Inventory Management-Introduction

In the financial parlance inventory is defined as the sum of value of raw materials, fuels and lubricants, spare parts, maintenance consumable, semi-processed materials and finished goods stock at any given point of time. The operational definition of inventory could be the amount of raw materials, fuel and lubricants, spare parts and semi processed to be stocked for smooth running of plant. Since resources are idle when kept in stock, inventory is also defined as an idle resource of any kind having an economical value.

Inventories are assets of an organization and represent investment. Like all investments, inventory may be too high or too low; it may be well managed or poorly managed. While any redundant inventory is wastage of capital that should otherwise be earning a return, properly maintained and controlled inventories can be a great asset.

Functions of inventory: Inventories have many useful functions in spite of the facts that it is very costly to maintain them. But for the inventories, the whole production distribution system of an economy may breakdown. If it is possible to procure or process materials without any loss of time, the major need for inventory disappears. But this is just not possible, given the market of industrial goods in the country. There is always a delay between raising of materials requisition and receipt of materials(lead-time). Also this delay is not uniform or constant. This introduces uncertainty of supply. There is also uncertainty in demand. It is very difficult to forecast the exact requirement of materials and the main function of inventory thus is to serve as a cushion and to protect the production distribution system from shocks due to uncertainty in demand and supply. If no inventories are kept, unvertainty in demand and supply will break the production distribution system, increasing ultimately the

cost. Thus inventories make it unnecessary to gear production directly to consumption of force consumption to adopt itself to necessities of production.

It is common practice to buy or produce materials in larger quantities than what the immediate requirements justify, to obtain quantity discounts, to get advantage from seasonal reduction in price, to keep ordering and set up cost low, to keep transportation costs in check. Hence for the purpose of economy, inventories are kept. It is because of inventories that various stages of production operate independently, efficiently and economically.

Another important factor, which warrants maintaining inventories, is high idle time cost of machine and men and as such urgency of requirements, if men and machines in a factory could wait and so also the customer, thus materials need not wait for them and inventory would not be necessary. However, in this industrial age, it is very costly to keep men and machine waiting for materials. So the materials should have to wait for them and inventories are maintained for this purpose.\

The inventories are kept in the form raw materials, work-in-process and finished good. The reasons for keeping inventories at these stages are given below: 1. Raw Materials: Economic bulk purchasing Seasonal factors of availability and price advantages. As protective buffer against I. Delay in supply II. Change in production rate, due to market fluctuations for the finished product etc. 2. Work-in-progress inventories: As liquid stock to cater for variety and shorten the manufacturing cycle. As protective buffer against product breakdown, rejections For economic lot size production.

3. Finished goods inventories: To ensure ex-stock delivery. This is especially required for consumer type goods where customers cannot be expected to wait during, procurement, processing and supply stages. As protective buffers against sales rate changes. To absorb economic production lot. To stabilize the level of production and employment when sale is of seasonal variety. Functional classification of inventories 1. Movement inventories These are necessary because it takes time to move products from one place to another. The average amount of movement inventory is worked out by: I=ST where S is the average sale rate (say per week) and T is the transit time in week and I, the movement inventories required. This is particularly important when finished goods and sent from the factory to different warehouses or distribution centres. 2. Lot size inventories: Such inventories are carried to obtain quantity discounts, to keep down transportation cost, buying cost and cost of receipt and holding. For example, it will be obviously uneconomical for a textile mill to buy cotton everyday rather than in bulk during the cotton season. Not only daily supplies will entail higher cost, they will also expose the mill the serious shutdowns arising from any mishaps in procurement. 3. Fluctuation stocks: These stocks are carried to ensure ready supplies to consumers in the face of irregular and unpredictable fluctuations in their demand. Consider, for example the case of a sugar mill, which is marketing 12 varieties of sugar, such as cubes, crystals, powder, while and brown etc. it may also be presumed that a costumer will demand immediate supplies and will not wait for the mill to produce his requirements after he has placed the order.

