INVENTORY

Introduction
Adequate inventories facilitates production activities and help to customers satisfaction
by providing good service.
The basic financial inventory management aim is holding the inventory to a minimally
acceptable level in relation to its costs. Holding inventory means using capital to finance
inventory and links with inventory storage, insurance, transport, obsolescence, wasting and
spoilage costs. However, maintaining a low inventory level can, in turn, lead to other problems
with regard to meeting supply demands. The inventory management policy decisions, create the
new inventory level in a firm. It has the influence on the firm value. It is the result of opportunity
costs of money tied in with inventory and generally of costs of inventory managing. Both the
first and the second involve modification of future free cash flows, and in consequence the firm
value changes.
Inventory changes (resulting from changes in inventory management policy of the firm)
affect the net working capital level and the level of operating costs of inventory management in a
firm as well. These operating costs are result of storage, insurance, transport, obsolescence,
wasting and spoilage of inventory.
Maximization of the owners wealth is the basic financial goal in enterprise management.
Inventory management techniques must contribute to this goal. The modifications to both the
value-based EOQ model and value-based POQ model may be seen in this article. Inventory
management decisions are complex. Excess cash tied up in inventory burdens the enterprise with
high costs of inventory service and opportunity costs. By contrast, higher inventory stock helps
increase income from sales because customers have greater flexibility in making purchasing
decisions and the firm decrease risk of unplanned break of production. Although problems
connected with optimal economic order quantity and production order quantity remain, we
conclude that value-based modifications implied by these two models will help managers make
better value-creating decisions in inventory management.

Introduction Of Inventory
Inventories constitute the most significant part of current assets of a large majority of
companies in India. On an average, inventories are approximately 60% of current assets in public
limited companies in India. Because of the large size of inventories maintained by firms, a
considerable amount of feuds is required to be committed to them. It is therefore, absolutely
imperative to mnage inventories efficiently and efficiently in order to avoid unnecessary
investment. A firm neglecting the management of inventories will be jeopardizing its long run
profitability and may fail ultimately. It is possible for fore a company to reduce its levels of
inventories to a considerable degree e.g. 10 to 20 percent, without any adverse effect on production
and sales, by using simple inventory planning and control techniques. The reduction in excessive
inventory carries a favourable impact on a companys profitability.

Meaning Of Inventory
Inventory is the physical stoke of goods maintained in an organization for its smooth
sunning. In accounting language it may mean stock of finished goods only. In a manufacturing
concern, it may includes raw materials, work-in-progress and stores etc. In the form of materials or
supplies to be consumed in the production process or in the rendering of services.
In brief, Inventory is unconsumed or unsold goods purchased or manufactured.

Nature Of Inventories
Inventories are stock of the product a company is manufacturing for sale and components
that make up the product. The various forms in which inventory exist in a manufacturing company
are raw materials, work in progress and finished goods.
Raw Materials
Raw materials are those inputs that are converted into finished product though the
manufacturing process. Raw materials inventories are those units which have been purchased and
stored for future productions.

Work In Progress
These inventories are semi manufactured products. They represent products that need more
work before they become finished products for sales.
Packaging Material
Packaging material includes those items which are used for packaging of

perfumery

product i.e. cap of the bottle, pump, coller, liver, box etc.
Finished Goods
Finished goods inventories are those completely manufactured products which are ready
for sale. Stock of raw materials and work in progress facilitate production. While stock of finished
goods is required for smooth marketing operation. Thus, inventories serve as a link between the
production and consumption of goods.
The levels of four kinds of inventories for a firm depend on the nature of its business. A
manufacturing firm will have substantially high levels of all three kinds of inventories, while a retail
or wholesale firm will have a very high and no raw material and work in progress inventories.
Within manufacturing firms, there will be differences. Large heavy engineering companies produce
long production cycle products, therefore they carry large inventories. On the other hand, inventories
of a consumer product company will not be large, because of short production cycle and fast turn
over.

Inventory Management
As the cost of logistics increases the manufacturers are looking to inventory management
as a way to control costs. Inventory is a term used to describe unsold goods held for sale or raw
materials awaiting manufacture. These items may be on the shelves of a store, in the backroom
or in a warehouse mile away from the point of sale. In the case of manufacturing, they are
typically kept at the factory. Any goods needed to keep things running beyond the next few hours
are considered inventory.
"Inventory" to many small business owners is one of the more visible and tangible
aspects of doing business. Raw materials, goods in process and finished goods all represent

various forms of inventory. Each type represents money tied up until the inventory leaves the
company as purchased products. Likewise, merchandise stocks in a retail store contribute to
profits only when their sale puts money into the cash register.
In a literal sense, inventory refers to stocks of anything necessary to do business. These
stocks represent a large portion of the business investment and must be well managed in order to
maximize profits. In fact, many small businesses cannot absorb the types of losses arising from
poor inventory management. Unless inventories are controlled, they are unreliable, inefficient
and costly.
Inventory management simply means the methods you use to organize, store and replace
inventory, to keep an adequate supply of goods while minimizing costs. Each location where
goods are kept will require different methods of inventory management. Keeping an inventory, or
stock of goods, is a necessity in retail. Customers often prefer to physically touch what they are
considering purchasing, so you must have items on hand. In addition, most customers prefer to
have it now, rather than wait for something to be ordered from a distributor. Every minute that is
spent down because the supply of raw materials was interrupted costs the company unplanned
expenses

