management of inventory.ppt
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Management of Inventory
Dr. Teena Shivnani
WCM / Dr. Teena 1
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Meaning of Inventory
•
Inventory is one of the most visible andtangible aspects of doing business.
• In simple words, inventory is defined as
the sum total of value raw material, WIPand FG though it depends largely uponthe type of business.
• Inventory works as link betweenproduction & consumption of goods.
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Types of Inventory
Material Inventory• Raw Material• Work in Progress• Finished goods• Consumables
• SparesLiquidity Inventory• Cash & marketable securities :- cash and
marketable securities can be thought of as aninventory of liquidity that allows separation of
collection from disbursement. Without thisliquidity inventory payment of bills would be tiedto collection of accounts, in some cases, withpayment delayed until accounts receivable are
collected.
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Inventory Management
• The techniques of maintaining stock, keeping
items at desired level whether they are raw
material, WIP or finished goods.
• Inventory management means efficient control
and management of capital invested in rawmaterials and supplies, work in progress &
finished goods for the purpose of obtaining
maximum return from the investment.
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Cont……..
•
Inventory management is mostimportant as it involves around 25% to30% of the total investment.
•
It is the role and responsibility ofpurchase and production function asalso of the manufacturing andmarketing functions.
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Objectives
• Operating objectives
1. Regular flow of material
2. Risk minimization
3. Avoiding over stocking and under stocking
• Financial objectives1. Making possible a minimum level of investment
2. Ensure no losses
3. No duplication of purchases so maintaining thestocks likewise
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Purpose and Benefits of maintaining
Inventory
• To facilitate uninterrupted production and
smooth running of business
– The transaction motive
– The precautionary motive
– The speculative motive
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Risk associated with inventory
•The risk in inventory management signifies the chance thatinventories cannot be turned over into cash through normal sale
without a loss.
• These risks are due to three factors:-
1. Price decline :- it may result from an increase in the market supply
of products, introduction of new competitive product and pricereduction by competitors.
2. Product deterioration :- it may result due to holding a product too
long or it may occur when inventories are held under improper
conditions of light, heat, humidity and pressure.
3. Obsolescence :-it is due to changes in customer taste, newproduction techniques, improvement in product design,
specifications etc.
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Cost of holding Inventory
The optimum level of inventory depends onthe following costs:-
1. Material Cost
2. Ordering cost3. Carrying cost
4. Stock out cost/ shortage cost
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Material Costs
• These are the cost of purchasing the goodsplus transportation and handling charges.
• It may be calculated by adding the
purchase price (less any discount), thedelivery charges and sales tax, if any.
• Purchase Price + Delivery charges +
sales tax – Discount.
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Ordering cost • Every time of an order is placed for stock replenishment,
certain costs are involved. The ordering cost may varydependent upon the type of item.
• Ordering cost pertain to placing an order for thepurchase of certain items of raw materials.
• This cost includes:-
1. Cost of preparation of purchase order. (typing, dispatch,postage, etc.)
2. Cost of sending reminders to get the dispatch of theitems
3. Cost of transportation of goods
4. Cost of receiving and verifying the goods5. Cost of unloading of the item.
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Cont……..
• A large organization can fixed the ordering
cost regardless the number of order can
change.
• Ordering costs are inversely related to the
level of inventory.
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Carrying cost
• Carrying cost constitute all the costs of holdingitems in inventory for a given period of time. They can expressed either in rupees per unitper period or as a % of the inventory value perperiod.
It includes:-• Storage & handling costs
• Interest on capital
• Taxes, depreciation and insurance.
• The cost of fund invested in inventories
• Product deterioriation and obsolescence.
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Cont……..
•
The level of inventory and carrying cost arepositively related and move in the samedirection.
• Like ordering cost inventory carrying cost contain
both fixed & variable components.
• Mostly carrying cost vary with the inventory level but a certain portion of them such as warehouse
rent and depreciation on inventory handlingequipment are relatively fixed over the short run.
