Question

Define and discuss two purposes of carrying these inventories: raw materials. Illustrate with examples how companies can use each of these to their advantage.

Answer 1

Two purposes of carrying raw material inventory are:

1. When the raw materials are stored as inventory, the company can have a fixed cost of raw materials. The raw material cost will not fluctuate as per market conditions.

2. Can adapt quicker to higher demand- When there is a sudden demand for the company's end product, the business can quickly use the stored raw material rather than having to order them

Example: A company producing paints. Paints require crude oil as one of the ingredients for producing paint.

They can store inventory of crude oil (raw material) so that their cost of production is fixed and profits do not suffer. Secondly it’s a seasonal industry and hence may have seasonality in sales. So there may certain periods which require more production and the business can use the crude oil (raw material) stored.