Influence of inventories on elements of working capital

Author: Iloka Benneth Chiemelie

Published: 15-October-2014

Introduction

There are different definitions for inventory management but in the case of this paper, it is defined as the stockpiles of resources, suppliers, components, work in progress, and finished goods that surfaces in the production and logistics channel of a firm at some point in time (Ballou, 2004).

Inventory management is beneficial to companies in a number of ways, but controlling and maintaining inventory is a significant problem faced by vast amount of the economy. Inventory management is very important because all companies have to deal with inventories on daily basis, and neglecting such importance can lead to the company closing down, especially in cases where production factors are not carefully managed in order to meet the needs of customers. In that, this paper will seek to analyze benefits of inventory management, why companies have different inventories, and the level of inventory adopted can influence other elements of production in the company.

Advantages of inventories

Companies keep inventory for a number of reasons and five of such reasons have been identified by Leedy and Ornrod (2001). They are:

Attaining economies of scale – by adopting inventories, firms are able to realize economies of scale in their purchasing, transportation and manufacturing sectors. For instance, when the firm purchases large amount of resources, it is able to get discounts, and since transportation can be done in larger volume for these resources, it can gain economies of scale through equipment utilization (Musenga, 2005). Manufacturing also results in higher amount of inventories with materialized utilized in terms of allowed reduction in per unit fixed cost.

Creating a balance between supply and demand – some products (such as toys) are experience higher demands during seasonal periods (such as Christmas). Thus, inventory allows the company to stock such products during periods of low demands against period of high demands (Musenga, 2005). By stocking, idle plant capacity is also reduced and it becomes possible to maintain a relatively stable workforce in the process, thus production cost is kept down.

It allows for specialization – for firms with subsidiaries, inventory allow them to specialize. This is because different plants can be used to produce different goods and the finished goods shipped to customers. In the long-run, this will bring about economies of scale and specialization also reduced uncertainties born from producing different products with the same plant (Musenga, 2005).

It allows for interfaces to be buffered – through inventory, companies can be able to shield the gap in major components of the supply chain system. For instance, inventory can allow them to buffer the gap between purchases and supply, supply and manufacturing, manufacturing and distribution, and finally consumption (Musenga, 2005). In the process, the company will be able to better utilize time and space in the process.

Reasons why companies change their level of inventory management

The major reason why companies change their level of inventory management is because of changes in demand. As demands increases, the company need to increase production and supply, while decrease in demand will bring about decrease in production and supply (Musenga, 2005). Thus, demand is the major factor that influences company’s decision to change the amount of inventory they keep over the course of time.

How changes in inventory management can influence other elements of working capital

From the above discussion, it becomes obvious and clear that an increase in inventory will bring about a subsequent increase in other elements of working capital and vice versa. Thus, inventory management is correlated with other working capital (Musenga, 2005). For instance, if the inventory of the company increases as a result of increase in demand, the company will need to increase its supply, production, distribution and services – which can bring about subsequent increase in plant utilization, manpower demand, machineries and other working capitals.

Conclusion                                                                       

Inventory management is essential for the company because it bridges the gap between consumers’ demand and company’s supply ability. Through inventory management, the company will be able to understand what consumers needs and produce accordingly. However, such process is not easy as it does come with a number of setbacks.

References

Ballou, R., H. (2004). Business logistics / supply chain management: planning, organizing and controlling the supply chain. 5^th edition. Pearson-Prentice hall. USA.

Leedy, P., D., and Ormrod, J., E, (2001). Practice research. Planning and design. 7^th edition, Menrril Prentice Hall.

Musenga, F., M., (2005). Inventory management as a determinant force improvement of customer service. University of Pretoria, South Africa. Available at: http://upetd.up.ac.za/thesis/submitted/etd-12222005-101331/unrestricted/dissertation.pdf [Accessed on: 27^th of September, 2014].