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21). Conversely, Michman and Greco (1999) point out that, "Some department stores have failed because many have provided a stale and unexciting physical environment to customers. Another reason has been that some department stores have been unable to implement effective inventory management systems, thereby lowering costs to either match or at least approach the prices offered by discounters" (p. 4).
Effectively managing inventory also requires the ability to monitor current inventory levels with an accurate inventory system. To the extent that inventory records are inaccurate is likely the extent to which managers will be required to spend inordinately larger amounts of time in material expediting or placing orders for too much inventory (Young & Nie, 1999). According to these authorities, "A general rule-of-thumb is that the 'A' items should be the most accurate of all inventory items" (Young & Nie, 1999, p. 55). The recommendations provided by the American Production and Control Society (APICS) indicate that the inventory records for "A" items should be about 99.5%, "B" items should be about 99% and "C" items should be approximately 95% (Young & Nie, 1999).
Although these optimal inventory levels may appear easy to achieve, the harsh reality of the situation for most organizations is that their inventory records are not sufficiently timely or accurate to provide managers with the information they need to make informed decisions. In this regard, Young and Nie emphasize that, "These percentages do not appear difficult to achieve, but the fact is that many inventory record systems fall painfully shy of these standards" (1999, p. 55). Although cyclical inventory accounting can help resolve these discrepancies, there are a number of factors that may be involved that must be taken into account in developing optimal inventory management practices that avoid inventory inaccuracy. The causes of inventory inaccuracy include, but are not limited to, the following:
1. Unit-of-issue difference. Products may be received in cases of four boxes and then distributed in boxes. The failure to convert from cases to boxes could cause count errors.
2. Inventory is used without proper accounting. For example, a clerk fails to record the distribution of a box of copier paper to an office.
3. Inventory is lost, misplaced, or stolen (Young & Nie, 1999, p. 55).
A number of companies only conduct physical inventories once a year, but clearly more frequent cycles will help managers by identifying inaccurate inventory levels as quickly as possible to avoid further problems up and down the supply chain (Young & Nie, 1999). Even here, though, there are some important tradeoffs and cost-benefit analyses involved. For example, Young and Nie point out that, "A greater frequency of cycle counts helps reduce the record discrepancy that builds up over time. As the cycle counting frequency increases, the labor cost of cycle counting increases, stockouts decrease, and record accuracy increases" (1999, p. 56). To facilitate the control process, managers should arrange for automatic computer-generated notices to identify the need for an inventory cycle (Young & Nie, 1999). Because every organization will be unique in some fashion, the cost-benefit analysis involved in this area will ultimately depend on the exigencies of the situation. In this regard, Young and Nie conclude that, "Ultimately, the choice of how frequently to cycle count is an economic decision. The total cost of inventory accuracy becomes the sum total of the cost of cycle counting and the cost of stockouts" (1999, p. 55).
Fortunately, this cost-benefit analysis can be facilitated by the application of some basic inventory management practices. According to Thierauf (1998), "The fundamental concerns of management in formulating basic inventory decisions are: the quantity to order at one time and when to order this quantity. In approaching these two decisions, one path is ordering large amounts (to minimize ordering costs), while the other path is ordering small amounts (to minimize inventory carrying costs)" (p. 58). Regardless of which of the three types of inventory are involved, best industry practices indicate that a middle-ground approach is appropriate for many situations. In this regard, Thierauf cautions that, "Either course pushed too far will have an unfavorable effect on profits," and concludes that, "The best course in terms of minimizing costs is a compromise between the two extremes" (1998, p. 58).
Because the fundamental aim of developing effective inventory control methods is to minimize the total costs associated with inventory levels, it is first necessary to identify these costs following the maxim that in order to improve something it must first be measured. The costs associated with inventory can be grouped into three basic categories: (a) ordering costs, (b) inventory carrying costs (these are interrelated), and (c) outages costs (these are experienced by companies when stockouts of items occur (Theirauf, 1998, p. 58).
As noted above, the first two costs, order and inventory carrying, are interrelated because of the potential to lose out of sales if there is insufficient inventory available or production may be disrupted if inventory levels are not maintained (Thierauf, 1998). These first two costs are important because a basic inventory management model assumes that stockouts do not occur. In other words, optimally, inventory is received in specified quantities and then used for sales or production at a constant rate (Thierauf, 1998). Therefore, formulating the basic inventory management control model involves first identifying ordering and inventory carrying costs without regard to stockouts. In this regard, Thierauf advises that, "Under these idealized conditions, the firm experiences no stockouts. Hence, only ordering costs and inventory carrying costs are needed in formulating basic inventory control models" (Theirauf, 1998, p. 58). These three inventory management costs are described further below.
Ordering or Acquisition Costs. These are those costs that are associated with acquiring purchased items until it is placed in a company's inventory; such costs are experienced anytime orders are placed, beginning with the purchase requisition but also including issuing the purchase order, follow-up, receiving the goods, quality control, placing them into inventory, and paying suppliers (Thierauf, 1999). According to Thierauf, "Acquisition costs pertaining to company-manufactured items include several of the above-mentioned items, but they also comprise other categories" (p. 58). A representative list of costs for both of these conditions is provided in Table 1 below:
Sample List of Costs for Purchased vs. Manufactured Items
Purchase order (includes expediting)
Receiving and Inspection
Receiving and inspection
Placing in storage
Placing in storage
Accounting and auditing: Inventory
Accounting and auditing: Inventory
Source: Thierauf, 1998, p. 59
Inventory Carrying or Holding Costs. These costs associated with inventory are experienced as a result of management decisions to maintain specified levels of inventory (Thierauf, 1998). Here again, although every company's situation will be unique in some fashion, these costs will vary. Moreover, they are frequently difficult to calculate with precision because of a lack of timely inventory data. Nevertheless, it is possible to determine with some generality the extent of these costs for most companies and the following composite of data shown in Table 2 below provide representative ranges for these costs.
Representative Ranges for Inventory Carrying or Holding Costs
Interest (on money invested in inventory)
Storage (may include climate control)
Obsolescence and depreciation
Source: Thierauf, 1998, p. 60
Outage Costs. This final category of costs associated with inventory is even more difficult to calculate with precision, but most managers have some feel for the implication of outages based on past experiences and can help identify appropriate triggers to avoid repeated outages (Thierauf, 1998).
Besides keeping better physical track of inventory, companies are also realizing improvements in their inventory management practices through changes in their accounting practices through a practice termed "vendor-owned inventory management arrangements" or "VOIM" (Rungtusanatham, Rabinovich, Ashenbaum & Wallin, 2007). In contrast to traditional accounting practices whereby retailers acknowledge receipt of inventory items for retail sale from a supplier and the corresponding ownership rights for the inventory items are then transferred from the vendor to the retailer, in VOIM arrangements, the vendor maintains ownership rights to and replenishment and maintenance responsibilities for such items until they are actually sold. The net effect of this practice on inventory control costs can be significant. According to Rungtusanatham (2007) and his colleagues, "This [practice] allows the retailer to focus on activities related to marketing and customer acquisition instead of inventory management - a focus which ultimately translates into revenue maximization for both the retailer and the vendor" (2007, p. 112).
Effective inventory management practices attempt to maintain optimal inventory levels through an analysis of inventory records in an effort to maximize profits by developing a good balance between inventory investment and seamless production. The research showed that organizations of all types and sizes, including both for-profit as well as non-profit organizations, can benefit from improved inventory management practices, with the latter involving reductions in the costs associated with acquiring,…[continue]
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