Stocks,
often referred to as inventory, are the unsold quantity
of items bought for the prime purpose of resale at the
end of a financial year. A retail outlet dealing in
general utility items would have various quantities
of goods that remain unsold at the end of the day, which
the owner would look forward to selling on the following
day. Larger businesses involved in retailing or production
would also have quantities of raw materials, work in
progress and/or finished goods at year-end; the value,
i.e. the lower of realisable value or cost, would be
entered in the balance sheet and carried over to the
next financial year.
Reserves of goods in
stock are important for businesses to function smoothly.
If there are no reserves, a customer may have to be
turned down, who may do one of three things:
-
Hunt a competitor
for the goods required, and return to you once you
have it available;
-
Look for your competition
to satisfy current requirement and stick with them
if they get a good service; or
-
Wait till you can
supply them the service.
To maintain an appropriate
quantity of stock you will need to plan ahead. This
is discussed in detail below.
Stocks are current assets
(short-term assets) as they can be converted to cash
and cash equivalents within a reasonable time frame,
especially finished goods. They are however, quite illiquid
and are therefore the focus of our attention at the
moment, and we shall learn how to maintain a low level
of stock and yet be able to satisfy all customer needs
accordingly.
There may be various
reasons to hold goods in stock, inflation and avoiding
delivery time lags to name a couple of them. It is apparent
that businesses would try to minimise stock holding
costs as they can also pose a problem by increasing
per unit cost of goods. Further, stock holding costs
generally include:
-
The cost of storage
-
The cost of obsolescence,
wear and tear
-
The cost of capital
required to furnish the purchase and stocking costs
Therefore, an apt solution
would be to keep the quantity as minimal as required,
ensuring the order costs are not excessively paid. The
Economic Order Quantity technique determines the quantity
of stock that should be ordered per order so as to achieve
a lower per unit stockholding charge, and ordering costs.
| Economic Order Quantity = |
 |
| where: |
C = Cost to order
D = Annual Demand
H = Stock holding cost per unit |
Another stock management
technique, very popular in the UK and European region,
Just-in-time involves the keeping of stock at minimal
levels and ordered when they are required. Emerging
in Japan, technically it requires a high level of organisational
skill and a close connection with your suppliers. Most
often the delivery is made within minutes of complete
stock out, therefore eliminating or drastically reducing
any stock handling costs. Having healthy relations with
the supplier may get a good ordering cost figure.
Here the question arises
as to how a business should finance its stock purchases.
The obvious and the easiest solution is to have suppliers
allow credit for some time, generally more than what
you would allow to your credit customers. The equation
comes out to something like this when you consider the
number of days each is allowed:
(Debtor days
plus Stock days) less than or equal to Creditor
days
This equation allows
you to keep your working capital in order, requiring
you to adjust your credit policies to cover up much
of the short term needs of the business without requiring
you to touch outside suppliers of short-term capital.
Along with other measures
that you may wish to take to improve your stocking systems,
you should also ensure that you have an acceptable level
of stock turns. This means that stock should be bought
and sold repeatedly to match the industry level for
the particular product. All goods have a different stock
turn level, and should not be compared with other dissimilar
goods at any time. A classic example is often stated
to prove this point: expensive assets are generally
slow movers, while less costly ones are fast movers.
To add to this theory, the more essential the good or
service is to the individual, the quicker the stock
turn.
The idea of stock management
is to maximise the utility of available short-term funding
from within the organisation. However, there are other
options available which may tell you to consider seeking
external credit services to finance your short-term
spending requirements, which must be investigated in
detail before proceeding.
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