INTRODUCTION

NEED FOR INVENTORY

Inventory is very vital to every Company is that without inventory no company would
survive. Inventory is meant for ‘protection’ and for‘economy’ in cost. Keeping inventory of
sufficient stocks will help to face lead times component, demand and supply fluctuations and
any unforeseen circumstances in the procurement of materials. Though to have inventory is
must, inventory is such a thing that will pile up and creep into the area of profits to turn them
as losses and can put the company in red. It is therefore, necessary to have control over
inventory to save the company from piling up of inventories and to avoid losses. Better said
than done is the world that suits the inventory control.

DEFINITIONS:

Inventory control can be defined as “Determining and maintaining optimum investment

in inventory given the significance of benefits and cost association with holding inventory
”.
Inventory Control relates to “ a set of policies and procedure by which an industries

determines which materials it will hold in stock and the quality of each that it will

carry in stock “. Therefore inventory control is otherwise known as STOCK CONTROL.

OBJECTIVES OF INVENTORY CONTROL

Inventories constitutes second largest category of all manufacturing operation exceeded

only by plant and equipment and followed by receivables. The objectives of inventory

control are:

a) To keep required stock of materials so that production and maintenance actitives do not

suffer.

b) Minimum blockage of funds in inventory. Optimization can be achieved and efforts need to

be made to improve input output ratio of materials by scientific methods of determining.

2.1.4 TYPES OF INVENTORIES

Depending upon the types of business, generally the Inventories Varies. But in a

manufacturing industry the inventory can be classified into four broad categories:

1. Production Inventory: It contains materials purchased from market like raw

materials; Ready made parts, component, spares and also special parts and

components manufactured in their own industry and kept in stock for self

consumption for use in manufacture.

2. Maintenance, Repair & Operating Inventory: Contains materials purchased

from vendors to maintain the production process and these maintenance,

repair and operating inventory do not form part of the finished products.

3. Work in progress Inventory: This contains manufactured good kept in

stores, warehouse or retail outlets, Stock Yard for sales to consumers.

To put this into a diagram, the Constituent of Inventory is as follows:

RAW WORK IN FINISHED

MATERIALS PROGRESS GOODS

2.1.5 FACTORS INFLUENCING INVENTORY

“How much to buy at onetime” and “When to buy this quality “. These are two

fundamental things on which inventory control depends. Many factors govern these

fundamental things. The prime factors that govern these two fundamental things are:

1. Requirements

2. Quality in stock or on order

3. Lead time

4. Obsolescence.
2.1.6 CONTROL, MAINTENANCE AND MANAGEMENT

The essence of inventory control, broadly speaking consists of revolving the following

three factors:

1. Necessity for stocking an items

2. Time for reordering the items

3. Quality per order to be order.

Continuous and periodical review is required in the evaluation of inventory management

and treats it as a continuous process as costs, source of supply, availability of materials;

consumption will vary in the course of time making the previous assessment invalid.

This process also helps in standardization of materials for procurement by using near

equivalents and eliminating material, which are discontinued as a regulation, which will

remove obsolescence.

2.2.INVENTORY CONTROL TECHNIQUES

Inventory is being maintained as a cushion in supply of materials for continuous

production without causing stock out situation. This cushion should not be suicidal to

any organization. The following scientific techniques and methods are being used in

control of inventory.

1. Inventory Management Techniques

2. Standardization

3. Selective Inventory Control

4. Just In Time
 5. Perpetual inventory system

6. Inventory turnover ratio

2.1.7.1 INVENTORY MANAGEMENT TECHNIQUES

1. Economic Order Quantity

If the firm is buying raw materials, it has to decide lots in which it has to be

purchased on replenishment. If the firm is planning a production run, the issue is

how much production to schedule. These problems are called order quantity problems,

and the task of the firm is to determine the optimum or economic order quantity.

(a) Ordering cost:

The term ordering cost is used in case of raw materials and includes

the entire costs of acquiring raw materials.

(b) Carrying cost:

Cost incurred for maintaining a given level of inventory is called

carrying cost.

Economic Order Quantity is given by the formula:

𝟐𝑨𝑶
EOQ = √ 𝑪

And the total cost of inventory is given by the formula:

Total cost of inventory = (A×P) + (A×O) + (EOQ×C)

EOQ 2

Where A = Annual consumption (in units)

 O = Ordering cost per order (in Rs)

C = Carrying cost per unit (in Rs)

P = Price per unit (in Rs)

2. Reorder Point

The reorder point is that inventory level at which an order should be placed to

replenish the inventory. To determine reorder point:

(a) Lead time is the time normally taken in replenishing inventory after

the order has been placed.

(b) Average usage

(c) Economic order quantity

3. Safety stock

The demand for material may fluctuate from day to day. The actual delivery time

may be different from the normal lead time. If the actual usage increases or the

delivery of inventory is delayed the firm can face problem of stock out, which can

be costly. So, in order to guard against the stock out the firm may maintain a safety

stock.

