31 Types of Inventory

Kajal Kiran

31.0 OBJECTIVES

After reading this chapter, students will be able to
Understand the basic concept of inventory
Explain various types of inventories
Formulate effective policies for inventory management on the basis of classification of inventory

31.1 INTRODUCTION

Every manufacturing Concern requires inventory for smooth flow of its activities. It is one of the most important assets and its turnover is the major source of the revenue for a business and ultimately shareholder’s earning. The dictionary meaning of inventory is ‘Stock of good’ or ‘List of goods’. However, in broader sense, inventory refers to all the materials held by an organization to facilitate production, to facilitate activities or for ultimate sale or service to customers. The materials held to facilitate production refer to raw material or semi-finished goods. Some materials are not directly required for production but help in facilitating or supporting the production activities e.g. maintenance material, fuels, lubricants etc. These are also called as indirect material. Thus, inventory includes all the materials, tools, parts, work in progress, supplies and finished goods kept in warehouse or stocks for some period of time. Inventory can be described from different perspectives as under.

DEFINITIONS

International Accounting Standard Committee (I.A.S.C) defines inventories as “Tangible Property

Held for sale in the ordinary course of business
In the process of production for such sale or
To be consumed in the process of production of goods or services for sale “

In the words of Mr. Lammer Lee and Donald W. Dobler , “ Inventory includes the following categories of items:

Production inventories – raw materials, parts and components which enter the firm’s product in the production process. These may be of two general types namely,

(i) Special items manufactured to company specifications and

(ii) Standard industrial items purchased “off the shelf”

MRO inventories – such as maintenance, repair and operating supplies which are consumed in the production process. But which do not become part of the product say lubricants, soap, grease, maintenance spares and the like
In-process inventories namely, semi – finished products found at different stages in production operation
Finished goods inventories consisting of completed products ready for shipment ”

According to Mr. B.D. Khare , “ The term inventory includes material – raw – in process, finished packaging, spare and others stocked in order to meet an unexpected demand or distribution in future.”

The American Institute of Certified Public Accounts (AICPA) defines inventory “ in the sense of tangible goods, which are held for sale, in the process of production and available for ready consumption.”

According to Fred Hannoman, inventory can be defined as “An idle resource of any kind provided such resources have economic value.”

31.2 CLASSIFICATION OF INVENTORY

Systematic grouping or categorization of inventory considering some common features is called classification of inventory. There are different bases to classify the inventory namely nature, manufacturing process, value, purpose etc. Thus inventory can be classified as

(i) ON THE BASIS OF NATURE

On the basis of nature, inventory can be classified as:-

Direct Material:- These are those materials which can be easily identified with a product. In other words direct material can be easily measured and directly charged to the product e.g. wood in furniture, steel in almirah, brick, cement, concrete and sand in a building etc.
Indirect Material :– Those materials which cannot be directly identified with a product. Hence these materials cannot be charged directly to the various products. However these materials facilitate and support the production activities e.g. cotton waste for cleaning the machinery, lubricants for oiling the machinery, diesel for generating power, nails etc.

(ii) ON THE BASIS OF MANUFACTURING PROCESS UNDERTAKEN

Raw Material:- Generally raw material describes the material which is taken from the nature and is either in completely unprocessed form or is minimally processed e.g. wood for a table, cotton for cloth, iron for machinery etc. Thus raw material inventories are those units which are purchased and stored for further production.
Work in Progress:- The inventory which is in the mid way of production i.e. neither in the form of raw material nor in the form of finished goods is called work in progress or semi finished goods. Work in progress represents the products which require more work before they become final products for sale e.g. a bed and a table manufactured but yet to be polished.
Finished goods or finished products :- These represent those inventories which are completely manufactured and ready for sale. These can also be described as the goods on which nothing remains to be done but have not yet been sold or distributed to the end users e.g. furniture ready for sale in the market after polishing.

(iii) ON THE BASIS OF MOVEMENT OF STORES

Inventory can be classified on the basis of movement or rate of consumption as fast moving stock, slow moving stock and dormant stock.

