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Inventory Management

The application of managerial function on the basis of management principles in

the field of inventory is termed as inventory management. Managerial functions are
performed with respect to inventory; it may be called inventory management.

Efficient system of inventory management will determine:

 What to purchase
 How much to purchase
 From where to purchase
 Where to store, etc.
What are inventories?
 Inventories are assets:-
• Hold for sale in the ordinary course of business.
• In the process of production for such sale.
• In the form of materials or supplies to be consumed in the production
process or in rendering of services

The term ‘inventory’ includes:

 Inventory of Raw Materials
 Inventory of Stores and Spare Parts
 Inventory of W.I.P.
 Inventory of Finished Goods

Three motives for holding inventories

 To facilitate smooth production and sales operation (transaction motive).
 To guar time (precautionary motive) against the risk of unpredictable
changes in usage rate and delivery .
 To take advantage of price fluctuation (speculative motive)

Need for inventory management:

Production management:
large inventory of raw materials and of such a good quality
Marketing management:
aims at satisfying ever increasing demands for improved customers’ service
Financial management:
effort towards to keep investments in different types of inventory at a minimum
possible level .

How are inventories valued under AS-2?

 Inventories are valued at the lower cost and net realizable value. The cost
of inventories should comprise all costs of purchase, costs of conversion and
other costs incurred in bringing the inventories to their present location

1. Economic Order Quantity (EOQ)

The prime objective of inventory management is to find out and maintain optimum
level of investment in inventory to minimize the total costs associated with it.
The EOQ is the optimum size of the order for a particular item of inventory
calculated at a point where the total inventory costs are at a minimum for that
particular stock item. It is an optimum size of either a normal outside purchase
order or an internal production order that minimizes total annual holding and
ordering costs of inventory. Stock-out costs are difficult to incorporate in this
model, since they are based on qualitative and subjective judgment. The ordering
costs are the costs of placing a separate order multiplied by the number of
separate orders placed in the period. The carrying costs can be calculated based
on the assumption that annual cost of carrying a particular stock item on average,
half the stock is on hand all the time in addition to the safety or buffer stock.
The fewer the orders, the lower costs of ordering, but the greater the size of the
order the greater the costs of carrying. The safety or buffer stock has no bearing
on the EOQ, only on the timing of orders. The economic order quantity (EOQ) is an
optimum quantity of materials to be ordered after consideration of the following
three categories of costs:

Ordering Costs: The costs of ordering inventory include the following:

• Preparation of purchase order
• Costs of receiving goods
• Documentation processing costs
• Transport costs
• Intermittent costs of chasing orders, rejecting faulty goods
• Additional costs of frequent or small quantity orders
• Where goods are manufactured internally, the set-up and tooling costs
associated with each production run.

Carrying Costs: The carrying costs of inventory include the following:

• Storage costs (rent, lighting, heating, refrigeration, air-conditioning
• Stores staffing, equipment maintenance and running costs.
• Handling costs.
• Audit, stock taking or perpetual inventory costs.
• Required rate of return on investment in current assets.
• Obsolescence and deterioration costs.
• Insurance and security costs.
• Costs of money tied up in inventory.
• Pilferage and damage costs.
Stock-out Costs: The stock-out costs are associated with running out of stock
which includes the following:
• Lost contribution through the lost sales caused by the stock-out.
• Loss of future sales because customers go elsewhere.
• Loss of customer goodwill.
• Cost of production stoppages caused by stock-outs of WIP or raw material.
• Labour frustration.
• Over stoppages.
• Extra costs associated with urgent replenishment purchases of small

Assumptions of EOQ:
To be able to calculate a basic EOQ certain assumptions are necessary:
• That there is a known, constant stockholding cost.
• That there is a known, constant ordering cost.
• Those rates of demand are known and constant.
• That there is a known, constant price per unit, i.e., there are no price
• That replenishment is made instantaneously, i.e., the whole batch delivered
at once.