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Shortage cost (costs of stock out)
• Shortage costs or costs of stock out are such costs whichthe company would incur in case of shortage of certain
items of raw material required for production or theshortage of certain items of finished goods to meet theimmediate demands of the customers.
• Shortage of inventories of raw materials may affect the
company in one or more of the following ways:-1. the company may have to pay some what higher price,
connected with immediate procurements.
2. The company may have to compulsorily resort to somedifferent production schedules, which may not be as
efficient and economical.
Stock out of finished goods, however may result in thedissatisfaction of the customers and the resultant loss of sales.
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Relationship between OC, CC & TC
• The order quantity that minimize total
annual inventory costs, can be determinedgraphically by plotting inventory cost.
TC = OC + CC + Pur. Price
• As no. of orders ordering cost• As no. of orders carrying cost
• Total cost initial decrease till OC & CC arenot equal. When OC = CC, total cost startincreasing.
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Example
O OC CC TC1 100 20 120
2 80 30 110
3 70 40 1104 50 50 100
5 30 90 120
6 20 110 130
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TC CC
OC
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Techniques
Modern
Technique
Traditional
Technique
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Modern Techniques
EOQ
ROL
Stock Levels
Selective Techniques
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Traditional Techniques
Perpetual Inv. System
Periodic order system
Two Bin System
Inventory Ratio
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EOQ / OOQ Model
• If a firm order for its total annual requirement of material
in one lot and keeps it in stock, its ordering costs will below but carrying cost will rise.
• On the other hand in case the firm orders small quantities
at different times in more than one order, its carrying costs
would be low but ordering cost will increase.• Therefore, a firm should place an order for that quantity
where there is a trade-off between ordering cost and
carrying costs becoz at this point the total cost of inventory
would be minimum.• EOQ or OOQ is that size of the order where total inventory
costs ( OC + CC ) are minimized.
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Assumptions1. The usage demand of the various items of inventory is equal
through out the period.2. There is no lead time involved
3. There only two distinct costs involved in computing the total
costs:- (a) ordering cost (b) carrying cost
4. The cost of every order remains uniformly the same, irrespective of the size of the order.
5. The inventory carrying cost is a fixed % of the average value of
inventory.
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Formula Method • It is also known as “ Square Root Formula “ or “Wilson
Formula method”.
• The EOQ is three steps :-
Step 1 = calculation of EOQ
EOQ = (2AO) / PC
O = Cost per Order (it is assumed to be fixed or constant)
A = Annual Usage or Sales
P = Price per UnitC = Carrying cost % or PC = carrying cost in amount
Step 2:- No. of order = Sales or usage / EOQ
Step 3:-Time gap between two orders= 365 / no of orders
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Example 1• The annual sales of friends electrical limited is
estimated at 1800 units, the cost price per unit isRs. 80/-. The ordering cost per order is (fixed) Rs.
60/- and the inventory carrying cost per unit is Rs.
2/-.
EOQ = (2AO) / PC
Eoq= (2x 60x 1800) / 2
Q= 328.63 or 329/-
No. of order = 1800 / 329 = 5.47 orders or 6 orders
Time gap between two orders = 365 / 6 = 60.83 days
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Calculation of Total Cost of
Inventory
• Total Cost of Inventory = Cost of Purchases +
Ordering Cost + Carrying cost
• Cost of Purchase = Annual Consumption x
purchase price
• Ordering cost= No of order x ordering cost
• Carrying Cost = EOQ / 2 x carrying cost
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Example
A Ltd uses an average of 1000 bags of cement each
year. They have an ordering cost per order of Rs.
60/-, order in quantities of 350 bags and have
carrying costs of Rs. 10 per bag each year.
Calculate total cost.• Total Cost of Inventory = Cost of Purchases +
Ordering Cost + Carrying cost
= 1000x 60 + 1000 / 350 x 60 + 350/2 x 10
= 61921/- .
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Calculation of TC in case of Discount
• Reduced the cost price by discount amount
• Calculate new carrying cost becoz as purchase
price is changed CC will also change.
