ENTREPRENEURSHIP SKILLS

An entrepreneur is a person who bears all risks of the business. In other words an entrepreneurs is a
person who identifies a business opportunity and then takes the initiative and risk to organize the required
factors of production to exploit the business opportunity
Meaning of entrepreneurship
Entrepreneurship is the process of creating an opportunity and pursuing it regardless of the
resources currently controlled. It is the ability to make factors of production like land, labour and
capital to produce new goods and services. It can also be defined as the ability to create and build
something from nothing
Basic Concepts & Characteristics of Entrepreneurship
The basic concepts and characteristics of entrepreneurship are concerned with developing a vision of
what a company should be, and then executing that vision by translating it into concrete steps and
following through. Entrepreneurs tend to be personally involved in building and shaping their companies,
but business success also depends on understanding personal limits, and developing strategies and
systems to transcend these limits. Although many business magazines publish long lists of entrepreneurial
traits, entrepreneurship is more a way of thinking and behaving than a set of specific, sharply defined
character traits.
Measured Risk
Entrepreneurs are risk takers, staking money, time, and personal reputations to manifest their visions. But,
like others, entrepreneurs are rarely reckless. Rather, successful entrepreneurs take measured risks,
weighing the stakes and the potential consequences, and then stepping into unknown territory to generate
results. As risk takers, successful entrepreneurs understand that failure can be a vital part of success, and
that learning from mistakes can be a way of reaping benefits from situations that might otherwise feel like
failures.
Fiscal Responsibility
Businesses run on money, so entrepreneurs must have a solid sense of how to raise and manage funds.
Successful entrepreneurs have an intuitive sense of how much money they will need to run their
companies, but they supplement this sense with concrete documentation and calculations to mitigate
uncertainties. Entrepreneurs are willing to risk money by making investments in building their businesses,
but they keep a close eye on the numbers in order to understand how much they are spending and whether
their expenditures are bringing about the desired results.
Creativity
Starting a business is a creative endeavor that starts with conceptualizing a product or service, and then
building a practical infrastructure that can sustain itself while delivering that product or service.
Entrepreneurship requires creative problem solving as well as creative product development, and
entrepreneurs have the creative freedom to think outside the box and develop unique strategies that
balance personal values with practical constraints.
Management Skills
Successful entrepreneurs see the big picture. They have the skills and the humility to define their own role
in company operations, and the interpersonal skills to successfully delegate the tasks they can't complete
themselves. Successful entrepreneurs are successful managers, sharing the company's vision and clearly
communicating the ways that this vision is infused into mundane daily tasks. An entrepreneur's
management skills come into play in the process of carefully choosing employees, and these skills carry
over into careful training, as well as the daily challenges of motivating and organizing workers.
FUNCTIONS OF AN ENTREPRENEUR
For the business to grow from the perception stage to the successful level, an entrepreneur must play the
following functions.
1. Planning. This is the first stage towards setting up business venture. The steps of planning done
by an entrepreneur involves scanning the environment for the business alternatives selecting the
best alternatives from many, determination of the business type, estimation of capital resources
required for the business set up, determining the sources of capital, selection of business site,
determining labour requirements.
2. Organization. Entrepreneur coordinates, assemble and supervise the other factors of production to
ensure proper and optimum utilization of the available resources.
3. Management. He/she has to manage the operations of the business on a daily basis. He directs the
human resources, manages finance and other resources of the business.
4. Risk bearing. Entrepreneurs bear risks and under takes the responsibilities for the losses that may
occur as a result of unforeseen situations in future.
5. Decision maker. An entrepreneur has to take various decisions of the business ranging from
determining the objectives and goals of the firm, which machinery to buy for the business, which
human resource is required for what job and their qualifications, the technology to be used in the
production of goods and services.
6. Innovation. An entrepreneur has to find out ways of doing new things or doing the already
existing things in different ways to get market and compete in the market.

