INVENTORY MANAGEMENT

Ishan Verma (roll no.13) Deepak Vajpayee(roll no. 12) FMS-BHU

Introduction
Inventory means stock of goods. It may mean stock of raw material, stock of WIP, stock of finished goods, stock of consumables or stock of spares. It serves as a link between production and distribution processes. Generally there is time lag between recognition of a need and its fulfillment. The greater the time lag, the higher the requirements for inventory. The unforeseen fluctuations in demand and supply of goods also necessitate the need for inventory.

Continued
The investment in inventories constitutes the most significant part of current assets/working capital in most of the undertakings. Thus, it is very essential to have proper control and management of inventories. A proper planning of purchasing ,handling, storing and accounting should form a part of inventory management. Sometimes conflicts also arises between different departmental heads over the issue of inventory.

Benefits of holding inventories

There are three main purpose or motives of holding inventories: The Transaction motive The precautionary motive The speculative motive

Risk and Cost of holding inventories

The various costs and risks involved in holding inventories are as below : Capital cost Storage and handling cost Risk of price decline Risk of obsolescence Risk of deterioration in quality

Objective of inventory management

To ensure continuous supply of materials, spares and finished goods so that production should not suffer at any time and the customers demand should also be met. To avoid over-stocking and under-stocking. To maintain investments in inventories at the optimum level as required by the operational and sales activities. To keep material cost under control so that they contribute in reducing cost of production and overall cost. To eliminate duplication in ordering or replenishing stocks. This is possible with the help of centralizing purchases.

Continued
To minimize losses through deterioration, wastages and damages. To design proper organization for inventory management. To ensure right quality goods at reasonable prices. Suitable quality standards will ensure proper quality of stocks. The price-analysis, cost-analysis and value analysis will ensure payment of proper prices. To facilitate furnishing of data for short-term and long-term planning and control of inventory.

Tools & techniques of inventory management

Effective inventory management requires an effective control system for inventories. The following are the important tools and techniques of inventory management and control: 1. Determination of stock level 2. Determination of safety stocks 3. Selecting a proper system of ordering for inventories 4. Determination of Economic Order Quantity 5. A.B.C. analysis 6. V.E.D. analysis 7. Inventory turnover ratio

Continued
8. Aging schedule of inventories 9. Classification and codification of inventories 10. Preparation of inventory reports 11. Lead time 12. Perpetual inventory system 13. JIT control system

Continued
1. Determination of stock levels To prevent frequent stock-outs involving heavy ordering cost and unnecessary tie-up of capital, an efficient inventory management requires to maintain certain optimum level of inventory. Various stock levels are : a) Minimum level- Following factors are taken into account while fixing minimum stock level: i. Lead time ii. Rate of consumption iii. Nature of material Minimum stock level= Re-ordering level-( Normal consumption * normal re-order period).

Continued .
b) Re-ordering level The rate of consumption, number of days required to replenish the stocks and maximum quantity of materials required on any day are taken into account while fixing re-ordering level. Re-ordering level = (maximum consumption * maximum reorder period)

Continued ..
c) 1) 2) 3) 4) 5) 6) 7) 8) 9) Maximum level maximum stock level will depend on following factors: Availability of capital for purchase of material Maximum requirement of material at any point of time Availability of space for storing the material Rate of consumption of materials during lead time Cost of maintaining the stores Possibility of fluctuations in prices Nature of material Availability of materials Restrictions imposed by govt.

Maximum stock level = re-ordering level+ re-ordering quantity- (minimum consumption * minimum re-ordering period).

Continued
d) Danger level if danger level arises then immediate steps should be taken to replenish the stocks even if more cost is incurred in arranging the materials. Danger level = (average consumption * maximum re-order period for emergency purchases). e) Average stock level it is calculated as, average stock level = (minimum stock level + of re-order quantity).

Continued
2. Determination of safety stocks To protect against the stock-out arising out of usage fluctuations, firms usually maintain some margin of safety or safety stocks. The basic problem is to determine the level of quantity of safety stocks. Two costs are involved in the determination of this stock i.e. opportunity cost of stock-out and the carrying costs. If a firm maintains a low level of safety frequent stock-out will occur resulting into larger opportunity cost. On the other hand, the larger quantity of safety stocks involve higher carrying costs.

Continued
3. Ordering systems of inventory The basic problem of inventory is to decide the re-order point. There are three prevalent systems of ordering , which are following : a) fixed order quantity system generally known as economic order quantity (EOQ) system b) Fixed period order system or periodic re-ordering system or periodic review system c) Single order and scheduled part delivery system

Continued
4.

Economic Order Quantity (EOQ) Economic order quantity is the size of the lot to be purchased which is economically viable. This is the quantity of materials which can be purchased at minimum cost. In determining economic order quantity it is assumed that cost of managing inventory is made up of solely of two parts i.e., ordering cost and carrying costs. a) Ordering cost - these costs include :  Cost of staff posted for ordering of goods  Expenses incurred on transportation of goods purchased  Inspection cost of incoming materials  Cost of stationary , typing, postage & telephone charges etc.

