Basics of Supply Chain Management

Unit 1
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Lesson 6
Basics of Inventory Management
 Basics of Supply Chain Management

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Preface............................................................................................................3
Course Description................................................................................................................. 3
Lesson 6 – Basics of Inventory Management...................................................4
Introduction and Objectives.................................................................................................. 4
Characteristics of Inventory .................................................................................................. 4
Types of Inventory ................................................................................................................. 4
Aggregate Inventory Management ....................................................................................... 7
Item Inventory Management ................................................................................................. 8
Reasons for Holding Inventory ............................................................................................. 8
Inventory Functions and Objectives..................................................................................... 8
Costs of Inventory ................................................................................................................ 11
ABC Inventory Control ....................................................................................................... 13
Inventory and Financial Accounting .................................................................................. 14
Summary ............................................................................................................................... 16
Further Reading ................................................................................................................... 16
Review ................................................................................................................................... 17
What’s Next? ........................................................................................................................ 18
Appendix.......................................................................................................19
Answers to Review Questions .............................................................................................. 20
Glossary ........................................................................................................22

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Preface
Course Description
This document contains the sixth lesson in the Basics of Supply Chain Management unit, which
is one of five units designed to prepare students to take the APICS CPIM examination. The
Basics of Supply Chain Management unit provides the foundation upon which the other four
units build. It is necessary to complete this unit, or gain equivalent knowledge, before
progressing to the other units. The five units, which together cover the CPIM syllabus, are:
Basics of Supply Chain Management
Master Planning of Resources
Detailed Scheduling and Planning
Execution and Control of Operations
Strategic Management of Resources
Please refer to the preface of Lesson 1 for further details about the support available to you
during this course of study.

This publication has been prepared by E-SCP under the guidance of Yvonne Delaney MBA,
CFPIM, CPIM. It has not been reviewed nor endorsed by APICS nor the APICS Curricula and
Certification Council for use as study material for the APICS CPIM certification examination.

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Lesson 6 – Basics of Inventory Management
Introduction and Objectives
In this lesson the requirement for effective inventory management is examined. The lesson looks
at the functions of various inventories, the objectives of inventory management and the costs
related to carrying inventory. It also covers various methods of inventory management.
On completion of this lesson you will be able to:
Explain the importance of effective inventory management in a manufacturing
organization
Classify inventory based on flow of material
Identify the functions of various types of inventory
State the objectives of inventory management
Identify cost factors when making inventory decisions
Determine the costs of ordering and carrying inventory
Analyze and explain simple financial stateme nts
Calculate inventory turns

Characteristics of Inventory
Inventory is defined by APICS as stocks or
items used to support production, including
raw materials and work- in-progress items. It
also covers stocks or items for supporting
activities such as ma intenance, repair and
operating supplies. Finally, inventory also
includes stocks of finished goods and spare
parts.
The way in which inventory is managed is
influenced by the purpose of the inventory, its
importance and the relative costs of
purchasing and storing the inventory item in
question.

Types of Inventory
Raw Materials
APICS defines raw materials as ‘purchased items or extracted materials that are converted via
the manufacturing process into components and products.’ Raw materials are always changed or
converted during production in contrast with purchased components, which are used in their
original state as part of the build for a more complex product.
For example, in the production of an electric kettle, a company buys in plastic
and heating elements. The plastic must be moulded to the correct shape for the

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kettle. The element is inserted but is not modified in any way. In this case the raw material is the
plastic and the element is a purchased component.
In engineer-to-order or make-to-order environments, raw materials may be ordered only when a
customer order is received, resulting in long lead times. More often, replenishment systems are
often used to ensure that raw material is always available when a customer order is received.
Assemble-to-order and make-to-stock organizations tend to use MRP to calculate top level
requirements, then calculating the amounts to order by using netting and order rules.