2.1.7.2 STANDARDIZATION

Standardization is very essential to control the inventory, as by standardization

reduction in variety of material is possible. And because of the reduction in variety the

advantages are low order cost, low inventory, less storage stocks, conservation of

materials, variety reduction, less paper work, easy follow up with suppliers, less number

of orders.
 The importance of this field has been recognized since the days of F.W. Taylor,

who first drew attention to this fundamental need in any organization. Just as work

study is necessary preliminary to work simplification, and a basic technique for

production control, quality control, materials handling, estimated cost control, etc.,

“Standardization “ are preliminary necessity to design a basic technique on build control

and standardization procedure.

2.1.7.3 SELECTIVE INVENTORY CONTROL MANAGEMENT

Any manufacturing organization consumes few thousand items of stores. A high

degree of control on inventories of each item would, therefore neither be practical

considering the work involved, nor worthwhile since all items are not of equal

importance. Hence, it is desirable to classify or group items to control, commensurate

with importance. This is the principle of selective control as applied to inventories and

the technique of grouping is termed as selective technique.

Selective inventory means variation in the methods of inventory control from

items to item and this differentiation should be on selective basis by classification. A

company has to stock thousands of items of raw materials, standard parts, stores and

spares, sub contract items, tools, stationery etc. To have better control over the inventory/

stock on hand, selective inventory control technique should be used in isolation/ or in

conjunction.

Thus selective control means selecting the area of control so that required objective is

achieved as early as possible without any lost of time due to taking care of full area

–
  Minimum lost of energy and efforts.

 At minimum cost without loss of time.

There are following selective control techniques:

* ABC Analysis

* FSN Analysis

* XYZ Analysis

* VED Analysis

* HML Analysis

a) ABC ANALYSIS

ABC analysis is a selective control technique which is required to be applied when we

want to control value of consumption of the item in rupees obviously when we want

to control value of the consumption of the material we must select those materials

where consumption is very high.

In any company manufacturing, there are number of items which are consumed or

traded it may run into thousands. It is found after number of studies for different

companies that –

Value of consumption of No. Of items Grade

items (value in Rs).

70% of consumption 10% of no. Of items A

20% of consumption 15% of no. Of items B

10% of consumption 75% of no. Of items C

A items these are those items which are found hardly 5% 10% but their consumption

may amount 70% 75% of the total money spend on materials.

B items these are those items which are generally 10% 15% of he total items and

their consumption amounts to 10% 15% of the money spend on the materials.

C items these are large number of items which are cheap and inexpensive and hence

insignificant. They are large in number s running into hardly 5% 10% of the total

money spends on materials.

'A' Class Items ‘B’ Class Items 'C Class Items

(High consumption value) (Moderate consumption (Low consumption value)
value)

1. Very strict control 1. Moderate control 1. Loose control.

2. No safety stocks or very 2. Low safety stocks. 2. High safety stocks

Low safety stocks.

3. Maximum follow up 3. Periodic follow up 3. Follow up and

and expediting in exceptional
Expediting cases

4. Rigorous value analysis 4. Moderate value analysis 4. Minimum value analysis

5. Must be handled by senior 5. Can be handled by 5. Can be fully delegated

officers management

b) FSN ANALYSIS

This type of analysis is more concerned from the point of view of movement of the

item or issue of the item or issue of the item under this type of analysis.
 ‘F’ items are those items, which are fast moving i.e. in a given period of

time, say a month or a year they have been issued up till number of items. Although

fast moving does not necessarily mean that these items are consumed in large quantities.

‘S’ items are those items which are slow moving in the sense that in the

given period of time they have been issued in a very limited number of time

‘N’ non moving items are those, which are not at all issued for a considerable

period of time.

Thus, stores department whose concerned with the moving of items would like to

know and classify that the items are storing in the categories FSN. So that they can

manage operate and plan stores activity accordingly.

For example, for efficient operations it would be necessary that fast moving items as

far as possible should be stored as near as possible to the point of issue. So that it

can be issued with minimum of handling. Also such items must be stored at the floor

level avoiding storing them at high heights.

Similarly, if the items are slow moving or issued once in a while in a given

period of time they can be stored in the interior of the stores and even at the higher

heights because handling of these items becomes very rare.

Further it is necessary for stores in charge to know about non moving items for

various reasons:

1. They mean unnecessary blockage of money and affecting the rate of returns of

the company.
 2. Further they also occupy valuable space in the stores without any usefulness and

therefore it becomes necessary to identify these items and go into details and

find reasons for their non moving and if justified to recommend to top

management for their speedy disposal so that company operations are performed

efficiently.

Also inventory control to some extent can also be exercised on the basis of FSN

analysis.

For example, fast moving items can be controlled more severely, particularly when their

value is also high. Similarly, slow moving items may not be controlled and reviewed

very frequently since their consumption may not be frequent and their value may not

be high.

c) XYZ Analysis

This type of analysis is carried out from the point of view of value of balance stocks

lying in the stores from time to time and classifies all the items as given below.

‘X ‘items are those items whose value of balance stocks lying in the stock are very

high.

‘Y’ items are those items whose value of balance stock is moderate.

