CHAPTER-I

CONCEPTUAL FRAMEWORK

INTRODUCTION TO FINANCIAL MANAGEMENT

Finance in the modern business world is regarded as the life and blood of a
business enterprise. Finance function has become so important that it has given birth
to financial management as a separate subject. So this subject is acquiring a universal
applicability.

Financial management is that managerial activity which is concerned with the

planning and controlling of the firm’s financial resources. As a separates activity or
discipline it is of recent origin it was a branch of economics till 1890. Still today it has
no unique body of knowledge of its own, and it draws heavily on economics for its
theoretical concepts.

The subjects of financial management are of immense interest to both

academicians and practicing managers. It is of great interest to academicians because
the subject is still certain areas where controversies exit for which no unanimous
solutions has been reaching as yet. Practicing managers are interest in this subject
because among the most crucial decisions of the firm’s are those which relate to
finance and un understandings of theory of financial management provides them with
conceptual and analytical insights to make decisions skillfully.

The modern thinking in financial management accords a rare greater importance to

management in decision making and formulation of policy. Financial management
occupies key position in top management and plays a dynamic role in solving
complex management problems. They are now responsible for shaping the fortunes of
the enterprise and are involved in allocation of capital.
DEFINATIONS:

“Financial Management is an area of financial division making, harmonizing

individual motives and enterprise goats”,

_ Weston and Brigham

“Financial Management is the application of the planning and control functions to the
finance function, -_ Howard and Upon

“Financial Management is the operational activity of a business that is responsible of a

business that is responsible for obtaining and effectively utilizing the funds necessary
for efficient operations”. _ Joseph and Messie

What Is Inventory

Inventory is the term for the goods available for sale and raw materials used to produce goods
available for sale. Inventory represents one of the most important assets of a business because
the turnover of inventory represents one of the primary sources of revenue generation and
subsequent earnings for the company's shareholders.

Understanding Inventory

Inventory is the array of finished goods or goods used in production held by a company.
Inventory is classified as a current asset on a company's balance sheet, and it serves as a
buffer between manufacturing and order fulfillment. When an inventory item is sold, its
carrying cost transfers to the cost of goods sold(COGS) category on the income statement.

Holding inventory for long periods of time is disadvantageous given storage costs and the
threat of obsolescence.

Inventory can be valued in three ways. The first-in, first-out (FIFO) method says that the cost
of goods sold is based on the cost of the earliest purchased materials, while the carrying cost
of remaining inventory is based on the cost of the latest purchased materials. The last-in,
first-out (LIFO) method states that the cost of goods sold is valued using the cost of the latest
purchased materials, while the value of the remaining inventory is based on the earliest
purchased materials. The weighted average method requires valuing both inventory and the
cost of goods sold based on the average cost of all materials bought during the period.

MEANING OF INVENTORY MANAGEMENT:

“Inventory Management” means planning, procurement, holding and

accounting and distribution of these and materials .In industries using agricultural raw
materials the percentage is still higher, thus a large part of working capital is invested
in inventories.

The management of inventories is therefore necessary is therefore necessary to

avoid heavy loss due to leakage, theft and wastage because neglecting the
management of inventories may jeopardize. The long on profitability of the concern
may fall ultimately. The reduction in excessive inventories carries a favorable impact
on a companies profitability.

The financial manager actually is a kind of watchdog over functional areas.

Broadly speaking the inventory management problem is one of maintaining for a
given financial investment an adequate supply of something in order to meet an
accepted distribution or pattern of demand.

Infant, the very existence of inventory creates costs. Sometimes it is difficult to

see what value is received from costs incurred. Inventory management may be
diffident as the sum total of those activities, which are necessary for the acquisition,
storage sale and disposal, or use management .It is a subject. This merits the attention
of the top-level management and the decisions of the planning and executive
personnel.
 Definition[edit]
The scope of inventory management concerns the balance between replenishment
lead time, carrying costs of inventory, asset management, inventory forecasting, inventory
valuation, inventory visibility, future inventory price forecasting, physical inventory,
available physical space, quality management, replenishment, returns and defective goods,
and demand forecasting. Balancing these competing requirements leads to optimal inventory
levels, which is an ongoing process as the business needs shift and react to the wider
environment.