Fast Moving Stock :– The material or the stores which exhaust very rapidly due to high demand in production process of a manufacturing concern are called fast moving stock.
Slow Moving Stock :- The items of materials or stores which due to low demand in production process are exhausted or consumed at a very low speed are put in the category of slow moving stock.
Dormant Stock :- Dormant stores indicate those store items which have no demand in current time period but may be demanded in future e.g. seasonal materials which are demanded in specific seasons.

(iv) ON THE BASIS OF VALUE

On the basis of value, inventory may be divided into :-

Category ‘A’ :- This category consist of the materials which constitute 10% of the total items in the stores but account for nearly 70% of the total store value.
Category ‘B’ :- Under this category, those materials which constitute 20% of the total items in the store and also represent 20% of the total store value are placed.
Category ‘C’ :- This category cover those items which represent 70% of the items of material but contribute only 10% of the value of the total store.

(v) ON THE BASIS OF CRITICALITY TO THE PRODUCTION PROCESS

This classification is applied mainly in respect of spare parts and is also known as VED analysis. On the basis of criticality, inventory is classified as vital, essential and desirable.

Vital :- The inventory (spares) the non availability (stock out) of which even for a very short time will make the production process stand still.
Essential :- Those items , the absence of which cannot be borne for more than a few hours or a day.
Desirable :- The items which are needed for production process but their non availability for even a week or more will not cause interruption in production.

(vi) ON THE BASIS OF FUNCTION

Transit Inventories :- These are also called movement inventories or pipeline inventories. Their existence owes to the fact that transportation time is involved in moving the inventories from one place to another. Such, inventories while in transit, cannot provide any service to the customers. For example, when oil is transported from the oilfields to the industrial towns by tanks, it can sometimes take days or even weeks to go to a retail facility and hence during that time period, It cannot provide any service to the customers.
Buffer Inventories :- The inventory which is held to cope up with the fluctuations in demand and supply is called buffer stock or safety stock. Such inventory is used to protect against demand and supply uncertainty as well as a cushion for unpredictable events like poor delivery reliability or poor quality of supplier’s products. Thus, it is the inventory which is held over and above the current requirement in order to meet any contingency. No doubt, the size of such inventory affects the working capital requirement of a business but is required to ensure better customer service. Buffer stock also helps to meet the lead time requirement i.e. the time gap between placement of an order and receipt of delivery.

For example, let it takes normally 2 days to receive a lot after placing an order. But due to some unavoidable circumstances, it takes 5 days. So, during these additional 3 days, some inventory is required to ensure smooth flow of production and this requirement can be met only if some higher level of inventory (buffer stock) is kept by the organization over and above its current (normal) needs.

Decoupling Inventories:- Decoupling inventories acts as shock observer/ cushion to ensure smooth flow of production by ensuring the existence of inventories in large quantity at major connecting points of production. Decoupling inventory is required because

(a) It is quite rare, that all the machineries in the production process produces at exactly the same rate. Rather one machine may do processing many times faster than the machines which are either in front of or behind it.

(b) If it is a situation, where are the machineries are operating at the same rate, there may arise a possibility that some machines may have to be stopped for sometime due to repair needs or some form of preventive maintenance.

The above given points necessitate the existence of some inventory to avoid production irregularities due to difference in operating speed of machines or some machines requiring cease functioning for the want of repair. Decoupling inventories are mainly required where output of one production process is input for other production process i.e. sequential requirement of the production system.

e.g. a production system having 10 machineries operating simultaneously to produce finished goods where machinery 1,2,3 constitute 1st stage of production, Machinery 4,5,6,7 form 2nd stage of production and machinery 8,9,10 encompasses 3rd stage of production, thus decoupling inventory will be required as follows to ensure smooth flow of production.