Inevitable, therefore, the mill will have to keep stocks of all the varieties and in quantities normally sufficient to meet variable demands. Fluctuation stocks may also be carried in semi-finished form to balance out the load among manufacturing departments. These so called fluctuation stocks are not absolutely essential. A business could go along without them if it were willing and able to make its customer wait until the materials they want could be ordered in, or until their orders could be scheduled into production in convenient fashion. In some cases, stock to fill this need is patently uneconomical as, for example, finished inventories of battle-ships for sale. In most cases, anticipating all fluctuations, is uneconomical, back order will arise at some time. Fluctuation stocks are part of serving customers wants(and whims) rather than having them take what they can get. 4. Anticipated stocks: Such stocks are kept to meet predictable changes in demand or in availability of raw materials. The case of fruit processing factory, which is to buy tomato in the tomato season to meet regular demand of tomato ketch-up through out the year is an example of seasonal availability or raw materials. What is true is generally true of most other agricultural products, which form the raw materials of several industries. It is much more economical to build up stocks than to change production rate since, with changes in production rates, it is not feasible to stabilize employment or to secure optimum utilization of capital facilities. Lot size, fluctuation and anticipated stocks can be said to be organizational inventories because as more and more of these are carried, less coordination and planning are needed, less clerical efforts are needed to handle order, and greater economies can be achieved in manufacturing and shipping. The only difficulty is that these gains are not achieved in direct proportion to the size of inventory. As inventories are increased, even if they are kept well balanced and properly located. The gain from additional stock become less and less. On the other hand, storage, obsolescence and capital

costs associated with possessing inventories rise in proportion to, or perhaps even at a faster rate than the inventories themselves.

Inventory control Inventory control is a planned method of determining what to indent, when to indent, how much to stock so that purchasing and storing costs are the lowest possible, without effecting production and sales.

In this process investment in material and parts carried in stock is so maintained as to ensure smooth and continuous operations of production and sale and the cost of inventories are kept at the lowest possible level.

Importance of inventory management:

The primary objectives of inventory management are: To minimize losses, due to idle time of men and machine and customer goodwill, caused as a result of shortage of materials. To keep down investment in inventories, inventory carrying cost and obsolescence. As is evident these two objectives are of conflicting nature and efficiency of inventory management lies in balancing one against the other so as to achieve optimum results. Where inventory management is sound both operational and financial objectives are attained. On the other hand, where inventory management is poor, the operations are often hampered for want of stores and there may be large number of items having huge stocks but no issue from stores. The result is shortage and excess go hand in hand. Poor inventory control effects productive units more than trading since the need for liquidity is much greater in industry. The reason is that manufacturing is a process of continual conversion of raw materials into

finished product involving expenditure of machine, power and wages bill. On the contrary a trader has to maintain only a sales establishment and no other expenses as in case of industry, are involved. In trading almost the entire capital is invested in stock-in-trade, which possesses inherent convertibility. An industrialist has, therefore, much greater cause to be alert and on tip top about his capital turn over. The importance of capital turnover ratio shall he clear from the following: Return of capital = profit/capital investment = profit/ sales * sales/capital (profit margin) (capital turn over rate) The profit margin depends upon external factors like Competition and Government control etc. Hence it cannot be increased at the sweet will of the undertaking. The second alternative to increase the return on capital is to increase the capital turn over rate. This can be achieved either by increasing the sales, maintaining the same level of investment or by reducing the capital maintaining the same level of sales or both increasing the sales and reducing the capital investment. Increase in sales, again have limitations and other way is to reduce the investment. Now the capital investment is both in fixed assets and working assets. Fixed assets cannot be reduced normally whereas working capital can be controlled which forms nearly 40-50% of total investment. Nearly 75-80% of the working capital is blocked in inventories. If the inventory management is efficient, this percentage can be brought down and higher return attained. On the contrary, if inventory management is poor, much of the profit will be eaten away by the excessive inventories. Advantages of inventory management/control: The following are some of the benefit, which accrue from intelligent and scientific management of inventories: Inventory control ensures an adequate supply of raw materials, stores, spare etc. minimizes stock-out and shortages, and avoid costly interruption in operations.

 It keeps down investment in inventories; inventory carrying cost and obsolescence losses to the minimum. It facilitates purchasing economies through the measurement of requirements on the basis of recorded experience. It eliminates duplication in ordering or in replenishing stocks by centralizing the source from which purchase requisitions emanate. It permits a better utilization of available stocks by facilitating interdepartment/inter-unit transfers within the organization. It provides a check against the loss of materials through carelessness or pilferage. It facilitates cost accounting activities by providing a means for allocating material cost to product, department and other operating accounts. It enables management to make cost and consumption comparisons between operations, periods and units. It serves as a means for the location and disposition of inactive and obsolete items of stores. Perpetual inventory values provide a consistent and reliable basis for preparing financial statements.

