Controlling Inventory

Last Updated Feb 14, 2008 7:21 PM EST

Inventory control ensures that a company's inventory level meets predetermined standards of services and can release enough funds for working capital. Strategic inventory is the inventory without which the organization cannot function, that is, essential inventory. Nonstrategic inventory is the basic commodities that are not critical to the overall functioning of the organization and that can be readily sourced.

What You Need to KnowWhy is inventory control important?

Inventory control is important at both ends of the supply spectrum. Too much inventory ties up cash, prejudices cash flow, and in extreme cases jeopardizes the very survival of the company. Too little inventory threatens prosperity and growth if goods cannot be delivered to customers. Inventory control is therefore very important—but often neglected.

How can my company benefit by introducing inventory control?

The introduction of effective inventory control requires the commitment of significant effort and resources. However, inventory control can benefit your company by:

  • releasing cash for the major functions of the organization;
  • achieving a standard of service consistent with predetermined policy;
  • minimizing the costs associated with holding inventory—financing, storage, insurance, handling, obsolescence, pilferage.
What to DoUnderstand What Is Involved

Inventory control systems vary from the extremely simple, ledger books and card indexes, to sophisticated computerized operating environments.

A system, simple or complex, should provide you with regular reports about current inventory and record supplies received, sales, deliveries, outputs, and usage. Your system need not be based on precise records for every item held in inventory. Use common sense; the cost of the system and its operation should not exceed the cost of the problem it is intended to solve. However, the following information must be built into any inventory control system:

  • a report of current inventory levels; a record of receipts/dispatches;
  • the identification of reorder levels and quantities (through analysis of lead times, volume discounts, price stability). This has a cost in itself in the form of higher ordering costs, loss of bulk discounts, and perhaps additional handling charges;
  • a schedule of regular auditing and inventory checking.
Analyze Usage

Analyze the usage of all items in terms of:

  • volume;
  • strategic/nonstrategic status.

You will need to:

  • identify which products must be available on demand;
  • classify products in terms of their importance to sales, not in product families or in other broad product groupings;
  • analyze sales to identify the real money makers. You can probably assume that 50 percent yields only 10 percent of the total value, so this half requires less attention;
  • focus on the items that produce the most profit; resist giving equal attention to all inventory items.

Identify the level of inventory you need to hold to avoid the risk of missing real opportunities or failing to supply the basic needs of your best customers. Identify nonstrategic inventory and reduce it through:

  • special offers;
  • nonreplacement;
  • repackaging;
  • scrapping for salvage value.

In extreme cases, write it off.

Do not waste time monitoring items that yield 5 to 10 percent of annual revenue. Reduce stocks of them. The 80/20 rule applies: monitoring the right 20 percent will give you control over 80 percent of the total value of your inventory. Arbitrarily reducing inventory by a fixed percentage across the board is likely to result in reduced service levels without your having identified areas of wasted investment.

Identify the level above which excess inventory ties up cash and diminishes your return on capital.

Plan Your Storage Area
  • Locate frequently used items in an accessible place.
  • Train your staff in manual handling methods and the operation of mechanical handling equipment.
  • Choose appropriate stacking methods such as pallets, drums, bins, shelving, pipe racks. Do not try to store all items using the same system.
  • Consider storing large or bulky items with your suppliers if you have insufficient space, making sure that they are available when you need them.
  • Use an appropriate labeling system for identifying inventory items—bar coding or a simple handwritten label.
  • Take shelf life into consideration and implement a stock rotation system. Review environmental conditions such as temperature and humidity.
Calculate the True Cost of Holding Inventory

Take into account the cost of:

  • financing (the cost of funds or opportunity cost);
  • storage, including equipment and labor;
  • providing protection from damp, cold, or damage;
  • insurance;
  • handling;
  • losses through obsolescence;
  • losses through pilferage;
  • rental income you might have received from your storage facilities.
Use Common Sense

You cannot control every item by quantity—you would not expect someone to count paper clips or screws. Consider classifying such items as consumables and make it a policy not to count them. Some types of inventory may be controlled by weight.

Link to Other Departments

Try to link your inventory control system into other departments' systems. A system that works closely with accounting will reduce the workloads of both departments. Good communication with sales, buyers, and dispatch departments will lessen the risk of the staff and facility being overworked one day and underoccupied the next.

What to AvoidYou Fail to Commit the Necessary Personnel

Do not underestimate or overestimate the staff required for running your inventory control system in terms of numbers or quality—too few and you will lose control of your inventory; too many and the cost of running your system will be prohibitive. An inventory control system need not be expensive and complex. A basic system run by the right people may give you adequate control at a cost below the resulting savings.

You Fail to Identify Areas of Shrinkage

Do not assume you are not suffering from pilferage, excessive waste, or some other form of shrinkage. You conscientiously lock your safe when it contains only $100, but how much thought do you give to securing the warehouse containing $500,000 in inventory?

You Fail to Plan Inventory Levels

Well-run companies plan inventory levels, relating them to known or anticipated sales, deliveries, demand, and usage. Set and regularly review reorder levels and quantities. Do not exaggerate the possible consequences of running out of something or hold inventory just to fill a warehouse. And do not buy on speculation or assume that every quantity or early delivery discount is to your advantage. Think of inventory as cash.

Where to Learn MoreBook:

Muller, Max. Essentials of Inventory Management. American Management Association, 2002.

Web site:

Modern Materials Handling: www.mmh.com