"Too much inventory value! Do something now to lower the working capital invested in the stock!" This exchange between Finance and Operations is as typical as it is challenging to execute. A request is made (or an order is given!) to free up working capital by optimizing inventory, without jeopardizing availability.
But how? Reducing working capital to meet budgets requires making real-world changes to specific items to lower your inventory levels. The first step to doing so is identifying the different types of stock in your warehouse or storeroom. In this article, we’ll look at the ten different types of stock that can be recognized within working capital, and useful strategies for managing each of them.
INVENTORY OPTIMIZATION ACCORDING TO STOCK TYPE
This type of stock is directly related to the different batch sizes used to process orders. The correct lot size is the one that delivers the lowest total cost, striking a balance between the cost of placing orders and the cost of maintaining inventory.
For example, if you receive an order for 1,000 units of a specific product, it might seem simple enough to buy or produce precisely that many. However, if a cost analysis shows that it is more efficient to buy or make 1,500 units, then merely fulfilling the order as it is given is not an optimal use of resources. In this case, the 500 extra units are the stock type known as “lot size.” This stock exists because an order was increased to meet the lot size established by the company.
If you knew exactly how much your future demand would be, then you’d never need to order extra inventory. However, things aren’t that easy in the real world. Instead, predicted future demand must be balanced against expected lead times. Safety stock is kept in your warehouse to help cover future uncertainty in either demand or lead times or both. While it does require more working capital, the ability of safety stock to help you maintain service level pays off in the long run by ensuring strong customer relationships.
Imagine a company that sells umbrellas all over the world. In some of the locations – like the rainy coast of Southern Chile - it will sell units year-round. But at most sites, the highest sales will always occur during the wettest months of the year, so inventory during those months is also higher.
Because sales for these items follow the seasons – whether it’s holidays, sports or climate - this is known as “seasonal stock.” Because this is usually when a majority of these items are sold, the seasonal demand patterns must be planned for. For instance, if the highest sales for umbrellas in Northern California are between June and August, orders for them may be concentrated between May and July.
This type of stock is commonly found in manufacturing companies with resource-intensive operations. It is defined as the excess stock that is maintained during the period where demand is less than the productive capacity.
For instance, imagine a company that manufactures glass ornaments, and whose furnaces cannot be turned off. The monthly production capacity can be 10,000, although the demand fluctuates between 15,000 in some months and 5,000 units in others. Inventory optimization occurs by maximizing the productive capacity of the oven. Stock capacity units will be sold in those months where demand is higher.
Work in Progress Stock
It makes sense that manufacturing companies carry a stock of raw materials and finished products. However, they also commonly carry partially finished products, depending on production best practices and expected demand.
These partially finished items are “work in progress stock,” and they help businesses react more quickly to customer requirements such as seasonality. Optimization is achieved when Instead, resources are used to prepare products some of the way towards completion when demand is low. Doing so allows order to be completed in days instead of weeks once they are received.
Your product assortment is made up of hundreds or maybe hundreds of thousands of items; however, some are more important than others. If your company makes door hinges but sources your screws through a third party, having access to brass, nickel and steel are more important on a day-to-day basis than screws. Because they are essential to the operation of your business, these items are known as “strategic stock.”
Many raw goods – such as metals, ores, or lumber - are strategic stock in part because they are not always available. They may come from unstable parts of the world, or be highly dependent on unpredictable phenomena such as tropical storms or sea ice. Strategic stock is similar to safety stock. However, the difference is that it is determined by senior management and not statistically. For this reason, identifying strategic stock is essential for inventory optimization.
STOCK CLASSES FOR INVENTORY OPTIMIZATION
In addition to the six types of the stock listed above, there are four other stock classes. These classes did not fit a strict definition of stock types, but they are usually presented as such.
Although this inventory is available in theory, in practice, it is essentially useless. It corresponds to items that have no movement. Some companies decide to keep it "just in case," while others make great efforts to clean it and financially assume obsolescence. Read our advice on how to handle obsolete inventory here –
Machinery companies always need to have the necessary spare parts available as a cost of doing business. This means they have to keep specific items in stock indefinitely, to respond to customer warranty claims. Doing so allows your customers to keep their machinery running and builds positive customer relationships.
These are items that for a variety of reasons – e.g. predictable demand, strategic importance, etc. - have minimum order levels, which they should never be below.
Stock Pending to Receive
This is an administrative class of stock that shows the units which are pending to arrive from the supplier to the warehouse. It is understood that it is a component of the financial stock and that it could be accounted for financially based on the "cost of ownership."
Are the different types of inventory easily identifiable in your company?
Does each type of stock effectively have a different inventory optimization?
If you wanted to lower the working capital of your company, in which of these types of inventory, do you think you could do inventory management?
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