The following formula is used in calculation of EOQ:

EOQ = √2QO
Q = Annual consumption C = Cost per unit
O = Cost of placing an order S = Storage and other inventory carrying cost.


A particularly unrealistic assumption with the basic EOQ calculation is that the
price per item remains constant. Usually some form of discount can be obtained by
ordering increasing quantities. Such price discounts can be incorporated into the
EOQ formula, but it becomes much more complicated. A similar approach is to
consider the costs associated with the normal EOQ and compare these costs with
the costs at each succeeding discount point and then ascertain the best quantity
to order. Price discounts for quantity purchase have three financial effects, two
of which are beneficial and one adverse.

Beneficial effects - Savings will come from:

(a) Lower price per item, and
(b) The large order quantity means that fewer orders need to be placed and hence,
ordering costs are reduced.
Adverse effects - Increased costs arise from the extra stockholding costs caused
by the average stock level being higher due to the larger order quantity.

2. ABC Analysis
In this technique, the items of inventory are classified according to value of
usage. The higher value items have lower safety stocks, because the cost of
production is very high in respect of higher value items. The lower value items
carry higher safety stocks. ABC analysis divides the total inventory list into
three classes A, B, and C using the rupee volume, as follows:
• Items in class 'A' constitute the most important class of inventories so far
as the proportion in the total value of inventory. The 'A' items consists of
approximately 15% of the total items, accounts for 80% of the total material
• Items in class B' constitute an intermediate position, which constitute
approximately 35%of the total items, accounts for approximately 15% of the total
material consumption.
• Items in class 'C’ are quite negligible. It consists remaining 50% items,
accounting only 5% of the monetary value of total material usage.

The numbers are just indicative and actual break-up will vary from situation to
situation. The above categorization is represented in the table given below:
Class of items %of items %of value
A 15 80
B 35 15
C 50 5
100 100

The ABC analysis of inventory class 'A' is made up of inventory items which are
either very expensive or used in massive quantities. Thus these items, though few
in number contribute a high proportion of the value of inventories. Class 'B'
items are not so few in number, but also they are not too many either. Value wise
also, they are neither very expensive nor very cheap. Moreover, they are used in
moderate quantities. Class 'C contains a relatively large number of items. But
they are either very inexpensive items or used in very small quantities so that
they do not constitute more than a negligible fraction of the total value of
inventories. The control of inventory through
ABC analysis is exercised as follows:

• 'A' class items merit a tightly controlled inventory system with constant
attention by the purchase and stores management. A larger effort per item on only
a few items w ill cost only moderately, but the effort can result in large
• 'B' class items merit a formalized inventory system and periodic attention
by the purchase and stores management.
• For 'C class items still relaxed inventory procedures are used.

The table given below shows how an organization treats the various classes of
items according to their consumption value. For 'A' class items, the inventory
policy, i.e. order quantity and re-order point should be carefully determined and
the close control over the usage of materials is desirable. For 'B' class items,
the economic order quantities and reorder level calculations can be done and
larger stocks can be maintained. The review of these items may be done quarterly
or half-yearly. In case of 'C class items, generally one year supply can be
maintained. Periodic review once a year may be sufficient.

The technique tries to analyze the distribution of any characteristics by stock

values of importance in order to determine its priority. This technique can be
applied in all facets of organization. Many organizations are applying this
technique in materials management and spare parts management to identify the
contribution made by the materials/spares in the total inventory value. On the
basis of stock value, materials procurement strategy and consumption strategy is

3. VED Analysis
VED analysis divides items into three categories in the descending order of their
critically as follows:

• V’ stands for vital items and their stock analysis requires more attention,
because out-of stock situation will result in stoppage of production. Thus, 'V
items must be stored adequately to ensure smooth operation of the plant.
• 'E' means essential items. Such items are considered essential for efficient
running but without these items the system would not fail. Care must be taken to
see that they are always in stock.
• 'D’ stands for desirable items which do not affect the production
immediately but availability of such items will lead to more efficiency and less

VED analysis can be very useful to capital intensive process industries. As it

analyses items based on their critically, it can be used for those special raw
materials which are difficult to procure.