• Consider the minimum quantity of discount as
new EOQ.
• Calculate the total cost according to formula.
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Example of Discount
• In Maheshwari company the annual
consumption of a particular item is 4000
units. The purchase price per unit is Rs. 10.
ordering cost is 60/- per order. Carrying
cost is 30% of the value of inventory. Thesupplier is offering a bulk discount of 1%
on lots of 800 units.
• Advice whether the EOQ should be raisedto 800 units.
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Graphic Method
• The EOQ can also be determined with the help of graph. Under this method OC, CC and TC
according to different lot sizes are plotted on the
graph.
• The point at which the line of inventory carrying
cost and the line of ordering cost intersect each
other is the EOQ. At this point the total cost line
is also minimum.
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Example
O OC CC TC1 100 20 120
2 80 30 110
3 70 40 1104 50 50 100
5 30 90 120
6 20 110 130
WCM / Dr. Teena 31
TC CC
OC
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Trial & Error Method
• Under this method, annual consumption of
goods are divided into imaginary different lot
sizes and total inventory cost (CC & OC) for
each lot size is calculated.
• The lot size , where TC is minimum is chosen
as EOQ or most profitable quantity to be
purchased.
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Re-Order Point / ROL
• It is a level of inventory at which an order should be placed for replenishing of current stock of
inventory.
• This can well done by ensuring that the order is
placed when sufficient balance of stock is still left
to take care of the lead time.
• But for this we may have to know the rate of
usage of material & lead time exactly.
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Lead Time• Lead time is the time lag that takes place
between the placement of an order and theactual supply / delivery made in the companygodown.
• As we have seen earlier the standard EOQ modelpresumes as if there is no lead time involved. It
means the order can place when inventory levelcomes to zero. It is not possible.
• Therefore we should directly take account thelead time too while calculating EOQ.
• This can be done by introducing a slightmodification in the standard EOQ analysis.
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Usage Rate
• This is the rate per day at which the item is
consumed in production or sold to customers.
• It is expressed in units.
• It is calculated by dividing the total
consumption by no of days in a year or 360.
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Safety stock
• Safety stock as the minimum quantity of
inventory which a firm decides to keep alwaysprotect itself against the risk & losses.
• In actual practice one can neither estimate the
lead time nor the daily usage so accurately andexactly.
• Accordingly we should always keep some safetystock with us to meet such uncertainty.
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Uncertainty & Inventory Management
•
Inventory is related to consumption of materialor selling of FG. But on both the aspect may have
uncertainty.
• To face the uncertainty, always maintain safety
stock in the organization. As the level of uncertainty is high, it require more safety stock
and viva versa.
•
Uncertainty safety stock• Uncertainty safety stock
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ROL Formula• Re- Order point can computed as in case safety stock
is not given =
Re-Order point = Lead time X Daily usage
= 5 X 20 kg. = 100 kg. is order point.
• Re- Order point can computed as in case safety stockis given =
Re- Order point = ( lead time X daily usage ) + safetystock
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Stock Level
•For avoiding the under stocking and overstocking most of the large companies adopt a
scientific approach of fixing stock levels. These
levels are :-
1. Maximum Level
2. Minimum Level
3. Re-order Level
4. Re-order Quantity / EOQ
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Maximum stock Level
This is the level above which stock level should not
normally be allowed to rise. The maximum level
is fixed after taking into account such factors
as:-
1. Rate of consumption of material2. Space availability
3. Cost of storing above normal stock
4. Amount of capital needed and available forpurchasing of stock
5. Re-order quantity
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Formula
• Max. stock =
ROL + ROQ – (Min consumption x Min re-order period)
ROL = Re-order level
ROQ = Re –
order quantity
If safety stock is given than formula will be =
Max. stock = EOQ + Safety Stock
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Minimum Level / safety stock
• It is that level below which stock should not
normally be allowed to fall.• This is essential safety stock and is not normally
touched.
• In case of stock falling below this level there is arisk of stoppage in production.