IMPORTANCE OF ENTREPRENEURSHIP
1. It helps to obtain the required knowledge and skills to start up, operate and sustain venture
successfully
2. It helps and prepares the learners to opt for a career in entrepreneurship and become self-
employed and also employ others.
3. It enables learners to work towards job creation while reducing on the reliance on white color
jobs which are not enough.
4. Through learning entrepreneurship, the learners acquire good communication skills, marketing
skills, planning and financial management skills all of which help him/her run business well and
expand.
5. It helps in scanning the environment and identify the relevant business opportunities windows
that can be set up for the benefit of an individual.
6. It encourages creativity and self-sustenance among the learners and various stakeholders so as to
be able to take on risks and create wealth.

Myths about Entrepreneurs

Myth No. 1: Entrepreneurs Are High Risk Takers
Entrepreneurs, Rye states, are often thought of in terms of the risk they assume. Even the dictionary
describes an entrepreneur as one who assumes business risks. However, like all prudent businesspeople,
entrepreneurs know that taking high risks is a gamble. Entrepreneurs are neither high nor low risk takers.
They prefer situations in which they can influence the outcome, and they like challenges if they believe
the odds are in their favor Entrepreneurs tend to carefully seek the best risk/reward action.

They seldom act until they have assessed all the risks associated with an endeavor, and they have an
innate ability to make sense out of complexity. These are traits that carry them on to success where others
fail.

I certainly agree with Rye. Entrepreneurs generally seek the best risk/reward situation. Like most humans,
they are often are a little hesitant to risk everything and take wild chances.

One way entrepreneurs can limit the risk they are exposed to is by choosing one of the best business
ideas out there. Knowing which businesses to start and which to avoid is the first step towards success.

Myth No. 2: Entrepreneurs Are Born

Many people, Rye says, believe that entrepreneurs possess innate, genetic talents. However, experts
generally agree that most entrepreneurs were not born; they learned to become entrepreneurs. The recent
proliferation of college and university courses on the subject supports this point. Entrepreneurship is
currently being successfully taught.

Again, I agree with Rye. I can’t overemphasize the fact that almost anyone can be a successful
entrepreneur. However, every aspiring entrepreneur should ask themselves these questions before
committing to a business. Starting your own company is not an easy decision and you must understand
that it will change your life in many ways.

Myth No. 3: Entrepreneurs Are Mainly Motivated to Get Rich

Any successful entrepreneur, argues Rye, will tell you that starting a business is not a get-rich-quick
alternative. New businesses usually take from one to three years to turn a profit. In the meantime, you’re
considered to be doing well if you break even. During the business start-up stage, entrepreneurs do not
buy anything they do not need, such as fancy cars. Most drive junk cars and use their surplus money to
pay off debt or reinvest it in the business. Their focus is on creating a company with a strong financial
base for future expansion.

I largely agree with Rye. For entrepreneurs, money isn’t everything. But there’s nothing embarrassing
about being partially motivated by money, as are most entrepreneurs. If entrepreneurs didn’t have the
ability to get rich and get financially rewarded for their work, the United States could be almost as poor as
Cuba. It is OK to make money, build a business, and help build your local economy in the process.

Myth No. 4: Entrepreneurs Give Little Attention to Their Personal Life

All successful entrepreneurs, Rye says, work long hours, which cuts into their personal life. However,
long working hours are not unique to entrepreneurs. Many corporate managers and executives work well
beyond the average 40-hour workweek. The primary difference between the entrepreneur and his or her
corporate counterpart is schedule control.
In the corporate world, you may not have control over your schedule. If some higher-level manager calls
a Saturday meeting, you’ve got no choice but to be there. Entrepreneurs don’t mind working 60- to 70-
hour weeks, but they will do everything they can to preserve their private time. They schedule important
meetings during the week so that they can have weekends off for their personal life, which is very
important to them.

Entrepreneurs are not afraid to work long hours, but they will do everything to preserve their private time
and schedule control.

I find what Rye says is true, that most entrepreneurs do not give a lot of attention to their personal lives. I
have, at times, been an outlier and had almost no personal time, such as when I was a full-time student at
Harvard Business School and running four start-up businesses at the same time, or was a full-time college
student and starting an independent newspaper business. Sometimes, as an entrepreneur with an
especially fast-growing business, you are going to have to sacrifice personal time.

