Managing Inventory (Stock)

Inventory is necessary to allow production to continue or for sales to take place. The higher the level of inventory, the lower the stock turnovers figures. The importance of effective inventory management was illustrated in the previous section on the cash conversion cycle.

The focus of inventory management is to maintain the appropriate level of inventory. Minimum levels of stock should be kept when bearing in mind that there are costs involved in holding stock. Production and marketing staff, on the other hand, prefer higher levels of stock. Companies must strive for an optimum level between these two conflicting requirements.

The costs involved in holding stock are:

• Order costs
• Storage costs
• Insurance costs
• Opportunity (financial) costs
• Cost of deterioration and obsolescence

Techniques for managing inventory levels:

• Economic Order Quantity (EOQ)
• Just-in-Time (JIT)

Note: A detailed discussion of these last two topics falls beyond the scope of this course. Interested students are referred to Lawrence J. Gitman’s Principles of Managerial Finance, 7th Edition, or Brigham and Gapenski’s Intermediate Financial Management, 5th Edition, for more information on the topics. Although these topics are covered in all good financial management handbooks, these two are strongly recommended. The first is written in easily-understood language; the latter is more advanced and requires a fair degree of financial background.