Low inventory

The low inventory definition is any moment when your inventory dips below a normal fluctuation. As
you sell products each day your inventory will get lower by an amount you can set your watch to.
However, there will be times when your inventory is lower than you would consider normal.

While you want to sell through your inventory on a regular basis, a shockingly low inventory count could
cause some concern. The reasons for a potential low inventory are things you should look out for,
including:

Supply chain issues

Breakage and loss

Improper storage resulting in loss

Inventory holding costs are the fees incurred for storing goods or inventory in a warehouse. Stored
inventory is a liability that hits profit margins and increases businesses’ operating costs. Inventory
carrying cost, or holding costs, is an accounting term that identifies all business expenses related to
holding and storing unsold goods.

The total carrying costs include the related costs of warehousing, salaries, transportation and handling,
taxes, and insurance as well as depreciation, shrinkage, and opportunity costs

Rent for space, security, depreciation costs and insurance are among inventory holding costs.

As these costs increase, businesses must consider deploying demand planning and demand sensing.
These tools can allow enterprises to maintain the optimum amount of stock.

OPPORTUNITY COST or CAPITAL COST

Cost of capital is the opportunity cost of investing in an asset relative to the expected return on assets of
similar risk.

Capital cost is the largest component of carrying cost incurred by businesses. It includes the interests
added and the cost of money invested in the inventory. Capital cost is always expressed as a percentage
of the total value of the inventory being held. For example, if a company reports that its capital cost is
30% of its total inventory costs, and the total inventory is worth $8,000, then the company’s capital cost
is $2,400.

The opportunity cost of capital definition is the return on investment a company or an individual loses
because they choose to invest their funds in another project rather than invest it in a security that
provides a return. The opportunity cost of capital is a cost that typically occurs when a company or a
firm does not make the best use of its resources.
Imagine that you have $100,000 and want to open a business. The total cost of opening the business will
take up all $100,000. But is that the only cost you face when opening a business? What about the
opportunity cost of using the $100,000 on another alternative? You could instead use the $100,000 to
invest in a stock that is projected to have a return of 7%. Would it still be worth opening your own
business if you can invest the money and get a viable return? Read on to find the answer to this
question and all there is about the opportunity cost of capital

what is the opportunity cost of keeping inventory on hand for manufacturers?

When organizations keep too much inventory on hand, the funds they spend to store and maintain that
inventory could be alternatively used for other investments. The money it takes to purchase raw
materials or produce finished goods is already spent at this point, and more has to be spent to house
that inventory. So, it can’t be used for things like updating equipment, marketing efforts, or other
important investments for a successful operation. One important note is that not all inventory can be
stored in a typical warehouse. Some items require refrigeration or specific lighting to keep their quality.
This is even more costly and takes more funds away from liquid assets that could be better served
elsewhere. Other examples of costs incurred from housing inventory that could potentially be better
served elsewhere include:

 Personnel Costs: Manufacturers need warehouse personnel every time inventory moves from
one location to another. When a product is moved to storage after production and then must be
moved again once the inventory is purchased – this doubles the work for personnel and
increases costs for the business.

 Insurance: Organizations have to carry insurance, and many carriers will charge higher
premiums for those keeping excess inventory on hand, as it is determined by the value of that
on-hand inventory.

STORAGE SPACE COST

Storage space cost includes the rent paid to warehouse your products, air conditioning and heating,
lighting, transportation, and other costs associated with the physical warehouse. This cost has a fixed
component and a variable component. The rent is a fixed cost, whereas the costs of handling the
materials will vary constantly based on demand and the number of products stocked.

TAXES, INSURANCE, SHRINKAGE

Inventory tax must be paid by the business owners on items that remain unsold at the end of the tax
year.

Insurance on assets increases when there is more to insure.

Inventory insurance covers you against damage to your inventory, usually including electronics and
computers. These insurances cover you, for example, in the event of fire, water damage, vandalism, or
theft.

Shrinkage is the difference between recorded inventory and actual inventory. Inventory lost to shrinkage
results in lost profit. Shoplifting, vendor fraud, employee theft and administrative error are some causes
of shrinkage.

Types of Shrinkage

1. PILFERAGE - theft of inventory by customers or employees.

2. OBSOLESCENCE – occurs when inventory cannot be used or sold at full value, owing
to model
changes, engineering modifications, or unexpectedly low demand.

3. DETERIORATION – physical spoilage or damage

Why are inventories necessary?

CUSTOMER SERVICE

 Creating inventory can speed delivery and improve on-time-delivery.

 Customer Service is the Heart of Inventory Control and Supply Chain Strategy

 As a business, if your supply chain is unable to cater to the delivery requirements of

your customers, you are going to have dissatisfied customers on your hands. They will
move to another business that satisfies their requirements.