Definitions Of Inventory Management

1. Policies, procedure and techniques employed in maintaining the optimum number or
amount of each inventory item.
2. Systems and processes that identify inventory requirements, set targets, provide
replenishment techniques and report actual and projected inventory status.
3. Handles all functions related to the tracking and management of material. This would
include the monitoring of material moved into and out of stockroom locations and the
reconciling of the inventory balances. Also may include ABC analysis, lot tracking, cycle
counting support etc.

Definitions Of Inventory
1. Inventory: goods that businesses intend to sell to their customers or raw materials or inprocess items that will be converted into salable goods
2. Inventory is the stock of idle resources which has economic value and is maintained to
fulfill the present and future needs of an organization
3. In Manufacturing Organization : Inventory can be as raw

materials, spare parts,

components and finished goods etc

4.

In Service Organization : Inventory of any Bank can be broachers, forms, pamphlets

and also can be currency notes and coins. Hospitals can have inventory as syringes,
glucose bottles, medicines etc.

Importance Of Inventory

Inventory represents one of the most important assets that most businesses possess,
because

the

turnover

of

inventory represents one

of

the primary

sources

of revenue generation and subsequent earnings for the company's shareholders/owners.

The word 'inventory' can refer to both the total amount of goods and the act of counting
them. Many companies take an inventory of their supplies on a regular basis in order to avoid
running out of popular items. Others take an inventory to insure the number of items ordered
matches the actual number of items counted physically. Shortages or overages after an inventory
can indicate a problem with theft or inaccurate accounting practices.
Possessing a high amount of inventory for long periods of time is not usually good for
a business because of inventory

storage,

obsolescence

and

spoilage

costs.

However,

possessing too little inventory isn't good either, because the business runs the risk of losing out
on potential sales and potential market share as well.

Objectives Of Inventory Management

The basic managerial objectives of inventory control are two-fold; first, the avoidance
over-investment or under-investment in inventories; and second, to provide the right quantity of
standard raw material to the production department at the right time. In brief, the objectives of
inventory control may be summarized as follows:

A.
(1)

Operating Objectives:
Ensuring Availability of Materials: There should be a continuous availability of all types of
raw materials in the factory so that the production may not be help up wants of any material.
A minimum quantity of each material should be held in store to permit production to move
on schedule.

(2)

Avoidance of Abnormal Wastage: There should be minimum possible wastage of

materials while these are being stored in the go downs or used in the factory by the workers.
Wastage should be allowed up to a certain level known as normal wastage. To avoid any
abnormal wastage, strict control over the inventory should be exercised. Leakage, theft,
embezzlements of raw material and spoilage of material due to rust, bust should be avoided.

(3)

Promotion of Manufacturing Efficiency: If the right type of raw material is available to

the manufacturing departments at the right time, their manufacturing efficiency is also
increased. Their motivation level rises and morale is improved.

(4)

Avoidance of Out of Stock Danger: Information about

availability of materials should

be made continuously available to the management so that they can do planning for
procurement of raw material. It maintains the inventories at the optimum level keeping in
view the operational requirements. It also avoids the out of stock danger.

(5)

Better Service to Customers: Sufficient stock of finished goods must be maintained to

match reasonable demand of the customers for prompt execution of their orders.
(6) Highlighting slow moving and obsolete items of materials.
(7)

Designing poorer organization for inventory management: Clear cut accountability

should be fixed at various levels of organization.

B. Financial Objectives:
(1) Economy in purchasing: A proper inventory control brings certain advantages and
economies in purchasing also. Every attempt has to make to effect economy in purchasing
through quantity and taking advantage to favorable markets.
(2) Reasonable Price: While purchasing materials, it is to be seen that right quality of material
is purchased at reasonably low price. Quality is not to be sacrificed at the cost of lower price.
The material purchased should be of the quality alone which is needed.
(3) Optimum Investing and Efficient Use of capital: The basic aim of inventory control
from the financial point of view is the optimum level of investment in inventories. There
should be no excessive investment in stock, etc. Investment in inventories must not tie up
funds that could be used in other activities. The determination of maximum and minimum
level of stock attempt in this direction.

