INVENTORY MANAGEMENT AND CONTROL*

INVENTORY MANAGEMENT AND CONTROL concerns most managers of agricultural marketing and supply businesses, whether they are retail, wholesale, or service oriented. The value of a manager to an agricultural marketing and supply business depends on his ability to manage inventories effectively. The total cost of maintaining the desired inventory level must be held down to a reasonable figure, but the inventory must also be large enough to permit the company to effectively merchandise the products and services it sells. If the manager doesn't control his inventories to accomplish both of these objectives, the business may not be able to prosper or even to survive against competition. The information in this circular suggests to the manager ways on how best to do four things: Y How to control inventories. Y How to visualize the inventory costs to be included in determining how much inventories are costing the company. Y How to determine the level of inventory that is most profitable. Y How to determine how much to order and how often to order.

Controlling Inventories

Purchase systematically. Place orders for materials long enough beforehand so there will not be a shortage between ordering and delivery. Let the inventory become relatively low before reordering but keep enough on hand to meet current needs. There are costs associated with keeping large inventories. Likewise, there are costs if you deplete your stock. Don't hold “dead” lines or items.

Keep track of inventories. When stock is received, be sure that what was ordered was delivered. Make sure that the amount received is added to the inventory. Physical inventories should be taken frequently to find out which items are not selling so you can discontinue them as quickly as possible, to spot shortages in merchandise that may be due to theft, to note deterioration that may occur, and to decide when to reorder.

Make someone responsible for checking the inventory. Delegate the responsibility for specific parts of the total inventory effort to the persons in the organization who are best qualified to do the job. Be sure those to whom you delegate responsibility know exactly what they are supposed to do.

Use storage facilities efficiently. Assign space to each item in stock. Arrange the storage area to permit the handling of stock with the least amount of effort and in such a way that stock can be easily found, the quantity determined and recorded, and the stock removed if necessary. Arrange the warehouse and sales area so the items that sell rapidly can be most easily picked up by the customer or restocked in the display area readily by the employees. Use mechanical means to handle and move supplies whenever the volume warrants it. This will reduce the amount of labor used in handling stock. Plan to use space interchangeably with seasonal items and thus reduce the cost of storage space.

Be aware of inventory turnovers. Know what the turnover of each commodity is and if possible compare this with the turnover of the same items by other similar firms. Inventory turnover ratio is determined by dividing the volume of sales of merchandise by the level of inventory at a point in time, such as the first of each month. For example, the sales of fertilizer in May amounted to $143,000 and the fertilizer inventory at the end of May was $16,300. The inventory turnover ratio for May thus was $143,000/$16,300, or 8.8 to 1. That is, there was an $8.80 turnover of fertilizer for every dollar’s worth in stock at the end of the period in question. A zero inventory, which would give you a ratio of infinity, would not be desirable because the objective of management is to maintain the level of inventory at a level that will permit the most effective merchandising. The most profitable inventory turnover ratio varies with each commodity. Generally, high inventory is needed for rapidly moving commodities if the merchandising effort is going to be efficient and effective. Good examples of this are feed and grain. Other commodities move more slowly but require that a small stock be on hand at all times. Farm machinery is a good example of this. The demand for some items, such as seed, is

seasonal and requires large inventories at certain times of the year. Increase selling efforts or reduce the average stock of slow-moving items. If an item can’t be sold, discontinue stocking it immediately. Dead items are real losers.

Know the costs of inventories. Because costs of inventories are very closely related to size of inventories, the manager should keep his inventory as small as possible consistent with a good merchandising program. The costs of carrying inventories can be a large percentage of the sale value of the inventory. The costs are often 20 to 25 percent or more of the total value of the inventory. The manager should know the costs of holding an inventory and then try to reduce the price of an item to the inventory holding cost to dispose of the items instead of holding them in inventory.

Avoid holding lines of merchandise that compete with one another. Stocking too many lines is asking for inventory problems. Choose the lines of merchandise carefully and then vigorously sell a limited number of lines. Duplication of items that occurs when the company carries multiple lines can more easily result in larger inventories and increased inventory holding costs.