Cycle Inventories :- Cycle Inventories are also known as lot-size inventory result from ordering in batches or lot sizes rather than ordering material strictly as per actual requirement. Thus when material is purchased only when the need arises, there will be no cycle inventories but it can prove very risky if material is not readily available. Thus in real life, the firm usually formulates a periodic replenishment policy so that cycle inventory can be established which will vary in size from day to day. e.g. a manufacturing concern may order raw material in quantities of 20000 units while the average consumption rate per unit is 1000 units per day. It means it takes 20 days to exhaust one order. On 21st day, another lot of 20000 units will arrive for consumption over the next 20 days and so on. Each cycle begins with replenishment and ends with complete depletion/exhaustion of the inventory. The following diagram depicts cycle inventories.
Anticipation Inventories :- Such inventories are held in anticipation of future demand on special occasion or season or some special event. For example: demand of air- conditioners before summer and demand of heaters, sweaters, coats before winter. The purpose of such inventories is to meet special demand on those occasions and to ensure smooth flow of production. It is beneficial from firm’s point of view also as resources do not remain idle during slack season and during occasions/seasons when such inventory is actually required, over time can be avoided.
M.R.O Inventories :- These are maintenance, repair and operation supplies which do not become the part of the product but are used in the production process e.g. oil, nuts, bolts, screw, packing material etc.

31.3 CASE 1: WALMART’S INVENTORY MANAGEMENT

Walmart is the leading retailer in the industry occupying a leadership position. The company operates internationally in number of countries. Walmart works on the model of everyday low price. According to this model the company provides variety of products to its varied customers. The company is able to decrease its cost of operation by increasing volumes of products being sold. This would lead to decrease in per unit cost. Also the company operates in big warehouses accruing the benefits of economies of scale. As the company is only distributor and not manufacturer of products so storing such huge volume of number of products becomes a complex and enormous task. The two challenges that inventory management of company faces is storing huge volume and at same time high variety of products. Its inventory management system plays a critical and crucial role in its success. The company has perfected the art of innovating its inventory management methods and strategies. Thus, Walmart is an example of the benefits of advanced technology and innovation in optimizing inventory management performance. While there are a variety of other factors contributing to the success of this business, advanced inventory management is at the core of Walmart’s leadership in the retail industry.

Inventory model applied by Walmart

Walmart uses vendor managed inventory model where vendors play an active and interactive role in managing inventory of the company. All vendors have access to current and past data regarding movement of various products from different warehouses to different retail outlets of the company. Technology plays an important role in managing such complex task.

Walmart’s vendor-managed inventory has the benefit of minimizing delays in the movement of inventory across the supply chain. This benefit is achieved because suppliers can directly access data about the inventory of their goods at Walmart stores. Another beneficial effect of using the vendor-managed inventory model is the minimization of costs in inventory management activity. Walmart does not need to spend for extra personnel to manage each supplier’s goods. Instead, this financial and human resource expense is directly passed on to the suppliers.

By using innovative and contemporary technology the vendors of Walmart access current data from the company. The data regarding inventory such as current inventory levels, how many units are left, how much is volatility in demand, how many units need to be shipped for each type of product is handled quite efficiently by state-of –the-art information systems and other software applied by the company. Suppliers decide when to send additional goods to Walmart, while the company monitors and control the actual transit of goods from warehouses to the stores.

Types of Inventory at Walmart

Walmart uses many types of inventory. Each type fulfills a certain role in the firm’s inventory and supply chain. However, the following types of inventory are the most notable in Walmart’s practices:

Finished goods inventory. The finished goods inventory type is the most significant in Walmart’s business. Finished goods arrive at the company’s stores. These goods are stored and the inventory is replenished regularly. Thus, the role of this type of inventory is to support Walmart store operations, where the finished goods are sold from the inventory to the customers.
Transit inventory. Walmart uses the transit inventory type as the second most significant in supporting the company’s business. This type of inventory refers to the goods that are held while in transit. The global extent of Walmart’s supply chain means that some goods are in transit for days or months. The role of this inventory type is to support the replenishment of the finished goods inventory in Walmart stores.
Buffer inventory. Walmart uses the buffer inventory type in its stores by keeping a small margin of extra goods in case demand suddenly fluctuates. There will always be an extra stock of goods at Walmart stores. The role of this type of inventory is to ensure the capacity of the firm to satisfy sudden increases in demand.
Anticipation inventory. Walmart also uses the anticipation inventory type. This type is similar to the buffer inventory because the company maintains extra stocks of goods to address an increase in demand. However, the anticipation inventory type is based on seasonal changes. For example, Walmart dramatically increases its inventory size right before and during festival days to meet increase in demand. Walmart does not use the anticipation inventory type during regular shopping days, which are basically the rest of the year. The role of this inventory type is to enable the company to satisfy expected seasonal increases in demand.