While the importance of inventory control to company and national economy has been well realized in other industrialized countries, a similar realization is also being felt in our country. But having taken to industrialization we cannot afford, for long, to ignore the subject of inventory control. It is because, as has already been pointed out, our necessity is more serious than that of industrially advanced country and the sooner we made a regular and systematic start, the better it would be for us. Scientific management of inventories can help: Conserve valuable foreign exchange Release capital, so scarce in this country, and Reduce costs associated with both shortages and possession of surplus inventories and thus increase our competitiveness in foreign market.

Functions of inventory control: To develop policies, plans and standards essential to achieve objectives. To build up logical and workable plan of organization for doing the job satisfactorily. To develop procedure and methods that will produce the desired results economically. To provide necessary physical facilities. To maintain overall control by checking results and taking corrective actions. The above functions can be broken down to the following elements: Determine items to be carried out in inventory items on stock or an item to be processed as and when necessary. To lay down the specifications of the items in relation to requirements of the organization. To assess the requirement level and consumption patter of individual item in stock. To determine how much to procure and when. To carry out standardization and variety reduction and classification of stores items. To identify slow moving, obsolete, defective and damaged items and take action for their disposal or use in some other form. To signal under stocking or overstocking of inventories in relation to current and future demands and take corrective action. To maintain proper records in respect of inventory position. To check up physical inventory quantities in relation to records. To keep a constant watch on overall situations for the control purpose.

Symptoms of poor inventory management Continuous increase in the value of inventories beyond level of normal inflation in the market prices.

 Spares critically required are either not available or desired quantities are not there and those not required are available in abundant i.e. shortages and excesses are hand in hand. Materials shortages causing excessive down time cost i.e. high stock-out cost by way of production, profit losses or loss of customer goodwill. In production industry, frequent cancellation of customer order due to nonadherence of delivery schedules. Uneven production with frequent lay-off or hiring of manpower. Periodical lack of storage space. High number and value of cash/rush purchases. High expediting cost by deputing personnel to vendors works for expediting dispatches. High transportation cost for rush deliveries. Large number of discrepancies in the process of stocktaking. High number and value of non-moving and obsolete items. High write-offs due to deterioration losses of materials.

Cost concepts in inventory management There are three costs, which are one way or the other associated in inventory management and are guiding factors in fixing the inventory levels. Inventory carrying cost/ stock holding cost Ordering cost/set up cost Stock-out cost/ non-availability cost.

Inventory carrying cost: Inventory is liquid asset like money, but it is not so liquid as money in the bank. Money in the bank earns interest while it actually costs to maintain inventories.

The main elements of inventory carrying cost are: Capital cost: this normally is the interest charge, which are to be paid to the bank and may be 15-18%. But it will be more realistic, especially under prevailing conditions, to consider opportunity cost of money. By opportunity cost is meant the cost that is incurred in withdrawing funds from a productive activity to invest them in inventories. Opportunity cost of capital is the rate of return earned by the company on its total investment. If this is considered then capital cost may be around 25-30%. Storage and handling cost: this is the most obvious inventory carrying cost. This includes rent of storage facilities or depreciation, if owned by the company; salaries of personnel and related storage expenses, handling and insurance; security and preservation of materials and so on. The storage cost vary widely with the type of material stored, type of storage facilities used and other factors and may be around 2-5% of the value of the materials stored per year. Deterioration & obsolescence cost: the usage of every material cannot be judged very accurately and some material gets stored for a longer time tha what is generally desirable. This results in deterioration of materials, which is very high for certain type of material such as paints, rubber goods. Obsolescence is one of the prices that must be paid for industrial and technological advancements. With the rapid changes in design and engineering, obsolescence becomes, a very alarming problem. Obsolescence cost is high in regard to store and spares required for the maintenance of machinery and equipment subject to rapid technological changes and low in regard to stabilized items of stores and raw materials. The larger the accumulation of inventory and higher is the risk of wastage and obsolescence. This may cost to the organization between 2-5%. If for capital cost, market rate of interest may be adopted, inventory-carrying cost may lie between 20-25%. On the other hand if opportunity cost of capital is to be considered, it may well lie between 30-35%.