4. FNSD Analysis

Age of inventory indicates duration of inventory in organization. It shows moving

position of inventory during the year. If age of inventory is minimum it means,
the turnover position of that particular item of inventory is satisfactory. If the
age of any particular item of inventory, it indicates the slow moving of stock
which may be due to lower demand for the product, inefficiency in shocking policy,
excessive stocking etc. The excessive investment in stocks means, high investment
is locked-up in inventory leads to lower profitability of the firm due to excess
carrying costs. FNSD analysis divides the items into four categories in the
descending order of their usage rate as follows:

• 'F' stands for fast moving items and stocks of such items are consumed in a
short span of time. Stocks of fast moving items must be observed constantly and
replenishment orders be placed in time to avoid stock-out situations.

• 'N' means normal moving items and such items are exhausted over a period of
a war or so. The order levels and quantities for such items should be on the basis
of a new estimate of future demand to minimize the risks of a surplus stock.

• 'S' indicates slow moving items, existing stock of which would last for two
years or more at the current rate of usage but it is still expected to be used up.
Slow moving stock must be reviewed very carefully before any replenishment orders
are placed.

• 'D' stands for dead stock and for its existing stock no further demand can
be foreseen. Dead stock figures in the inventory represents money spent that
cannot be realized but it occupies useful space. Hence, once such items are
identified, efforts must be made to find all alternative uses for it. Otherwise,
it must be disposed off.

Definition of ERP (Enterprise Resource Planning)

Enterprise resource planning (ERP) is the industry term used to describe a broad
set of activities supported by multi-module application software that helps a
manufacturer or other business manage the important parts of its business. These
parts can include product planning, parts purchasing, maintaining inventories,
interacting with suppliers, providing customer service, and tracking orders. ERP
can also include application modules for the finance and human resources aspects
of a business.

Some of the bigger players in the ERP outsourcing market are SAP, PeopleSoft, and
J. D. Edwards. New comers include Oracle, IBM, and Microsoft

Software solution that addresses all the needs of an enterprise with the process
view of an organization to meet the organizational goals and integrate all the
functions of the enterprise

Enterprise resource planning (ERP) is a company-wide computer software system used

to manage and coordinate all the resources, information, and functions of a
business from shared data stores.
An ERP system typically has modular hardware and software units and "services"
that communicate on a local area network. The modular design allows a business to
add or reconfigure modules (perhaps from different vendors) while preserving data
integrity in one shared database that may be centralized or distributed.

Origin of the term

 Value Methodology (also called Value Engineering, Value Analysis or Value
Management) is a powerful problem-solving tool that can reduce costs while
maintaining or improving performance and quality requirements.
 It is a function-oriented, systematic team approach to providing value in a
product or service.
 The value methodology helps organizations compete more effectively in local,
national and international markets by:
 Decreasing costs
 Increasing profits
 Improving quality
 Expanding market share
 Saving time
 Solving problems
 Using resources more effectively

Value Analysis
VA is an step by step approach to identify the functions of a product, process,
system or service; to establish a monetary value for that function and then
provide the desired function at an overall minimum cost without affecting any of
the existing parameters like Quality, Maintainability, Productivity, Safety and
other Performance characteristics

Value Engineering
 Value Engineering is where the value of all the components used in the
construction of a product from design to final delivery stage are completely
analyzed and pursued.

 Value Engineering began at General Electric Co. during World War II. Because
of the war, there were shortages of skilled labor, raw materials, and component
parts. Lawrence Miles and Harry Erlicher at G.E. looked for acceptable
substitutes. They noticed that these substitutions often reduced costs, improved
the product, or both. What started out as an accident of necessity was turned into
a systematic process. They called their technique as “Value Analysis”.
 In the year 1954, US Navy Bureau of ships adopted same technique in their
effort at ‘cost avoidance’ during the design stage and saved millions of dollars.
They named it as “Value Engineering”. VE follows thought process that is based
exclusively on “function”, i.e. what something ‘does’ not what it is.