Just-in-Time Cross-Docking in Walmart’s Inventory Management

Walmart uses different methods to manage its inventory. Just-in-time inventory is the application of the just-in-time method to inventory management. This method involves minimizing storage. In Walmart, the just-in-time inventory method is applied in the form of cross-docking. In cross-docking, suppliers’ trucks and Walmart’s trucks meet at the company’s warehouses. Goods are transferred from the suppliers’ trucks directly to Walmart’s trucks, which deliver the goods to the stores. The main benefit of cross-docking at Walmart’s warehouses is

the reduced inventory size.
Fewer goods are stored at the warehouses.
A smaller inventory is less costly to maintain.
Also, cross-docking enables Walmart to quickly deliver goods to the stores.
This condition enables the firm to rapidly respond to fluctuations in demand and related changes in the market.

Walmart’s Measures of Inventory Performance

Walmart uses numerous variables as measures of inventory performance. However, the following measures are the most significant:

Inventory turnover
Stock-out rate
Inventory size

Inventory turnover is the rate at which Walmart’s inventory is sold out and replenished. It is a measure of the cost of keeping each item in stock. A higher inventory turnover rate is more desirable for Walmart. The stock-out rate is the frequency at which Walmart’s inventory becomes inadequate in satisfying demand. A lower stock-out rate is desirable. The company uses inventory size as a gauge of cost. As noted, Walmart spends less for a smaller inventory.

31.4 CASE 2: GOOGLE’S INVENTORY MANAGEMENT

Google is an American multinational technology company specializing in Internet-related services and products that include online advertising technologies, search, cloud computing, software, and hardware. Google’s inventory management involves diverse activities. The company’s varied businesses require different supply chains. In inventory management, the company aims to optimize its operational capacity. Also, Google is concerned about minimizing the costs of its inventory. Theoretically, business organizations minimize their inventory because maintaining it requires funding. A larger inventory is more costly. In consideration of Google’s large organizational size, diverse product lines, and prominent position in the global market, it is realistic to assume that the company has effective inventory management strategies and practices that help minimize expenditure. As Google grows and diversifies, its inventory management also expands to include a larger inventory, with different types and roles. Google’s inventory management is a reflection of successful inventory design and strategic choices.

Types of Inventory at Google

Even though Google has different products, certain types of inventory are most significant in the business. Each type fulfills a role in the company. The following are the most significant inventory types and their roles in Google’s approaches to inventory management:

Raw Materials Inventory. Google’s raw materials inventory involves the input materials used to produce some of its products, such as components for digital media players, and fiber optic cables for the Google Fiber Internet and cable television service. In managing inventory, the role of this type of inventory is to support the production processes at Google.
Work-in-Progress/Work-in-Process Inventory. Google’s inventory management uses this type of inventory in the production of some of its products. For example, in producing digital media players, the work-in-progress inventory involves intermediary products that are stored before the last steps in the production are completed. The role of this type of inventory is to enable Google to sustain a consistent rate of production.
Finished Goods Inventory. Google’s inventory management also involves finished goods inventory of products before they are shipped to sellers. For example, Google Nexus units are stored before they are boxed and shipped for retail sale. The role of this type of inventory is to enable the company to keep addressing sellers’ demand for these products.
Transit Inventory. The company’s inventory management also uses transit inventory for some of its goods. For example, digital media player units become transit inventory while they are transported from warehouses to sellers. The role of this type of inventory is also to enable Google to consistently address sellers’ demand for these products.
MRO Goods Inventory. This type of inventory refers to the items uses for supporting the firm’s operations. Google’s inventory management uses maintenance, repair and operating (MRO) goods inventory in practically all areas of its business. For example, MRO goods include office supplies like paper and pens, maintenance supplies like janitorial materials and special cleaning solutions for computer equipment, and other goods like coffee and food provided to Google’s employees. The role of this type of inventory is to support Google’s operations in direct and indirect ways.

Google’s Inventory Methods

Serialized inventory. Google uses the serialized method in managing inventory. This method involves assigning a unique serial number to each item in the inventory, instead of recording them per batch. For example, Google’s inventory management uses serialization for and Nexus items. In online advertising, the company also uses serial numbers for advertisers and publishers.
FIFO. The first in, first out (FIFO) method is used in Google’s inventory management. In this method, the first items to arrive are also the first to be sold. For example, the firm’s Nexus smart phones and digital media players are managed through the FIFO method. This inventory management method enables Google to minimize the accumulation of old items in storage.