Even if you are likely to sacrifice some of your personal time to get your business off the ground, starting
it isn’t the most time-consuming part of the process. It doesn’t take much time to start your own business.
Running it and getting it to the next level is another story…

Myth No. 5: Entrepreneurs Are Often High-Tech Wizards

We are all aware, says Rye, of a few high-tech entrepreneurial wizards who have made it. Media attention
overplays the success of these few high-tech entrepreneurs. Only a small percentage of today’s personal
businesses are considered high tech, and what was considered high tech just a few years ago is not
considered high tech by today’s standards.

It takes high profit margins, not high tech, to make it as an entrepreneur. One has only to look at the
recent problems that have plagued the computer industry to understand this basic principle. High-tech
personal computers did very well when they made high profit margins. The industry then went into a
nosedive when profits fell.

Yes, I think Rye is right on the money. Very few businesses require high tech abilities. In fact, I have
started and ran a multimedia business, an interactive software business, and two Internet businesses, with
virtually no tech experience or expertise. (Although, to be sure, I did learn to do a little computer
programming along the way when I started these businesses, to help me appreciate what the engineers
were doing.) Furthermore, most businesses are not even tech businesses at all

Myth No. 6: Entrepreneurs Are Loners and Introverts

Initially, Rye says, entrepreneurs might work alone on a business idea by tinkering in the solitude of their
garage or den. On this myth, I don’t totally agree with Rye. The astute entrepreneur knows that he or she
must draw on the experience and ideas of others in order to succeed. Entrepreneurs will actively seek the
advice of others and will make many business contacts to validate their business ideas. The
entrepreneur who is a lone and will not talk to anybody will never start a successful business.
Entrepreneurs need to seek the advice of others. A loner will find it difficult to start a successful business.

I’ve spent a lot of time working largely in isolation during the early stages of building businesses. I think
a lot of other entrepreneurs have, too. Not ideal in hindsight, but that’s what I often did. Generally, I think
entrepreneurs are willing to work independently if it is necessary to succeed. But even independent-
minded people can get lonely, especially if you are working day and night in small home-based business.

Myth No. 7: Entrepreneurs Are Job Hoppers

A recent study of successful entrepreneurs, notes Rye, showed that most of them worked for a large
corporation for a number of years before they started their own business. In every instance, they used the
corporate structure to learn everything they could about the business they intended to establish before
they started their own. Entrepreneurs are not job hoppers.

I tend to agree with Rye. I think most entrepreneurs have usually had a good track record in the
workplace. Most have spent years working for other people before going on their own. But you don’t
have to do so to succeed. The longest single job I ever held lasted about eight weeks, but in total I’ve only
worked a few months for anyone else in my entire lifetime.

Myth No. 8: Entrepreneurs Finance Their Business with Venture Capital

Entrepreneurs, Rye says, know that venture capital money is one of the most expensive forms of
funding they can get. Consequently, they will avoid venture capitalists, using them only as a last resort.
Most entrepreneurs fund their business from personal savings, or by borrowing from friends or lending
institutions. Venture capitalists only finance a tiny proportion of small businesses.

I often remind people that venture capital is a relatively small industry and, as such, finances an extremely
minute number of small businesses. To be financed by a VC firm, your business might need to meet all
kinds of criteria, and then find a VC firm that totally loves it. Furthermore, since VC firms tend not to
want to put much money into any one startup, most VC-funded startups have to get money from not one
but several different firms.

Myth No. 9: Entrepreneurs Are Often Ruthless or Deceptive

Rye thinks that some people believe that to make it as an entrepreneur, you have to be deceptive and step
on anybody who gets in your way. On the contrary, this mode of operation doesn’t work for the
entrepreneur. The truly ruthless or deceptive entrepreneur will often alienate others and be forced to waste
time and energy repairing relationships with employees, customers, and suppliers, or simply fail.
I don’t know if people are predisposed to think negatively of entrepreneurs as Rye states. But, in any
event, I think entrepreneurs have some bad apples in their ranks. Not many, but some. I have lost sales to
competitors who fabricate the facts, exaggerate the truth, slander their competitors, and engage in all
kinds of other unethical behavior. But I have found that such competitors eventually implode. A truly
ruthless or deceptive entrepreneur will fail.