Continued .
b)      Carrying costs these costs include : Cost of capital invested in inventories Cost of storage Loss of materials due to deterioration and obsolescence Insurance cost Cost of spoilage in handling of materials

Assumptions of EOQ 1) Supply of goods is satisfactory 2) Quantity to be purchased by the concern is certain 3) Prices of goods are stable, it results to stabilize carrying costs

Continued

EOQ can be calculated with the help of following formula : EOQ = (2AS/I) where A= annual consumption, S= cost of placing order, I = inventory carrying costs of one unit.

Continued

5. A-B-C Analysis The materials are divided into a number of categories for adopting a selective approach for material control. In A-B-C analysis, the materials are divided into three categories viz., A,B and C. It is generally seen in manufacturing concern, where a small percentage of items contribute a large percentage of value of consumption and vice-versa.

Continued

6. VED Analysis The VED analysis is used generally for spare parts. The requirements and urgency of spare parts are different from that of materials. In this, spare parts are classified as Vital (V) ,Essential (E) and Desire (D). If the lead time of these spares is less, then stocking of these spares can be avoided.

Continued
7. Inventory Turnover Ratios These ratios are calculated to indicate whether inventories have been used efficiently or not or can say to ensure minimum blocking of funds in inventory. It is expressed as, Inventory Turnover Ratio = cost of goods sold (average inventory at cost) Inventory conversion period = days in a year (Inventory turnover ratio)

Continued

..

8. Aging schedule of inventories classification of inventories according to the period of their holding also helps in identifying slow moving inventories thereby helping in effective control and management of inventories.

Continued
9. Classification and codification of inventories For proper recording and control of inventory, a proper classification of various types of items is essential. The inventories should first be classified and then code numbers should be assigned for their identification. The identification of short names are useful for inventory management not only for large concerns but also for small concerns. Lack of proper classification may also lead to reduction in production.

Continued

..

10. Inventory reports From effective inventory control, the management should be kept informed with the latest stock position of different items. This is usually done by preparing periodical inventory reports. These reports should contain all information necessary for managerial action.

Continued

11. Lead time Lead time is the period that elapses between the recognition of a need and its fulfillment. There is a direct relationship between lead time and inventories. The level of an inventory depends upon the length of its lead time.

Continued
12. Perpetual inventory system
The stock taking may either be done annually or continuously. In this method, record is being maintained on a continuous basis. Procedure of Perpetual Inventory Systemi. The up to date position in stores ledger and bin cards should be made to know the current balance of stores. ii. The stores are selected in rotation for checking the items physically. Some items are taken up every day for verification. The program is planned in such a way that in a year every item is checked 3-4 times.

Continued
iii. The stores which have not been inspected as yet should not be mixed with other stores because no entries are made for such items. iv. There is a surprise checking for every-time. The store keeper is informed of stock taking only on the day of checking. This prompts store-keepers to keep their records up-to date. v. The physical stock available in the store after counting, weighing etc. is recorded on sheets provided for this purpose.

Continued

..

Advantages of perpetual inventory system i. Quick calculation of closing stock ii. Helpful in formulating purchase policies iii. Check on stores personnel iv. Helpful in production planning v. Investments under check vi. Errors and shortages easily detected vii. Increasing efficiency of organization

Continued
13. Just In Time (JIT) inventory control system
Just in time philosophy aims at eliminating waste from every aspect of manufacturing . There are broadly two aspects of JIT i. Just in time production ii. Just in time purchasing Just in time inventory control system involves the purchase of materials in such a way that delivery of purchased material is assured just before their use or demand. The philosophy of JIT control system implies that the firm should maintain a minimum(zero level) of inventory and rely on suppliers to provide materials just in time to meet the requirements.

Continued
Objectives of JIT i. Minimum/zero inventory ii. Elimination of non-value added activities iii. Minimum batch/lot size iv. Zero breakdowns and continuous flow of production v. Ensure timely delivery schedules both inside and outside firm vi. Manufacturing the right product at right time

Continued ..
Features of JIT
i. It emphasizes that firms following traditional inventory control system overestimate ordering cost and underestimate carrying costs associated with holding of inventories. ii. It advocates maintaining good relations with suppliers so as to enable purchases of right quantity of materials at right time. iii. It involves frequent production/order runs because of smaller batch/lot sizes. iv. It requires reduction in set up time as well as processing time. v. The major focus of JIT approach is to purchase or produce in response to need rather than as per the plans and forecasts.

Continued
i.

Advantages of JIT inventory control system

The right quantities of materials are purchased or produced at the right time. ii. Investment in inventory is reduced. iii. Wastes are eliminated. iv. Carrying or holding cost of inventory is also reduced because of reduced inventory v. Reduction in costs of quality such as inspection, cost of delayed delivery, early delivery, processing documents etc. resulting into overall reduction in cost.

Reference : Financial Management By: I.M.Pandey Management Accounting By: Shashi K. Gupta, R.K.Sharma