Inventory management involves a retailer seeking to acquire and maintain a

proper merchandise assortment while ordering, shipping, handling and related costs are kept
in check. It also involves systems and processes that identify inventory requirements, set
targets, provide replenishment techniques, report actual and projected inventory status and
handle all functions related to the tracking and management of material. This would include
the monitoring of material moved into and out of stockroom locations and the reconciling of
the inventory balances. It also may include ABC analysis, lot tracking, cycle counting
support, etc. Management of the inventories, with the primary objective of
determining/controlling stock levels within the physical distribution system, functions to
balance the need for product availability against the need for minimizing stock holding and
handling costs.

NEED FOR THE STUDY

In any organization, all functions in the others, with inventory management.

Inventory of raw materials and suppliers are needed for sustaining production. The
nature of business activity will have a bearing on the inventory policies, Based on the
study of inventory management will not allow keeping money blocked and it will load
to smooth performance of the industry and also lea economic function and
profitability.

The increases in the number of mills have also resulted in the increase in the
production capacity. As there is through competition I market to dispose of spinning
bundles at profit, only a company with efficient distribution system can survive and
overcome the stiff competition further physical distribution system can survive and
overcome the stiff competition further physical distribution transportation and were
housing also plays a dominant on the distribution system.

OBJECTIVES OF THE STUDY

The objectives of the study include both primary and secondary objectives:

• To know the profile of the industry

• assess the performance of inventory control section of 3F LTD.,

• To analyze the efficiency of inventory management 3F LTD.,

• To have an overview of the purchase and stores department contribution to

inventory control and maintence.

• To have an insight into the company future plans and diversification.

• To study the methods and techniques of inventory control adopted by the

company.

THEORETICAL FRAME WORK OF

INVETORY MANAGEMENT

Inventory management is very important in an organization in order

to have a smooth move of it. The term inventory refers to the stockpile of the
products a fire is offering for sale and the components that make up the
product. In other words. inventory is composed of assets that will be sold in
future in the normal course of business operations.
• Inventory as a current asset differ from other assets because only
financial managers are not involved, rather all functional areas finance,
andmarketing,production and purchasing are involved. The view concerning
the appropriate level of inventory would among the different functional areas.
 • The job of the financial manager is to reconcile the conflicting
viewpoints of the various functional areas regarding the appropriate inventory
level in order to fulfill the overall objective of maximizing the owners wealth.
Thus, inventory management should be related to the overall objective of the
firm. The basic responsibility of the financial manager is to make sure the firms
cash flows are manager efficiently. Efficient management of inventory should
ultimately result in the maximization of owner wealth.
• Although our discussion of inventory management will focus on the
finance perspective it is important to understand that good inventory
management is vital to the success of virtually all firms. In fact inventory is the
key to being a top player in many industries today including both retailing and
manufacturing because of its importance, imagers at all levels, and in all
functional areas, are involved management.
• Inventory management activities can range from ensuring that there is
an adequate selection of different sizes of clothing available in a retail store to
stocking necessary replacement parts for commercial Aircraft.

Objectives of inventory management:

In the contest of inventory management the firm is faced with the problem of meeting
to conflicting needs.

• To meet the demand for the product by efficiently organizing the production
the production and sales operations.

• Control investments in inventories and keep it an optimum level.

• To minimize investments in inventory.

• To ensure against delays in deliveries.

• To utilize the advantage of price fluctuations.

• To take advantage of quality discount control.

The inventory management includes the following aspects

• Maximum

• Minimum

• Establishing timing schedules, procedures and lot of sizes fir new orders.
Ascertain minimum safety levels.

• Co-ordinate sales production and inventory policies providing proper storage

facilities.

These objectives can express in terms of cost and benefit associated with
inventory. Inventories provide benefits to the extent that they facilitate the smooth
functioning of the firm.

Need to hold inventories:

Maintaining inventories involves tying up of companies find and incurrence of

storage and handling costs. There are three general motives for holding inventories.

Transitive motive emphasizes the need to maintain inventories to facilitate

smooth production and sales operations.