Work-In-Process (WIP)
WIP inventory is any material in production. That is all raw material that has been released for
initial processing, any material throughout the production process up to completely processed
material awaiting final inspection and sign off as finished goods. This classification may include
partially finished stock and components. WIP covers any material out on the factory floor and
allocated to a manufacturing order or work center account. It also covers partially finished
product that has been manufactured and then stored for use at a later stage of production.
Material held in stock has three cost elements: material, labor and overhead. Parts in process in
manufacturing should carry any costs they have incurred up to the current point of their progress
through the production process. WIP increases as the levels in a BOM increase. By reducing
BOM levels so there are fewer sub-assembly levels, WIP can be reduced. Lead times also affect
the amount of WIP inventory: the longer the lead time, the higher the level of WIP.
Assemble-to-order businesses hold a higher level of WIP than of finished goods.
This is because product is stored as part-finished and raw materials until a
customer order is received that triggers final assembly. This can be more
economical than holding finished stock of all possible product configurations. In
Dell, all components of computers are stored but the final product is assembled
only when a customer order is received with a detailed specification of
requirements.

Finished Goods
Finished goods or finished products inventory comprises all items that have moved completely
through manufacture and final testing and are available for shipment to customers as either end
items or repair parts. End items are any items subject to a customer order or sales forecast.
Completed end items that have been manufactured for a specific customer order are classed as
finished goods until shipment. During shipping they are classed as goods in transit. Items that
have been made for stock, have passed final inspection and have been booked into the store are
also classed as finished goods. There are three reasons for holding finished goods inventory;
It enables manufacturing to produce in economical lot sizes
It creates a buffer between manufacturing and customer demand
It reduces customer lead times.
Finished goods inventory comprises safety stock, which supports customer service levels by
protecting against demand variation, and lot size inventory or cycle stock, which is stock that has
been manufactured for sale.

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Service Parts
Service parts are components that will be used to replace an original part. Usually, the part is
used in manufacturing to build an end item. However, it must also be sold by the service
department to various outlets as a spare part. For such items there are
two different demands: demand dependent on final product demand
and independent demand for spare parts. Forecasting requirements for
service parts is difficult but must be attempted if customer service
levels are to be maintained. For example, in the manufacture of
washing machines a heating element is needed in the production of
each new washing machine. It is also required as a spare part for the
repair of washing machines already sold.

Maintenance, Repair and Operating Supplies (MRO)

These three types of supplies are classed as one inventory category but are each treated in
different ways.
Maintenance parts are spare parts for the machinery on the production floor and must be held to
enable the machinery to run and to be repaired quickly. Such parts are usually kept in an
engineering store and are controlled by the maintenance engineering department. Replenishment
of these parts may be scheduled. This is done by generating a BOM for each standard machine
service when it is known that certain parts will be replaced.
Repair parts will be needed to cover failure or breakdown of machines. These may be held on a
simple replenishment system or bought as required.
Operating supplies are all materials used in production but not included in the BOM. These are
generally classed as an expense and do not add va lue to the final product but rather add to the
factory overhead. Examples of operating supplies include rubber gloves needed by operators to
protect against product contamination or paper towels used during production to mop up small
spills. Other examples include machine lubrication oil, tape and glue for packaging etc. These
items may be classed as factory consumables. Usually a max/min order point rule is used for
their replenishment. Where possible, companies aim to list operating supplies on the bill of
material to ensure that the supply of items is in line with demand and to charge the correct
amount to each product.
The diagram below illustrates the various inventories and flow of materials in a typical
manufacturing facility.

Raw materials,
Suppliers Warehouses Customers
purchased parts
and materials

WIP Finished
Goods

Production Facility

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Aggregate Inventory Management
Aggregate inventory management controls inventory according to its classification and by the
function it performs rather than by the item itself. The most usual classifications are:
Raw material
WIP
Finished goods
Spare parts
Maintenance, repair, and operating supplies (MRO)
The following diagram explains the positioning of the different types of inventory in the
manufacturing process. Raw materials, components, and MRO inventory are brought in by
suppliers at the beginning of the manufacturing process. During production, items at various
stages in the production process are termed work- in-progress or work- in-process (WIP)
inventory. Finally, the stock of product that is ready to send to the customer is termed finished
goods inventory.

