costs of Special Shipping

Typically, organizations who are short on raw materials and must wait for fresh raw materials will encounter production delays.

There are occasions when the corporation must utilize a special rapid shipping expedition to ensure that the items arrive on time at the customer's location. It could be via airline, truck, ship, or any other fast and expensive form of transportation.

This increase in shipping costs may be damaging to the company's bottom line, or at the very least lower income.

Disrupted Production

Production might also be hampered by a lack of raw resources. When raw materials are in short supply, production is halted until new raw materials arrive.

However, the time spent waiting for new raw materials consumes a significant amount of time, causing production timelines to shrink.

When the raw materials are finished, the time tolerance is reduced, and the production of goods is completed quickly.

Because the corporation prioritized the manufacturing that was almost late, other items' production was also hampered.

Production Schedule Disruption

If production cannot run on schedule owing to a material scarcity, there is a lost opportunity cost.

The production of products or other items is disrupted as a result of the shifting schedule. This can have an impact on the amount of production produced, the quality of items produced, and the cost of commodities.

Goods Inventory Types

The following are the several types of inventory found in manufacturing companies:

a. Goods Inventory Management - Raw and Auxiliary Materials

Raw materials are those that will be used in the final product and whose costs can be easily traced.

Auxiliary materials, on the other hand, are commodities that are part of the finished product but whose quantity is modest or whose cost is difficult to calculate.

Examples of raw materials in a concrete company are:

  • Cement
  • Sand
  • Stone

While the auxiliary materials are chemicals to harden concrete.

b. Factory Supplies – Goods Inventory Management 

Factory supplies are items that have the function of launching the production process.

Examples include engine oil and engine cleaning agents.

c. Work in Process Inventory 

Work in process refers to products that are being worked on (processed) but have not yet been completed as of the balance sheet date.

More work is required before the product may be sold.

In a paving block manufacturing company, for example.

Goods that have been printed cannot be sold immediately; they must first be dried until they meet the specifications and are ready for usage by the buyer.

d. Finished Goods Inventory

Finished goods are items that have completed the manufacturing process and are ready to be sold.

Chairs, tables, and other ready-to-sell products are examples of finished goods in a furniture or furniture company.

The items that will affect the financial statements, notably the balance sheet and income statement, are inventories of goods in both trade and manufacturing enterprises.

As a result, inventory kept for a given period must be split into two categories, one of which can be charged as an expense (cost of goods sold / COGS).

And which will be reflected on the income statement, and which will be inventory on the balance sheet because they are yet unsold.

Report on Inventory of Goods

Application of Inventory Management to Increase Company Profits

What is your opinion of the inventory report's presentation?

Inventories are included in the asset or company group, therefore the financial statements are in the form of a statement of financial position or a balance sheet.

The expense for inventory costs is reported on the income statement.

Let me now describe the format of the statement of financial status, also known as the balance sheet (balance sheet).

The Statement of Financial Position is made up of three primary accounts or items:

  • Current assets, such as cash and cash equivalents, receivables, inventories, and prepaid expenses, are split into two sections in Asset Accounts.
  • Land, buildings, machinery, and vehicles are examples of fixed assets.
  • Posts for Accounts/Liability. This article is also broken into two parts:
  • Short-term debt is an example of current liabilities.
  • Investment loans, for example, are long-term liabilities.
  • The following are examples of equity accounts or items:
  • Retained earnings or unshared gains are referred to as paid-in capital.
  • As a result, goods inventory is included in the group of current assets (note the red color above).
  • As a result, precise inventory tracking will improve the accuracy of the company's income statement and balance sheet.
  • The income statement and balance sheet will be impacted if inventory amounts are recorded incorrectly or insufficiently.
  • Having an impact on the current and future periods.

The Impact of Inventory Presentation in Financial Statements

What effect does showing goods inventory in financial statements have?

If the ending inventory is listed as being too large due to incorrect pricing. What is the effect of the number of products sold versus the quantity of items in the warehouse?

Because the closing inventory is too large and the profit is too large, COGS (cost of goods sold) is too small in the current year's income statement.

The inventory of commodities and capital on the balance sheet of the company are both excessively huge.

Meanwhile, because the initial inventory is too large and the profit is too small, the cost of goods sold (COGS) in the next quarter is too high on the income statement.

Inaccuracies in the prior period's balance sheet have been countered by errors in the current period's income statement, resulting in the balance sheet being correct (counter balanced).

Another scenario is when the ending inventory is understated and the accounts payable and purchases are not recorded at the end of the quarter.

So, while the income statement for the current year is too small for purchases, it is countered by a too small ending inventory, resulting in proper gross profit and net income.

The company's balance sheet contains a lot of cash, but its current assets and short-term debt are insufficient.

The inventory was initially too small on the income statement the following period, but this was offset by purchases that were too large.

The gross profit and net income are right because last year's purchases are reflected within this year. Last year's inaccuracy on the balance sheet had no bearing on this year's.

Accurate inventory management is required to ensure that the two situations listed above, or equivalent conditions, do not occur.

Conclusion

Goods inventory, often known as inventory, is an important aspect of a firm that requires care.

The company's growth and development will be considerably aided by good and accurate inventory management.

Unorganized inventory management, on the other hand, will be extremely destructive to the company.

Inventory management must be done from the beginning of the purchase process to the end of the use of the commodities.

In terms of goods storage and quality control, there are no exceptions.

Implementing Standard Operating Procedures is one of the most effective ways to run an inventory management system.

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