Managing Derived Demand Inventories

The third type of inventory management technique is used to manage derived-demand inventories. As we described earlier, demand for some inventory types is derived from or dependent on other inventory needs. A good example is given by the auto manufacturing industry, in which the demand for finished products depends on consumer demand, marketing programs, and other factors related to projected unit sales. The demand for inventory items such as tires, batteries, headlights, and other components is then completely determined by the number of autos planned. Materials requirements planning and just-in-time inventory management are two methods for managing demand-dependent inventories.

Materials Requirements Planning Production and inventory specialists have developed computer-based systems for ordering and/or scheduling production of demand-dependent types of inventories. These systems fall under the general heading of materials requirements planning (MRP). The basic idea behind MRP is that, once finished goods inventory levels are set, it is possible to determine what levels of work-in-progress inventories must exist to meet the need for finished goods. From there, it is possible to calculate the quantity of raw materials that must be on hand. This ability to schedule backwards from finished goods inventories stems from the dependent nature of work-in-progress and raw materials inventories. MRP is particularly important for complicated products for which a variety of components are needed to create the finished product.

Just-in-Time Inventory Just-in-time (JIT) inventory is a modern approach to managing dependent inventories. The goal of JIT is to minimize such inventories, thereby materials requirements planning (MRP)

A set of procedures used to determine inventory levels for demand-dependent inventory types such as work-in-progress and raw materials.

just-in-time (JIT) inventory

A system for managing demand-dependent inventories that minimizes inventory holdings.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VII. Short-Term Financial Planning and Management

21. Credit and Inventory Management

© The McGraw-Hill Companies, 2002

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