Supplier A Supplier B Supplier C

MRO Components Raw Materials

WIP

Finished
Goods

Warehouse 1 Warehouse 2

Consumer Consumer

Figure 1 Inventory Types and Their Position in the Supply Chain

Aggregate inventory management is concerned with managing inventory costs; the costs of
procuring and storing inventory. It involves examination of:
The flow of inventory
The types of inventory required
Supply and demand patterns
The functions that inventory performs
The objectives of inventory management
The costs associated with inventory

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1. Select the best description of MRO inventory.
A. Raw materials used in production planning
B. Items used in production that are not part of the product

Review Q C. Stationary and similar items used in administrative planning

D. Finished goods in distribution

Item Inventory Management

At individual inventory level, decision rules are required about each single inventory item. These
rules will identify the importance of the inventory item, the way it which it is to be controlled,
the minimum or optimum order amount and when an order should be placed for the item.

Reasons for Holding Inventory

Manufacturing operations connect one inventory or stock point to another. The main purpose of
inventories is to separate, or uncouple, the various sequential stages of the supply chain. This
separation allows the differentiation of the types of inventories.
In turn, this differentiation allows for greater control over the management of each of the
following classifications of stock:
Raw material inventory uncouples the manufacturer from its suppliers.
WIP uncouples each step of the production process from the next step.
The finished goods inventory uncouples the manufacturer from its customers.

Inventory Functions and Objectives

Inventory is held to help meet three conflicting objectives. These are:
Best customer service: supplying the customer with what is wanted when it is wanted.
Low cost plant operation: inventory allows for more flexible outputs in different work
centers, so that production may be more efficient through production levelling and
reduced number of production runs.
Minimum inventory investment: in both purchasing and carrying costs

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Customer Service
Customer service is the ability of a company to satisfy the needs of customer service. With
regard to inventory, the term describes the availability of items as needed. The customer in
question may not be the final purchaser. Distributors or other plants in the organization, or work
stations requiring material can be classed as customers.
Customer service can be measured in several ways, depending on the needs of the organization,
for example:
Percentage of orders shipped on schedule
Percentage of line items shipped on schedule
Order-days out of stock
To guard against uncertainty of demand it is often necessary to carry extra inventory, called
safety stock, which is carried to ensure that customer service levels are maintained.

Low-Cost Plant Operation

There are several ways in which maintenance of appropriate inventory levels improves plant
efficienc y:
Inventories enable operations with different production rates to operate separately with
inventories built up between. Each operation performs at the most efficient rate with
neither operation dependent on the speed of the other.
Inventories can be built up in anticipation of varying seasonal demand, allowing for a
level production equal to average demand, and resulting in lower costs in overtime, hiring
and firing, training, subcontracting, and capacity.
Building inventories allows for longer production runs thereby reducing setup costs per
item and increasing production capacity as less time is needed for setup.
Maintaining inventories allows production to purchase in larger quantities, thereby taking
advantage of quantity discounts and reducing order costs per unit.
Maintaining inventories carries a cost and investment in inventory must be balanced with the
costs of chase production, placing orders, and transporting inventory. Another factor that must be
balanced against inventory costs is customer service. When inventory levels are high, customer
service levels rise as the likelihood of stockouts diminishes. Inventory should be maintained at
the optimum level to ensure the desired level of customer service is maintained.

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Functions of Inventory
Inventory may be held for a variety of reasons and may perform several functions. For example,
inventory may be held to:
Anticipate future demand (to cover for promotions, peak selling season, potential strikes,
holidays etc)
Cover for fluctuations in supply or demand and avoid stockouts
Save money (where holding costs are less than purchase costs of small lots)
Cover transportation times using transportation, pipeline or movement inventories
Protect against exposure to price fluctuation in critical supplies using hedge inventories
In batch manufacturing, inventories are used to decouple supply and demand. Inventories buffer
between supply and demand, customer demand and finished goods, finished goods and
component availability, requirements for an operation and the output from the preceding
operations, parts and materials to begin production and the suppliers of materials.

