Just-in-Time (JIT) Inventory Management: A Comprehensive Guide

The Just in Time (JIT) style of inventory management – also sometimes referred to as the Toyota Production System (TPS) – is a strategy of managing inventoryInventoryInventory is a current asset account found on the balance sheet, consisting of all raw materials, work-in-progress, and finished goods that a and/or production that links the ordering of raw materials to production scheduling. It differs from other strategies of inventory maintenance.

Most companies create and hold inventory in excess, meaning they create goods in anticipation of other orders. The Just in Time method involves creating, storing, and keeping track of only enough orders to supply the actual demand for the company‘s products.

Summary: 

• Companies rely on the Just in Time method to efficiently manage production and fulfill the orders they receive.
• Companies find the JIT method advantageous because it helps them cut down on waste and maintain positive cash flow.
• A potential problem with the JIT system arises if there is a sudden, unexpected increase in demand for a company’s products.

Why Do Companies Use the Just in Time Method?

Companies utilize the Just in Time method of inventory accounting so that it directly aligns with the goods they are producing. They create goods directly related to the orders being placed, instead of making extra goods to meet the needs of any potential orders that may be placed.

The JIT method ultimately helps companies cut down on waste from making too many products (or supplying too many goods). Therefore, they don’t use up raw materials that may or may not actually be necessary to fulfill the orders they have. In turn, it cuts down on the costs they have for inventory, freeing up cash flow.

Originated by Toyota, the JIT inventory/production system has since become popular with other major manufacturing companies such as Harley-Davidson Motorcycles and Dell Computers.

Advantages and Disadvantages of the Just in Time Method

Again, the Just in Time method of accounting for inventory is advantageous to companies because of the reduction of waste it offers. If, for example, a company produces six orders of one product – specifically created for Company A – they have successfully met the need they have.

If they went forward and created ten orders of the same product, they would be doing so with the assumption that one (or more) other companies would be submitting an order for the same product. If no other company (or companies) submit an order for the manufactured goods, they would then have four more products sitting in their inventory that are unnecessary. They would have wasted the raw materials on the additional products, materials that could have been used toward the creation of other goods.

The Just in Time method is reliant upon several factors, including:

1. A company efficiently using raw materials, leaving little to no raw materials left over after production;
2. SuppliersSupplier PowerIn Porter’s Five Forces, supplier power is the degree of control a provider of goods or services can exert on its buyers. Supplier power is linked to the ability of suppliers to increase prices, decrease quality, or limit the number of products they will sell. getting the raw materials to the company in a timely way; and
3. Companies utilizing the raw materials in a timely way so as to fill orders on a timely basis.

A potential disadvantage is that the producing company rarely has any extra stock on hand to fill unexpected orders, which can create two possible problems. The first is that if a customer needs an order filled immediately, the company is unlikely to be able to provide the needed goods because they don’t keep a large, general inventory supply on hand.

The second possible problem may arise if there is a sudden, unexpected surge in market demand for the company’s products. Again, because the company doesn’t maintain a sizable stock inventory, it may be unable to meet the market demand on a timely basis.

Example of the JIT Method – Good and Bad

Let’s continue with the example mentioned above, where Company A ordered six pieces of a certain good. If the producing company only has orders from Company A, the Just in Time system is advantageous for them. They’ve successfully ordered enough raw materials to produce the goods for Company A, and that is the only order they have for those goods. They don’t end up paying for the production of a lot of unneeded inventory.

However, let’s say now that Company B and Company C then submit orders for 15 pieces for the same product as Company A. The producing company has only secured enough raw materials or parts to fill Company A’s order. Companies B and C must wait for raw materials to be delivered to the producer and for production to manufacture the needed goods.

The producing company may face a significant problem if, for example, the delivery of raw materials is delayed for some reason. There is also the customer service problem of trying to keep Company B and Company C happy while they are having to wait for their order to be filled. If the wait causes problems for the buyers, those companies may decide to use an alternate supplier in the future, which means that the producing company loses their business.

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

• Cost of Goods Manufactured (COGM)Cost of Goods Manufactured (COGM)Cost of Goods Manufactured (COGM) is a term used in managerial accounting that refers to a schedule or statement that shows the total
• Inventory AuditAuditing InventoryAuditing inventory is the process of cross-checking financial records with physical inventory and records. It can be completed by auditors and other
• LogisticsLogisticsLogistics, or logistical planning, refers to the process that a business uses in order to coordinate its supply chain operations. It includes a wide variety
• Supply and DemandSupply and DemandThe laws of supply and demand are microeconomic concepts that state that in efficient markets, the quantity supplied of a good and quantity