Benefits in Purchasing

If the purchasing of raw materials and other goods is not tied to production sales, that is, a firm can purchase independently to ensure the most efficient purchase, several advantages would become available. In the first place, a firm can purchase larger quantities than is warranted by usage in production or the sales level. This will enable it to avail of discounts that are available on bulk purchases. Moreover, it will lower the ordering cost as fewer acquisitions would be made. There will, thus, the significant saving in the costs. Second, firms can purchase goods before anticipated or announced price increases. This will lead to a decline in the cost of production. Inventory, thus, serves as a hedge against price increases as well as shortages of raw materials. This is a highly desirable inventory strategy.

Benefits in Production

Finished goods inventory, serves to uncouple production and sale. This enables production at a rate different from that of sales. That is, production can be carried on at a rate higher or lower than the sales rate. This would be of special advantage to firms with seasonal sales pattern. In their case, the sales rate will be higher than the production rate during a pan of the year (peak season) and lower during the off season. The choice before the firm is either to produce at a level to meet the actual demand, that is, higher production during peak season and lower (or nil) production during off season, or, produce continuously throughout the year and build up inventory which will be sold during the period of seasonal demand. The former involves discontinuity in the production schedule while the latter ensures level production. The level production is more economical as it allows the firm to reduce the cost of discontinuities in the production process. This is possible because excess production is kept as inventory to meet future demands. Thus, inventory helps a firm to coordinate its production scheduling so as to avoid disruptions and the accompanying expenses. In brief. since inventory permits least cost production scheduling production can be carried on more efficiently.

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