Suppliers Raw Work Station WIP Work Station Finished Customer

material 1 buffer 2 goods Demand
buffer buffer

Manage Uncertainties
One of the reasons why a manufacturing organization carries
inventories is to manage uncertainties in supply and demand,
which are part of any business. Inventory of this sort is often
called safety stock.
No organization can predict the demand for products and
services over an extended period of time. Nor can the
organization be sure that all suppliers are going to provide
raw material and components on time, in the right quantity, and to the right quality.
Manage Funds Efficiently
Another reason for carrying inventory is that an organization may be better able to manage
financial resources by high- volume stockholding. Financial gains through high- volume
stockholding may include:
Bulk-buying discounts
Economies of transport and administration resulting from less frequent
supply
Possible reduction of machinery set-up and downtime
Plan for Anticipated Changes
The third reason why a manufacturing organization carries inventories is to plan for anticipated
changes in demand or supply. This would be particularly important in industries that are seasonal
by their nature.

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For example, an organization manufacturing games for the Christmas market would build up its
finished goods levels in August, September, and October in anticipation of demand for its
products. Some organizations, such as component suppliers, may stockpile certain components,
especially if there is a fear of future shortages.
Cover for Stock in Transit
The fourth, and main, reason why a manufacturing organization carries
inventories is to cover for stock in transit. This means compensating for
transit times between the supplier and the manufacturer and between the
manufacturer and the customer.
For example, if a company in Europe is purchasing printed circuit boards
(PCBs) from Asia, it will usually hold approximately six weeks of the
PCBs in stock to allow for transit time by sea from Asia.

2. All of the following are reasons to hold anticipation inventory except:

A. Price breaks
B. Approaching peak season

Review Q C. Shutdown for vacation

D. Potential strikes

Costs of Inventory
Inventory should only be carried beyond what is currently required if it costs less to carry it than
to procure it when it’s required. There are several costs associated with holding inventory. These
include costs of purchasing, storage, insurance, quality, coordination, poor responsiveness,
obsolescence, ordering, manufacturing, lost sales, and assessing inventories.

Carrying Costs
Carrying costs cover the cost incurred as a result of carrying inventory. These costs include the
money tied up in inventory, the costs of storing and managing the inventory, such as warehouse
costs, equipment costs, inventory management systems, personnel etc. Costs associated with the
risk of damage, loss, scrap, wear and tear, and obsolescence must also be included here, along
with the cost of insuring against some of these risks.

Purchasing Costs
An organization has to invest funds to buy the relevant components and raw materials in order to
build up the inventory. This investment comes from savings, cash flow, or borrowings.

Storage Costs
Regardless of the type of inventory held, space will be needed to store the
material. The cost of space is significant in any business, and unnecessary
levels of stock should be avoided. Warehousing costs include maintenance
of warehouse and equipment, the capital cost of the storage facility (for
example rental), and, most significantly, the cost of labor required to
manage and move materials.

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Insurance Costs
Most manufacturing organizations insure their goods against losses due to
factors such as fire, flood, and theft. Therefore, the higher the value of
goods in storage, the higher the insurance costs.

Quality Costs
If there are large amounts of inventory in storage and a quality problem is identified in the
manufacturing process, significant costs will be incurred in unpacking, retesting, and, if
necessary, reworking, and repacking the product. Moreover, by the time a problem is identified
and fixed, other volumes of product are likely to have been produced with similar or different
defects. The cost associated with this could be considerable.

Cost of Obsolescence
The greater the level of inventory in a process, the higher the risk that
components or finished products may have to be scrapped because of
obsolescence. For example, if engineering personnel decide to change a
feature on a product in response to customer demands, the customers
might not want the older model. An engineering change may also mean
that a particular component is no longer needed for the organization’s
products.

Cost of Ordering
Inventory management can reduce the overall ordering costs of raw materials and components by
ordering in larger quantities, which decreases the number of orders. However, the total landed
cost of the item, and not just the price of the item itself, needs to be taken into account. This
includes the cost of receivers who take in material, the costs of setting up suppliers, and the cost
of material planners and buyers, and any other cost associated with placing orders on either the
factory or suppliers.