• Min level = ROL – ( Normal consumption X Normal
re-order period)• If safety stock is given than Min. stock will be =
safety stock
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Re-order Level
• When to place a order is also an important question
requiring a suitable answer.• The optimum order point or order level is the level of
inventory at which the EOQ of stock (it means EOQ isordering second, third time etc) should be ordered
again.• ROL = Max. daily usage X Max. lead time
OR
• ROL = Max consumption X Max re-order period
• If safety stock is given than add safety stock in aboveformula.
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Average stock
• It represent the stock which is maintainedin the stores. This level is above the
minimum level and below the maximum
level.• AS = Min stock + Max. stock / 2
• AS = Min stock + ½ Re-order quantity
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Formula
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Formula
• There are two opinion based formulas forcalculation of danger level:-
• 1st opinion= It being emergency period, thesepurchases are costly and hence to be boughtminimum of quantity.
DL =Minimum rate of consumption X Emergency
delivery period
• 2nd opinion = emergency has no definite limit, somaximum quantity to be bought to tide over
further arising problems.DL=Maximum rate of consumption X
Emergency delivery period
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Example
• Two material A & B are used as follows:-
Min = 50 units per week eachMax. = 150 unit per week each
Normal uses = 100 units per week each
Re-order quantity = A = 600 unit
B = 1000 unit
Delivery period = A = 4 – 6 week
B = 2 – 4 week
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Example
• A company uses annually 50,000 units of an item
each costing 1.20/- each. Each order cost 45/-. Andinventory carrying cost 15% of the annual average
inventory value.
• Find out = EOQ
= if the company operates 250 days a
year the procurement time is 10days and safety
stock is 500 units find ROL, max. & Min. inventory
and average stock
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So ution
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So ution• EOQ = 5000 units (Calculate)
• Consumption per day =
50,000 / 250 days = 200 units
• ROL = safety stock + (Lead time x consumption per day)
= 500 + (10 x 200)
= 500 + 2000 = 2500 units
• Max. inventory = ROL + EOQ – (Min consumption during lead
time)2500 + 5000 – ( 10X200)
= 5500 units
• Min inventory = ROL – (Normal consumption in lead time)
= 2500 – (10 x 200) = 500 units
• Average stock = 500 + 5500 / 2 = 3000 units
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Inventory Control Models
• ABC Analysis
• VED Analysis
• SED Analysis
• FSN Analysis.
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A C A l i
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ABC Analysis
• Always Better Control (ABC) is an application of
the principle of “ Management by Exception” to
the field of inventory control.
• Under this technique all the items of inventory
are classified in the following three categoriesi.e. A, B, C on the basis of usage rate.
• The A, B, & C category value will be decided by
company. The value is vary according tocompany. Different company may have differentvalue of A, B, & C category. This value may bechange as per time also.
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ABC Analysis
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ABC Analysis
Category % of Total Value % of Total Quantity
A 70 – 80 % 5 -10 %
B 20 – 25 % 20 – 30 %
C 5 – 10% 60 – 70 %
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•ABC analysis may be defined as a technique whereinventories are analyzed according to their value so
that costly items are given greater attention and careby management.
•Classification can be done on the basis of value of
stock not on the basis of quantity of stock.A Category items are of high value .B category items are of moderate valueC category items are of low.
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Objective of ABC
• The main purpose of ABC analysis is to
indicate the degree of control required for
inventory items of each category.
• A category items will require tight control.
• B category items will require less control.
• C category items require general control.
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80 20 l i ABC M d l
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80 -20 rule in ABC Model
•
Maximum value is contribute by very fewitems.
• Managers should focused on this A
category. Same way calculate B & Ccategory.
• In C category item will many but
contributing to very small value of stock.
So the management can ignore C category.
