Type of Inventory – in transit | WIP | finished goods
Type of inventory
Every manager wants of holding no inventory. In theory, this means only having inventory needed to meet specific customer orders. Just in time. But, in practice, those managers discovered that you do, indeed, need inventory. Zero is not the answer.
The key is to manage your inventory to the lowest level possible while still meeting your customer’s needs, and the first step to managing inventory is to understand the different types of inventory. Because all inventory is not the same you want to manage each type in a slightly different manner, and there are four basic types of inventory. I’ve included a handout that outlines each type for you to follow along.
First, there’s cycle inventory which is the inventory needed to meet customer demand, and there are four categories of cycle inventory each requiring a different approach to inventory control. The first category is the stuff you buy from suppliers to make your product like raw materials, components, and sub-assemblies. These items can be quite expensive so you don’t want to hold excessive inventory. However, you also do not want your factory to stop production because you ran out of these resources. So it is important to find the right balance, and to constantly re-evaluate this level.
Second is work in process inventory also known as WIP. WIP is the factory inventory that is in the process of being made into your final product. Products that are partially completed. You operate your factory as efficiently as possible so that WIP inventory is maintained at the lowest level possible while still delivering orders on time.
The third category of cycle inventory is finished goods. This is the most expensive inventory you can hold because all of your manufacturing costs are now reflected in the value of your completed product. So inventory management at this level is especially critical. This is where forecasting demand play such a critical role. The better the plan the lower your finished good inventory.
The last category is maintenance, repair, and operating supplies often referred to as MRO. For the factory this includes everything from machine oil, and wipes to repair parts for equipment. Standard office supplies are in this category also. Much of this is routine, and inexpensive so most companies do not hesitate to hold additional MRO inventory to ensure operations continue smoothly.
The second type of inventory is safety stock, and it applies to each of the four categories of cycle inventories. For example you might hold additional finished goods inventory just in case demand for your product increases unexpectedly, or you might hold additional raw materials in case your primary supplier is late with delivery. Safety stock is based on your analysis of risk.
The third type of inventory is in transit, or transportation inventory. This includes supplies that are coming into your company, and products that are being shipped to your customers. Sometimes it makes sense to ship this inventory slower at a lower cost, and other times fast delivery is the right approach. The last type of inventory is anticipation inventory. Coordinating with your marketing department you often will increase inventory before a big sales campaign, or perhaps you make a seasonal product like ski apparel.
You make inventory in advance of the winter season in anticipation of increased sales. Timing of production cycles is very important here. One important consideration for inventory management is the location of your suppliers, and your customers. Inventory management is much more difficult when suppliers, and customers are scattered widely around the world. Coordination, and communication with your key partners is important to having the right inventory in the right place at the right time. Using your understanding of the different types of inventory you can begin to analyze how your company uses different approaches to inventory management. I recommend safety stock as a good place to start an investigation.