Cost of Items
Suppliers do offer bargains and discounts for bulk buying. However, it
should be remembered that the total landed cost of the component is more
important than the price of the component itself. The potential cost
associated with poor quality, storage space, obsolescence, and insurance
for these bargain components must be considered.

Cost of Production Setup

In many manufacturing organizations, the setup cost is considerable. This
cost can be reduced by having machines processing the same material and
producing the same product for longer periods of time. Frequent changeover
of the stock slows production down.

Cost of Stockouts and Lost Sales

If deliveries are not made on time to customers or if products are not available on the market
consistently, sales are likely to be lost. The cost of a missed sale is very difficult to calculate, but
the potential of losing a customer and sales must be factored into any cost analysis.

Cost of Assessing Inventory

Most manufacturing organizations perform a physical inventory at least annually, and production
activities cease during this period. Physical inventories are time-consuming and usually require

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human and time resources for stock count and discrepancy rectification. The
manual nature of physical inventories can result in counting errors and
recounts. The greater the in-house inventory, the greater the resource
requirement and the likelihood of error becomes.

Capacity-Related Costs
These costs result from changes to levels of manufacture. They include overtime and undertime
costs, hiring, layoff and training of staff, and shift premiums. They can be avoided by levelling
production and building inventory in slack periods that will be used to help meet demand in busy
periods.

3. Which of these costs are included in the cost of ordering items?

1. Costs of setting up suppliers
2. Costs of maintaining material planners

Review Q 3. Costs of buyers

4. Costs of receivers to take in the items.
A. All except 4
B. All except 3
C. All except 2
D. All

ABC Inventory Control

The way in which inventory items are managed will vary from item to item depending on its
importance and associated costs. ABC classification is often used to categorize items by
importance and assign different levels of inventory control to each classification. Usually, the
importance of an item is based on annual dollar usage but other criteria may be used.
ABC classification is a method derived from the Pareto principle or 80 20 rule which states that
about 20% of items account for 80% of the significant measurement. Applying ABC
classification to inventory involves the following approximate assumptions:
A. 20% of items account for 80% of dollar usage
B. 30% of items account for 15% of dollar usage
C. 50% of items account for 5% of dollar usage
The greatest number of items will fall into the C category although they are least significant from
a financial management point of view.
Those items that fall into the A class should be the focus of inventory management efforts as this
is where the greatest savings may be made. There is little to be gained by closely monitoring and
managing C class inventory items.

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4. What is the major cost of operating a warehouse?
A. Labor
B. Maintenance of warehouse equipment

Review Q C. Warehouse system costs

D. Cost of capital

Inventory and Financial Accounting

Accounting systems in most organizations categorize all financial activities into five types of
account:
Assets, or items of value to the business, such as cash, accounts receivable, inventory,
and machinery
Liabilities, or money owed by the company, for example, accounts payable, salaries and
company loans for equipment
Owner’s equity, the net balance between assets and liabilities
Revenue, which is money generated as the result of a sale of goods or services
Expenses or costs incurred during the day to day operation of the company. These may
be the costs incurred during production and general or administrative expenses.

Balance Sheets and Statements of Income

Balance sheets and income statements are used to represent the accounts information. Balance
sheets explain the state of a company’ s assets, liabilities and owner equity, which income sheets
detail the revenue and expenses generated as a result of making goods or providing services.
Assets = Liabilities + Owner’s equity
Income = Revenue - Expenses

Cash Flow Analysis

A vital aspect of a company’s financial health is its cash flow status. Even if a company
is profitable, it will suffer serious difficulties and could even risk bankruptcy if the cash
flow situation is poor and the company is unable, for example, to pay its bills on time.
Cash flow refers to the flow of cash into and out of a business over a given period of time. If
there is a shortfall of cash at any stage, the company must provide for this by raising cash from
other means such as borrowing.
When inventory is purchased as raw material it is recorded as an asset. When in production it is a
work in progress. As the material progresses along the production line, its value is increased by
the amount of direct labor applied to it and the overhead costs associated with its processing.
When this happens, the material is ‘absorbing overhead’.
Although it is much more valuable as finished goods, revenue is not produced by inventory until
it is actually sold. However, the materials used to produce the finished goods inventory must all
be paid for.