‘Z’ items are those items whose value of balance stock lying in the stocks is very

low.

After knowing this type of classifications and their items can be taken to control the

situation as shown below:

1] From security point of view high value items must be stored and kept under lock

and key or if not possible they should be kept in such a way that they are always

under supervision. Similarly arrangement can be made for y and z items accordingly.

2] From inventory control point of view we must know why there is high inventory

for ‘X’ items. We should review inventory control procedure for each and every high

item because stock should be maintained to take care of lead time consumption and

also to provide safety stocks. For high value items lying in stores we should review

the reasons for long lead time as well as demand variations and see whether lead time

consumption and safety stocks can be reduced. Thus proper inventory control procedures

can be developed on the basis of XYZ analysis.

Thus proper selective control methods should be selected to control the materials and

prevent from facing loss, taking advantage and knowing what exactly is to be done.

d) VED ANALYSIS

VED analysis is carried out to control situation, which are critical. When applied to

material in VED analysis we try to identify material according to their criticality to the

production, which means the material, without which the production will come to stop

and so on from this point of view material classified into three categories.

V vital,

E essential,

D desirable.

Vital categories of the items are those items for the want of which the production will

come to stop. For e.g. Power in the factory.

 Essential group of items are those items because of non availability of which the

stock out cost is very high.

Desirable group of items are those items because of non availability of which there is

no immediate loss of production and stock cost is very less and it may cause minor

disruption in the production for a short time.

e) HML ANALYSIS

This analysis, analysis the material according to their prices and then classifies them as

H items or M items or L items.

H stands for high price,

L stands for low price and

M stands for medium price.

Since price is more concerned of purchase department mostly purchase department

people analyses the material according to HML analysis.

HML analysis must be carried out from any one of the following objectives or some

of the objective as the case may be.

 When it is desire that purchasing responsibility should be delegated to right level

of people.

 When it is desired to evolve purchasing policies then also HML analysis is

carried out i.e. whether to purchase in exact quantities as required or to purchase

in EOQ or purchase only when absolutely necessary.

  When the objective is to keep control over consumption at the department level

then authorization to draw materials from the stores will be given to high level

H item, low level for L items and medium level for M item.

 When it is desired to decide frequency of stock taking then very frequently H

category, very rarely L category and averagely M category.

 When it is desired to arrange security arrangements for the items, then H item

under lock and key, L items keep open on the shop floor and under supervision

for M items

2.1.7.3 JUST IN TIME INVENTORY SYSTEM

Keeping in view the enormous carrying cost of inventory in the stores and go downs,

manufacturers and merchandisers are asking for more frequent deliveries with shorter

purchase order lead times from their suppliers. Now days organizations are becoming

more and more interested in getting potential gains from making smaller and more

frequent purchase orders. In other words, they are becoming interested in just in time

purchasing system. Just in time purchasing (JIT) purchasing is the purchase of material

or goods in such a way that delivery of purchased items is assured before their use or

demand.

Just in time purchasing recognizes too much carrying costs associated with holding high

inventory levels. Therefore, it advocates developing good relations with suppliers and

making timely purchases from proven suppliers who can make ready delivery of goods

available as and when need arises. EOQ model assumes a constant order quantity

whereas JIT purchasing policy advocates a different quantity for each order if demand
fluctuates. EOQ lays emphasis on ordering and carrying costs but inventory management

extends beyond carrying and ordering costs to include purchase costs quality costs and

stock out. Just in time purchasing takes into consideration all these costs and move—

outside the assumptions of the EOQ model.

Advantages of JIT purchasing

1. Investment in inventory is reduced because more frequent purchase orders of small

quantities are made.

2. Carrying cost is reduced as a result of low investment in inventory.

3. A reduction in the number of suppliers to be dealt with is possible. Only proven

suppliers who can give quick delivery of quality goods are given purchase orders . As

a result of this reduction in negotiation time is possible. The use of long—run contracts

with some suppliers with minimal paper work involved is possible.

4. Quality costs such as inspection cost of incoming materials or goods , scraps and

rework costs are reduced because JIT purchasing assures quick and frequent delivers of

small size orders which results in low level of inventories causing minimum possible

wastage. Therefore, JIT purchasing is frequently applied by organizations dealing in

perishable goods.

2.1.7.4 PERPETUAL INVENTORY SYSTEM

The Chartered Institute of Management Accountants, London, defines the perpetual

inventory as “a system of records maintained by the controlling department, which

reflects the physical movements of stocks and their current balance”. Bind cards and

the stores ledger help the movements of the stock on the receipts and in maintaining

this system as they make a record of to physical movements of the stocks on the

receipts and issues of the materials and also reflect the balance in the stores. Thus, it

is a system of ascertaining balance after every receipt and issue of materials through

stock record to facilitate regular checking and to avoid closing down the firm for

stocktaking. To ensure the accuracy of perpetual inventory records (i.e. Bin card and

stores ledger), physical verification of the stores is made by bin cards or stores ledger

may differ from the actual balance of stock as ascertained by physical verification. It

may be done to the following avoidable and unavoidable causes.