Amy has a master's degree in secondary education and has taught math at a public charter high school.
As you watch this video lesson, you will see how important it is to have just the right amount of inventory for your production process. Watch what happens when you have too much and when you have too little.
If you are in the business of making things, then having good control of your inventory is very important. The word inventory here is defined as the materials needed to make products, in-process products, and finished products. Imagine that you are the owner of a business called Sticker Books. You make small books filled with stickers. Your inventory includes the sticker sheets you use to print your stickers on, the book binding materials needed to make your books, and the book covers, to name a few. The materials you use to make your sticker books and the sticker books themselves are considered your inventory. Managing your inventory is an important part of your production process because having too much or too little can mean your business is losing money.
Too Much Inventory
If your business has too much inventory, then you lose money. When you have too much inventory, it means that your business is making more products than it is selling. You are losing money by purchasing and making too many products. All the products that don't sell cost you money in the materials needed to make them and in storage for them. You've also lost precious time you could have used to develop new products that would sell.
When you first started your company, Sticker Books, you thought your customers would love the sticker book with stickers of pets in it. So you made sure to make an abundance of this sticker book. You made 500 of the pet sticker books and 100 of the all the other sticker books. But, after a month, you saw that the pet sticker books didn't sell any more than the other sticker books. You sold only 80 of the pet sticker books, 84 of the cartoon sticker books, 74 of the ocean sticker books, 100 of the dinosaur sticker books, and between 60 and 100 for all the other sticker books.
Because you only sold 80 of the pet sticker books, you are left with 420 at the end of the month. That's a lot of sticker books that didn't sell. It costs you $3 to make each book, so you are looking at a cost of $1260 just sitting there taking up valuable space in your warehouse. You could have spent this money on research to produce another sticker book that your customers would purchase.
On the other hand, if you have too little inventory, then your business will lose money in lost sales. If you only made 100 of an item, and 120 people want to buy the item, then you have to turn 20 people away because you don't have enough of the item. Multiply these 20 items by the sales price of your item, and you are looking at what you have lost in sales.
You are looking over your sticker sales for the past, and you notice that you sold out of some of the sticker books. For example, you sold 100 of 100 of the dinosaur sticker books. You think back, and you remember that your business has received several calls from people asking about the dinosaur sticker books. You had to tell them that you were sold out. You realize that not everybody calls in to ask. Because you didn't print enough of the dinosaur sticker books, you have lost some sales.
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You review your activity log for the month and see that you received 20 phone calls and 30 emails asking about the dinosaur sticker books. That could have been 50 additional sales of the dinosaur sticker book. These sell for $5 each, so that means you have lost $250 in sales.
When you have just the right amount of inventory, you are making enough products to meet your demand. You are not losing money because you are making too many products, and you are not losing money due to lost sales. Achieving this balance is the result of keeping good records of your sales so you can forecast, or somewhat predict, how many future sales you will have.
As Sticker Books continues to grow, you get better and better at predicting how much of each item you need per month. You see the seasonal trends that happen at certain times of the year and use this information so you can print more sticker books to sell at those times. It has been several years now since you started and had to deal with too much and too little inventory. You are now able to keep up with the demand.
You have realized that your customers don't always purchase the things that you think they will purchase. You produce your sticker books according to what your customers want now instead of what you think they want. You have had several months where you produced just enough stickers to meet the demand. No more, no less. Your records and forecasting were spot on.
Let's review what we've learned. The word inventory here is defined as the materials needed to make products, in-process products, and finished products. Keeping track of your inventory is a very important part of your production process. If you have too much inventory, you have lost money in making products that aren't selling. If you have too little inventory, then you're losing money from turning your customers away. Keeping good sales records and performing your forecasting just right will help you to make enough product to meet your demand. This will help you save and earn the most money to grow your business.
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