Inventory Management

Topics

 Meaning of inventory management

 Types of inventories
 Need for inventory
 Cost of holding inventories
 Characteristics of inventory situations
 Selective inventory control
 Inventory Control Models
 Control devices
 Inventory management & valuation
 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
(a) what to purchase
(b)how much to purchase
(c)from where to purchase
(d) where to store
 Objects of inventory
Mgmt.
TO ENSURE CONTINUOUS SUPPLY OF RAW MATERIAL,
SPARES AND FINISHED GOODS.
TO AVOID BOTH OVERSTOCKING AND UNDERSTOCKING
OF INVENTRY.
TO MAINTAIN INVESTMENTS IN INVENTRIES AT OPTIMUM
LEVEL.
TO KEEP MATERIAL COSTUNDER CONTROL.
TO ELIMINATE DUPLICATION IN ORDERING OR
REPLENISHING STOCKS.
TO MINIMIZE LOSSES THROUGH WASTAGE AND
DAMAGES .
TO FACILITATES 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.
 COST OF INVENTORIES
 The determination of inventory cost is essentially an
income measurement problem. Relevant inventory costs
which change with the level of inventory are listed below:

a) Ordering cost: Every time an order is placed for stock

replenishment, certain cost are involved. This cost of
ordering includes:
- Paper work costs, typing & dispatching.
- order inspection cost, checking & handling.
b) 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.
c) 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:
-Expenses of placing special orders.
-Expediting income orders.
-Cost of production delays.
 CHARACTERISTICS OF
INVENTORY SITUATIONS
1) Lead time:
Obtaining inventory usually requires a time lag from
the initiation of the process until the inventory
starts to arrive. This lead times may be few min.or
months.
2) Sources & level of risk:
Where there are substantial uncertainties & where
the costs of stockout are important . Strategies for
addressing risk must be formulated.
3) Static versus dynamic problems:
In static inventory problems, the goods
have a one-period life; there can be no
carryover of goods from one period to next.
In dynamic inventory problems, the goods
have value beyond the initial period; they do
not lose their value completely overtime.
 Selective Inventory Control
I. Explosion process:
In many manufacturing organization, production requirements are
based directly on the sales forecast. For each of its products, the
company prepares a bill of material needed for various products.

II. Past-usage methods:

The other method used for determining the production requirements
relies on the past usage, rather than on the sales forecast . If a
certain item was used at the rate of 100 units per month during the
past year or during some other period is likely to be used at the
same rate in future.
III. Value-volume Analysis:
This analysis is used to determine which
inventory accounts should be controlled by
the explosion method & which should be
controlled by past usage method. In value-
volume analysis the no. of each item used in
the past year is multiplied by its unit to find
the annual activity for the item.
IV. A-B-C ANALYSIS:
The materials are divided into three categories viz, A ,B &C
 CATEGORY-A:
 Under this almost 10% of the items contribute to 70% of
value of consumption.
 CATEGORY-B:
 Under this category 20% of the items contribute about 20%
of value of consumption.
 CATEGORY-C:
 Under this category about 70% of items of material contribute
only 10% of value of consumption.
V. HML Classification:
The HML (high, medium, low) classification is similar to ABC
classification, but in this case instead of the assumption
value of the item, the unit value of the item is considered.

VI. XYZ Classification:

The XYZ classification has the value of inventory stored as
the basis of differentiation.
X items are those whose inventory value are high while Z
items are those whose value are low.
VII. VED ANALYSIS:
The VED analysis is used generally for spare parts. The requirements and urgency of spare
parts is different from that of materials. spare parts are classified as vital (V), essential (E)
,desirable (D).

 VITAL SPARE PARTS:

These are must for running the concern smoothly.

 ESSENTIAL SPARE PARTS:

Necessary but stock kept at low figures.

 DESIRABLE SPARE PARTS:

May be avoided at times
VIII. FSN Analysis:
Movement analysis forms the basis for FSN (fast moving,
slow moving, non-moving) classification & the items are
classified according to their assumption pattern.
IX. SDF & GOLF Analysis:
The SDF (scarce, difficult, easy to obtain) classification & the
GOLF (government, ordinary, local, foreign sources) are the
systems where analysis is done on the basis of general
availability & the source of suppliers.
 INVENTORY CONTROL
MODELS
1) EOQ MODELS:
Economic order quantity is the
size of the lot to be purchased
which is economically viable.
EOQ IS MADE UP OF TWO
PARTS
ordering costs: requisitioning, order
placing, transportation, receiving, 2AO
inspecting and storing, administration EOQ =
– carrying costs: warehousing, c
handling, clerical and staff,
insurance, depreciation and
obsolescence
– ordering and carrying costs trade-off:
2. Just-In- Time Inventory Management
System:
A key part of just-in-time techniques is the
replacement of production in large batches with a
continous flow of smaller quantities. It is based on
the idea that all required inventory items should be
supplied to the production process at exactly the
right time & in right quantity.
 CONTROL DEVICES
i) Control Account:
The control is maintained in the general ledger by
accounting. All material purchases are charged against
the account & all issuances are credited to it.
ii) Physical Counting:
Physical counting of stock on hand for tax & cost
accounting functions & as a means of verifying the
balance showed on perpetual inventory records & in the
control account.
iii) Visual Review:
A highly subjective method of determining when to reorder is
a visual reviews of stock in inventory. For ex: in the old time
general store, the owner would inspect his inventory &
determine what should be ordered.
iv) Two-bin system:
The two-bin system divides each item of inventory into two
groups. In first, sufficient supply is kept to meet current
demand, In second, additional items are available to meet
the demand during load time.
v) Minimum- maximum system:
The minimum-maximum system is frequently used in
connection with mannual inventory control systems. The min
quantity is established in the same way as any reorder point.
vi) Periodic order system:
Under this system, the stock levels for all inventory accounts
are reviewed at established intervals, & orders are placed to
bring all accounts up to their max level.
INVENTORY MANAGEMENT &
VALUATION
A) Average cost method:
For determining the valuation of inventories,
consistency from year to year is of prime
importance & for this average cost method is
appropriate. In this method, weighted average
prices are taken with price of each type of material
in stock are taken together.
B) First-in-First-out Method:
Under FIFO method, Items received first are
assumed to be used first & therefore prices charged
are those paid for early purchase. care has to be
taken to ensure that each quantity is issued at the
correct price.
C) Base Stock Method:
Under this method, the base quantity is carried
forward at the cost of the original stock. If a quantity
of goods larger than the base stock is owned at the
end of any period, the excess will be carried at its
identified cost or at the cost determined under FIFO
method.
D) Last-In, First-Out Method:
Under LIFO it is assumed that the stock sold or
consumed in any period are those most recently
acquired or made. The result at the LIFO method is
to charge current revenues with amount
approximating current replacement cost.