Precautionary motive necessities holding of inventories to guard against the

risk of unpredictable changes in demand and supply forces and other factors.

Speculative motive influences the decision to increase or reduce. Inventory

levels to take advantage of price fluctuations

Different Types of Inventories:

An Inventory is an idle resource that possesses economic value. It is an item that is

stored or reserved for meeting future demand such items may be materials, machines,
money, or even human beings.

Inventories are stock of product a company is manufacturing for sale and components
that make up the product. Inventories are composed in to:
 • Raw materials

• Work in Progress

• Finished goods

• Consumables

• Bought out Components

• Packing materials

• Spare parts

Raw Materials:

Raw materials are those items purchase to be processed and are the major input into
an organization and from the bulk, which gets converted into output.

The function of raw materials is to act a buffer between procurement and

manufacturing

There are 2 important factors:

1.Internal Factors:

Production Technology

Criticality of the item

2.External Factors:

• Lead time(administrative and suppliers ) Vendors relations

• Availability of materials

• Government policy

• Seasonally

• Credit situation and govt, restriction

Consumables:

These are the materials which act as catalyst in the production process and not directly
found in the end product. These enable the production process to function smoothly.
The inventory level of these consumables can be fixed based on the past consumption

Bought Components:

Organizations especially those in consumer goods and engineering industry do not

always produce 100% of their output from raw materials. At times they find it cheaper
and more convenient to buy from regular vendors.

This enables them to concentrates more on critical parts and assembly.

The important factors that influence the bought components are:

• Make or buy decision

• Source development

• Vendor relations

Make or buy decision must be taken through “touch economic analysis”

Source Development is laborious and time consuming more if the unit is located in
backward area or region.

Vendor relations are built up over the years depending upon quality.

Regularity or supply and financial transactions. Usually vendors operate at much smaller
level.

Work in Progress:

The process inventories exist so long as we have been considering inventory as buffer
between two or three subsystems, work –in-progress acts as a buffer with in
manufacturing sub-system. There can be group of machines, which can be termed as
work centers. The raw materials will have to go through a combination of operations
before it takes shape as a “salvable product” .
 The rate of production at each production center depends upon the technology.
While the production executive tries his best to balance lines there is certain break
downs which will effects downstream productions. To overcome this work – in
progress inventories is stored as work centers.

Finished goods:

Finished goods are those gods available for delivery to consumer, finished goods act
as buffer between production and marketing department. The input in quite
predictable but output depend upon the behavior of market. The purpose of this
inventory is to assure a constant supply in distribution channels.

Some of the factors that contribute to high finished goods inventory.

• Errors caused in forecasting

• Eagerness to satisfy the customers

• Economic batch production

• Multiply stock points

• Imports

• Distribution system

Packing materials:

Packing materials does not add to the value of the product. It protects what it
sells and sells what is protects. Hence this cost comes out of one profit. Some consider
packing material as consumable, the difference being that these are consumables for
marketing subsystem to give a face lift to the product.
Spare Parts:

Spare parts are the important inventory. Their consumption pattern differs from
raw materials, consumbles or finished goods conversely stocking policies are
different.

Many problems occur in case of these spares some are:

• Determination of level inventory for placing replenishment order and the

quality to be ordered.

• The extent of delay in supplies and the extent of variations in demand which
inventory should be able to withstand.

Some spares are thus classified into:

• Capital Spares

• Insurance Spares

• Routable Spares

• Maintenance Spares

• Over hauling spares

Capital spares and insurance spares are those spares of the machine, which have
nearly equal life of the machine.Characteristics of these spares is.

• These are held as contingency against any break down

• Their consumption is very low

• The procurement lead times is very high

• Normally these spares are procured along with original equipment.

Maintenance apares are those which have definite requirement compared to capital
and insurance spares. These are required for the replacement of the old parts caused
due to replacement of wear and tear; they are fast moving and are repetitive.
 Ratable spares are costly so they are not usually scrapped but they are prepared
and stored for use. The demand for such a spare part for any single machine is low but
for group of machines is high. Queuing theory is practiced to control routable spares.