Often, they lose their best employees, whom they also treat poorly, or they lose their customers. Once,
when I was in a dogfight with a totally ruthless competitor in a business that was extremely dependent
upon sales, his three best sales people, as well as his sales manager, approached me on their own initiative
and ended up joining my team.

Myth No. 10: Entrepreneurs Have Limited Dedication

Rye says it is a myth that entrepreneurs are not dedicated to any one thing. But he adds that dedication is
an attribute that all successful entrepreneurs exhibit. They are dedicated to becoming their own boss. To
this end, they’ll work like a dog to make their business succeed.

While I agree with Rye that entrepreneurs will work like a dog to succeed, I do think that many
entrepreneurs can change businesses or direction quicker than other people. Often, this ability to switch
direction quickly can be essential for success, and entrepreneurs tend not to switch direction recklessly,
although there are always exceptions.

Types of Entrepreneurship
1. Small Business Entrepreneurship
Today, the overwhelming number of entrepreneurs and startups are still small businesses.
Small businesses are grocery stores, hairdressers, consultants, travel agents, internet commerce
storefronts, carpenters, plumbers, electricians, etc. They are anyone who runs his/her own business. They
hire local employees or family. Most are barely profitable. Their definition of success is to feed the family
and make a profit, not to take over an industry or build a $100 million business. As they can’t provide the
scale to attract venture capital, they fund their businesses via friends/family or small business loans.

2. Scalable Startup Entrepreneurship

Unlike small businesses, scalable startups are what Silicon Valley entrepreneurs and their venture
investors do. These entrepreneurs start a company knowing from day one that their vision could change
the world. They attract investment from equally crazy financial investors – venture capitalists. They hire
the best and the brightest. Their job is to search for a repeatable and scalable business model. When they
find it, their focus on scale requires even more venture capital to fuel rapid expansion.
Scalable startups in innovation clusters (Silicon Valley, Shanghai, New York, Bangalore, Israel, etc.)
make up a small percentage of entrepreneurs and startups but because of the outsize returns, attract almost
all the risk capital (and press.)
3. Large Company Entrepreneurship
Large companies have finite life cycles. Most grow through sustaining innovation, offering new products
that are variants around their core products. Changes in customer tastes, new technologies, legislation,
new competitors, etc. can create pressure for more disruptive innovation – requiring large companies to
create entirely new products sold into new customers in new markets. Existing companies do this by
either acquiring innovative companies or attempting to build a disruptive product inside. Ironically, large
company size and culture make disruptive innovation extremely difficult to execute.
4. Social Entrepreneurship
Social entrepreneurs are innovators who focus on creating products and services that solve social needs
and problems. But unlike scalable startups their goal is to make the world a better place, not to take
market share or to create to wealth for the founders. They may be nonprofit, for-profit, or hybrid.

Values of Entrepreneurship
Growing up, I always wanted to do something big, I always wanted to be my own boss. Being an
entrepreneur is an amazing lifestyle – it is fun, it’s moving, and it can open up a lot of doors for you.

These days a lot of people want to have their own brand or movement, but it is important to understand
that this is a lifestyle that requires a lot of discipline and toughness.

Below are six core values every entrepreneur needs to have.

Relentless work ethic

Being an entrepreneur means you are always working 24/7. It can be grueling at times, but the reward is
beautiful. There will be sleepless nights and long workdays; you won’t always be in your comfort zone
either. You have to embrace the grind if you really want your dreams to come true.

At the end of the day, you’ll always be judged by your product and service. But what you do when
everyone is watching is a reflection of what you did when nobody was watching.

Humility

As an entrepreneur you have to put your ego aside, especially if you are offering a service to people. It’s
not always about you; it’s about connecting your ideas/skills with people.

Always be willing to learn new things, take criticism and never let any ounce of success get to your head.
Treat everyone equally, be prepared to ask for help and be nice to everyone.

Never look down on anyone. Just because you own something, it doesn’t mean you’re better than anyone.
People who are genuinely humble and doing what they do for the right reasons usually rise to the top and
remain there.

