Inventory Management deals essentially with balancing the inventory levels. Inventory is categorized into two types based on the demand pattern, which creates the need for inventory. The two types of demand are Independent Demand and Dependant Demand for inventories.
An inventory of an item is said to be falling into the category of independent demand when the demand for such an item is not dependant upon the demand for another item.
Finished goods Items, which are ordered by External Customers or manufactured for stock and sale, are called independent demand items.
Independent demands for inventories are based on confirmed Customer orders, forecasts, estimates and past historical data.
If the demand for inventory of an item is dependant upon another item, such demands are categorized as dependant demand.
Raw materials and component inventories are dependant upon the demand for Finished Goods and hence can be called as Dependant demand inventories.
Take the example of a Car. The car as finished goods is an held produced and held in inventory as independent demand item, while the raw materials and components used in the manufacture of the Finished Goods - Car derives its demand from the demand for the Car and hence is characterized as dependant demand inventory.
This differentiation is necessary because the inventory management systems and process are different for both categories.
While Finished Goods inventories which is characterized by Independent demand, are managed with sales order process and supply chain management processes and are based on sales forecasts, the dependant demand for raw materials and components to manufacture the finished goods is managed through MRP -Material Resources Planning or ERP - Enterprise Resource Planning using models such as Just In Time, Kanban and other concepts. MRP as well as ERP planning depends upon the sales forecast released for finished goods as the starting point for further action.
Managing Raw Material Inventories is far more complicated than managing Finished Goods Inventory. This involves analyzing and co-coordinating delivery capacity, lead times and delivery schedules of all raw material suppliers, coupled with the logistical processes and transit timelines involved in transportation and warehousing of raw materials before they are ready to be supplied to the production shop floor. Raw material management also involves periodic review of the inventory holding, inventory counting and audits, followed by detailed analysis of the reports leading to financial and management decisions.
Inventory planners who are responsible for planning, managing and controlling Raw Material inventories have to answer two fundamental questions, which can also be termed as two basic inventory decisions.
Answering the above two questions will call for a lot of back end work and analysis involving inventory classifications and EOQ determination coupled with Cost analysis. These decisions are always taken in co ordination with procurement, logistics and finance departments.