Ordering cost: the ordering cost covers the cost of originating an indent, calling of quotations, processing the tenders, placing the order, verifying the invoices and payments. The composition of buying cost can be grouped as under: Purchase: Cost of inviting quotations and fixing most suitable supplier for the item. Cost of preparing and placing order. Expediting & miscellaneous costs: Salary of purchase personnel. Administrative and over-head costs. Expediting cost. Other Misc. cost.

Receipt & Inspection: Cost of receiving and handling Cost of inspection Cost of delivery from receiving to stores or direct to using department.

The reasons for including the above costs in calculation of ordering cost is that no such cost would be incurred if no purchasing were made. It is evident that if more purchases are made more people are required to order, follow up on orders, receive, inspect and handle them. The average cost per item order over a period, say a year shall be the sum of the costs as stated above and divided by the numbers of item orders during the year. The cost of placing an order would be naturally different for different categories of items such as locally available items, indigenous items from the national market and imported items. Tentatively, the ordering cost may be Rs.1,00,000.00 and Rs.25,000.00 per item order against open tender and limited/single tender respectively.

When the problem of inventory control refers to the manufactured item, the corresponding cost is the set up cost. Every time a production run is taken up, there is loss of machine time, operator time etc. and the cost of this time is included is the set up cost. In addition set up cost includes cost of paper work, inspection, etc. involved with every production run. The set up cost increases when the batch size is smaller and the number of batches is large. Stock-out cost: when an item is required and it is not available in stock, it is called stock-out. Because of stock-out, certain consequences follow and there is a certain cost associated with those consequences. Such a cost is known as the stock-out cost. If the consequences are serious such as break down or shut down of plant and machinery, men idle time, loss of production and profit, failure of customer services or loss of goodwill, the stock-out cost is considerable. On the other hand, a stock-out may involve a little more than carrying cost, stock-out cost is highly variable from item to item and place to place and depends upon both intangible and tangible factors so that its determination is much more complicated than that of possession costs. Each firm has to calculate its own stock-out costs for different items. As stated above, stock-out cost varies from item to item. For example, the stock out of a critical spare part, which is not readily available in the market, may be tremendous. On the other hand, the stock-out cost of supply item of a non-critical nature, readily available, may be insignificance.

Facts to be considered while working out stock-out cost In case of down time due to stock out of production materials, another product or a change in schedule can also be considered. The alternative may not apply while considering down time due to machinery itself. It is necessary to calculate stock out cost realistically. The real cost attributable to the stock out of spares( at site or at stores) is only the cost of additional down time due to such stock-out the portion of down time directly attributable to necessary maintenance work itself cannot be shown as the stock out cost of the spare part.

 it is further more realistic to base the stock out cost on the actual loss in production rather than merely on down time. For example: another machine may have spare capacity to take up the load. Then only reduction in production can be taken as stock out cost. In some cases, the machine itself may have enough extra capacity, so that the down time does not reduce the output over the required period. Then the stock out cost will only be the cost of stopping and restoring the work.

The Stock out cost is the sum of: Actual loss of production, due to added down-time or running at lower capacity. Actual cost of additional set ups and other costs associated with the change in schedule etc. The additional procurement costs incurred, liked air freight, deputing a man to the market solely for this purpose etc. and; The higher price paid for the item itself. This includes special pick up arrangements, procurement of a higher quality, than actually required, paying a higher price for quick availability.

V.E.D. analysis (Vital, Essential and Desirable) is primarily based on the stock-out cost of the items. The items, which have very heavy down time cost, are categorized as vital items. Stock outs may result in break down, shut downs or failure of customer services, and all of which are costly. It is, therefore, necessary to carry stocks so as to minimize chances of stock outs. At the same time, it is uneconomical to carry surplus inventories. Since both shortages and surpluses are costly, it is necessary to balance one against the order, which of course is a very difficult job. Left to themselves, inventories have a tendency to grow and grow beyond limits. The reasons for this phenomenon are that stock out are not only costly but they also attract immediate and adverse attention and criticism. To play safe, inventory