Calmness

Personally, I put everything I do in God’s hands and do my part by working extremely hard and smart. In
business, it’s important to never get too high and never get too low. If you can remain calm and patient in
entrepreneurship, you’ll be in a good position to be successful.
It’s important to understand that nothing is guaranteed. You’ll have good days and bad days and if you
can accept that then you’ll always be able to move forward and continue growing.

Don’t rush things and don’t over stress. Entrepreneurship isn’t a one-day or one-week project, it is 24/7
and you have to learn how to control and channel your emotions.

Integrity
If you aren’t an honest and ethical person at heart it can be extremely tough to understand
entrepreneurship. Always remember, the whole concept is to provide people with a service and share your
passion/talent. Your product and the environment in your organization is a reflection of the person you
are. Do what you are doing for the right reasons. Treat people with respect and provide them with the
absolute best of you.

Over-deliver

The most passionate entrepreneurs tend to naturally over-deliver. Don’t do a basic job; make the
experience for your client or consumer the absolute best among the field. When you over-deliver, your
product is truly felt. Always be willing to go the extra mile.

Mental toughness

Entrepreneurship is not for the faint-hearted. You have to be an absolute beast mentally. Be prepared and
be able to handle anything that comes your way.

There will be tough moments, things won’t always go the way you want and you have to be able to
bounce back and continue working hard while remaining true to yourself and sticking to the core values
you believe in.

Types of Business Records

Owning a small business comes with a lot of paperwork. Sometimes, it’s hard to decide which
documents to keep, especially when they pile up in your office. You need to keep several kinds of records
to stay compliant with laws and measure your progress. Accounting software can help, but do you know
what types of business records are essential for staying on track?

Types of business records

Make sure you keep track of these five types of records for your business.

1. Accounting records

Accounting records document your business’s transactions. These records include information about your
income, expenses, and equity. You can compile the figures from your accounting records into financial
statements and small business ratios.
You must track accounting records for several purposes. Accounting records help you see your business’s
financial health. You can measure your company’s profitability over time, look at patterns in your records
to help make decisions, and see if you have enough capital to cover your expenses.
The government requires you to keep financial documents that show income and expenses. You use
accounting records to file your income tax return.

Once you file your tax return, be sure to keep tax records. The IRS can penalize you for up to six years
after you don’t report income. For this reason, you should keep tax records of your small business
finances for seven years.
2. Bank statements

Bank statements are records of all your accounts with the bank. These accounts might include records of
your checking, savings, investments, and credit cards.

You can reconcile bank statements with your accounting records. Comparing bank records to your
financial records helps you see mistakes in your books. If your bank statements do not match your
accounting records, there might be an error.
Like accounting records, bank statements help you track your business’s progress. You will also use this
information to file taxes.

3. Legal documents

Depending on your type of business structure, you have different legal documents. For example, if you
own an incorporated company, you should keep track of your articles of incorporation.

You have legal documentation if you operate under different business structures. Usually, a partnership
has a partnership agreement. Sole proprietors also have legal documents. Keep legal documents in your
business records as proof that you own your company.
4. Permits and Licenses

Your location and industry may require you to have a permit or license. For example, you may need a
permit from your city to assure that your parking area meets specific codes. Or, if your city restricts the
size of your business sign, you may need a sign permit.

Keep up-to-date records of all your permits and licenses. You need documentation of permits and licenses
to show you follow regulations.

5. Insurance documents

As a small business owner, you may need insurance for different aspects of your company.
General business liability insurance protects your business from losses. You may also need other policies,
like auto or renters insurance.
To use your insurance, you need proof that you are covered. For example, you may need to prove your
coverage if your business is damaged by fire. Or, insurance can protect you during legal disputes. Your
insurance documents include information needed to report incidents, such as your policy number.

INVENTORY TYPES
Inventory is defined as a stock or store of goods. These goods are maintained on hand at or near a
business's location so that the firm may meet demand and fulfill its reason for existence. If the firm is a
retail establishment, a customer may look elsewhere to have his or her needs satisfied if the firm does not
have the required item in stock when the customer arrives. If the firm is a manufacturer, it must maintain
some inventory of raw materials and work-in-process in order to keep the factory running. In addition, it
must maintain some supply of finished goods in order to meet demand.