 Today’s customers want products to be delivered faster in an absolutely error-free

manner

 While satisfying these expectations might sound challenging at first, all of them can be
addressed if you maintain optimal inventory levels, and work toward seamless supply
chain management.

STOCKOUT – occurs when an item that is typically stocked isn’t available to satisfy a demand the
moment it occurs, resulting in loss of the sale.

BACKORDER – is a customer order that can’t be filled when promised or demanded but is filled later.

ORDERING COST - For the same item, the ordering cost is the same regardless of the order size.

-Cost of preparing a purchase order for a supplier or a production order for the shop
SETUP COST - It is also independent of the order size. It is the cost involved in changing in changing
over a machine to produce a different component or item

LABOR AND EQUIPMENT UTILIZATION

By creating more inventory, management can increase work-force productivity and facility utilization.

TRANSPORTATION COSTS

Outbound and inbound transportation cost can be reduced by increasing inventory levels.

PAYMENT TO SUPPLIERS

A firm often can reduce total payment to suppliers if it can tolerate higher inventory levels.

QUANTITY DISCOUNT – price per unit drops when the order is sufficiently large. It is an incentive to
order larger quantities.

TYPES OF INVENTORIES

Cycle stock is the inventory necessary to keep production running and customer orders fulfilled. This
includes the raw materials used in the manufacturing and the finished products waiting to be shipped.

To calculate cycle stock, businesses need to consider both manufacturing lead time demand and
production quantity. Lead time demand is the amount of time it takes for an item to be delivered from a
supplier — or for a raw material to be delivered from the point of production.

Production quantity is the number of units produced during each production run.

Lead time demand is the amount of time it takes for an item to be delivered from a supplier — or for a
raw material to be delivered from the point of production.

Production quantity is the number of units produced during each production run

Importantly, cycle stock does not include safety stock.

Cycle stock are the goods allocated to meet regular customer demand over a certain amount of time.
Safety stock, on the other hand, is more like backup inventory. Think of it as product kept in your facility
to cover unforeseen circumstances, such as when planned production output falls short or when actual
sales comfortably exceed forecasts.

For instance, perhaps your company runs a major promotion in the lead-up to the holidays, and sales
outperform the previous season’s sales and latest forecast by a wide margin. In this case, you will run
out of cycle stock, so you tap into your safety stock. Without those additional reserves that you hold for
just this type of occurrence, the company will lose sales and customers, who may never return after this
kind of frustrating experience.

Safety stock is the inventory buffer that’s maintained to protect against unforeseeable disruptions, like
supplier delays or natural disasters. On the other hand, cycle stock is based on predictable, forecasted
customer demand and production schedules. While both are important for a well-run operation, cycle
stock is often the focus of inventory management because it directly impacts working capital.

IMPORTANCE OF CYCLE INVENTORY

One of the worst things that can happen to a company is a stockout. This is when inventory runs out,
and customer orders can’t be fulfilled. Stockouts can have a major impact on businesses:

Lost sales — When customers can’t get the products they want, they’ll go to a competitor. This leads to
lost revenue for the business

Damaged reputation — Stockouts damage reputation because it shows that the company isn’t able to
meet customer demand. This can lead to long-term damage as customers may never come back

Inefficient production — If the inventory isn’t available, production will have to stop. This leads to
inefficiencies and can cause further disruptions down the line

It’s important to note that stockouts don’t just happen because of low inventory levels. They can also be
caused by poor planning, inaccurate forecasting, and inefficient processes. This is why cycle inventory
management is so important. By having a good handle on your cycle stock, you can avoid the costly
consequences of stockouts.

Factors that impact cycle inventory

Your cycle stock levels are impacted by the following factors:

Customer demand — This is the most important factor in forecasting cycle inventory. If customer
demand is high, businesses will need to maintain higher levels of stock

Supplier lead times — Longer supplier lead times will require businesses to order inventory further in
advance, increasing cycle stock levels

Production quantity — If a business can produce more units per production run, it’ll need less inventory
on hand to meet customer demand

Production lead time — Longer production lead times will require businesses to order raw materials
further in advance, increasing cycle stock levels
Seasonal changes — Seasonal changes in demand can impact cycle inventory levels. As a cycle inventory
example, a business selling winter coats will need to maintain higher levels of stock in the months
leading up to winter

Cycle stock = Total inventory on hand – Safety stock

Lot size refers to the quantity of an item ordered for delivery on a specific date or manufactured in a
single production run. In other words, lot size basically refers to the total quantity of a product ordered
for manufacturing.

SAFETY STOCK

Safety stock is an extra quantity of a product which is stored in the warehouse to prevent an out-of-
stock situation. It serves as insurance against fluctuations in demand.