Importance Of Inventory Management

1. COUNTING CURRENT STOCK
All businesses must know what they have on hand and evaluate stock levels with respect to
current and forecasted demands. You must know what you have in stock to ensure you can meet
the demands of customers and production and to be sure you are ordering enough stock in the

future. Counting is also important because it is the only way you will know if there is a problem
with theft occurring at some point in the supply chain. When you become aware of such
problems you can take steps to eliminate them.
2. CONTROLLING SUPPLY AND DEMAND
Whenever possible, obtain a commitment from a customer for a purchase. In this way, you
ensure that the items you order will not take space in your inventory for long. When this is not
possible, you may be able to share responsibility for the cost of carrying goods with the
salesperson, to ensure that an order placed actually results in a sale. You can also keep a list of
goods that can easily be sold to another party, should a customer cancel. Such goods can be
ordered without prior approval.
Approval procedures should be arranged around several factors. You should set minimum and
maximum quantities which your buyers can order without prior approval. This ensures that you
are maximizing any volume discounts available through your vendors and preventing overordering of stock. It is also important to require pre-approval on goods with a high carrying cost.
3. KEEPING ACCURATE RECORDS
Any time items arrive at or leave a warehouse, accurate paperwork should be kept, itemizing the
goods. When inventory arrives, this is when you will find breakage or loss on the goods you
ordered. Inventory leaving your warehouse must be counted to prevent loss between the
warehouse and the point of sale. Even samples should be recorded, making the salesperson
responsible for the goods until they are returned to the storage facility. Records should be
processed quickly, at least in the same day that the withdrawal of stock occurred.
4. MANAGING EMPLOYEES
Buyers are the employees who make stock purchases for your company. Reward systems should
be set in place that encourage high levels of customer service and return on investment for the
product lines the buyer manages.

Warehouse employees should be educated on the costs of improper inventory management. Be

sure they understand that the lower your profit margin, the more sales must be generated to make
up for the lost goods. Incentive programs can help employees keep this in perspective. When
they see a difference in their paychecks from poor inventory management, they are more likely
to take precautions to prevent shrinkage.
Each stock item in your warehouse or back room should have its own procedures for
replenishing the supply. Find the best suppliers and storage location for each and record this
information in official procedures that can easily be accessed by your employees.
Inventory management should be a part of your overall strategic business plan. As the business
climate evolves towards a green economy, businesses are looking for ways to leverage this trend
as part of the big picture. This can mean re-evaluating your supply chain and choosing
products that are environmentally sound. It can also mean putting in place recycling procedures
for packaging or other materials. In this way, inventory management is more than a means to
control costs; it becomes a way to promote your business.

Successful Inventory Management

Successful inventory management involves balancing the costs of inventory with the
benefits of inventory. Many small business owners fail to appreciate fully the true costs of
carrying inventory, which include not only direct costs of storage, insurance and taxes, but also
the cost of money tied up in inventory. This fine line between keeping too much inventory and
not enough is not the manager's only concern. Others include:

Maintaining a wide assortment of stock -- but not spreading the rapidly moving ones too

thin;
Increasing inventory turnover -- but not sacrificing the service level;
Keeping stock low -- but not sacrificing service or performance.
Obtaining lower prices by making volume purchases -- but not ending up with slow-

moving inventory; and

Having an adequate inventory on hand -- but not getting caught with obsolete items.
The degree of success in addressing these concerns is easier to gauge for some than for
others. For example, computing

About Inventory Control

Inventory consists of the goods and materials that a retail business holds for sale or a
manufacturer keeps in raw materials for production. Inventory control is a means for maintaining
the right level of supply and reducing loss to goods or materials before they become a finished
product or are sold to the consumer.
Inventory control is one of the greatest factors in a companys success or failure. This part of
the supply chain has a great impact on the companys ability to manufacture goods for sale or to
deliver customer satisfaction on orders of finished products. Proper inventory control will
balance the customers need to secure products quickly with the business need to control
warehousing costs. To manage inventory effectively, a business must have a firm understanding
of demand, and cost of inventory.

