Inventory Management

The term inventory includes materials. Raw, in process, finished, packaging, spares and others stocked in order to meet an unexpected demand or distribution in future Every enterprise needs inventory for smooth running of its activities. The investment in inventory constitute the most significant part of current assets & working capital in most of the undertakings. The purpose of inventory management is to ensure availability of materials in sufficient quantity as & when required & also to minimize investment in inventories.

Meaning Of Inventory Management

Inventory management is concerned with keeping enough product on hand to avoid running out while at the same time maintaining a small enough inventory balance to allow for a reasonable return on investment. Excessive level of inventory, results in large inventory carrying cost.

An efficient system of inventory management will determine what to purchase How much to purchase From where to purchase Where to store

Objectives of Inventory Management

To ensure continuous supply of raw materials, spares & finished goods. To avoid both overstocking & understocking of inventory. To maintain investment in inventories at optimum level. To keep material cost under control. To eliminate duplication in ordering or replenishing stocks. To minimize losses through wastage and damages . To facilitate finishing of data.

Types Of Inventories
(a) RAW MATERIAL: A inventory of raw materials allows separation of production scheduling from arrival of basic inputs to the production process. (b) WORK-IN-PROGRESS: An inventory of partially completed units allows the separation of different phases of the production process. (c) FINISHED GOODS: An inventory of finished goods allows separation of production from selling. (d) CASH & MARKETABLE SECURITIES: Cash & marketable securities can be thought of as an inventory of liquidity that allows separation of collection from disbursement.

Need for Inventories

Transaction motive: The transaction motive for holding inventory is to satisfy the expected level of activities of the firm. Precautionary motive: The precautionary motive is to provide a cushion in case the actual level of activity is different than anticipated. Speculative motive: The speculative motive is to purchase larger quantity of materials than normal in anticipation of making abnormal profits.

Determinations of Inventory Control Levels Re-order level: It is the level of stock availability when a new
order should be raised. The stores department will initiate the purchase of material when the stock of material reaches at this point. This level is fixed between the minimum & maximum stock levels & the following formula is used for this purpose. Max usage X max lead time.

Minimum stock level: It is the lower limit below which the

stock of any stock items should not normally be allowed to fall. This level is also called as safety stock or buffer stock level. The main objective of establishing this level is to protect against stockout of a particular stock item. Lead time are given prime consideration. Reorder level (avg or normal usage X avg lead time).

Contd..
Maximum stock level: It represents the upper limit
beyond which the quantity of any item is not normally allowed to rise to ensure that unnecessary working capital is not blocked in stock items. Reorder level + EOQ (min usage X min lead time).

Danger level: It is fixed below the minimum stock level &

if stock reaches below this level, urgent action for replenishment of stock should be taken to prevent stock out position. Avg consumption X lead time for emergency purchase.

Economic Order Quantity (EOQ)

The prime objective of inventory management is to find out & maintain optimum level of investment in inventory to minimise the total costs associated with it. EOQ or Economic Order Quantity 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 min for that particular stock item. It is an optimum size of either a normal outside purchase order or an internal production order that minimises total annual holding costs of inventory. 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 EOQ is an optimum quantity of materials to be occurred after consideration of the following three category of costs:

Ordering cost: Every time an order is placed for stock replenishment, certain cost are involved. This cost of ordering includes: - preparation of purchase order. - costs of receiving goods. - documentation processing costs. - transport costs. Carrying costs or cost of holding inventories: Carrying costs constitute all the cost of holding items in inventory for a given period of time. This cost involves: Capital Cost -Storage & handling costs. -obsolescence & deterioration costs. -Insurance. -Taxes. -The cost of funds invested in inventory.

Stock out costs:

Stock out costs are incurred whenever a business is unable to fill orders because the demand for an item is greater than the amount currently available in inventory. This cost involves: -loss of future sales because customer go elsewhere. - loss of customer Goodwill. - labour Frustration. - cost of production stoppages caused by stock-outs. Formula used:

EOQ=

2AB CS

Where, A= Annual consumption B= Cost of placing an order. C= Cost per unit. S= storage & other inventory carrying cost.

