What Is Economic Inventory?

Malcolm Tatum

An economic inventory is a term used to describe all items that are currently found in a physical inventory, plus all items that are currently on order but have not yet been received and placed into the physical inventory. That figure is then adjusted to allow for any disbursements from the physical inventory that are scheduled but have not yet taken place. Sometimes referred to as economic stock, this type of inventory calculation makes it much easier to identify the amount of expense that a business currently has committed to the physical inventory, allowing for what is already there and what will be arriving shortly. Using this approach also makes it easier to determine when to order additional items without exceeding any budgetary limitations or running into the possibility of having to shut down some part of the operation due to a lack of supplies from the inventory.

Businesswoman talking on a mobile phone
Businesswoman talking on a mobile phone

The general idea behind an economic inventory is to not only account for what is on hand at the present time, but also consider items that will soon be added to the inventory along with items that are committed for disbursement and cannot be allocated to fill other requests. This approach can go a long way toward preventing additional orders that lead to an overstock situation, an undesirable state that can increase the tax liability of the company by a significant margin. At the same time, the calculation of the economic inventory also minimizes the chances of using items that are already committed to pending sales or other types of orders to fill new orders, an error that could create severe consequences for the company both in terms of canceled sales and possibly impacting the production process.

Conducting an economic inventory can also provide data that helps to identify weaknesses in the processes and procedures used manage ordering new stock that will go into the inventory as well as the steps used to pull items to fill outbound orders. In terms of ordering replacement stock, the results of the inventory can make it easier to determine if current quantities of certain items are being ordered in accordance with the rate of usage within the operation. If not, this provides the chance to adjust those ordering limits accordingly. At the same time, the inventory may also identify areas in which tracking the commitment of certain inventory items to filling customer orders or making disbursements to departments within the company could be improved, so those committed items can be issued and the transactions completed in less time.

Companies of all sizes can make use of the general concept of the economic inventory. Corporations that use a central purchasing model while also operating plants in several different geographical regions can use the inventory to track what is happening with each plant in term of usage of materials and the disbursement of finished goods to fill orders. Smaller companies can easily utilize an economic inventory approach to manage the physical inventory to best advantage, including setting up ordering schedules that ensure necessary items are on hand but do not linger in the inventory for any more time than absolutely necessary. From this perspective, this inventory approach makes it possible to tie up fewer resources in managing the supply chain and the physical inventory, which in turn means less expense for the company.

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