Chapter 13 • Management of working capital
may be stated either in terms of physical units of inventories or in money terms. It is
important that both inputs are stated in similar terms; usually cost is used.
The ratio may be calculated for the whole of a business’s inventories (in which case
the inputs would need to be expressed in money terms), for a section of the invent-
ories (for example, inventories of tyres for a car manufacturer), or for specific items
(such as inventories of a particular size and quality of tyre). Such figures may be used
as a check that policies laid down are in fact being followed.Security and authorisation
Routine systems should be established in an attempt to ensure that inventories may
only be ordered (or manufactured) and used on the authority of some fairly senior
employee. This involves specifying the employees who are empowered to authorise
the placing of orders and ensuring that inventories are kept in some enclosed area,
only to be issued on the authority of other specified employees. Clearly, management
needs to use some common sense here so as not to make the purchase and issuing
of inventories a major obstacle to the business’s activities. However, a system where
anyone can order inventories and where they can be used without authority is likely
to lead to chaos and loss.
To summarise, these practical points are really concerned with establishing routines
to be applied systematically. Inventories management should not be a haphazard
operation.13.7 Just-in-time inventories management
The just-in-time philosophy
There is a tendency, which seems to have originated in the USA, but to have been
developed in Japan, for manufacturing businesses to operate a system where there is
a fairly continuous flow of raw materials inventories into the factory, of work in
progress (WIP) through the factory and of finished inventories to the customer. In
such a system, large amounts of inventories (raw materials, WIP and finished pro-
ducts) would never build up. Finished goods would be produced just as they are
needed to be supplied to customers, inputs of internally manufactured components
and sub-assemblies would be produced and pass to the next stage of production just
as they are needed to be used, and raw materials deliveries would arrive from sup-
pliers just as they are needed in production. In essence, the just-in-time (JIT) approach
means that production and purchasing are linked closely to sales demand on a day-to-
day, even an hour-to-hour, basis, avoiding the need to hold buffer inventories to see
the business through unexpected demand peaks.
Although at first sight JIT appears to be a technique of inventories and production
control, its effective implementation requires the acceptance of a particular philosophy
and culture. An effective JIT system requires a flexible attitude on the part both of sup-
pliers and of the internal workforce, to expand and contract output at short notice. It
also requires close attention to quality of outputs at each stage, both by suppliers and
by the internal workforce. If raw materials inventories are to arrive just in time to go
straight into production, those inventories must be of guaranteed quality, and not
need to be tested or checked before being taken into production. The same general
point about quality follows through each stage of production and into sales.