Managing Inventory

Video Transcript

Welcome to Managing Your Inventory. In this course, you will learn how to keep minimum inventory within a minimum space for a minimum time period, analyze sales and forecast demand, Determine the minimum inventory level and your reorder point. Use the first in, first out inventory management method, or FIFO. As a business owner, it's important to learn how to manage your inventory in order to control your costs. Inventory can be a high cost and an expense.

If you have too much inventory that goes unsold, you lose money. With too little inventory, you risk losing customers and sales. Inventory consists of two major forms. Number one, your raw materials. These are the ingredients for making your product.

For instance, if you owned this bakery, your raw materials would consist of ingredients like flour, eggs, and milk. Number two, your finished products. These are the products you sell. At the bakery, your finished products are bread, rolls, or other baked goods. Learning to keep the proper balance of both can help your business be more profitable by enabling you to sell more products when needed and reducing expenses by paying for only the amount of raw materials you actually need.

When it comes to managing your inventory, your main goal is to maintain the minimum level of inventory needed to run your business successfully, while maintaining enough inventory so that you don't lose sales or customers. So what are the three main minimums you should strive to keep? Number one, minimum inventory. Instead of keeping too little or too much stock on hand, you should strive to keep the minimum amount of raw materials or products that will still meet your sales needs. Number two, minimum space.

It will benefit your business and finances by seeking the minimum amount of space required to store your products and raw materials in order to reduce your storage expenses. Number three, minimum time periods. Lastly, not only do you want to keep the minimum amount of stock in the smallest amount of space required, you also should keep it for the shortest time possible to reduce your cash outflow. Avoid waste due to storage fees and spoilage in the case of perishable items. To achieve these minimum goals, you need to estimate how much inventory to keep on hand or your minimum inventory level.

Anytime your inventory falls to that level, you should put a new order. This will be your reorder point. You also need to accurately determine the correct amount to order. It's always a good idea to order a little extra to protect yourself against unforeseen delivery delays and to allow for potential increases in use. This is often referred to as safety stock.

Let's first look at the business records of your bakery to determine how much raw materials do you use in an average week. This is your average usage. And what is the longest amount of time it takes you to receive your raw materials after you put in an order? This is the maximum lead time of your order. To determine how much inventory to keep on hand or your reorder point, you should simply multiply your average usage by the maximum lead time of your order, and add the amount of safety stock.

Let's say that you use 70,000 kilograms of flour per week to make bread, and you normally keep 10,000 kilograms extra on top of what you need. If it takes you a week to get a new supply of flour after you order it, you need to have at least 80,000 kilograms of flour on hand when you place a new order of 70,000 kilograms you will need. But if it takes you two weeks to get your order, you will need to order a 140,000 kilograms of flour, and your reorder point, in this case, would be a 140,000 plus 10,000. What about peak times of the year? For example, holidays.

Well, the equation is similar. Simply find the average amount of flour you use during a peak week or your maximum usage. Multiply it by the number of weeks it takes you to receive your order or the maximum lead time, and add safety stock to determine your reorder point for your peak times. For example, let's say your maximum flower usage at peak times is a 140,000 kilograms. Multiply this number by your maximum lead time, in this case, one week, and add the 10,000 extra kilograms to determine that at peak times, you should put a new order every time your inventory of flour reaches a 150,000 kilograms.

Keeping track of your inventory expenses can sometimes be difficult because the prices of raw materials tend to change over time. And often it's difficult to distinguish between the materials purchased from one week to the next. For example, in the bakery, all the eggs are stored in the refrigerator for future use. Once they're in the refrigerator, it's difficult to tell if you're using the eggs purchased two days ago at a dollar 20 per dozen, or the ones purchased one week ago at $1.15 per dozen. To address this problem, accountants use a practice called first in first out, or FIFO, FIFO.

Under this approach, you assume that the first materials you purchased are the first ones you use. When you calculate your cost of goods sold, you use the price of the oldest materials on hand first. For example, in your bakery store, you will most likely use the FIFO method. That is, using the eggs left over that you received yesterday instead of the freshest eggs you received today in order to make your loaves of bread. That way, you'll use the raw materials that might spoil the earliest in order to get them out quickly in a fresh product.

Once you use the oldest raw materials you have in your possession to make your loaves of bread, you can place those loaves of bread towards the front of the bakery case so that they're sold first. As you make new loaves of bread, the freshest bread would flow down the back, so there's a constant stream of fresh bread being sold and not allowed to get stale.