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Inventory Management

15 January, 2016 - 09:50

Inventory management is another major area of concern for manufacturers—particularly those that are operating in just-in-time environments. How does a company ensure that it can provide the required finished goods for one of its partnering companies on a just-in-time basis? If you are a specialized parts supplier for a large automaker, such as General Motors, and you cannot consistently fill orders in the desired time frame, you probably will not be a partner company for long!

A major challenge for the inventory manager becomes one of determining appropriate levels of raw materials and finished goods inventory that should be maintained in order to assure that production can be maintained and finished goods delivered in a timely manner. As a case in point, refer back to the discussion of Lite- On Technology Corporation in Technology Application 10.2. This discussion noted that Compaq and IBM now require shipment of CD orders within just four hours after orders are placed. Balancing inventory levels to satisfy customer demands in this type of environment can be a tricky business.

The importance of maintaining adequate inventory levels should be apparent at this point. Keep in mind, however, that we must balance the desire for high inventory levels with the need to avoid both excessive inventory carrying costs and leftover supplies of materials that are no longer required in revamped production processes. The events of September 11, 2001, however, made many organizations rethink their inventory strategies. For example, because transportation systems were disrupted for several days after September 11, many manufacturing operations shut down for lack of raw materials.

Inventory fraud is also a significant cause for concern, as illustrated in Technology Application 13.1. As such, inventory process controls are primarily oriented toward operational (i.e., effectiveness and efficiency) and security objectives. We focus here on three categories of control goals:


Inventory Fraud Examples

Case 1

Laribee Wire Manufacturing Co., a New York copper-wire maker, illustrates the link between inventory manipulation and accounting. Suffering from a huge debt and declining sales, Laribee borrowed $130 million, a major portion of the loan collateral being its reported inventories of copper rod. After the firm filed for bankruptcy court protection a year later, it was discovered that much of its inventory didn’t physically exist or was on the books at inflated values. It is estimated that the inventory fraud contributed $5.5 million to Laribee’s before-tax profits.

Case 2

A case of retail inventory fraud is that of Phar-Mor Inc., the deep-discount drugstore chain. Phar- Mor kept inventory on its books that had already been sold and created fictitious inventory at several of the chain’s stores. One of its major stockholders contended, in a suit filed against Phar-Mor’s auditing firm of Coopers & Lybrand, that the company’s balance sheet falsified and overstated inventory by more than $50 million!


  1. Effectiveness of operations relative to the following goals (note that these goals address the concepts discussed earlier in the chapter; namely, optimizingthe inventory investment):
  • to maintain a sufficient level of inventory to prevent stockouts,
  • to maintain a sufficient level of inventory to minimize operational inefficiencies, and
  • to minimize the cost of carrying inventory.
Sample controls in the area categorized as effectiveness of operations might include:
  • Perpetual inventory records: Maintenance of a continuous record of the physical quantities maintained in each warehouse facilitates inventory management.
  • Just-in-time materials acquisition: Just-in-time inventory acquisition essentially eliminates the risk of overstocks while minimizing inventory carrying costs.
  • Internal transfer procedures: Often, materials and finished goods inventory are stored in multiple warehouse or plant locations. Needs for raw materials or finished goods orders should initially be satisfied with excess inventory available through transfers from other locations.
  1. Efficiency of process operations. Sample controls in the area categorized as efficiency might include:
  • Just-in-time materials acquisition: Just-in-time inventory acquisition, when automated through EDI, XML or other related approaches, can improve the efficiency of the inventory process by reducing the amount of manual labor necessary to determine when to reorder materials inventory.
  • Warehouse bin location: This plan calculates the approximate amount of space to devote to each inventory item. It also analyzes the total warehouse space available to determine where to locate each item to increase requisition picking efficiency.
  1. Resource security. The resources of interest here are the raw materials, workin- process, and finished goods inventory assets and the information resources stored in the inventory master data. Sample controls in the area categorized as resource security might include:
  • Periodic physical inventory counts: Used in conjunction with a perpetual inventory process, this control plan assists in protecting materials, work-inprocess, and finished goods inventory by providing the warehouse manager or the inventory control supervisor with a record of the actual (on-hand) balance of each item of inventory. Differences between the physical counts and perpetual records may suggest the possibility of pilferage.
  • Locked storerooms: Locked storerooms contribute to the achievement of the operations system control goal of securing inventory.

Review Question

Why is inventory management and control important to the manufacturing and production processes?