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Inventory Turns
Where possible, it is a good policy to convert inventory into cash as quickly as possible. The
Inventory Turns ratio is a good way of measuring the speed of conversion to cash. It is calculated
as follows:
Annual cost of goods sold
Inventory Turns = --------------------------------
Average inventory in cash
ABC Beverages calculate an average cost of goods sold is $80,000. The average inventory in
dollars is $40,000. Using the formula above, the inventory turns ratio is 2 ($80,000 divided by
$40,000). This means that the cost of inventory is tied up for about 6 months. By improving the
management of inventory, so that levels can be reduced, the inventory turns ratio will increase
which will improve cash flow.

Strategic Performance Measures

The accounts information for a company, such as the balance sheet, income statement, cash flow
analysis, and inventory turns ratio, provides a good overall picture of the company’s
performance. This data is useful to both management and shareholders. In particular, the
information can be used by management to measure performance against the long-range strategic
objectives outlined in the Business Strategy document.
The main areas of measurement for a company are:
Profitability
Market share
Growth
Productivity

5. What are the three main objectives that inventory management must help
to meet?
A. Provide the best possible customer service
B. Reduce inventory turns
Review Q
C. Reduce plant operating costs
D. Minimize inventory investment

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Summary
This lesson examined the functions of various inventories, the objectives of inventory
management and the costs related to carrying inventory. It also looked briefly at methods of
inventory management.
You should be able to:
Explain the importance of effective inventory management in a manufacturing
organization
Classify inventory based on flow of material
Identify the functions of various types of inventory
State the objectives of inventory management
Identify cost factors when making inventory decisions
Determine the costs of ordering and carrying inventory
Analyze and explain simple financial statements
Calculate inventory turns

Further Reading
Inventory Management, The Leading Edge Group
www.e-scp.com
This document provides a basic overview of issues related to inventory
management.

Introduction to Materials Management, JR Tony Arnold, CFPIM,

CIRM and Stephen Chapman CFPIM
5th edition, 2004, Pearson Education International

APICS Dictionary
10th edition, 2002, APICS

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Review
The following questions are designed to test your recall of the material covered in
lesson 5. The answers are available in the appendix of this workbook.

6. Given that the annual cost of goods sold is $1,000,000 and the average inventory level in
cash is $30,000, calculate the Inventory Turns ratio.
A. 0.3
B. 33.3
C. 70
D. 970

7. Which is the best description of revenue?

A. Items of value to the business, such as cash, or accounts receivable
B. Liabilities, or money owed by the company, such as salaries
C. Money generated as the result of a sale of goods or services
D. The net balance between assets and liabilities

8. Select the best description of WIP inventory.

A. Purchased items or extracted materials that are converted via the manufacturing process
into components and products
B. All raw material that has been released for initial processing, any material throughout the
production process up to completely processed material awaiting final inspection and
sign off as finished goods
C. All items that have moved completely through manufacture and final testing and are
available for shipment to customers as either end items or repair parts
D. Components that will be used to replace an original part

9. The function of hedge inventory is to:

A. Take advantage of low prices in volatile worldwide markets
B. Guard against fluctuations in supply and demand
C. Minimize the effect of transit lead times on operations
D. Save money through quantity discounts

10. Which of the following are costs associated with carrying inventory?
A. Costs resulting from damage to inventory
B. costs of obsolescence
C. cost of stockouts
D. insurance costs

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What’s Next?
Lesson 6 covered issues, concepts and costs related to inventory management.
You should review your work before progressing to the next lesson which is:
Basics of Supply Chain Management – Lesson 7 Order Management