Sometimes, a firm may keep larger inventory than is necessary to meet demand and keep the factory
running under current conditions of demand. If the firm exists in a volatile environment where demand is
dynamic (i.e., rises and falls quickly), an on-hand inventory could be maintained as a buffer against
unexpected changes in demand. This buffer inventory also can serve to protect the firm if a supplier fails
to deliver at the required time, or if the supplier's quality is found to be substandard upon inspection,
either of which would otherwise leave the firm without the necessary raw materials. Other reasons for
maintaining an unnecessarily large inventory include buying to take advantage of quantity discounts (i.e.,
the firm saves by buying in bulk), or ordering more in advance of an impending price increase.

Generally, inventory types can be grouped into four classifications: raw material, work-in-process,
finished goods, and MRO goods.

RAW MATERIALS

Raw materials are inventory items that are used in the manufacturer's conversion process to produce
components, subassemblies, or finished products. These inventory items may be commodities or extracted
materials that the firm or its subsidiary has produced or extracted. They also may be objects or elements
that the firm has purchased from outside the organization. Even if the item is partially assembled or is
considered a finished good to the supplier, the purchaser may classify it as a raw material if his or her
firm had no input into its production. Typically, raw materials are commodities such as ore, grain,
minerals, petroleum, chemicals, paper, wood, paint, steel, and food items. However, items such as nuts
and bolts, ball bearings, key stock, casters, seats, wheels, and even engines may be regarded as raw
materials if they are purchased from outside the firm.

The bill-of-materials file in a material requirements planning system (MRP) or a manufacturing resource
planning (MRP II) system utilizes a tool known as a product structure tree to clarify the relationship
among its inventory items and provide a basis for filling out, or "exploding," the master production
schedule. Consider an example of a rolling cart. This cart consists of a top that is pressed from a sheet of
steel, a frame formed from four steel bars, and a leg assembly consisting of four legs, rolled from sheet
steel, each with a caster attached.
Generally, raw materials are used in the manufacture of components. These components are then
incorporated into the final product or become part of a subassembly. Subassemblies are then used to
manufacture or assemble the final product. A part that goes into making another part is known as a
component, while the part it goes into is known as its parent. Any item that does not have a component is
regarded as a raw material or purchased item. From the product structure tree it is apparent that the rolling
cart's raw materials are steel, bars, wheels, ball bearings, axles, and caster frames.

WORK-IN-PROCESS

Work-in-process (WIP) is made up of all the materials, parts (components), assemblies, and
subassemblies that are being processed or are waiting to be processed within the system. This generally
includes all material—from raw material that has been released for initial processing up to material that
has been completely processed and is awaiting final inspection and acceptance before inclusion in
finished goods.

Any item that has a parent but is not a raw material is considered to be work-in-process. A glance at the
rolling cart product structure tree example reveals that work-in-process in this situation consists of tops,
leg assemblies, frames, legs, and casters. Actually, the leg assembly and casters are labeled as
subassemblies because the leg assembly consists of legs and casters and the casters are assembled from
wheels, ball bearings, axles, and caster frames.

FINISHED GOODS

A finished good is a completed part that is ready for a customer order. Therefore, finished goods
inventory is the stock of completed products. These goods have been inspected and have passed final
inspection requirements so that they can be transferred out of work-in-process and into finished goods
inventory. From this point, finished goods can be sold directly to their final user, sold to retailers, sold to
wholesalers, sent to distribution centers, or held in anticipation of a customer order.

Any item that does not have a parent can be classified as a finished good. By looking at the rolling cart
product structure tree example one can determine that the finished good in this case is a cart.

Inventories can be further classified according to the purpose they serve. These types include transit
inventory, buffer inventory, anticipation inventory, decoupling inventory, cycle inventory, and MRO
goods inventory. Some of these also are know by other names, such as speculative inventory, safety
inventory, and seasonal inventory. We already have briefly discussed some of the implications of a few of
these inventory types, but will now discuss each in more detail.