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Process of ABC Calculation
1. Calculate TC of all the products
2. Arrange total cost in descending order.
3. Cumulative total cost
4. Calculate % of value on total cost as per A,B,C
5. Now break up the cumulative TC as per ABC
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Example
•
No of units were = 100• Value of total 100 unit were = 100000
• no of item value
• A 20 80,000• B 30 15000
• C 50 5000
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e.g. of calculation ABC Category
• Dinesh limited is considering a selective
control for its inventories. Prepare ABC Plan.:-
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Items Units Unit Cost
A 8000 5.50B 15000 1.70
C 5000 30.40
D 7500 1.50
E 5000 0.65
F 7000 5.14
G 2500 51.20
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1
Ite
m
s
Units
(1)
Unit Cost
(2)
Total Cost
( 1 X 2)
A 8000 5.50 44,000
B 15000 1.70 25,500
C 5000 30.40 1,52,000
D 7500 1.50 11,250
E 5000 0.65 3,250
F 7000 5.14 36,000
G 2500 51.20 1,28,000
TOTAL COST 4,00,000
WCM / Dr. Teena 61
Ite
m
s
TC in
Descending
order
Cumulative
TC
Cate.
C 1,52,000 1,52,000
G 1,28,000 2,80,000 A
A 44,000 3,24,000
F 36,000 3,60,000 B
B 25,500 3,85,500
D 11,250 3,96,750
E 3,250 4,00,000 C
2
VED Analysis
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VED Analysis
•Virtual , Essential, Desirable items.
• In this model item will be divided in V, E, D
category according to their importance.
• The organization may focus more on virtualand less focus on desirable items.
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VED & ABC M t i
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VED & ABC Matrix
V E D
A It require more attention,
Becoz A & V both arehere. Value is high as well
as importance is more.
Require averageattention in allthree category.
B
CIt require noattention due toD & C category.
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SDE Analysis
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SDE Analysis
•
SDE ( Scarce, Difficult and Easy) analysis evaluatesthe importance of the inventory items on the
basis of availability.
• Scarce (S) items are those items which are in
short supply and mostly such items constituteimportant items.
• Difficult (D) items refer to such items which
cannot be procured easily.
• Easy (E) items are the items which are easily
available in the market.
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FSN Analysis
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y• FSN (Fast, Slow, Non moving) in this technique
inventory are grouped according to the movement
into the following categories.
• Fast (F) moving = these are stored in large quantities and a close watch on the movement of such items is
kept. E.g Raw – Material
• Slow (S) =these are not frequently require by theproduction dept. E.g. production equipments
• Non-moving (N) =these are rarely required by theproduction dept. A smaller number of items arekept in stores.
WCM / Dr. Teena 65
I
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Inventory systems
• Records pertaining to quantity and value of inventory in hand can be maintained
according to any of the following systems:-
1. Periodic inventory system
2. Perpetual inventory system
3. Just in Time Inventory System
WCM / Dr. Teena 66
Periodic inventory system
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Periodic inventory system
• In case of this system the quantity and value of
inventory is found out only at the end of theaccounting period after having a physicalverification of the units in hand.
• The system does not provide the informationregarding the quantity and value of material inhand on a continuous basis. In this systemfollowing formula will be followed:-
opening stock + purchases – closing stock
WCM / Dr. Teena 67
Perpetual inventory system
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Perpetual inventory system
• It is also known as an automatic inventory system• “It is a method of recording inventory balances after
every receipt and issue to facilitate regular checking
and to obviate closing down for stocktaking.”
• In case of this system the stores’ ledgers give balance
of goods on a continuous basis.
• The basic objective of this system is to make
available the details about the quantity and value of stock of each item at all times.
WCM / Dr. Teena 68
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Perpetual Inventory Techniques
1. FIFO Method
2. LIFO Method
3. Average price Method
4. Weighted Price Method
5. Base Stock Method
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• First in First out (FIFO) :- under this method, it
is assumed that the materials / goods firstreceived are the first to be issued/ sold.
• Last in first out (LIFO) :- this method is based
on the assumption that last item of material /goods purchased are first to be issued / sold.
IMPORTANT:- In both method if openingbalance of stock is there then this balance qty& its price always shown in balance columnonly.
