Every business organization that is engaged in manufacturing, trading or dealing with salable products holds inventories in one form another.
Inventory is held in the form of raw materials or in the form of salable goods.
Since every unit of inventoried item has an economic value and is itemized in the books of account of the company, inventory can be considered to be an asset of the company.
Inventory Management is a critical function performed by planners to balance the inventory holding so as to ensure that optimum inventory levels are maintained. Any excess inventory will result in incremental costs of maintaining inventory and affects the financials of the company as it blocks working capital.
Under inventory on the other hand can seriously hamper the market share. Any customer order that is not fulfilled due to a stock out is not at all a good sign. Therefore the responsibility of striking a fine balance in holding lean inventory calls for smart planning and continuous monitoring of the inventory levels coupled with quick decision-making.
Due to the above factors all organizations generally tend to avoid holding inventories except at certain times.
Inventory Buildup Can be a Sign of Hidden Problems
It has been noticed that inventory build up in process and manufacturing industries is often a sign of hidden problems, which lie underneath and are not visible at the surface level. In other words one can say that to cover up inefficiencies in the internal systems, people build up inventories as safety stocks.
Stock build up can occur as a solution to cover up supplier inefficiencies. If the vendors are not reliable and the flow of raw materials cannot be ensured, there results a trend to hold buffer inventories in the form of raw materials or semi manufactured Work in Process inventories.
In other cases inventory build up can happen due to bad quality. The inventory cost increase and resultant inventory storage cost can be attributed to cost of quality.
If the production is not consistent with quality, the goods produced will get rejected leading to an increase in rejected inventory.
Secondly, to make up for the loss due to quality rejection, one would have to increase production and hold finished goods inventory.
In other cases production delays can lead to build up of inventories too. Production delays can be attributed to varied reasons such as bad design of the product, production layout inefficiencies, production stoppage due to breakdowns, Lengthy process times etc. Besides these causes, there could be many other problems related to people and management resulting in slackness on the shop floor, which can add to inventory holding at various stages.
Such inventory build-ups not only block the working capital and increase un necessary cost of maintaining and storing the inventories, but also hide the problems which can cause serious threat to the business. Management should be watchful to identify any such inventory buildups and investigate into the root cause and solve such problems.
An inventory build up at the raw material side as well as the finished goods side gives cause for worry to the finance controllers. Any non moving inventory is a cause for concern because it not only blocks up the funds of the organization but the incremental cost of holding the inventory keeps increasing over a period of time and effect the bottom line figures.
More importantly inventory over a period of time is susceptible to loss, theft, pilferage and shrinkage. It can also become obsolete and deteriorate over a period of time if not used within the shelf life.
Hence inventory levels are always on the radar of not only finance controllers, but of the top management as well.
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FAQs
The longer your inventory sits on the shelf, the more they lose value, and the more they cost you to hold. To move these products out of your inventory faster, you will have to sell them at a reduced price. You will earn a lower profit from these goods, and this will affect your balance sheet.
Why is holding inventory a risk? ›
More often than not, holding onto excess inventory puts your company at risk of accumulating additional holding costs, tying up your available cash flow, and creating a lot of unnecessary waste.
What are three circ*mstances that may require a company to hold inventory? ›
Four of the most important reasons for holding inventory are:
- Meeting customer demand quickly.
- Buffering against unexpected demand surges – or planning for seasonal demand.
- Taking advantage of dropping prices.
- Hedging against future purchase price increases.
Storing inventory is expensive. And when products are left to gather dust on shelves, their potential value is taken out of the business. This limits your cash flow until it is sold, which puts your business at risk of being unable to make crucial payments on time.
Why avoid holding inventory? ›
The longer your inventory sits on the shelf, the more they lose value, and the more they cost you to hold. To move these products out of your inventory faster, you will have to sell them at a reduced price. You will earn a lower profit from these goods, and this will affect your balance sheet.
Which is the bad part of holding inventory? ›
Excess inventory can create storage issues
If you're holding onto an inventory of products, you'll soon discover that excess stock takes up valuable storage space. Be wary of how much space it takes up — and find a solution for dealing with it quickly.
What are the primary 4 reasons for holding inventory? ›
Meeting customer demand promptly means you're better poised to reach your revenue and profit targets.
- Reduce customer lead times. You can fulfill orders immediately without having to order from suppliers and wait for delivery. ...
- Avoid stockouts. ...
- Reduce costs. ...
- Avoid supply chain disruptions.
First and foremost, you might carry extra inventory to ensure you meet customer expectations. A safety stock of finished goods, for example, can make sure you feel your best customer's orders even when demand suddenly increases. Additional spare parts can help you meet emergency service needs.
Why is inventory high risk? ›
Inventory management is implemented due to some of the risks surrounding inventory. Inventory risk encompasses uncertainties tied to managing inventory: stockouts causing lost sales, overstocking leading to financial losses, storage expenses, demand fluctuations, and supply chain disruptions.
What are the two motive of holding inventory? ›
To maintain sufficient inventory of raw materials in periods of short supply. To maintain sufficient inventory of finished goods so that demands of customers are duly met. To minimise the carrying costs of inventory namely cost of godown, insurance expenses, cost of funds involved in inventory.
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.
Who needs to keep inventory? ›
Any business that sells products must manage goods properly to survive. If you don't have goods in stock to sell, or if you can't find items to fill orders, you have no income. It's that simple.
What are the risks of holding inventory? ›
Inventory risk is the probability of an organisation being unable to sell its goods or the chance that inventory stock will decrease in value.
What are the disadvantages of inventory? ›
Storage and carrying costs of the inventory lead to an unnecessary increase in the overall costs of the business. Higher inventory increases the chances of stock obsolescence. If stock value declines, the business may not be able to cover the cost incurred in the production or acquisition of the stock.
What is the problem of inventory? ›
Having too little or too much stock is a problem that results from poor control over inventory sourcing. Both have an impact on cash flow and can result in lost profits when inventory goes bad. Likewise, constantly running low means that your business could miss an opportunity for a greater number of sales.
What are the advantages of inventory? ›
Benefits of inventory management
Lower costs and saves money. Prevent overspending on warehouse storage. Minimize storage needs. Reduce losses to improve cash flow.
What are the advantages and disadvantages of inventory control? ›
It also enables businesses to maintain the right amount of stock, avoid stock-outs, and notify when to restock. On the other hand, poor inventory management can lead to dissatisfied customers, slower sales, excess cash tied up in warehouses, and increased carrying costs.
Which of the following is an advantage of holding inventory? ›
The benefits of holding inventories are; Avoiding Lost Sales. Gaining Quantity Discounts. Reducing Order Cost.
What are the advantages of holding stock? ›
More Cost-Effective
One of the main benefits of a long-term investment approach is money. Keeping your stocks in your portfolio longer is more cost-effective than regular buying and selling because the longer you hold your investments, the fewer fees you have to pay.
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The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on 