Inventory

Management

- Uday Bansode
uday.bansode@rediffmail.c
om

Introduction
Constitute significant part of current assets
A considerable amount of fund is required
Effective and efficient management is imperative to avoid
unnecessary investment
Improper inventory management affects long term profitability
and may fail ultimately
10 to 20% of inventory can be reduced without any adverse
effect on production and sales by using simple inventory planning
and control techniques

Meaning and Function

Meaning Inventories are resources of any kind having an economic value.
Properly maintaining adequate stocks to ensure uninterrupted service

Function
Inventory functions as a bank and decouples successive stages of operations.
Operating sub-systems Materials, Manufacturing and Marketing
Non-operating sub-systems Finance and Personnel

Need for inventory

Inventory is held for transaction purposes.
To maintain a given volume of sales to satisfy customers.
As a precaution or contingency for increase in lead time or a
consumption rate.
To decouple the materials department from the consuming
department.

Scope and Importance

New effective tools and techniques evolved for efficient
management of inventories.
Private and Public undertaking sectors can make savings in
inventories by effecting internal and external economies.
Savings can be achieved in
Material purchase by competitive bidding, value analysis
Economic ordering
Reducing deterioration
Obsolescence in storage
i.e. reducing working capital blocked up

Inventory Problem
Inventory problem is one of balancing various costs so that total
cost should be minimized. These costs are :Cost of ordering - Cost of carrying Quotation or tendering Warehousing or storage
Requisitioning
Handling
Order Placing
Clerical and staff
Transportation
Insurance
Receiving inspecting & Storing Interest
Quality control
Deterioration, wastage
Clerical and staff Taxes
Under stocking and Overstocking cost Loss of sale
Failure to meet delivery commitments

Lead Time influences the

Inventories
Lead time Time between placing an order and receiving it
Influence of various types of lead time on inventory decisions are :Administrative lead time
up orders

due to identification of needs and

follow-

Manufacturing lead time

goods

due to dependability on the supplier of the

Transporting lead time depends on the mode of transport and

formalities
Inspection lead time
arises due non-availability the standard to
compare the quality of the received
item.

Techniques of Inventory Management

1. Selective Inventory Control
2. Setting up various stock levels
3. Systems of Inventory Control
4. Economic Ordering Quantity or E.O.Q. Formula
5. Re-order Point and Safety Stock
6. Application of Computers for Inventory
7. Just-in-Time Inventory Management
8. Inventory Ratio
9. Aging Schedule of Inventory
10.Inventory Audit

1. Selective Inventory Control

Analysis and classification of inventory for effective inventory management :TitleUse Main use
ABC (Always Better Control)
Value of conception
progress inventories in the business

to control raw material, components and

work-in-

HML(High, Medium, Low) Material Unit price to control purchase

XYZ

Value of the items to review the inventories and their uses at

VED(Vital, Essential, Criticality of the

Desirable)
component
parts

in storage

scheduled intervals

to determine the stocking level of the spare

FSN(Fast, Slow, Non moving)

of the component
SDE(Scarce, Difficult, Easy to
obtain) procurement

consumption pattern

to control obsolescence

GOLF(Govt Ordinary, Local,

Foreign Sources) material

source of the procurement strategies

problems faced in lead time analysis and purchasing strategies

SOS(Seasonal, Off-Seasonal)Nature of supplies procurement strategies for seasonal items

Selective Inventory Control (contd..)

ABC Analysis :ABC (Always Better Control)
ABC analysis divides the total inventory into 3 classes A,B and C using the rupee volume,
as follows
'A' items are very important for an organization because of the high value of these items.
A items 20% of the items accounts for 70% of the annual consumption value of the
items.
'B' items are important, but of course less important, than A items and more important
than C items. Therefore B items are intergroup items.
B items - 30% of the items accounts for 25% of the annual consumption value of the
items.
'C' items are marginally important.
C items - 50% of the items accounts for 5% of the annual consumption value of the items.

Selective Inventory Control

(contd..)
ABC Analysis :-

Selective Inventory Control

(contd..)
ABC Analysis :-

Selective Inventory Control (contd..)

Advantages of ABC Analysis :Control - Stocking a better mix of the right inventory allows a company to
control over-supply and under-supply of important stock keeping units.
Costs - Once a company has determined which items fall into each ABC
category it can establish cost-reduction initiatives at the stock keeping units
level.
Improved service - ABC analysis provides a company with information to stock
the right-mix of inventory. When a company has the right inventory at the right
time it reduces backorders and unfilled orders. This has a positive impact on
customer service and gives a competitive advantage to the company that uses
this methodology.
Warehouse - Implementing ABC inventory management in the warehouse
reduces labor cost and increases productivity.