Google’s inventory management approaches have a beneficial impact on the firm’s costs. For example, the FIFO method ensures that most old models are sold before new models are released to the market. The serialized inventory method maximizes the efficiency of tracking and monitoring materials and products. The combination of the different types of inventory also supports Google’s business operations. These benefits lead to operational efficiency and optimized spending for inventory management.

Google’s Measures of Inventory Performance

Google uses different measures of inventory performance, considering that the firm has different types of inventory. However, for the company’s physical goods like Nexus, the following are the most relevant measures of inventory performance:

Inventory turnover
Average inventory level
Cycle time

Inventory turnover measures the rate of sale of Google’s products. Average inventory level measures the average size of the inventory. An increase in the average inventory level corresponds to an increase in spending for inventory management. Cycle time is the duration of the process of filling inventory with new products or models. A shorter cycle time means higher efficiency of Google’s inventory management practices.

Managing Inventory across Google’s Supply Chain

Inventory Value in the Supply Chain. Inventory value is maintained and optimized through Google’s use of information systems to monitor items and identify potential issues. The company’s advanced information systems are used to predict possible stock-outs and changes in demand. Based on such information, Google acts proactively to maximize inventory value throughout its supply chain.

Bullwhip Effect. The bullwhip effect refers to the propagation and worsening of errors, delays and deficiencies in the supply chain. This effect is likely to occur in Google’s inventory of consumer electronics. In digital products and online advertising, the company does not experience the bullwhip effect. Even so, Google’s inventory management involves information systems to identify and minimize errors, delays and deficiencies in the supply chain.

31.5 SUMMARY

Inventory is the stock of items kept for production or sales. There are various basis to classify the inventory. On the basis of nature, inventory can be classified as direct and indirect material. On the basis of manufacturing process undertaken, inventory is categorized as raw material, work in progress and finished goods. On the basis of movement, stock can be classified as fast moving, slow moving and dormant. On the basis of value, stock can be put in category A, B or C and on the basis of function; inventory can be classified as transit inventories, decoupling inventories, buffer inventory, cycle inventory, Anticipation inventory, MRO inventory. Spare parts can be classified as vital, essential and desirable. The classification of inventories helps in grouping of store items, easy location, proper accounting, proper care, avoidance of duplication and standardization.

31.6 GLOSSARY

Direct Material :- Material which can be directly identified with the finished product e.g. wood in furniture.
Pipeline Inventory :- The goods which are still in company’s distribution system as these are yet to be purchased by ultimate consumers.
Lot:- Batch/Group of items.
Semi Finished:- Inventory which is neither raw material nor finished good as it is in the midway of production.

31.7 REFERENCES/ SUGGESTED READINGS

Mahadevan, B., Operation Management: Theory and Practices, Pearson, New Delhi
Krajewski and Ritzman, Operations Management, McGraw Hill, New Delhi
McGreger,D., Operations Management, McGraw Hill, New Delhi
Adam and Elbert, Production and Operations Management, Prentice Hall, New Delhi

31.8 SHORT ANSWER QUESTIONS

1) The material which cannot be directly identified with a product is called

(a) Buffer stock

(b) Indirect material

(d) Work in progress

Answer :- (b)

2) On the basis of value, Inventory can be categorized as

(a) Category A, Category B, Category C

(b) Vital, Essential, desirable

(d) Raw Material, Work in progress, Finished goods

Answer :- (a)

3) True/False

The inventory, the non availability of which cannot be tolerated even for a very short time period as the production process will come to a standstill is called vital inventory.

Answer :- True

4) ___________ Inventories are mainly required where output of one production process is input for other production process.

Answer :- Decoupling

31.9 MODEL QUESTIONS

1) How will you define Inventory? Discuss different types of Inventory.

2) Discuss the following

(a) Decoupling Inventories

(b) Cycle Inventories

(d) Anticipation Inventory

(e) Transit Inventory

3) Classify the inventory on the basis of

(a) Value

(b) Movement of stores

(d) Nature