Over hauling spars include those items which are specially needed during regular
overhaul. These items are like valves, couplingsetc. The strategy that adopted to
control these spares are based on past consumption Therefore initial provisioning
either when starting a new industry or machinery is problematic.

Features of Inventory Management:

Comprised of many components, the inventory management system makes handling the
inventories an easy and simpler task.

Owing to the inventory management services, the overall efficiency and productivity time
consuming chores efficiently and this in turn lets the focus be on the production of the
business improves.

It is essential to use such kinds of inventory software for the business as they handle the
regular tasks and part.

Following are few of the features of inventory management system.

1. Order management:

With the help of a proper and effective inventory system, an adequate amount of inventory
can be maintained at all times.

The system raises an alarm in the case where the inventory drops down a specific threshold
limit or exceeds over and above the prescribed limit. In both the conditions, due steps are
taken and the needful is done.

2. Asset tracking:

Tracking of the asset is yet another feature of asset management.

In the case where there is a requirement of a specific product/ raw material and it is not easily
traceable with the naked eye or is stored in the warehouse, then in that case measures are
taken and the location of the same is identified using the software.

This easy tracking of the product helps a great deal in saving the time and energy of the
person in charge of finding it and the same can be invested somewhere else and productivity
can be reaped.

The identification in such a case can be made through serial number, barcode etc.

3. Service management:

In the case of companies which deal primarily into the service industry, this kind of
management system helps in tracking the cost of the materials which are used for providing
services and includes the cost of cleaning, supplies etc.

This in turn helps in attaching the cost to the total cost of the services.

4. Inventory optimization:

An inventory management method helps a great deal in optimizing the inventory. It helps in
deciding the reorder point for a manufacturing process, i.e., when should the fresh order for
inventory be placed along with the appropriate quantity of inventory.

It also helps in managing the stock in hand as well the days for which the stock will be
available in case there arises some emergency due to which the fresh order cannot be placed
for new stock.

The main functions of inventory management

 Managing the raw materials

(Materials and components used to make a product)
 Managing the production of goods
(from raw material to finished goods)
 Managing the stock of goods produced
(finished goods ready for sales)
  Managing the goods for resale
(returned goods that can be resold)
 Tracking the sales process of the goods
 Monitoring the stock in transit
 Managing the consignment stocks
 Maintenance supply

Challenges of inventory management:

1. Understanding the Inventory –

Organizations should take a holistic view into knowing both basic vs. non-
basic matter and at what time they should be ordered. Basic items are those that you
sell ant time of the year and need incessant replenishing of stock. By sorting these out
from non-basic or seasonal items inventory levels can be much more allied with a
recognized schedule and product lifecycle. However, knowing your items are is just
the first step. One must have knowledge about stock capacity, what is going to be
ordered, the size of the order, and what needs to be refilled.
2. Incompetent Processes –

Built on or rely on dated software or manual processes are used for inventory
management systems. This creates an extremely demanding work setting for anybody
caught up in the inventory management process. One must begin with a review of
current standard operating procedures and settle on where gaps may lie in the systems.
3. Client Demand –

Customers needs are varying daily and they are looking to their distributors to
allow for elasticity in orders. With the mounting demand of struggle it becomes more
taxing to keep up with the exclusive needs of the consumers to reassure they do not
have those needs met by some other firm. All these factors help in understanding
inventory management.
Principle of inventory proportionality

Purpose

Inventory proportionality is the goal of demand-driven inventory management. The

primary optimal outcome is to have the same number of days' (or hours', etc.) worth
of inventory on hand across all products so that the time of runout of all products
would be simultaneous. In such a case, there is no "excess inventory," that is,
inventory that would be left over of another product when the first product runs out.
Excess inventory is sub-optimal because the money spent to obtain it could have
been utilized better elsewhere, i.e. to the product that just ran out.

The secondary goal of inventory proportionality is inventory minimization. By

integrating accurate demand forecasting with inventory management, rather than
only looking at past averages, a much more accurate and optimal outcome is
expected.

Integrating demand forecasting into inventory management in this way also allows
for the prediction of the "can fit" point when inventory storage is limited on a per-
product basis.