levels are kept higher so that not allow any stock-out. Another reason for playing safe it that whenever there are stock-outs management thinks of only immediate losses and forgets the considerable gains which the organization might have obtained from low level of stock and control. On the contrary, the over stock have a way of escaping notice until deliberately discovered. There is consequently a tendency to ignore their growth. If the excessive investment is made in the stock, there is going to be an adverse effect on the operational efficiency of undertaking due to non-availability of funds for other productive activities as the funds, which are scare are locked in surplus inventories. In fact by their very definition, surplus inventories secure no additional security. As units are added to inventory holding of an item the probability of stock out is reduced. But the additional carrying cost is also incurred as the holdings are increased. At some level of holdings, the cost of storing additional unit is balanced by the expected savings through avoidance of stockout. Holding beyond this level or surplus and uneconomical to carry.

SELECTIVE INVENTORY CONTROL TECHNIQUES: In a large size stores, there may be a few thousands item having different characteristics. Annual consumption value of some the items may be very high whereas for some items this value might be insignificant. Some items might be moving very fast, i.e. there might be many issues from stores in a month whereas there may be some items, which might not have moved from stores for years together. Some items may be imported whereas some might be indigenously available. Some items may be vital in the operations of the organization and nonavailability might result in huge production losses if they are required.

In view of this varying nature of various items, it really becomes difficult to formulate parameters to control them. It is here, the selective control techniques help us to control such a large variety of materials. Following are some of the selective techniques, commonly used for the purpose of inventory control. Classification ABC Analysis (also known as Always consumption of better control) Annual Value of Items(not based on unit price of items or the importance of items in operation)

VED Analysis(Vital, Essential & Desirable)

Criticality of the items i.e. Non-availability of items shall effect Operations to what extent(stock-out cost)

FSN(fast moving, slow-moving and Non-moving)

Movement i.e. issues from stores

HML(high, medium and low unit rates)

Unit price of the items

SDE(scarce, difficult and easy)

Purchasing problems with regard to availability in the market.

GOLF(Govt. controlled , ordinary, Source from which the material is local, foreign) obtained. MUSIC-3D (multi unit spares inventory Control-three dimensional approach) Finance, maintenance & Materials

XYZ

Value of items in the inventory at a given time, say end of financial year

ABC Analysis Why Selective Control Are we wasting our time on the unimportant and insignificant? We probably are if we are making the mistake of treating all the things being equally important. Why not direct our energy and time to few really important items in any group of materials, parts, products, operations, indirect costs, delay causes, customers, vendors, tooling etc. Such an approach will inevitably be more productive.

For any group, a small number of items in the group will, account for the bulk of the total value. Example, 70-80% of the wealth of the country is in the hands of 10-15% people. Similarly, 15-20% of the items in our family-budget, account for almost 80% of rupee expenditure.

Peretos Law Paretos law is relatively simple concept that identifies and concentrates on only important items. Developed by economist Vilfredo Pareto, in 1886, the law states that in any series of elements to be controlled, a selected fraction in terms of number of elements would always account for a large fraction in terms of effect. Conversely, the majority of the items will be on relatively minor significance in terms of effect. Paretos law is an important management concept although its practical value was not recognized for several decades. Today it influences management control system of every kind. There is most common application of Paretos law in inventory management system, where it is familiarly known as ABC method of inventory control. ABC and Inventory Control The first important step in the scientific inventory management is to adopt a selective approach in laying down inventory levels, order quantities and extent and closeness of control to be exercise. In absence of a selective approach to the problem of control. One or both of the following consequences are bound to arise: The cost of control rises so uneconomically high that it exceeds the value of any benefit arising out of control action. Control becomes so diffused and desultory that its very purpose is lost. In an industry there may be several thousand items, which may be required to be purchased or manufactured and kept in stock. It is very difficult to exercise control on such a large number of items. ABC analysis helps getting over this difficulty.