 It may change the present stage of the product or operation
 It is worked out mostly with help of knowledge and experience VALUE
 the changes are executed at the initial stages only.
 It requires specific technical knowledge.
• Use good human relations
• Inspire team Work
• Work on specifics
• Overcome roadblocks
• Apply good business judgement
• Secure the facts
• Determine the costs
• Fix costs on specifications and requirements
• Define the functions
• Evaluate functional relationships
• Establish positive thinking
• Develop Creative ideas
• Refine and combine ideas
• Establish costs on all ideas
• Develop alternative ideas for functions
• Evaluate by comparison
• Use company and industry standards
• Consults vendors and specialists
• Use specialty products, processes and procedures
• Present facts
• Present costs
• Motivate positive action

Distinguish between centralized purchasing and decentralized purchasing:

Organisation of the purchase function will vary with conditions and ideas.
Purchase may be centralized or decentralsied.There is a separate department
entrusted with task of making all purchases of all types of materials in
centralised purchasing. The person one who heads the purchase department is known
as ‘Purchase Manager’.

Advantages of Centralised Purchasing:

a. It brings about economies of scale in bulk purchasing.
b. Specialised purchasing staff can be concentrated in one department
c. It ensures consistent policy with regard to purchase. It eliminates haphazard
buying and the consequent effect on the finances of the organisation.
d. Stadardisation of quality raw material is facilitated.
e. Keeping all records of purchase transactions at one place helps in control.

1. The creation and maintenance of a special purchasing department leads to higher
administration costs. The small firms may not be in a position to afford.
2. Centralised purchasing is not suitable for plants located at different places,
which are far afar.

The branches of plants are, in some undertakings, located at distant places. It

may not be possible for these undertakings to centralize the purchases. Each
department or branch, therefore, is empowered to make its own purchase. It is
called decentralized purchasing. The decentalised purchasing can better meet the
situation by making purchases in the local market by plant or branch managers.

Advantages of Decentralised Purchasing:

1. It is quite flexible. It can be quickly adjusted in accordance with the changed
requirements of a particular plant.
2. Localised purchasing is best suited in case of emergency.
3. Technical requirements of each plant can be ascertained.

1. It offers lesser economy of scale in purchasing.
2. There are problems of co-ordination among various departments of the
organisation and it usually leads to unplanned buying
3. Uniformity in prices may not be experienced because every branch head may not
posses the calibre of an expert buyer.

It can be arrived from the above analysis that centralised purchasing is decidedly
better than decentralised purchasing. However, the methods may be decided based on
the nature of the organisations. A manufacturing firm, which operates several
branches at different places can have decentralised purchasing.

What are the various steps involved in purchases?

The purchase procedure may differ from one concern to another. The following are
usual steps followed in purchasing and receiving materials.

1. Purchase Requisition:
A form known as Purchase Requisition is commonly used as a formal request to
the purchasing department to buy materials specified therein. The requisition is
received from certain authorised persons. They are storekeeper, purchase planner,
plant engineer, department heads.

A purchase requisition has the following purposes:

a. It sets the purchasing process in motion
b. It is a written record of details like quantities, any speciation etc.
c. It provides date for reference i.e., date when materials are required. Dates
are important in case responsibility for stoppage in production due to shortage of
materials is to be determined.

2. Selecting the Supplier:

When the purchase department receives a duly authorised purchase requisition, the
department invites tenders for the supply of materials. A comparative statement
known, as ‘schedule of quotation’ should be prepared so that supplier may be
selected. The important rule here is to buy best quality materials at the lowest
possible price after giving due consideration to delivery dates and other terms of

3. Purchase order:
When the supplier is identified, the most common procedure is the preparation of a
purchase order. The purchase order is the form used by the purchase department
authorising the supplier to supply the specified materials at an agreed price and
terms. The purchase order should be carefully prepared as it forms a basis of
legal contract between parties concerned.