EOQ Cost Model

Annual cost Slope = 0 Minimum total cost CcQ Carrying Cost = 2

Total Cost

CoD Ordering Cost = Q Optimal order EOQ Order Quantity, Q

Assumptions of EOQ
To be able to calculate a basic EOQ certain assumptions are necessary. There is known, constant stockholding cost. There is known, constant ordering cost. Rates of demand are known & constant. There is known, constant price per unit I,e there are no price discounts. Replenishment is made instantaneously, I,e the batch is delivered at once.

Monitoring & control of inventories

Inventory Control is the process by which inventory is measured and regulated according to predetermined norms such as economic lot size for order or production, safety stock, minimum level, maximum level, order level etc.

Inventory control pertains primarily to the administration of established policies, systems & procedures in order to reduce the inventory cost.

Objectives of Inventory Control

To meet unforeseen future demand due to variation in forecast figures and actual figures. To average out demand fluctuations due to seasonal or cyclic variations. To meet the customer requirement timely, effectively, efficiently, smoothly and satisfactorily. To smoothen the production process. To facilitate intermittent production of several products on the same facility. To gain economy of production or purchase in lots.

Contd..
To reduce loss due to changes in prices of inventory items. To meet the time lag for transportation of goods. To meet the technological constraints of production/process. To balance various costs of inventory such as order cost or set up cost and inventory carrying cost. To balance the stock out cost/opportunity cost due to loss of sales against the costs of inventory. To minimize losses due to deterioration, obsolescence, damage, pilferage etc. To stabilize employment and improve labour relations by inventory of human resources and machine efforts.

Benefits of Inventory Control

Ensures adequate supply of materials. Minimizes inventory costs. Facilitates purchasing economies. Eliminates duplication in ordering. Better utilization of available stocks. Provides a check against the loss of materials. Facilitates cost accounting activities. Enables management in cost comparison. Locates & disposes inactive & obsolete store items. Consistent & reliable basis for financial statements.

ABC Analysis
This technique divides inventory into three categories A, B & C based on their annual consumption value. It is also known as Selective Inventory Control Method (SIM) This method is a means of categorizing inventory items according to the potential amount to be controlled. ABC analysis has universal application for fields requiring selective control.

Procedure for ABC Analysis

Make the list of all items of inventory. Determine the annual volume of usage & money value of each item. Multiply each items annual volume by its rupee value. Compute each items percentage of the total inventory in terms of annual usage in rupees. Select the top 10% of all items which have the highest rupee percentages & classify them as A items. Select the next 20% of all items with the next highest rupee percentages & designate them B items. The next 70% of all items with the lowest rupee percentages are C items.

Items A
1. Very strict control 2. No safety stocks (or very low) 3. Frequent ordering or weekly deliveries 4. Weekly control statements

Items B
1. Moderate control 2. Low safety stocks

Item C

1. Loose control 2. High safety stocks 3. Bulk ordering, 3. Ordering once in 3 months once in 6 months 4. Monthly control statements 4. Quarterly reports 5. Follow-up in 5. Maximum follow-up and expediting 5. Periodic follow-up exceptional cases 6. Minimum value 6. Rigorous value analysis 6. Moderate value analysis analysis. 7. As many sources as possible for 7. Two sources for each item 7. Two or more reliable sources each item 8. Accurate forecasts in materials 8. Estimates based on past planning data 8. Rough estimates 9. Minimisation of waste, obsolete, and surplus (review every 15 days) 9. Quarterly review 9. Annual review 10. Individual postings 11. Central purchasing and storage 12. Maximum efforts to reduce lead time 13. To be handled by senior officers 10.Small group postings 11.Combination purchases 12.Moderate efforts 13.To be handled by middle management 10. Group postings 11. Decentralized purchasing. 12. Minimum efforts 13. Can be fully delegated.

Advantages of ABC Analysis

Helps to exercise selective control Gives rewarding results quickly Helps to point out obsolete stocks easily. In case of A items careful attention can be paid at every step such as estimate of requirements, purchase, safety stock, receipts, inspections, issues, etc. & close control is maintained. In case of C items, recording & follow up, etc. may be dispensed with or combined. Helps better planning of inventory control Provides sound basis for allocation of funds & human resources.

Disadvantages of ABC Analysis

Proper standardization & codification of inventory items needed. Considers only money value of items & neglects the importance of items for the production process or assembly or functioning. Periodic review becomes difficult if only ABC analysis is recalled. When other important factors make it obligatory to concentrate on C items more, the purpose of ABC analysis is defeated