2. Setting up Various Stock Levels

Maximum Level = Re-order Level Expected minimum consumption in units
during minimum weeks to obtain delivery + Re-order qty
Example:
Normal usage100 units per day. Max. usage130 units per day. Minimum usage70 units per
day. Re-order period 25 to 30 days. Economic order quantity 5,000 units.
Calculate maximum limit or level. In order to calculate maximum limit of stock we must
calculate re-order point or re-order level first.
Ordering point or re-order level = Maximum daily or weekly or monthly usage
Maximum re-order
= 130 30
= 39,000 units
Calculation:
Maximum limit or level = Re-order level or ordering point Minimum quantity used in
re-order period usage + Economic order quantity
= 3900 (70 25) + 5,000
= 7150 units

Setting up Various Stock Levels

(contd)
Minimum Level = Re-order Level - (Avg usage per period x Avg time to obtain
delivery)
Example:
Normal usage100 units per day. Max usage130 units per day. Min. usage 70 units per day.
Re-order period 25 to 30 days
Calculate: minimum limit or level. To calculate minimum limit of materials we must
calculate re-order point or re-order first.
Ordering point or re-order level = Maximum daily or weekly or monthly usage
Maximum re-order
= 130 30
= 3,900 units
Calculation:
Minimum limit or level = Re-order level or ordering point Average or normal usage
Normal re-order period
= 3900 (100 27.5*)
1150 units
*(25 + 30 ) / 2

Setting up Various Stock Levels

(contd)
Re-order Level =

Max Re-order period x Max usage

Example:
Minimum daily requirement 800 units. Time required to receive emergency
supplies 4 days. Avg daily requirement 700 units. Min. daily requirement
600 units. Time required for refresh supplies One month (30 days).
Calculate ordering point or re-order level.
Calculation:
Ordering point = Ordering point or re-order level = Maximum daily or
weekly or monthly usage Lead time
= 800 30
= 24,000 units

Setting up Various Stock

Levels
Various stock levels fixed to control Inventory holding are :-

Avg Stock Level = Maximum Level + Minimum Level

2

3. Systems of Inventory Control

The Main systems of Inventory control are :a) Perpetual Inventory (Automatic Inventory) system
Main Functions i. Recording store receipts and issues to determine at any time the stock in hand.
ii. Continues verification of physical stock with reference to the balance
recorded in the stores record.
b) Double Bin (Fixed Order Quantity) System
i. Used for low consumption value items.
ii. Ideal for items for which demand and lead time are regular.
iii. Avoids necessity of taking physical inventories.

4.

Economic Ordering Quantity or EOQ Formula

Economic Order Quantity is one of the techniques of inventory control which minimizes
total holding and ordering costs for the year.
Definition of EOQ :EOQ is essentially an accounting formula that determines at which the combination of
order, costs and inventory carrying cost are at the least.
EOQ Formula :- EOQ or D = 2Q(a) / c
Where,
Q = Annual requirements in units
a = Unit cost of placing an order
c = Annual carrying cost
D = Optimum lot quantity or Batch Size

Economic Ordering Quantity or EOQ Formula

(contd..)
Tabular presentation of Economic Order Qty of 200 Units
No o f
Orders

Order
Qty

Avg
Stock
Holding

Inventory Ordering
carrying
cost (Rs.)
cost (Rs)

Total Cost
(Rs.)

40,000

20,000

4,000

10

4,010

20,000

10,000

2,000

20

2,020

13,333

6,667

1,333

30

1,363

10,000

5,000

1,000

40

1,040

8,000

4,000

800

50

850

10

4,000

2,000

400

100

500

15

2,667

1,334

267

150

417

20

2,000

1,000

200

200

400

25

1,600

800

160

250

410

30

1,333

667

133

300

Economic Ordering Quantity or EOQ Formula

(contd..)
Cost of each article is one rupee. Annual demand is 40,000 units. Cost of
carrying inventory is 20%. Cost per order is Rs. 10/Using the formula :D = 2Q(a) / c = 2x10x40,000 / 1x0.20
D = 40,00,000
D = 2,000 units
Here, EOQ is 2,000 units. When EOQ is 2,000 units, the no. of orders to be
placed in a year is 20 and the total cost is Rs. 400/- ( ordering and inventory
carrying cost are the same)

5. Re-order Point & Safety Stock

Formula Re-order point = Average Daily usage x Lead Time in days + Safety Stock
Safety Stock extra inventory held as a protection against possibility of a
stockout.

6. Application of Computers for

Inventory
Advantages Immense scope in areas like Inventory Management
Saving Time
Speed and Efficiency
Document Generation
Timely Data
Disadvantages
Reliance on Technology
Expense
Risk of fraud

7. Just-in-Time ( JIT ) Inventory

Management
JIT is aimed at monitoring the inventory process in such a manner as to
minimize the costs associated with inventory control and maintenance.

