Chapter-05:

Inventory Management and Control

1. Definition of Inventory
Simply, an inventory is an idle resource that possesses economic value. Inventories are stock
of the product a company is manufacturing for sale and components that make up the
product. The various forms in hich inventories e!ist in a manufacturing company are:
i. Raw Materials
"a materials are those #asic inputs that are converted into finished product
through the manufacturing process. "a material inventories are those units
hich have #een purchased and stored for future productions.
ii. Work-in-Process
$ork-in-process inventories are semi manufactured products. They represent
products that need more ork #efore they #ecome finished products for sale.
iii. Finished goods
%inished goods inventories are those completely manufactured products hich
are ready for sale.
%irms also maintain a fourth kind of inventory, supplies or stores and spares.
. !"#ectives or $eeds to %old Inventories
The manufacturing companies hold inventories in the form of ra materials, $ork-in-
process and finished goods. There are three motives for holding inventories.
&. Transaction 'otive: To facilitate smooth production and sales operation.
(. )recautionary 'otive: To guard against the risk of unpredicta#le changes in usage
rate and delivery time.
*. Speculative 'otive: To take advantage of price fluctuations.
+. !"#ective of Inventory Management
Inventory management is important #ecause inventories constitute a#out
,0- of current assets of pu#lic limited companies. The o#.ective of inventory
management should:
&. to ensure a continuous supply of ra materials to facilitate uninterrupted
&
production,
(. maintain sufficient stock of ra materials in periods of short supply and
anticipate price changes
*. maintain sufficient finished goods inventory for smooth sales operation,
and efficient customer service,
+. minimi/e the carrying cost and time, and
5. control investment in inventories and keep it at an optimum level.
5. Dangero&s 'it&ations of Inventory Management
The e!cessive and inade0uate inventories are to danger points ithin hich the firm
should operate. The o#.ective of inventory management should #e to determine and maintain
optimum level of inventory investment. The optimum level of inventory ill lie #eteen to
danger points. The e!cessive level of inventories consumes funds of the firm, and thus it
involves an opportunity costs. The carrying costs, such as storage e!penses, etc., also increase
in proportion of volume of inventory. This may create physical deterioration of inventories
hile in storage. The inventories once purchased and stored normally are difficult to dispose
off su#se0uently at the same value. In other ords, the value of inventory reduces ith the
increasing holding period. The inade0uate investment in inventories involves the folloing
conse0uences.
i. "esults in fre0uent production interruptions.
ii. It may not #e possi#le for the company to serve the customers properly and they may
shift to competitors.
So, the aim of inventory management is to maintain sufficient inventory for the smooth
production and sales operations.
(. )conomic !rder *&antity +)!*,
The 123 refers to that order 0uantity, ithin the range of possi#le order 0uantities,
hich minimi/es total cost per annum 4and the average cost per unit5 for the items purchased.
This total cost consists of to parts:
2rdering Cost
Carrying Cost
)!* -
C
AO (
$here, 6 7 6nnual usages in units8
2 7 2rdering Cost for placing an order8
C 7 Carrying cost 4including interest5 of one unit for one year
4usually e!pressed as a percentage of the cost per unit5
(
.. Inventory Control
9eeping inventory at desired level is called inventory control. Inventory control is to
determine the optimum level of inventory hich is essential to carry out the various
operations of the organi/ation effectively and efficiently. It determines the level of
composition of inventories hich help the concern to achieve its desired goal. Some
important terms of inventory controls are as follos:
a. Minim&m level of 'tock: It is the level at hich the stock must not go any
time.
#. 'inimum :evel 7 "eorder level ; 4<ormal usages = <ormal i.e.8 average re-
order period5
c. Ma/im&m 0evel of 'tock: 'a!imum level is the level a#ove hich the stock
must not go any time.
d. 'a!imum :evel 7 "e-order level > "e-order 0uantity ; 4'inimum usage =
'inimum "e-order period5
e. Re-ordering 0evel: It is the level hich #eing reached #y the stock, the
purchase re0uisition is re0uired to #e sent to the #uying department.
f. "e-ordering :evel 7 'a!imum re-order period = 'a!imum usage
g. Danger 0evel: ?anger level hich #eing reached #y the stock, very urgent
measure for purchase is a need.
h. 1verage 'tock 0evel 7 @ 4'a!imum :evel > 'inimum :evel5
i. 0ead 2ime3 :ead time is the time normally taken in replenishing inventory
after the order has #een placed. In the case of certainty, the usage and lead time
do not fluctuate. So reorder point is simply that level hich ill #e
maintained for consumption during lead time.
