Presentation by

INVENTORY MANAGEMEN T AND CONTROL

INVENTORY MANAGEMENT
It is necessary for every management to give proper attention
to inventory management. A proper planning of purchasing, handling, storing and accounting should form a part of inventory management. An efficient system of inventory management will determine (a) what to purchase (b) how much to purchase (c) from where to purchase (d) where to store, etc.

There are conflicting interests of different departmental heads

over the issue of inventory. The finance manger, production manager. The purpose of inventory management is to keep the stocks in such a way that neither there is over-stocking nor under-stocking. The investments in inventory should be kept in reasonable limits.

PURPOSE / BENEFITS OF HOLDING INVENTORIES

Although holding inventories involves blocking of a firms
funds and the cost of storage and handling, every business enterprise has to maintain a certain level of inventories to facilitate uninterrupted production and smooth running of business. There are three main purpose or motives of holding inventories.

i.

The Transaction Motive which facilitates continuous production and timely execution of sales orders. inventories for meeting the unpredictable changes in demand and supplies of materials.

ii. The Precaution Motive which necessitates the holding of iii. The Speculative Motive which induces to keep inventories
for taking advantage of price fluctuations, saving in reordering cost and quantity discount, etc.

OBJECTS OF INVENTORY MANAGEMENT

The main objectives of inventory management are operational
and financial. The operational objective mean that the materials and spares should be available in sufficient quantity so that work is not disrupted for want of inventory. The financial objective means that investments in inventories should not remain idle and minimum working capital should be locked in it.

1. 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.

2. To avoid both over-stocking and under-stocking of inventory. 3. To maintain investments in inventories at the optimum level as
required by the operational and sales activities. reducing cost of production and overall costs.

4. To keep material cost under control so that they contribute in 5. To eliminate duplication in ordering or replenishing stocks. This is
possible with the help of centralising purchases. damages.

6. To minimise losses through deterioration, pilferage, wastages and 7. To ensure perpetual inventory control so that materials shown in
stock ledgers should be actually laying in the stores.

8. To ensure right quality goods at reasonable prices. 9. To facilitate furnishing of date for short-term and long-term
planning and control of inventory.

TOOLS AND TECHNIQUES OF INVENTORY MANAGEMENT AND CONTROL

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
The following are the important tools and technique of inventory management and control. Determination of stock levels. Determination of safety stocks. Selecting a proper system of ordering for inventory. Determination of economic order quantity. A.B.C. Analysis. V.E.D. Analysis. Inventory turnover ratios. Aging schedule of inventories Classification and codification of inventories Preparation of inventory reports.

1.

Determination of stock levels: Carrying of too much and too little of inventories is detrimental to the firm. If the inventory level is too little, the firm will face frequent stockouts involving heavy ordering cost and if the inventory level is too high it will be unnecessary tie-up of capital. Therefore, an affective inventory management requires that a firm should maintain an optimum level of inventory where inventory costs are the minimum and at the same time there is no stock-out which may result in lost of sale or stoppage of production. Various stock levels are discussed as such. Minimum Level: This represents the quality which must be maintained in hand at all times. If stocks are less than the minimum level then the work will stop due to shortage of materials. Following factors are taken into account while fixing minimum stock level:

a.

 Lead Time: The time taken in processing the order and then
executing it is known as lead time. It is essential to maintain some inventory during the period. in the factory.

Rate of Consumption: It is the average consumption of material Nature of Material: If a material is required only against special
orders of the customer than minimum stock will not be required for such materials. Minimum stock level can be calculated with the help of following formula: Minimum stock level = Re-ordering level (Normal consumption) Normal Re-order period)

b.

Re-ordering Level: Re-ordering level or ordering level is fixed between minimum level and maximum level. Re-ordering level is fixed with the following formula: Re-ordering Level = Maximum Consumption Maximum Re-order period.

c. Maximum Level: It is the quantity of material

beyond which a firm should not exceed its stocks. If the quantity exceeds maximum level limit then it will be overstocking. A firm should avoid overstocking because it will result in high material costs. Overstocking will mean blocking of more working capital, more space for storing the materials, more wastage of materials and more chances of losses from obsolescene. Maximum Stock Level = Re-ordering Level + Reordering Quantity (Minimum Consumption Minimum Re-ordering period).

d.

Danger Level: It is the level beyond which materials should not fall in any case. If danger level arises then immediate steps should be taken to replenish the stocks even if more cost is incurred in arranging the materials. If materials are not arranged immediately there is a possibility of stoppage of work. Danger level is determined with the following formula: Danger Level = Average Consumption Maximum reorder period for emergency purchases.

e.

Average Stocks Level: The average stock level is calculated as such: Average Stock Level = Minimum Stock Level + of reorder quantity.

2. Determination of Safety Stocks

Safety stock is a buffer to meet some unanticipated increase in
usage. The usage of inventory cannot be perfectly forecasted. It fluctuates over a period of time. The demand for materials may fluctuate and delivery of inventory may also be delayed and in such a situation the firm can face a problem of stock-out. The stock-out can prove costly by affecting the smooth working of the concern. In order 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-outs and the carrying costs. The stock outs of raw materials cause production distruption resulting into higher cost of production. Similarly, the stock-out of finished goods result into the failure of the firm in competition as the firm cannot provide customer service. If a firm maintain low level of safety frequent stock-outs will occur resulting into the large opportunity costs. On the other hand, the larger quantity of safety stocks involve higher carrying costs.

