Inventory Management

Inventory (also called stock) includes all the raw materials, work-in-progress (WIP), and finished goods that a business holds at any given time. Effective inventory management is essential — holding too much stock wastes resources and ties up cash, while holding too little risks production stoppages and lost sales.

Key Definition: Inventory management is the process of ordering, storing, and using a company's inventory, including the management of raw materials, components, work-in-progress, and finished goods.

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Types of Inventory

Type	Description	Example
Raw materials	Inputs that have not yet entered the production process	Flour, steel, fabric, electronic components
Work-in-progress (WIP)	Partially completed goods currently being processed	A car on the assembly line with engine installed but no interior
Finished goods	Completed products ready for sale or dispatch	Packaged smartphones in a warehouse
Consumables	Items used in the business but not incorporated into the product	Lubricants, cleaning materials, office supplies

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The Inventory Control Chart

The inventory control chart (also called a stock control diagram) is a graphical tool used to manage inventory levels over time. It shows the pattern of stock usage and replenishment and identifies key decision points.

Key Elements of the Chart

Term	Definition
Maximum stock level	The highest amount of stock a business is willing or able to hold, determined by storage capacity and budget
Minimum stock level (buffer stock)	The lowest level to which stock should fall — a safety net against unexpected demand or supply delays
Re-order level	The stock level at which a new order is placed with the supplier
Re-order quantity	The amount of stock ordered each time the re-order level is reached
Lead time	The time between placing an order and receiving the delivery

How the Chart Works

A typical inventory control chart shows a sawtooth pattern:

1. Stock starts at the maximum level after a delivery
2. Stock declines steadily as it is used in production
3. When stock reaches the re-order level, a new order is placed
4. Stock continues to fall during the lead time (the period between ordering and receiving)
5. The delivery arrives, and stock jumps back up
6. Stock should not fall below the buffer stock level if everything goes to plan

Setting the Re-Order Level

The re-order level must account for the rate of stock usage and the lead time. The formula is:

Re-Order Level = Lead Time × Average Daily Usage

Example: A business uses 200 units per day and lead time from its supplier is 5 days.

Re-Order Level = 5 × 200 = 1,000 units

When stock falls to 1,000 units, the business places an order. During the 5-day lead time, it uses 1,000 units, and the delivery arrives just as stock reaches zero (or the buffer stock level, if one is maintained).

The Role of Buffer Stock

Buffer stock provides a safety margin against:

• Unexpected increases in demand — if demand spikes, buffer stock prevents stockouts
• Supply delays — if a delivery is late, buffer stock keeps production going
• Quality issues — if a batch of materials is defective, buffer stock provides an alternative

However, buffer stock has costs:

Cost	Explanation
Storage costs	Warehouse space, shelving, climate control
Opportunity cost	Money tied up in buffer stock could be invested elsewhere
Waste and obsolescence	Stock may deteriorate, expire, or become obsolete
Insurance	Buffer stock must be insured against damage, theft, and loss