"eorder point 7 :ead time ! 6verage usage
4. 2echni5&es if Inventory 1nalysis
?ifferent types of analysis help in #ringing a practical solution to the control of inventory.
Some of the Techni0ues are:
i. 6AC 46lays Aetter Control5 6nalysis
ii. B1? 4Bital, 1ssential, ?esira#le5 6nalysis
iii. CIT 4.ust-in- Time5 'anagement etc.
6617C +1lways 7etter Control, 1nalysis
6 firm, hich carries a num#er of items in inventory hich differ in value, can follo a
selective control system. The firm should, therefore, classify inventories to identify hich
items should receive the most efforts in controlling. 6 selective control system, such as the 6-
A-C analysis, 4knon as 6lays Aetter Control5, classifies inventories into three categories
according to the consumption value of items: 6 Category consists of highest value items, C
category consists of loest value items8 and A category consists of high value items. Tight
control may #e applied on 6 category of items, and relatively loose control for C category
of items. The folloing steps are involved in implementing the 6AC analysis.
*
&. Classify the items of inventories, determining the e!pected use in units and
the price per unit for each item.
(. ?etermine the total value of consumption.
*. "ank the items in accordance ith total consumption value in ascending order.
+. Compute the ratios or percentages of num#er of items of each item to total units of
all items, and the ratio of total value of each item to total value of all items.
5. Com#ine items on the #asis of their value to form three categoriesD6, A and C.
Pro"lem $o. 13
The folloing information is availa#le in respect of ra material:
6nnual re0uirement *0,000 units
Cost per unit Tk. &5
2rdering Cost Tk. (00
Carrying cost (0- of average inventory
Instr&ctions3
a5 1conomic 2rder 3uantity
#5 :oss or gain if the annual re0uirement is produced #y a single order instead of
on the #asis of economic order 0uantity. (- discount is availa#le if #ought at
time.
Pro"lem $o. 3
6 holesalere supplies *0 stuffed dolls each eek day to various shops. ?olls are purchased
from the manufacturer in lots of &(0 each of Tk. &,(00 per lot. 1very order incurs a handling
charge of Tk. ,0 plus a freight charge of Tk. (50 per order. 'ultiple and fractional lots also
can #e ordered all orders are filled the ne!t day. The incremental cost is Tk. 0.,0 per year to
store a doll in inventory. The holesaler finances inventory investment #y paying its holding
company (- monthly for #orroed funds.
Instr&ctions3
a5 Eo many dolls should #e ordered at a time to minimi/e the total annual
inventory costF 6ssume that there are (50 eek days in a year.
#5 Eo fre0uently should the orderF
Pro"lem $o. 83
1!el :td. has received an offer of 0uantity discounts on its order of materials as under:
Price 9er 2one +2k., 2ones +$os.,
&(00 :ess than 500
&&G0 500 and less than &,000
&&,0 &,000 and less than (,000
&&+0 (,000 and less than *,000
&&(0 *,000 and a#ove
+
The annual re0uirement for the material is 5,000 tons. The ordering cost per order is Tk.
&,(00 and the stock holding cost is estimated at (0- of material cost per annum.
Instr&ctions3
a5 Hou are re0uired to compute the most economical purchase
level.
#5 $hat ill #e your anser to the a#ove 0uestion if there are no
discounts offered and the price per tonne is Tk. &,500F
Pro"lem $o. :3
%rom the folloing information of 6<I manufacturing concern calculate:
a5 1conomic 2rder 3uantity
#5 "e-ordering :evel8
c5 'a!imum :evel8
d5 'inimum :evel
e5 6verage Stock :evel of a ra material.
Total re0uirements +0,000 units J Tk. * per unit8 Cost per order Tk. *0 and carrying
cost (0- of average inventory.
'a!imum Consumption per eek &,000 units
'inimum Consumption per eek +00 units
<ormal consumption per eek 500 units
?elivery time (-+ eeks.
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