The number of copies of the purchase order depends on the size of the
organisation. A bigger concern usually issues 5 copies. The supplier receives the
original order. Purchase department retains the second copy. The receiving
department gets the third copy. Accounting department files the fourth copy to
make an entry in the stores ledger. Last copy is sent to the department
requisitioning the material as an intimation of the order and expected date of
receipt of materials.

4. Receipt of Materials:
Receiving Department receives all incoming materials. When the packages are
received, the receiving official gets them and makes a detailed verification of
the contents. The details of the materials received are entered in a Goods
received note. Five copies of the note are prepared. Receiving department keeps
one copy. The remaining copies are routed to the purchase department, the
department originating the purchase requisition, the stores department and the
accounting department.

5. Checking and Passing of Bills for Payment:

Invoice gives details of goods supplied and the amount to be paid. Account
department receives the invoice from the purchase department. Then, account
department checks the authenticity as well as the arithmetical accuracy. The
quantity and the price mentioned in the invoice are checked with reference to
goods received note and the purchase order respectively. The inspection report and
goods returned note should be compared with the invoice. It is also necessary to
check extensions and totals. After comparing these documents with the invoice, if
it is found that the invoice is in order, the purchase manager will sign it and
pass it to the accounts department for payment.

7. What are the characteristics of efficient system of store keeping?

Efficient store keeping should:
a. Ensure uninterrupted supply of materials and stores without delay to various
production and service departments of the organization
b. Protection of materials from losses due to fire, theft, evaporation etc.,
c. Avoiding over-stocking and under-stocking
d. Economical utilization of storage space.
e. Up-to-date stores records
f. Ensuring perpetual inventory
g. Immediate location of material required
h. Speedy receipt and issue of stores
i. Minimize the cost of storage.

8. Explain various functions and duties of storekeeper

The main functions of storekeeper are receipt, storage and issue of
materials.Apart from these main functions, there are quite a few other functions,
which areincidental to these. Various functions and duties of storekeeper are as
a. Receive materials into the stores after checking them with the contents of
the Goods Received Note;
b. Store the materials in the allotted places;
c. Maintain proper record of receipt, issue and balance of all items of
d. Employ location coding and stores coding for easy identification of every
item of stores
e. Maintain the Stores department in a tidy manner
f. Protect material from losses due to fire, theft, evaporation, obsolescence
g. Issue stores, against proper authorization, in right quantity of right
specification, and at the right time
h. Ensure that the stock neither exceed the maximum level nor go below the
minimum level at any point of time
i. Prevent unauthorized persons entering into the stores
j. Co-ordinate the work of staff in the stores department
k. Periodic comparison of bin card balances with physical quantities in the
l. Advise management of obsolete and slow moving stocks.
9. Describe about location and layout of stores
Location of Stores:
Location of stores should be carefully planned. The management should keep in mind
various important considerations before locating the stores department in a site.
It should be in close proximity to the receiving department. It should be close to
roads, railway sidings and wharfs.

Layout of Stores:
Layout of stores should facilitate easy flow of goods in and out with out any
barrier. Layout refers to the internal arrangement or placement of material inside
the stores. It aims at effective utilization of space available for storage of
materials. The stores should be divided into racks, which should be sub-divided
into small spaces. All these spaces are know as bins. A bin is allotted for every
kind of material. All bins should be serially numbered.

The stores should be equipped with racks, bins, shelves, boxes, barrels, jars,
drums, cylinders etc. The receptacles should be arranged in such a way as to make
the fullest utilization of available space. They should be easily accessible at
the same time. Sufficient space should be provided for the movement of trucks,
conveyors, lifts and other mechanical devices.