Importance of safety stock

Safety stock helps eliminate the hassle of running out of stock. If you hold sufficient safety stock, you
needn’t rely on your suppliers to deliver quickly or turn away customers because of depleted inventory
levels. Safety stock covers you until your next batch of ordered stock arrives. Let’s see how safety stock
is important for your business:

Protection against demand spikes

Safety stock protects you against the sudden demand surges and inaccurate market forecasts that can
happen during a busy or festive season. It serves as a cushion when the products you’ve ordered take
longer to reach your warehouse than you expected. It ensures that your company doesn’t run out of
popular items and helps you keep fulfilling orders consistently.

Buffer stock for longer lead times

Even if your supplier has been consistent with delivering products on time and you’ve never faced a
supply lag yet, this might not always be the case. Unexpected delays in production or transportation,
such as a bottleneck at your supplier’s end or a weather-related shipping delay, can cause your products
to reach you later than expected. During these situations, safety stock acts as your defense against a
possible stockout scenario and helps you fulfill your orders until your ordered stock is delivered to you.

Prevention against price fluctuations

Unpredicted market fluctuations can cause the cost of your goods to increase suddenly. This can be due
to a sudden scarcity of raw materials, an increase in price of raw materials, unexpected demand surges
in the market, new competitors, or new government policies. If you’ve got enough safety stock during
these unpredictable situations, it can help you avoid the costs of buying stock at higher prices without
sacrificing sales.

ANTICIPATION STOCK

Anticipation inventory or speculation inventory refers to extra finished products or raw materials a
business purchases to meet an anticipated jump in demand.

Companies purchase and hold anticipation inventory to prepare for an expected future event, such as an
expected seasonal jump in sales or a forecast increase in the cost of supplies or shortage of a needed
raw material.

Anticipation inventory is needed to help companies reduce their risk of stockouts, lost sales and
dissatisfied customers. It also hedges against increases in the cost of supplies or shortages of key raw
materials

A business typically holds anticipation inventory to meet a predicted increase in demand. In contrast,
the purpose of safety stock is to hedge against unforeseen delays related to suppliers that might mean a
shortage of key materials, potentially forcing a delay in production schedules.

PIPELINE INVENTORY
The phrase “in the pipeline” implies something is coming soon. In the context of inventory management,
this can refer to additional product lines, new scents or colors, and even just stock replenishment.

For many brands, it’s easy to overlook the first-mile delivery and drayage process (when purchased
inventory is in transit), but it’s an important part of ecommerce operations as it ensures new inventory
arrives at the right place at the right time.

Known as pipeline inventory, inventory in transit should be tracked alongside physical inventory on hand
to provide a holistic view of how much inventory is tied up in capital versus how much inventory is
readily available to sell.

Pipeline inventory refers to the value of finished goods ordered from a supplier or manufacturer that is
currently in transit and has yet to reach a physical store or distribution center.

Pipeline inventory, also called pipeline stock, is important to consider as it helps build a picture of how
much of your assets are tied up in stock.

Once a product is purchased by your business, it is considered your inventory, even if you don’t
physically

Assessing how much pipeline inventory is arriving makes it considerably simpler to plan for client
demand. The amount of inventory that is now present at every stage of the supply chain is also fully
depicted.have the inventory yet.

Calculating pipeline inventory uses demand forecasting and average production lead times to determine
the value of inventory that should be in transit.

Once you have the information needed, calculating pipeline inventory is simple:

Lead Time x Demand Rate = Pipeline Inventory

Assume that a dog food business sells 100 units of dog food at $30 a week. Their supplier takes 2 weeks
to deliver the goods. So their pipeline inventory amount would be:

2 x $3,000 = $6,000

This means that their supply chain should have about $6,000 worth of goods in transit from the supplier
to meet demand.

Gina Company provided the following information with respect to factoring of accounts receivable.

INVENTORY REDUCTION TACTICS

Inventory Models for Independent Demand

Economic order quantity (EOQ) is the ideal quantity of units a company should purchase to meet
demand while minimizing inventory costs such as holding costs, shortage costs, and order costs.

The economic order quantity (EOQ) is a company's optimal order quantity that meets demand while
minimizing its total costs related to ordering, receiving, and holding inventory.

The EOQ formula is best applied in situations where demand, ordering, and holding costs remain
constant over time.

One of the important limitations of the economic order quantity is that it assumes the demand for the
company’s products is constant over time.

Production order quantity (POQ) describes the optimal size of a production run. In simple terms, the
POQ tells your business how much to produce and when that production run should be completed.

A quantity discount is an incentive offered to buyers that results in a decreased cost per unit of goods or
materials when purchased in greater numbers. Enticing buyers to purchase in bulk enables sellers to
increase their units per transaction (UPT), lower their inventories, and potentially reduce per-unit costs.