Inventory is listed as an asset on a firm's balance sheet and consists of the stocks or items needed to maintain production, support activities such as maintenance and repair, and provide customer service. Inventory typically is categorized based on its flow through the production cycle, using such designations as raw materials, work in process, and finished goods. Maintenance, repair, and operating supplies also are stocked to support the functionality of the firm.
For planning and forecasting purposes, inventory is classified based on the source of its demand as either independent or dependent. Independent demand items are requested directly by the customer and thus must be forecasted. Demand for dependent items can be derived or calculated based on relationships to independent items, usually noted by higher levels in the bill of material.
5.2.1 Purpose of inventory
Inventory's primary purpose is to meet demand in support of production or customer service. Inventory is an expensive asset and needs to be carefully managed and controlled. The following terms are related to the different purposes of inventory.
Pipeline. Pipeline is inventory in the transportation network, including inventory shipped from a supplier but not yet received by the customer. The overall network design impacts the amount of pipeline inventory.
Cycle stock. Cycle stock typically is the most active inventory component. Its amount is based on lot-sizing rules as stocks are received and depleted.
Anticipation. Anticipation is the stocking of additional inventory to cover projected trends of increased demand from forecasted events such as sales promotions, seasonal fluctuations, plant shutdowns, vacations, supplier price increases, and possibilities of labor disruptions.
Decoupling. Decoupling is creating independence between supply and the use of material. It refers to inventory that often is collected between operations so that fluctuations in the production rate of the supplying operations do not limit the output of the next operation.
Safety stock. Safety stock is inventory carried in excess of expectations used to cushion against uncertainty in demand or in replenishment lead time.
Hedging. Hedging is purchasing inventory in advance to mitigate the impact of anticipated price increases or shortages.
Obsolescence. A critical condition in inventory management is keeping inventory in up-to-date, usable condition. Inventory that becomes obsolete typically becomes a write-off against profits on the profit and loss statement. Obsolescence can occur from effects such as spoilage, as in food; and loss of utility from the introduction of better or more economical products, methods, and facilities.
5.2.2 Inventory types
Inventory is a broad term. In service industries, it might mean classifications of worker skills and positions or repair equipment. In most fields, it also can refer to the equipment, fixtures, buildings, and materials used in production.
Raw materials. Raw materials require added value or labor to be converted into useable parts. The generally accepted accounting principles view of raw materials is as purchased items or extracted materials that are converted into components and products through manufacturing.
Work in process (WIP). WIP refers to goods in various stages of completion, including all material that has been released for initial processing and processed material awaiting final inspection. A value-added process applied to a raw material is considered WIP.
Finished goods. Finished goods are those on which all manufacturing or service operations have been completed. They are products available for delivery to the customer.
Distribution. Distribution refers to inventory located in the distribution system that is separate from manufacturing inventory. It includes items in transit and items in storage awaiting delivery to a customer.
Maintenance, repair, and operating supplies (MRO). MRO refers to items used to support general operations and maintenance (such as spare parts) and consumables used in the manufacturing process and supporting operations. In terms of dollars and quantity, this inventory is considered relatively minor; but in continuous process and flow industries, it may equal or exceed production inventory. Failure to have basic office supplies or a spare part when needed can be harmful to the profitability of a firm.
Service parts. Service parts are modules, kits, components, and individual parts used to replace an original without modification. Service parts usually are a segment of distribution inventory. Some firms, such as automotive original equipment manufacturers, are required by law to provide replacement inventory for vehicles years after sale.
5.2.3 Push systems and pull systems
Push systems. In a push system, items are produced on a schedule in advance of customer need. In material control, issuing material according to a schedule or to a job at its start time are hallmarks of a push system.
Pull systems. In a pull system, items are produced only as demanded for use or to replace items taken for use. In material control, pull systems withdraw inventory as demanded by operations. Kanban signals enable actual demand or usage to initiate the flow of materials. (See section 6.5.4.)
Push-pull boundary. Some businesses use both push and pull systems within the same facility. The push-pull boundary is the point where one system ends and the other takes over.
5.2.4 Customer order decoupling point
This is a point where inventory is carried to buffer at least part of the manufacturing system from individual customer orders. The selection of decoupling points is a strategic decision that determines customer lead times and inventory investment.
5.2.5 Lean concepts
See section 3.11.