10. State the procedure for issue of materials

Items in stores are meant issuance. The management generally lays down the
procedure for the issue of material. The storekeeper should ensure the following:

a. A properly authorized material requisition should be presented to him

b. A foreman should prepare the requisition.
c. Requisition should be prepared in triplicate, two copies should be sent to
the stores and the requisitioning department should retain the third copy.
d. The storekeeper should issue the necessary materials against the signatures
of the person receiving the materials.
e. The storekeeper uses one copy of material requisition in making necessary
entries in the bin card. The costing office receives the other copy for pricing
the issue and making necessary entries in the stores ledger.

11. Why should there be classification of stores? Write a note on classification

and codification of materials.

Importance of Classification:
The stores department of big organizations carries a number of items of different
grades and specifications. It generally faces the problem of locating and
identifying the items at the time of storage and issue. Delay due to difficulty in
locating an item causes production hold-ups. There is also possibility of the same
item of two different grades getting mixed up, thereby providing a wrong account
of the stocks of both the items. Therefore, everyone feels to have his or her
goods properly classified.

Classification is the process of arranging items into groups according to their
12. How a manufacturing concern is to be cautious while procuring materials?
13. How does purchase department effectively control purchases of raw materials?
14. Who is in charge of purchase department? What are the qualifications of a
purchase manager?
15. What are the procedures generally followed by purchase department?
16. What do you mean by the following inventory levels? How is computed?
1. Economic order quantity
2. Maximum level
3. Minimum level
4. Re-order level
10. Danger level (problems)
17. What do you mean by stores control and issues control?
18. What are the functions and duties of storekeeper?
19. What do you man by Bin Card? Or Bin tag or stock card? Bring out the specimen
of Bin card
20. What is meant by store ledger? What are the advantages of maintaining stores
ledger? Give specimen of a stores ledger.
21. What do you mean by perpetual inventory system? What are its advantages?
22. What do you mean by ABC method of stores control? Illustrate.
23. What do you mean y material requisition note? What are its contents?
24. Critically evaluate the various methods of pricing materials issues.
Problems: 1. Inventory Level 2. Pricing of Material Issues.

Stores Management
It is serving facility, inside an org., responsible for proper storage of the
material and then issuing it to respective departments on proper requisition. The
custodian of stores is generally known as store-keeper or store controller
Those item which are not in use for some specific duration e.g. spare parts and
the raw- materials are called as stores and building space where these are kept is
known as Store Room

“As per Maynard”

“The duty of store keeping are
“to receive materials,
to protect them while in storage from damage and unauthorized removal,
to issue the materials in the right qualities, at right time, to the right place
to provide these services promptly and at least cost”
Stores System
1. All materials are stored in a closed/controlled area.
2. No other person than the stores personnel is permitted in the area.
3. Materials can leave or enter the storage area only by authorized documents.
4. Maximum physical security.
5. Tight accounting control of inventory material
1. There is no specific area. Stores are maintained in the form of suitable/
convenient locations.
2. Every individual has access to any storage facility.
3. After the receipt of the material it is delivered to respective department
to expedite the production activity.
4. Chances of pilferage high.
5. Less emphasis on accounting control of the material.
Functions of Store-Keeping:
1. Receiving, handling and speedy issue of material.
2. Custodian of goods I store against damage and pilferage.
3. To ensure regular supply of materials .
4. Effective utilization of store space.
5. To provide service to the organization in most economical way.
6. To keep the details of the items available in store up to date.
7. Proper identification and easy location of items.
8. Physical checking of stocks.
Objectives of Store-Keeping
• Easy location of the items in store.
• Proper identification of items.
• Speedy issue of material.
• Efficient utilization of space.
• Reduction in need of material handling equipment.
Duties of Store- Keeper:
• The items in stores shd. Be placed in such a way that these can be easily
• To maintain the store premises neat and clean.
• Efficient and effective service to the org.