Determining Inventory Costs Inventory costs are real but they are also difficult to determine because they cannot be taken directly from accounting records. Inventory costs for individual items make it necessary to prorate costs of equipment, space, labor for handling, utilities, insurance, taxes on land and buildings, depreciation on buildings and handling equipment, clerical help, unemployment insurance for certain personnel, social security for all “space,” “handling,” and “inventory service” personnel, and a proportionate share of administrative overhead. The cost of holding inventories may make the payoff so great that the manager can’t afford not to do it. Also, when inventory costs have been determined once, it is a much simpler task to make the necessary adjustments in each of the costs. One way to view the total annual cost of carrying inventory is as a percentage of total inventory value. For example, if a company’s average inventory is $25,000 and the average inventory carrying cost is 20 percent, it will cost the company $5,000 per year to carry an average inventory of $25,000. An inventory holding cost that is 20 percent of the average value of inventory is probably too low. Estimates of inventory holding costs for agricultural supply businesses usually range from 20 to 35 percent. The costs that need to be included in the total inventory carrying cost are:

Storage space costs. These include taxes on land and buildings; insurance on buildings; depreciation on buildings and warehouses owned; rent (if paid); materials for repairs and maintenance on buildings; utilities; and janitor, watchman, and maintenance costs.

Handling costs. These include depreciation on equipment; fuel for equipment; maintenance and repair of equipment and insurance and taxes on equipment.

Risk costs on inventory. These include insurance on inventory; obsolescence of inventory; physical deterioration of inventory; pilferage; and losses resulting from inventory price declines.

Inventory service costs. These include taxes on inventory; labor costs of handling and maintaining stock clerical costs for inventory records; contribution to Social Security by employer based on prorated time devoted to inventories by employees; unemployment compensation insurance based on prorated time of “inventory involved” personnel; employer contribution to pension plans, and group life, health, and accident insurance programs based on prorated time of “inventory involved” personnel; and an appropriate proportionate share for administrative overhead, including all taxes, Social Security, pension, and employer contributions to insurance programs for administrative personnel who are involved.

Capital costs. These include interest on money invested in inventory; interest on money invested in inventory handling and control equipment; and interest on money invested in land and buildings to store inventory (if land and buildings are owned).

Cost summary. The information about the hypothetical company that follows shows how a manager can develop a better understanding of how he can use the knowledge he has about inventory holding costs to make better management decisions. The company management thinks they have a high cost of inventory holding but they don't know exactly what that cost is. Consequently they ask the manager to compute this cost. The average inventory value in 1971 was $25,000. This figure is arrived at by adding the quarterly inventory values, which were $21,000 on March 31, $33,000 on June 30, $29,000 on September 30, and $18,000 on December 31, to get a total of $101,000. This results in a quarterly average of $25,250, which is rounded to $25,000. The manager computed the holding costs on the average inventory and found that they were as follows:

Obsolescence cost based on the value of the average inventory ......... $1,500.00

Cost of capital on the average inventory ........................................... $2,500.00

Deterioration of average inventory or its prevention .................................... $1,250.00

Handling and distribution costs of average inventory ............................. $2,000.00

Transportation................................... $250.00

Taxes on average inventory ............. $187.50

Insurance of average inventory… $125.00

Storage facilities cost on average

inventory ........................................... $500.00

TOTAL.............................................. $8,312.50

The manager also had available the average industry-wide inventory holding costs listed below:

Obsolescence................................ 4 to 7%

Cost of capital ................................ 8 to 12%

Deterioration or its prevention ....... 4 to 5%

Handling and distribution ............... 2 to 3%

Transportation................................ .5 to 1%

Taxes ............................................. .5 to .75%

Insurance ....................................... 0.25%

Storage facilities ............................ .25 to .75%

TOTAL.........................................1..9.5 to 29.75%

The manager now compared his company’s costs with these percentages by computing the percentages that each of the company’s average inventory holding costs were of his total inventory costs. These computations yielded the following information:

Obsolescence....... $1,500 is 6% of $25,000

Cost of capital ....... 2,500 is 10% of 25,000

Deterioration or its prevention ............. 1,250 is 5% of 25,000

Handling and distribution ............ 2,000 is 8% of 25,000

Transportation....... 250 is 1% of 25,000

Taxes .................... 187.50 is .75% of 25,000

Insurance .............. 125 is .5% of 25,000

Storage facilities ... 500 is 2% of 25,000

TOTAL.......... $8,312.50 is 33.25% of $25,000