Components of Inventory

Principle & Practice of Management

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Components of Inventory

Inventory Components

From the above definitions, we can draw the inventory components. The various forms in which inventories exist in a manufacturing firm are, raw materials, work-in-process, finished goods, and stores & spares. The following Figure 12.1 gives the inventory components:
1. Raw Materials: Raw materials are those inputs that are converted into finished goods through a manufacturing or conversion process. These form a major input for manufacturing a product. In other words, they are very much needed for uninterrupted production.
2. Work-in-Process: Work-in-process is a stage of stocks between raw materials and finished goods. Work-in-process inventories are semi-finished products. They represent products that need to undergo some other process to become finished goods.
3. Finished Products: Finished products are those products, which are completely manufactured and ready for sale. The stock of finished goods provides a buffer between production and market.
4. Stores and Spares: Stores and spares inventory (include office and plant cleaning materials like soap, brooms, oil, fuel, light, bulbs etc.) are purchased and stored for the purpose of maintenance of machinery.

Inventory Components

Need for Balanced Investment in Inventory

Management of optimum level of inventory investment is the prime objective of inventory management. Inadequate or excess investment in inventories is not healthy by for any firm. In other words, a firm should avoid inadequately (under) investment or excess (over) investment in inventory. The investment in inventories should be sufficient. The optimum level of investment in inventories lies between excess investment and inadequate investment.
1. Dangers of Excessive (over) Investment in Inventory: The following are the dangers of excessive investment in inventory: (a) The excessive level of inventories consumes funds of the company, they cannot be used for any purpose since they have locked in inventory, and they involve opportunity costs.
(b) The excessive investment in inventory increases carrying a cost, that include the cost of storage, capital cost (interest on capital in inventories, insurance, handling, recording, inspection, obsolescence cost, and taxes. this cost will reduce the firm’s profits).
(c) Carrying excessive inventory over a long period leads to the loss of liquidity. It may not be possible to sell the inventories in time without loss.
(d) Another danger of carrying excessive inventory is the physical deterioration of inventories while in storage. In the case of certain goods or raw materials deterioration occurs with the passage of time or it may be due to mishandling and improper storage facilities.
(e) Excess purchases or storage leads to theft, waste and mishandling of inventories.
2. Dangers of Inadequate Investment in Inventories: Underinvestment in inventory is also not healthy one. It has some negative points, they are:
(a) Inadequate raw materials and work-in-progress inventories will disturb production.
(b) When the firm is not able to produce goods without interruption, that leads the inadequate storage of finished goods. If finished goods are not sufficient to meet customer demand, the customers may shift to the competitors, which will lead to loss of customers permanently.