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Appendix

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Answers to Review Questions

1. B
MRO inventories are items that are used in production but do not form part of the final product.
Examples of MRO inventories are rubber gloves, protective glasses, oil, grease and spare parts
for machinery, or hand tools.
2. A
Inventory may be accumulated in anticipation of events such as seasonal demand peaks, plant
shutdown due to holidays or strikes, increased demand due to promotions etc. Inventory that is
accumulated to take advantage of price breaks is considered lot size inventory.
3. D
Ordering costs include any cost that is associated with placing an order to the factory or to
suppliers, including such costs as processing the order and receiving the order.
4. A
Labor is the major operating cost for a warehouse. Labor is required to receive, move and
manage all inventory that enters the warehouse. It is important to closely monitor labor
productivity in this area.
5. A, C and D
The three main objectives that inventory management must help to meet are to provide the best
possible customer service while reducing plant operating costs and minimizing inventory
investment. The Inventory Turns ratio is a good way of measuring the speed of conversion to
cash but companies should seek to maximize rather than minimize inventory turns as this
indicates that they are turning the value of their inventory into cash more quickly.
6. B
The inventory turn ratio measures the number of times that an inventory cycles during a year. It
is calculated by dividing the annual cost of sales by the average inventory level (measured in
cash terms).
7. C
Accounting systems in most organizations categorize all financial activities into five types of
account: assets, or items of value to the business, such as cash, accounts receivable, inventory,
and machinery; liabilities, or money owed by the company; owner’s equity, which is the net
balance between assets and liabilities; revenue, which is money generated as the result of a sale
of goods or services and expenses.
8. B
WIP inventory covers all raw material that has been released for initial processing, any material
throughout the production process up to completely processed material awaiting final inspection
and sign off as finished goods Raw materials are defined as purchased items or extracted
materials that are converted via the manufacturing process into components and products. All
items that have moved completely through manufacture and final testing and are available for
shipment to customers as either end items or repair parts are classed as finished goods inventory.
Components that will be used to replace an original part are spare parts inventory.

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9. B
Hedge inventory is bought by companies to take advantage of low prices. Hedge inventories are
often used for commodities such as minerals and grains, which are subject to widely fluctuating
prices.
10. A, B, and D
Many costs are associated with carrying inventory, including the costs of damage, loss,
obsolescence and insurance. Carrying inventory guards against stockouts making them less
likely.

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Glossary

Term Definition
Aggregate This refers to the establishment of an overall monetary value of desired
inventory inventory and the implementation of measurements and controls to achieve
management this inventory level.

Inventory Stocks or items used to support production (raw materials and work- in-process
items), activities that support production (operating supplies, maintenance and
repair), and customer service (finished goods and spare parts).
Inventory turns The number of times that an inventory turns over during a year. This is
calculated by dividing the average inventory level into the annual cost of sales.
For example, an average inventory of $600,000 divided into an average cost of
sales of 1,800,000 means that inventory turned over 3 times during the year.
Maintenance, Items used in support of general operations and maintenance, for example
repair, and maintenance supplies, spare parts, and consumables such as rubber gloves,
operating supplies machine oil etc used in the manufacturing processes and supporting
(MRO) operations.
Market share The actual portion of current market demand that a company or product
achieves
Productivity An overall measure of the ability to produce a product, either goods or
services. It is the actual output of production compared to the actual input of
resources. Productivity is a relative measure across time or against common
entities. Some ratios available to measure productivity involve adding the
standard hours of labor produced plus the standard machine hours actually
produced in a given time period and dividing these by the actual hours
available for both labor and machines during that time.
Profitability A measure of the excess income over expenditure during a given period of
time
Raw materials Any extracted materials or bought items that are transformed in production
into products or components of products.
Safety stock This is a quantity of stock that is planned for inventory to protect against
fluctuations in demand or supply. In the context of master production
scheduling, the additional inventory and capacity planned as protection against
forecast errors and short term changes in the backlog. Overplanning can be
used to create safety stock. It is also known as buffer or reserve stock.
Work-in-process Also known as work in progress, this refers to products that are in a partial
(WIP) stage of completion throughout the plant. This includes all material from raw
material that has been released for initial processing up to completely
processed material awaiting final inspection and acceptance as finished
product.

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