Categorization of inventory items into A.B.C: If all the stores items in an undertaking representing the entire inventory are analyzed in terms of annual consumption of each in rupee. It will be found that not more than 10% items will be responsible for nearly 70-75% of the total annual consumption value, about 20% items will account for 15-20% of annual consumption value and balance 70% items will cover nearly 10-15% balance value. The small number of high consumption value items are known as A, medium consumption value items as B and the large number of items whose annual consumption value is very small as C items. It is to be clearly understood that ABC Analysis is not based on the unit cost of the items are important and that is why they are kept in stock. This can be made clear with the help of following examples: In a large Colliery annual consumption of electric bulbs may be nearly 20,000 and therefore annual consumption value of bulb may be around Rs. 2,00,000 based on the average unit cost of Rs. 10. This item may be categorized as A item, due to high consumption value and not as C item since the unit cost is Rs. 10 An expensive machine is to be installed on the foundation but the job could not be completed since four foundation bolts are not available. This may be C item, since its annual consumption may not be more than a thousand rupees, yet it is as important as the machine itself since without these bolts machine cannot be installed.

Necessary steps in ABC Analysis: Determine or find out the unit cost of each item to be purchased or manufactured. Estimate for each of the items or parts covering the entire range during a specific period, preferably a year. Multiplying the unit cost by estimated or actual consumption to establish the net value of the selective period of time. Once the annual consumption values are computed, each item should be listed in rank order i.e. the descending order of magnitude.

 Develop both the numbers of items within the inventory and total annual consumption figures involved. Obtain the percentage of total value of consumption contributed to each item. Starting at the top with the highest ranked items, develop cumulative percentage for both the numbers of items and annual consumption value. Select out points that establishes the inventory classification for control purpose. The classification procedure although simple, but is time consuming unless done with computer. The result shall follow the pattern indicated below:

Approx. number of items(% age of total)

Approx. annual consumption value(%age of total value) 70-75%

10-15%

15-20%

15-20%

70-75%

10-15%

Categorization of items into A,B and C class items can also be done, by using thumb rule based on past experience. For example any item in a stores whose annual consumption value is Rs. 1,00,000 or above may be classified as A item, consumption from Rs.10,000 and more but less than Rs.1,00,000 as B class items and items whose annual consumption is less than Rs. 10,000 may be classified as C class items. These monetary limits can be checked to arrive at the above table and if necessary, adjustment can be carried out. Effect of ABC Analysis on inventory policies: ABC Analysis helps to put first things first and get control with the least amount of controlling. It is analytical approach that helps to concentrate the efforts in the area, which needs it most. C items being numerous and inexpensive, the control on them is normally relaxed to the extent of even dispensing with inventory records of them. A large safety stock can be maintained. A items which are small in number but which have high consumption value, very careful attention is given in estimating requirements, scheduling the deliveries, in prompt delivery and inspection. Their deliveries are arranged on monthly, weekly or even on daily basis. These high consumption value items are frequently reviewed and a close watch is maintained on their consumption, stock and progress of replenishment orders. Little safety stock is maintained for these items and with all these inventory levels are kept under strict control. The method of fixing inventory policies is as under: A items Tight control Based on exact requirements B items Moderate control Based on exact requirements Individual posting in stock cards Individual posting in stock cards Low safety stock Medium safety stock Close checking of physical stocks Some checking Exact quality control Exact quality control Regular follow up and expediting Periodical follow up and expediting Review system of ordering Review system of ordering C items Least control Based on estimated usage Group posting or no posting Large safety stock Little checking Approx. or visual control Exceptional follow up and expediting Fixed order quantity system of ordering

Weekly control statement Vigorous control statement Central purchasing Max efforts to reduce the leadtime Must be handled by senior officer As many sources as possible for each item through the regular vendor enlisting activities

Monthly control statement Monthly value analysis Combined purchasing Moderate effort To be handled by middle management 6-8 reliable sources of supply

6-month control statement Minimum value analysis De-centralized purchasing Min. clerical work Can be fully delegated to lower level 3-4 reliable sources of supply.

ABC Analysis, an effective tool of inventory management The importance of ABC Analysis in relation to order quantity may be illustrated with the help of the following examples. A company which, has not made use of ABC Technique, has fixed the same order quantity for all the items. This is equal to 3 months so that 4 orders are placed for all the items in a year. Taking example of 3 items of different levels of annual consumption, their average inventory is worked out in the following table: Annual consumption Rs: 3,00,000 30,000 3,000 No. of orders 4 4 4 12 Average working inventory Rs. 37500 3750 375 41625

A B C Total

(Average inventory is half of the order quantity/value) Keeping the same number of order viz. 12, inventory can be reduced merely by number of orders to be placed, based on the annual usage and position may be as under.