WCM / Dr. Teena 70
• Receipt
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Receipt
Jan. 1 Balance 50 units @ 4/-
Jan. 5 Job no. 10, 40 units @ 3/-Jan. 8 job no. 12, 30 units @ 4/-
Jan. 15 job no. 11, 20 units @ 5/-
Jan. 26 job no 13, 40 units @ 3/-
ISSUE:- Jan. 10 , 70 units
Jan. 12, 10 units
Jan. 20, 20 units
Jan. 24, 10 units
24 April 2013 Material Control / Dr. Teena 71
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Average Price Method
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• The average price is calculated by adding all the
different prices of material in stock and dividedby the number of prices used in that total.
• In this method Ave. price is calculated for only
issue.• In the balance column ave. price is not written,
in it amt and qty. is calculated on the basis of previous qty & amt – issue qty & issue amt.
• this method can be combination of FIFO & Ave.method.
• Ave. Price = Prices of the stock / 2WCM / Dr. Teena 73
Average Price Method
Average Method
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Average Method
Qty P Amt Qty P Amt Qty P Amt
200 2.00 400 200 --- 400
300 2.40 720 500 -- 1120
250 2.20(Ave. P)
550 250 -- 570
250 2.60 650 500 -- 1220
200 2.5(A.P.)
500 300 -- 720
7424 April 2013 Material Control / Dr. Teena
Weighted Average Price Method
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• This method is based on the presumption that oncethe material or goods are put into a common bin,they lose their identity. Hence, the inventory consistsof no specific batch of goods.
• The inventory is thus priced on the basis of averageprices paid for the goods, weighted according to thequantity purchased at each price.
• In this method once stock is received then we haveto calculated weighted price. On this calculated pricewe have to show balance price and further issue tillwe are not receive any other quantity of stock. Itmeans as we receive stock we have to calculatedWeighted price.
24 April 2013 Material Control / Dr. Teena 75
Weighted Average Price Method
Weighted Average Method
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g g
Qty P Amt Qty P Amt Qty P Amt
200 2.00 400 200 2/-(w.a.p.) =
200 /400
400
300 2.40 720 500 2.24(w.a.p.) =
1120 /500
1120
250 2.24 560 250 2.24 560
250 2.60 650 500 2.42(w.a.p) =
1210 /
500
1210
200 2.42 484 300 2.42 726
300 2.42 726
7624 April 2013 Material Control / Dr. Teena
Base Stock Method
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• This method is based on the contention that
each enterprise maintain at all times a
minimum quantity of materials or FG in its
stock. This quantity is termed as “base stock”.
• The base stock is deemed to have been
created out of the first lot purchased and
therefore, it is always valued at this price andis carried forward as a fixed assets.
WCM / Dr. Teena 77
Base Stock Method
( )
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Just in Time (JIT) Inventory System
• JIT inventory system as its name suggestsmeans at the extreme there is zero inventory
and goods are produced or ordered only when
they are needed.• In other words, RM are received just in time to
go into production, manufactured parts are
completed just in time to be assembled intoproducts and products are completed “Just in
Time” to be shipped to customers.
WCM / Dr. Teena 78
Two Bin System
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Two Bin System
• Under this method all inventory items are storedin two separate bins.
• In the first bin, a sufficient supply is kept to meetthe current requirement over a designatedperiod of time.
• In the second bin a safety stock is maintained foruse during lead time.
• When the stock of first bin is used an order for
further stock is immediately placed. The materialin second bin is then consumed to meet stockneeds un till the new order is received.
WCM / Dr. Teena 79
Stock Turnover Ratio
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Stock Turnover Ratio• This ratio establishes a relationship between cost of
goods sold and average stock.• Cost of goods sold= O/S + purchases + direct
Expenses – C/S OR Net sales – G/P
• Average stock = O/S + C/S / 2
Stock ratio = cost of goods sold / average stock
• If cost of goods sold and average stock is not given,
then sales and closing stock are used.
Stock ratio = net sales / Average stock or C/S