INVENTORY CONTROL
INTRODUCTION
The term inventory means the value or amount of materials or
resource on hand. It includes raw material, work-in-process,
finished goods & stores & spares.
Inventory Control is the process by which inventory is
measured and regulated according to predetermined norms
such as economic lot size for order or production, safety stock,
minimum level, maximum level, order level etc.
Inventory control pertains primarily to the administration of
established policies, systems & procedures in order to reduce
the inventory cost.
OBJECTIVES OF INVENTORY CONTROL
To meet unforeseen future demand due to variation in forecast
figures and actual figures.
To average out demand fluctuations due to seasonal or cyclic
variations.
To meet the customer requirement timely, effectively,
efficiently, smoothly and satisfactorily.
To smoothen the production process.
To facilitate intermittent production of several products on the
same facility.
To gain economy of production or purchase in lots.
To reduce loss due to changes in prices of inventory items.
To meet the time lag for transportation of goods.
To meet the technological constraints of production/process.
To balance various costs of inventory such as order cost or set
up cost and inventory carrying cost.
To balance the stock out cost/opportunity cost due to loss of
sales against the costs of inventory.
To minimize losses due to deterioration, obsolescence,
damage, pilferage etc.
To stabilize employment and improve lab our relations by
inventory of human resources and machine efforts.
FACTORS AFFECTING INVENTORY CONTROL
Type of product
Type of manufacture
Volume of production
BENEFITS OF INVENTORY CONTROL
Ensures an adequate supply of materials
Minimizes inventory costs
Facilitates purchasing economies
Eliminates duplication in ordering
Better utilization of available stocks
Provides a check against the loss of materials
Facilitates cost accounting activities
Enables management in cost comparison
Locates & disposes inactive & obsolete store items
Consistent & reliable basis for financial statements
INVENTOR
Y
NATURE OF INVENTORY
Dependent demand- Demand for one product is linked with
demand for another product, such as components, subassemblies
etc.
Independent demand- Demand for a product/ service occurs
independently of demand for any other for any other product or
service, such as finished product, service parts, lubricants,
cutting oil, greases, preservatives etc.
ACCOUNTING FOR INVENTORY
Inventory value account for varying proportions of raw
materials, work in process parts, components or finished
products.
In continuous production/ mass production inventory for raw
materials and finished product is high and that of WIP parts is
less.
In batch production/ Job shop production inventory for raw
material & finished products is less and WIP inventory is
high.
DISTRIBUTION OF INVENTORY ACCOUNT
Raw WIP Finished Finished
Materials Inventory goods goods at
at distribution
factory
Capital 60% 20% 20% 00%
goods
Garment 30% 55% 5% 10%
industry
Consumer 5% 10% 30% 55%
product
INVENTORY
COSTS
TYPES OF INVENTORY COSTS
Ordering (purchasing) costs
Inventory carrying (holding) costs
Out of stock/shortage costs
Other costs
ORDERING COSTS
It is the cost of ordering the item and securing its supply.
Includes-
Expenses from raising the indent
Purchase requisition by user department till the execution
of order
Receipt and inspection of material
INVENTORY CARRYING COSTS
Costs incurred for holding the volume of inventory and
measured as a percentage of unit cost of an item.
It includes-
Capital cost
Obsolescence cost
Deterioration cost
Taxes on inventory
Insurance cost
Storage & handling cost
ALJIAN STATES CARRYING COSTS AS-
Capital costs
Storage space costs
Inventory service costs
Handling-equipment costs
Inventory risk costs
OUT-OF-STOCK COSTS
It is the loss which occurs or which may occur due to non
availability of material.
It includes-
Break down/delay in production
Back ordering
Lost sales
Loss of service to customers, loss of goodwill, loss due to lagging
behind the competitors, etc.
OTHER COSTS
Capacity Costs
Over-time payments
Lay-offs & idle time
Set-up Costs
Machine set-up
Start-up scrap generated from getting a production run started
Over-stocking Costs
INVENTORY
MODELS
ECONOMIC ORDER QUANTITY (EOQ)
EOQ or Fixed Order Quantity system is the technique of ordering
materials whenever stock reaches the reorder point.
Economic order quality deals when the cost of procurement and
handling of inventory are at optimum level and total cost is
minimum.
In this technique, the order quantity is larger than a single period’s
ne requirement so that ordering costs & holding costs balance out.