Advantages Of Inventory Control:

(1) Reduction in investment in inventory.
(2) Proper and efficient use of raw materials.
(3)No bottleneck in production.
(4) Improvement in production and sales.
(5) Efficient and optimum use of physical as well as financial resources.
(6)Ordering cost can be reduced if a firm places a few large orders in place of numerous small
orders.
(7)Maintenance of adequate inventories reduces the set-up cost associated with each production
Run.
Inventory Costs
There are three main types of cost in inventory. There are the costs to carry standard
inventories and safety stock. Ordering and setup costs come into play as well. Finally, there are

shortfall costs. A good inventory control system will balance carrying costs against shortfall
costs.
Safety Stock
Safety stock is comprised of the goods needed to be kept on hand to satisfy consumer
demand. Because demand is constantly in flux, optimizing the Safety Stock levels is a challenge.
However, demand fluctuations do not wholly dictate a companys ability to keep the right supply
on hand most of the time. Companies can use statistical calculations to determine probabilities in
demand.
Ordering Costs
Ordering costs have to do with placing orders, receiving and stowage. Transportation and
invoice processing are also included. Information technology has proven itself useful in reducing
these costs in many industries. If the business is in manufacturing, then to production setup costs
are considered instead.
The Cost Of Shortfalls
Stock out or shortfall costs represent lost sales due to lack of supply for consumers. Sales
departments prefer these numbers be kept low so that an ample stock will always be kept.
Logistics managers prefer to err on the side of caution to reduce warehousing costs.
Shortfall costs are avoided by keeping an ample safety stock on hand. This practice also
increases customer satisfaction. However, this must be balanced with the cost to carry goods.
The best way to manage stockout is to determine the acceptable level of customer service for the
business. One can then balance the need for high satisfaction with the need to reduce inventory
costs. Customer satisfaction must always be considered ahead of storage costs.
Cyclical Counting
Many companies prefer to count inventory on a cyclical basis to avoid the need for
shutting down operations while stock is counted. This means that a particular section of the
warehouse or plant is counted physically at particular times, rather than counting all inventory at

once. While this method may be less accurate than counting the whole, it is much more cost
effective.
Cyclical counting is preferred because it allows for operations to continue while inventory is
taken. If not for this practice, a business would have to shut down while counts were taken, often
requiring the hire of a third party or use of overtime employees. Cyclical counting usually
utilizes the ABC rule, but there are other variations of this method that can be used. The ABC
rule specifies that tracking 20 percent of inventory will control 80 percent of the cost to store the
goods. Therefore, businesses concentrate more on the top 20 percent and counter other goods
less frequently. Items are categorized based on three levels:

A Category: Top valued 20 percent of goods, whether by economic or demand value

B Category: Midrange value items

C Category: Cheaper items, rarely in demand

Warehouse staff can now schedule counting of inventories based on these categories. The A
category is counted on a regular basis while B and C categories are counted only once a
month or once a quarter.

Common Inventory Valuation Methods

The methods a company uses to value the costs of inventory have a direct effect on the
business balance sheets, income statements and cash flows. Three methods are widely used to
value such costs. They are First-In, First-Out (FIFO), Last-In First-Out (LIFO) and Average Cost.
Inventory can be calculated based on the lesser of cost or market value. It can be applied to each
item, each category or on a total basis.

FIFO
FIFO operates under the assumption that the first product that is put into inventory is also the
first sold. An example of this in action can be made when we assume that a widget seller
acquires 200 units on Monday for Rs.1.00 per unit. The next day, he spots a good deal and gets

500 more for Rs.75 per unit. When valuing inventory under the FIFO method, the sale of 300
units on Wednesday would create a cost of goods sold of Rs.275. That is, 200 units at Rs1.00
each and 100 units at Rs.75 each. In this way, the first 200 units on the income statement were
valued higher. The remaining 400 widgets would be valued at Rs.75 each on the balance sheet in
ending inventory.

LIFO
LIFO assumes instead that the last unit to reach inventory is the first sold. Using the same
example, the income statement and balance sheet would instead show a cost of goods sold of
Rs.225 for the 300 units sold. The ending inventory on the balance sheet would be valued at
Rs.350 in assets. When this method is used on older inventories, the companys balance sheet
can be greatly skewed. Consider the company that carries a large quantity of merchandise over a
period of 10 years. This accounting method is now using 10-year-old information to value its
assets.

Weighted Average
Average Cost works out a weighted average for the cost of goods sold. It takes an average cost
for all units available for sale during the accounting period and uses that as a basis for the cost of
goods sold. To site our example again, we would calculate the cost of goods sold at [(200 x Rs.1)
+ (500 x Rs.75)]/700, or Rs.821 each. The remaining 400 units would also be valued at this rate
on the balance sheet in ending inventory.

Rising Prices
When prices are rising, using FIFO will show a greater value on the balance sheet, thereby
increasing tax liabilities but also improving credit scores and the ability to borrow cash for
ongoing operations. Older inventory is being used to determine the cost of goods sold and newer
inventory is being used to report assets. LIFO decreases the value on the income statement, but
can reduce the level of depreciation you are able to take on assets. This is good for taxes but bad

for borrowing. Industries most likely to adopt LIFO are department stores and food retailers. The
method is rarely used in defences.