INVENTORY MANAGEMENT

Inventories According to IASC, inventories are “Tangible property

held for sale in the ordinary course of business in the process of production for such sale or to be consumed in the process of production of goods or services

for sale. ” It constitute the largest components of current assets in

many organizations. Inventory turnover ratio is obtained by annual demand

dividing by average inventory & it shows efficiency of the firm having higher turnover ratio.

Includes the following categories of items- Forms of Inventories Production inventories (Raw materials, parts,

components which enter the firm’s product in the production process)

Work in progress inventories (Semi finished products found at various stages in the production operation )

M.R.O. inventories / Spare part inventories (Maintenance, repair and operating supplies which are consumed in the production process but do not become a part of the product)

Finished inventories (Complete products ready for shipment)

Objectives of Inventory Control To ensure smooth flow of stock To provide for required quality of

material To control investment in stock Protecting against Fluctuating Demand Minimisation of risk & uncertainty Risk of obsolescence Minimisation of storage cost

Inventory Costs

Purchase Cost : price for purchase from outside the firm. It include transportation cost, tariffs, taxes, & any other costs incurs to make the item available at that point

Ordering Cost : In addition to the per unit purchase cost, there is usually an additional cost which is incurred whenever we order, reorder, or replenish the inventory. It is known as ordering costs

Cost of placing an order with a vendor of materialsPreparing a purchase orderProcessing paymentsReceiving and inspecting the material

Carrying Cost/ Holding Cost : The cost that accrues due to the actual holding of inventory over a time period is known as holding cost Costs connected directly with materials

○ Obsolescence○ Deterioration○ Pilferage

Financial Costs○ Taxes○ Insurance○ Storage○ Interest on cost of capital borrowed to acquire and

maintain the inventories

Shortage Cost : This cost is incurred for not having the inventory or not having enough inventory at the right place or at the be incurred Such as:

1. Backorders occurs when customer is willing to wait for inventory to be made available.

2. Lost sales occur when the customer responds to an out of stock situation by canceling the demand.

3. Lost customer cost 4. Disruption cost is that cost which results in delay in doing

the job.

Inventory Management & Control

Inventory Management- Involves the development and administration of policies. Systems and procedures which will minimize total costs relative to inventory decisions and related functions such as customer service requirements , production scheduling and purchasing

Inventory Control- pertains primarily to the administration of established policies, systems and procedures

Factors affecting Inventory Management & Control

Type of product

Type of Manufacture

Volume of production

Type of product If the materials used have high unit value,

closer control is required If the material used is in short supply or is

rationed by the government, this will influence the purchase of this material

Materails required to manufacture a standard product is easy to obtain and a close control is not necessary . Customized items need strict control to ensure no item is lost in the process of manufacture

Type of Manufacture Continuous manufacture requires

uninterrupted supply of inventories

Intermittent manufacture permits greater flexibility in the control of matetrial

Volume of production

Other factors Objectives of the company Qualifications of the staff personnel who

will design and coordinated the system Capability of present and future data

processing equipment

Inventory Control Techniques

ABC Inventory Analysis

1 2 3 4 5 6 7 8 9 10

1009080706050403020100

Percent of Inventory Items

Perc

ent o

f Ann

ual

Dol

lar U

sage

AItems

B Items C Items

ABC Inventory PoliciesPolicies for ‘A’ group items : 1. They should be ordered more frequently to

reduce capital lock up at a time in inventories as 10% of items cost 70% of total value

2. The stock report should be sent more frequently at least once in 15 days

3. The purchase of items should be with in the hands of top officials

Policies for ‘B’ group items: 1. This items should be ordered less frequently

than ‘A’ type items Policies for ‘C’ group items :1. Large quantities can be brought at a times

the total investment will be least2. Paper work can be reduced if orders are

once or twice a year

Advantages Of A B C Analysis1. This helps the manager to exercise

selective control & focus attention only on few items

2. Reduced losses arising out of obsolescence

3. Sufficient safety of low value or C group of items

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Economic Order Quantity (Model Assumptions)

Demand rate known and constant Item produced in lots, or purchased in orders Each lot or order received in single delivery Inventory holding cost based on average inventory Ordering, or setup costs are constant

EOQ

Order quantity

Annual costs

Holding Cost CurveTotal Cost Curve

Order (Setup) Cost Curve

Optimal Order Quantity (Q*)

Minimum

total cost

Replenishment i.e. Supply of item is instantaneous

There is no time lag between the placement of the order & its supply. The order is immediately supplied

Size of Inventory q

Time Period

C0 = procurement cost per order C = per unit cost of the item order Cs = per unit storage cost D = total demand in time t

q0 = 2DC0

Cs