Tc (Total Cost)
Carrying Cost (Q/2)H
DS/Q (Ordering Cost)
EOQ
Order Quantity Size (Q)
ASSUMPTIONS OF EOQ
Demand for the product is constant
Lead time is constant
Price per unit is constant
Inventory carrying cost is based on average inventory
Ordering costs are constant per order
All demands for the product will be satisfied (no back orders)
WEAKNESSES OF EOQ FORMULA
Erratic usages
Faulty basic information
Costly calculations
No formula is substitute for commonsense
EOQ ordering must be tempered with judgment
BASIC FIXED ORDER QUANTITY MODEL (EOQ)
Annual Annual
Total Annual Cost = Purchase Annual + Ordering
Cost + Holding Cost
Cost
Q D
TC DC H S
2 Q
TC = Total annual cost
D = Demand
2 C = Cost per unit
EOQ DS Q = Order quantity
H
S = Cost of placing order/setup cost
H = Annual holding and storage cost per
unit of inventory
ORDER POINTS & SERVICE LEVELS
IMPORTANT TERMS
Minimum Level – It is the minimum stock to be maintained for
smooth production.
Maximum Level – It is the level of stock, beyond which a firm
should not maintain the stock.
Reorder Level – The stock level at which an order should be
placed.
Safety Stock – Stock for usage at normal rate during the
extension of lead time.
Reserve Stock - Excess usage requirement during normal lead
time.
Buffer Stock – Normal lead time consumption.
CLASSIFICATION OF
INVENTORY CONTROL
ALWAYS BETTER CONTROL (ABC) ANALYSIS
This technique divides inventory into three categories A, B & C
based on their annual consumption value.
It is also known as Selective Inventory Control Method (SIM)
This method is a means of categorizing inventory items
according to the potential amount to be controlled.
ABC analysis has universal application for fields requiring
selective control.
PROCEDURE FOR ABC ANALYSIS
Make the list of all items of inventory.
Determine the annual volume of usage & money value of each
item.
Multiply each item’s annual volume by its rupee value.
Compute each item’s percentage of the total inventory in terms of
annual usage in rupees.
Select the top 10% of all items which have the highest rupee
percentages & classify them as “A” items.
Select the next 20% of all items with the next highest rupee
percentages & designate them “B” items.
The next 70% of all items with the lowest rupee percentages are
“C” items.
ADVANTAGES OF ABC ANALYSIS
Helps to exercise selective control
Gives rewarding results quickly
Helps to point out obsolete stocks easily.
In case of “A” items careful attention can be paid at every step
such as estimate of requirements, purchase, safety stock, receipts,
inspections, issues, etc. & close control is maintained.
In case of “C” items, recording & follow up, etc. may be
dispensed with or combined.
Helps better planning of inventory control
Provides sound basis for allocation of funds & human resources.
DISADVANTAGES OF ABC ANALYSIS
Proper standardization & codification of inventory items
needed.
Considers only money value of items & neglects the importance
of items for the production process or assembly or functioning.
Periodic review becomes difficult if only ABC
analysis is recalled.
When other important factors make it obligatory to concentrate
on “C” items more, the purpose of ABC analysis is defeated.
VED CLASSIFICATION
VED: Vital, Essential & Desirable classification
VED classification is based on the criticality of the inventories.
Vital items – Its shortage may cause havoc & stop the work in
organization. They are stocked adequately to ensure smooth
operation.
Essential items - Here, reasonable risk can be taken. If not
available, the plant does not stop; but the efficiency of
operations is adversely affected due to expediting expenses.
They should be sufficiently stocked to ensure regular flow of
work.
Desirable items – Its non availability does not stop the work
because they can be easily purchased from the market as &
when needed. They may be stocked very low or not stocked.
It is useful in capital intensive industries,
transport industries, etc.
VED analysis can be better used with ABC analysis in the
following pattern:
Category “V” items “E” items “D” items
“A” items Constant control Moderate stocks Nil stocks
& regular follow
up
“B” items Moderate stocks Moderate stocks Low stocks
“C” items High stocks Moderate stocks Very low stocks
FSN ANALYSIS
FSN: Fast moving, slow moving & non moving
Classification is based on the pattern of issues from stores & is
useful in controlling obsolescence.
Date of receipt or last date of issue, whichever is later, is taken to
determine the no. of months which have lapsed since the last
transaction.
The items are usually grouped in periods of 12 months.
It helps to avoid investments in non moving or slow items. It is
also useful in facilitating timely control.
For analysis, the issues of items in past two or three years are
considered.
If there are no issues of an item during the period, it is “N” item.
Then up to certain limit, say 10-15 issues in the period, the item is
“S” item
The items exceeding such limit of no. of issues during the period
are “F” items.
The period of consideration & the limiting number of issues vary
from organization to organization.