An inventory strategy companies employ to increase efficiency and

decrease waste by receiving goods only as they are needed in the production
process, thereby reducing inventory costs.
Lower Warehouse Cost
Better Supply Chain Management
Better Customer Satisfaction
Less Waste

8. Inventory Ratio Inventory Turnover Ratio

This ratio is used to evaluate the performance of the inventory function :ITR = Cost of sales during the period/Avg tock held during the period
where,
cost of sales means sales minus gross profit and
avg. stock indicates yearly avg.(average of opening and closing inventory)

Analysis - it is used to measure the inventory management efficiency of a business.

- a higher value indicates better performance and lower value means
inefficiency in controlling inventory levels.
- a lower inventory turnover ratio may be an indication of overstocking which
may pose risk of obsolescence and increased inventory holding costs.

Inventory Ratio Inventory Turnover Ratio

(contd)
Example:
During the year ended December 31, 2010 Loud Corporation sold goods costing
$324,000. Its average stock of goods during the same period was $23,432.
Calculate the company's inventory turnover ratio.
Formula - ITR = Cost of sales during the period/Avg tock held during the period
Solution
Inventory Turnover Ratio = $324,000 / $23,432 = 13.83

9. Aging Schedule of Inventory

Classification of inventories in accordance with age (days) assist in
identifying inventories which are moving slowly into production or sale.
Aging Schedule of Inventory as on 31 December 2011
Age
Dt of
Classificati Purchase/
on (days)
Mfg

Amount
(Rs.)

% of Total

0-20

December
11

10,000

20

21-40

December
7

5,000

10

41-60

November
21

3,000

61-80

November
5

25,000

50

81 and

October 20

7000

14

10. Inventory Audit

Aspects of Inventory Audit:-

i. Testing and appraisal of policy pursued for inventory forecasting,

planning and control
ii. Appraisal of inventory valuation method
iii. Testing and appraisal of inventory forecasting and planning models
iv. Testing and appraisal of control aspects
v. Testing the maintenance aspects of inventory & inventory records

Inventory Audit (contd..)

Auditors
conclusion
Process
By-products
Work-in-progress
ofobservation
manufacture
and&scrap
Inventory
Audit

Inventory Audit (contd)

Checking points for Auditing
i. process of manufacture auditor should be aware of technical
aspects of process of manufacture of main products and by-products
and scraps.
ii. Raw Materials auditor should ascertain that SOPs are followed
for purchasing, consuming raw material and also it should be
technically evaluated.
iii. Stores and Spares procurement and utilization of stores and
spares should be done for effective savings. Redundant investment
should be audited.
iv. Auditors observations and conclusions

Inventory Audit (contd)

Checking points for Auditing
iv. Auditors observations and conclusions Cost auditor should observe
following with respect to the inventory audit :a) whether firms funds have been used in a negligent or inefficient manner.
b) factors which could have controlled due to inventory but not done resulted in
increase in cost of production.
c) whether contracts/agreements related to purchase/selling of inventory items had
any undue benefits.
d) possibility of improvement in performance offering scope for cost reduction
and increase in productivity.
e) whether improved inventory policies will be useful for effective savings.

Case Study - McDonald's

Situation:-

There are multiple warehouses (Distribution Centers) located in

India and there exist common suppliers for each product. Also,
these suppliers are located across the country. Warehouses order as
per their requirement. Since the per trip loads are not enough to
send a dedicated truck from supplier to each warehouse, receiving
on-time deliveries and food safety of the products was a challenge.
This had affected inventory holding in warehouses leading to
higher inventory carrying cost, high inventory days, threat of
stock-out situation and in-transit damages, safety of food items in
transit and higher inbound cost. The need to transport products in a
cost effective manner and ensure on-time availability without
compromising on the integrity of the food products, was identified.

Case Study - McDonald's

Solutions Strategy:-

Ensure consolidation of stock at the nearest warehouse and move

full truck loads. To make it happen following steps were taken:
Movement of full truck load (consolidated load from multiple
warehouses) from supplier to the nearest warehouse.
Flexibility of consolidated movement viz. Freezer / Dry, Chiller /
Dry, etc in multi-temperature trucks.
Movement of stocks directly from vendor to the consumption
warehouse in case of high volume / fast moving products.
Planned pickup and delivery from vendors at least 15 days in
advance to ensure capacity utilization.
Fixed schedule of movement from consolidation warehouse to the
respective warehouses on Full Truck Load (FTL) basis.
Inventory days and safety stock maintained in line with the
scheduled movement.

Case Study - McDonald's

Results:Assured supply of goods, by optimizing inventory and frequency of delivery.
Cost benefit due to optimization of truck load.
Assured safety of products in transit.
Inventory under control i.e. reduced inventory holding from 20 days to 8 days.
Reduction in Inventory carrying cost.

Thank You