TRANSIT INVENTORY
Transit inventories result from the need to transport items or material from one location to another, and
from the fact that there is some transportation time involved in getting from one location to another.
Sometimes this is referred to as pipeline inventory. Merchandise shipped by truck or rail can sometimes
take days or even weeks to go from a regional warehouse to a retail facility. Some large firms, such as
automobile manufacturers, employ freight consolidators to pool their transit inventories coming from
various locations into one shipping source in order to take advantage of economies of scale. Of course,
this can greatly increase the transit time for these inventories, hence an increase in the size of the
inventory in transit.

BUFFER INVENTORY

As previously stated, inventory is sometimes used to protect against the uncertainties of supply and
demand, as well as unpredictable events such as poor delivery reliability or poor quality of a supplier's
products. These inventory cushions are often referred to as safety stock. Safety stock or buffer inventory
is any amount held on hand that is over and above that currently needed to meet demand. Generally, the
higher the level of buffer inventory, the better the firm's customer service. This occurs because the firm
suffers fewer "stock-outs" (when a customer's order cannot be immediately filled from existing inventory)
and has less need to backorder the item, make the customer wait until the next order cycle, or even worse,
cause the customer to leave empty-handed to find another supplier. Obviously, the better the customer
service the greater the likelihood of customer satisfaction.

ANTICIPATION INVENTORY

Oftentimes, firms will purchase and hold inventory that is in excess of their current need in anticipation of
a possible future event. Such events may include a price increase, a seasonal increase in demand, or even
an impending labor strike. This tactic is commonly used by retailers, who routinely build up inventory
months before the demand for their products will be unusually high (i.e., at Halloween, Christmas, or the
back-to-school season). For manufacturers, anticipation inventory allows them to build up inventory
when demand is low (also keeping workers busy during slack times) so that when demand picks up the
increased inventory will be slowly depleted and the firm does not have to react by increasing production
time (along with the subsequent increase in hiring, training, and other associated labor costs). Therefore,
the firm has avoided both excessive overtime due to increased demand and hiring costs due to increased
demand. It also has avoided layoff costs associated with production cut-backs, or worse, the idling or
shutting down of facilities. This process is sometimes called "smoothing" because it smoothens the peaks
and valleys in demand, allowing the firm to maintain a constant level of output and a stable workforce.

DECOUPLING INVENTORY
Very rarely, if ever, will one see a production facility where every machine in the process produces at
exactly the same rate. In fact, one machine may process parts several times faster than the machines in
front of or behind it. Yet, if one walks through the plant it may seem that all machines are running
smoothly at the same time. It also could be possible that while passing through the plant, one notices
several machines are under repair or are undergoing some form of preventive maintenance. Even so, this
does not seem to interrupt the flow of work-in-process through the system. The reason for this is the
existence of an inventory of parts between machines, a decoupling inventory that serves as a shock
absorber, cushioning the system against production irregularities. As such it "decouples" or disengages
the plant's dependence upon the sequential requirements of the system (i.e., one machine feeds parts to the
next machine).

The more inventory a firm carries as a decoupling inventory between the various stages in its
manufacturing system (or even distribution system), the less coordination is needed to keep the system
running smoothly. Naturally, logic would dictate that an infinite amount of decoupling inventory would
not keep the system running in peak form. A balance can be reached that will allow the plant to run
relatively smoothly without maintaining an absurd level of inventory. The cost of efficiency must be
weighed against the cost of carrying excess inventory so that there is an optimum balance between
inventory level and coordination within the system.

CYCLE INVENTORY

Those who are familiar with the concept of economic order quantity (EOQ) know that the EOQ is an
attempt to balance inventory holding or carrying costs with the costs incurred from ordering or setting up
machinery. When large quantities are ordered or produced, inventory holding costs are increased, but
ordering/setup costs decrease. Conversely, when lot sizes decrease, inventory holding/carrying costs
decrease, but the cost of ordering/setup increases since more orders/setups are required to meet demand.
When the two costs are equal (holding/carrying costs and ordering/setup costs) the total cost (the sum of
the two costs) is minimized. Cycle inventories, sometimes called lot-size inventories, result from this
process. Usually, excess material is ordered and, consequently, held in inventory in an effort to reach this
minimization point. Hence, cycle inventory results from ordering in batches or lot sizes rather than
ordering material strictly as needed.