3. Ordering systems of Inventory

The basic problem of inventory is to decide the re-order point. This point indicates when an order should be placed. The re-order point is determined with the help of these things: (a) average consumption rate, (b) duration of lead time, (c) economic order quantity, when the inventory is depleted to lead time consumption, the order should be placed. There are three prevalent system of ordering and a concern can choose any one of these: Fixed order quantity system generally known as economic order quantity (EOQ) system; Fixed period order system or periodic re-ordering system or periodic review system; Single order and schedule part delivery system.

a. b. c.

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 costs. Generally, economic order quantity is the point at which inventory carrying costs are equal to order costs. In determining economic order quantity it is assumed that cost of managing inventory is made up solely of two parts i.e., ordering costs and carrying costs. Ordering costs: These are the costs which are associated with the purchasing or ordering of materials. These costs include: Costs of staff posted for ordering of goods. A purchase order is processed and then placed with suppliers. The labour spent on this process is included in ordering costs. Expenses incurred on transportation of goods purchased. Inspection costs of incoming materials. Cost of stationery, typing, postage, telephone charges, etc.

1. 2. 3. 4.

 These costs are also known as buying costs and will arise
only when some purchases are made. When materials are manufactured in the concern then these costs will be known as set-up costs. These costs will include costs of setting up machinery for manufacturing materials, time taken up in setting, cost of tools, etc.

The ordering costs are totalled up for the year and then
divided by the number of orders placed each year.

B. Carrying Costs: These are the costs of holding the

inventories. These costs will not be incurred if inventories are not carried. These costs include:

1. The cost of capital invested in inventories. An interest 2. 3.

4. 5.

will be paid on the amount of capital locked-up in inventories. Cost of storage which could have been used for other purpose. The lost of materials due to deterioration and obsolescence. The materials may deteriorate with passage of time. The loss of absolescence arises when the materials in stock are not usable because of change in process or product. Insurance cost. Cost of spoilage in handling of materials.

 The longer the materials kept in stocks, the costlier it

becomes by 20 percent every year. The ordering and carrying costs have a reverse relationship. The ordering cost goes up with the increase in number of orders placed. On with the increase in number of units, purchased and stored. It can be shown in the diagram shown.

The ordering and carrying costs of materials being

high, an effort should be made to minimise these costs. The quantity to be ordered should be large so that economy may be made in transport costs and discounts may also be earned. On the other hand, storing facilities, capital to be locked up, insurance costs should also be taken into account.

 1. 2. 3. 4.

Assumptions of EOQ: While calculating EOQ the following assumptions are made. The supply of goods is satisfactory. The goods can be purchased whenever these are needed. The quantity to be purchased by the concern is certain. The prices of goods are stable. It results in stabilising carrying costs. When above-mentioned conditions are satisfied, economic order quantity can be calculated with the help of the following formula:

Where

2 S A EOQ = I A = Annual consumption in rupees.

S = Cost of placing an order. I = Inventory carrying costs of one unit.

 EOQ and Quality Discount: Customer is offered

some discount for bulk purchase or if the size of a single order is large. Thus, the price per unit of an item may decrease for buying larger quantities. The quantity discount affect inventory cost in three ways:

i.

As the price per unit is reduced, the total price for the lot is reduced. reduced and as a result the total ordering cost is reduced.

ii. The lot size is increased, the number of offers is iii. The average inventory holding increase and as a
result the storage cost will increase.

5. A-B.C Analysis
The materials are divided into a number of categories for
adopting a selective approach for material control. Under A-B-C analysis, the materials are divided into three categories viz, A, B and C. Past experience has shown that almost 10 percent of the items contribute to 70 percent of value of consumption and this category is called A Category. About 20 percent of the items contribute about 20 percent of value of consumption and this is known as category B materials. Category C covers about 70 percent of items of materials which contribute only 10 percent of value of consumption. There may be some variation in different organisations and an adjustment can be made in these percentages.

The information is following diagram: Class A B C

shown

in

the

No. of Items % 10 20 70

Value of Items % 70 20 10

A-B-C analysis helps to concentrate more efforts on

category A since greatest monetary advantage will come by controlling these items. An intention should be paid in estimating requirements, purchasing, maintaining safety stocks and properly storing of A category materials. These items are kept under a constant review so that a substantial material cost may be controlled. The control C items may be relaxed and these stocks may be purchased for the year. A little more attention should be given towards B category items and their purchase should be undertaken at quarterly or half-yearly intervals.

6. VED Analysis
The VED analysis is used generally for spare parts.
Spare parts are classified as Vital (V), Essential (E) and Desirable (D). The vital spares are a must for running the concern smoothly and these must be stored adequately. The non-availability of vital spare will cause havoc in the concern. The E type of spares are also necessary but their stocks may be kept at low figures. The stocking of D type of spares may be avoided at times. If the lead time of these spares is less, then stocking of these spares can be avoided. The classification of spares under three categories is an important decision. The classification of spares should be left to the technical staff because they know the need urgency and use of these spares.