A B C

Annual consumption Rs. 3,00,000 30,000 3,000

No. of orders 8 3 1 12

Average working inventory Rs. 18750 5000 1500 25250

A small adjustment in number of orders and ordered quantity i.e. frequent orders for A item, therefore in small quantities have resulted in approximately 39% reduction in inventory and also saving in proportionate carrying cost.

Advantage of ABC Analysis: Identification of both extremes concerning the vital few and the trivial many, the extent of the mal-distribution is usually shocking. ABC Analysis also facilities the development of appropriate policies, systems, and procedures suitable to bringing about improved control according to differing characteristics of the established inventory classifications. Resources are better apportioned and utilized in order to create cost savings and other benefits. It also helps in finding a consensus view concerning priorities. This is a major contribution as it sets the stage for action. Following are some of the practical advantages: Reduced purchase prices due to concentration of efforts on A & B items and larger order quantities of C items. Reduced receiving department costs through processing fewer orders. Reduced receiving department and receiving inspection costs through elimination of handling and processing the materials and/or paper work for many small value items Reduced materials handling and internal transportation costs because of fewer load and easier load. Reduced stores department costs because of fewer receipts that must be handled, processed to storage location and recorded.

 Reduced traffic department costs because of less premium freight and less emergency tracing action required. Reduced accounts payable department costs because of fewer invoices to process. Reduced stock-outs in stores operation through better and balanced inventory. Reduced cost of production control department because smooth flow of materials, eliminates the need for schedule revisions. Reduction in total average inventory after the initial surge of larger C items order quantities work down and as a better purchasing performance reflects in reduced costs of A and B items due to more concentrated purchasing. General improvements in all involved departments because of elimination of such unnecessary work and improvements attained through concentration of the resources so relieved.

Initially, adoption of ABC Analysis will result in a temporary increase in carrying charges, such as interest, obsolescence, insurance, and taxes. However, this disadvantage will turn into an advantage when the total inventory value is reduces below the former level.

The area of this technique extends to almost every aspect of material management viz. purchasing, receiving of materials, inspection, store-keeping, verification of bills, inventory control, value analysis both pre-design and prepurchase and related operations. V.E.D. Analysis In V.E.D. Analysis items are categorized as in V(vital), E(essential) and D(desirable) categories on the basis of criticality i.e. non-availability of the items shall effect the operations to what extend(stock-out cost).

V-vital- critical items which render equipment totally and immediately inoperative, or unsafe i.e. if not in stock will result in high losses and complete closure of plant for a considerable time. E-essential- important items, which reduce the equipment performance but do not render into unsafe or inoperative immediately. Stock out of such items would result in expensive procurement, stoppage of work in a major area of the plant for which no standby facilities are available. But if not made available with reasonable time, may become Vital. D-Desirable- desirable but non-functional items, which do not affect the performance of the equipment. Stock-out results in nominal disruption for a short duration. In case of spare parts VED classification has to be do with V E I N classification of equipments used in the plant i.e. equipment themselves are to be classified as Vital, Essential, Important and Normal. Combination of VED for individual item of spares and VEIN for the equipment shall help to identify most critical spares, nonavailability of which shall result immediate loss of production, the core business of the organization.

Determination of essentiality or criticality should be done with the help of maintenance and operation experts, whose judgment is essential to derive a ranking of the items as Vital, Essential and Desirable. The factor to be considered, are essentiality, importance of each part to the ultimate goal, degree to which it can be compensated for, if lost and urgency to which it must be replaced.

ABC/VED Analysis Conventional method of ABC has only a limited use in spare parts field. What is more important here is the criticality i.e. cost of not having a part which is known as under-stocking cost. Thus a C category bolt costing a few hundred rupees may be very critical to operate the machine and hence the first step for spare part management is VED Analysis.

Once the ABC/VED classification is done, jointly by Operating and Maintenance and Materials Management Departments, selective control becomes possible. Thus if a part is vital but a C category item, it is logical to carry a reasonably high stock . on the contrary, if a spare is only desirable but an A category item, then it is natural to carry as low stock as possible. The following table will give a broad guideline. LOGIC FOR INVENTORY SYSTEM:

COST Vital A B C medium stock high stock very high stock

CRITICALITY Essential low stock medium stock high stock Desirable very low stock low stock medium stock