MRO GOODS INVENTORY

Maintenance, repair, and operating supplies, or MRO goods, are items that are used to support and
maintain the production process and its infrastructure. These goods are usually consumed as a result of
the production process but are not directly a part of the finished product. Examples of MRO goods
include oils, lubricants, coolants, janitorial supplies, uniforms, gloves, packing material, tools, nuts, bolts,
screws, shim stock, and key stock. Even office supplies such as staples, pens and pencils, copier paper,
and toner are considered part of MRO goods inventory.

THEORETICAL INVENTORY

In their book Managing Business Process Flows: Principles of Operations Management, Anupindi,
Chopra, Deshmukh, Van Mieghem, and Zemel discuss a final type of inventory known as theoretical
inventory. They describe theoretical inventory as the average inventory for a given throughput assuming
that no WIP item had to wait in a buffer. This would obviously be an ideal situation where inflow,
processing, and outflow rates were all equal at any point in time. Unless one has a single process system,
there always will be some inventory within the system. Theoretical inventory is a measure of this
inventory (i.e., it represents the minimum inventory needed for goods to flow through the system without
waiting). The authors formally define it as the minimum amount of inventory necessary to maintain a
process throughput of R, expressed as:
Theoretical Inventory = Throughput × Theoretical Flow Time
I th = R × T th
In this equation, theoretical flow time equals the sum of all activity times (not wait time) required to
process one unit. Therefore, WIP will equal theoretical inventory whenever actual process flow time
equals theoretical flow time.

Inventory exists in various categories as a result of its position in the production process (raw material,
work-in-process, and finished goods) and according to the function it serves within the system (transit
inventory, buffer inventory, anticipation inventory, decoupling inventory, cycle inventory, and MRO
goods inventory). As such, the purpose of each seems to be that of maintaining a high level of customer
service or part of an attempt to minimize overall costs.

Why Is Inventory Important for a Business?

Inventory is a current asset on your company’s balance sheet. More important, it is a major part of your
ongoing business operations. For manufacturers, inventory includes raw materials used to make and
assemble products. For resellers, it includes products you acquire to resell to customers. In either case,
you need inventory to earn revenue.
Revenue and Profits
As a product seller, inventory is the driving force behind your ability to generate revenue and profits.
Revenue is the money you collect at the time you sell inventory. Profit equals your final income after you
subtract your variable costs. This means the ability to get inventory at the lowest cost possible and sell it
at the highest price is key to a successful, profitable operation.
Management
Managing your inventory in a cost-efficient way helps you optimize your profits. This begins with
negotiating the lowest costs with your suppliers. Buying in volume or committing to suppliers in long-
term relationships can help with this. Managing inventory once you have it is vital as well. If you order
too much inventory, you have to pay more money for employees to organize it and manage it. You have
more expenses for storage areas where you hold it. You also risk waste on expired or rotted items. Having
too little inventory can lead to stock-outs, which is bad for customer service.
Turnover
Turning over inventory efficiently is also important. Calculating your inventory turnover ratio allows you
to see how efficiently you sell through your inventory. The formula is costs of goods sold divided by your
average inventory level for a given period. A high turnover rate means you get products off the shelf
while they have maximum value to customers. You also make room for newer merchandise while it’s
trendy or in demand. A lower turnover ratio leads to higher management costs and more waste. It also
forces you to have more sales promotions to clear out excess products.
Just-in-Time
A common approach to inventory management in the latter 20th and early 21st centuries is just-in-time or
JIT inventory. This is a technology-driven method intended to keep your inventory at ideal levels where
you have enough on hand to cover customer demand, but not too much to lead to high costs. To use JIT,
you need strong relationships with key suppliers so you can integrate your inventory data through shared
software databases. This allows for automated ordering so suppliers can quickly get new inventory out to
your distribution center or stores as needed.