7 Important Factor Which Influence the Optimum Level of Inventory

Before deciding the optimum level of inventory following factors are being taken into considerations:

1. The rate of inventory turnover

2. Types of product

3. Market structure

4. Economies of production run

5. Costs

6. Financial position of the firm

7. Inventory policy and attitude of management

1. The rate of inventory turnover:

The rate of inventory turnover is the time period within which inventory completes the cycle of production and sales. When the turnover rate is high, investment in inventories tends to be low.

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2. Types of product:

Durable products are more susceptible to inventory holding as the risk of perishability and obsolescence is less. Perishable and fashion goods are not stocked in large amount. Thus, the type of product also influences the inventory level.

3. Market structure:

Under the conditions of imperfect competition, demand is uncertain and stocks must be held if the firm wants to take advantage of profitable sales opportunities. The optimum level of sales will depend upon the variability of sales and the cost revenue relationship. The level of inventory rises with increase in the difference between price and marginal cost. Thus, market structure influences the level of inventories.

4. Economies of production runs:

Economies of production run also determine the inventory level. Modern machinery is very costly and the cost of idle machine time is considerable. Therefore, every business firm likes to maintain sufficient stock of raw materials to ensure uninterrupted production.

5. Costs:

There are certain costs of carrying stock. Some of these costs (storage costs, setup costs, change-over costs, ordering costs, spoilage and obsolescence costs) are directly measurable.

On the other hand, certain costs (opportunity costs, cost of capital costs caused by price level changes, costs of loss of sales due to shortage of stock) are not measurable. All these costs influence the level of inventories.

6. Financial position of the firm:

Financial position of the firm has significant influence on inventory levels. A financially sound company may buy materials in bulk and hold them for future use. A firm starved of funds cannot maintain large stocks.

7. Inventory policy and attitude of management:

The inventory policy and attitude of management also influence the inventory level.