Applications

The technique of inventory proportionality is most appropriate for inventories that

remain unseen by the consumer, as opposed to "keep full" systems where a retail
consumer would like to see full shelves of the product they are buying so as not to
think they are buying something old, unwanted or stale; and differentiated from the
"trigger point" systems where product is reordered when it hits a certain level;
inventory proportionality is used effectively by just-in-time manufacturing processes
and retail applications where the product is hidden from view.

One early example of inventory proportionality used in a retail application in the

United States was for motor fuel. Motor fuel (e.g. gasoline) is generally stored in
underground storage tanks. The motorists do not know whether they are buying
gasoline off the top or bottom of the tank, nor need they care. Additionally, these
storage tanks have a maximum capacity and cannot be overfilled. Finally, the
product is expensive. Inventory proportionality is used to balance the inventories of
the different grades of motor fuel, each stored in dedicated tanks, in proportion to the
sales of each grade. Excess inventory is not seen or valued by the consumer, so it is
simply cash sunk (literally) into the ground. Inventory proportionality minimizes the
amount of excess inventory carried in underground storage tanks. This application
for motor fuel was first developed and implemented by Petrolsoft Corporation in 1990
for Chevron Products Company. Most major oil companies use such systems today.

Roots

The use of inventory proportionality in the United States is thought to have been
inspired by Japanese just-in-time parts inventory management made famous
by Toyota Motors in the 1980s.

High-level inventory management

It seems that around 1880 there was a change in manufacturing practice from
companies with relatively homogeneous lines of products to horizontally integrated
companies with unprecedented diversity in processes and products. Those
companies (especially in metalworking) attempted to achieve success through
economies of scope - the gains of jointly producing two or more products in one
facility. The managers now needed information on the effect of product-mix decisions
on overall profits and therefore needed accurate product-cost information. A variety
of attempts to achieve this were unsuccessful due to the huge overhead of the
information processing of the time. However, the burgeoning need for financial
reporting after 1900 created unavoidable pressure for financial accounting of stock
and the management need to cost manage products became overshadowed. In
particular, it was the need for audited accounts that sealed the fate of managerial
cost accounting. The dominance of financial reporting accounting over management
accounting remains to this day with few exceptions, and the financial reporting
definitions of 'cost' have distorted effective management 'cost' accounting since that
time. This is particularly true of inventory.
Hence, high-level financial inventory has these two basic formulas, which
relate to the accounting period:

1. Cost of Beginning Inventory at the start of the period +

inventory purchases within the period + cost of production within the period =
cost of goods available
2. Cost of goods available − cost of ending inventory at the end of the period
= cost of goods sold

The benefit of these formulas is that the first absorbs all overheads of production and
raw material costs into a value of inventory for reporting. The second formula then
creates the new start point for the next period and gives a figure to be subtracted
from the sales price to determine some form of sales-margin figure.

Manufacturing management is more interested in inventory turnover

ratio or average days to sell inventory since it tells them something about
relative inventory levels.

Inventory turnover ratio (also known as inventory turns) = cost of goods sold /
Average Inventory = Cost of Goods Sold / ((Beginning Inventory + Ending
Inventory) / 2)

and its inverse

Average Days to Sell Inventory = Number of Days a Year / Inventory Turnover

Ratio = 365 days a year / Inventory Turnover Ratio

This ratio estimates how many times the inventory turns over a year. This
number tells how much cash/goods are tied up waiting for the process and is
a critical measure of process reliability and effectiveness. So a factory with
two inventory turns has six months stock on hand, which is generally not a
good figure (depending upon the industry), whereas a factory that moves
from six turns to twelve turns has probably improved effectiveness by 100%.
This improvement will have some negative results in the financial reporting,
since the 'value' now stored in the factory as inventory is reduced.

While these accounting measures of inventory are very useful because of

their simplicity, they are also fraught with the danger of their own
assumptions. There are, in fact, so many things that can vary hidden under
this appearance of simplicity that a variety of 'adjusting' assumptions may be
used. These include:

 Specific Identification
 Lower of cost or market
 Weighted Average Cost
 Moving-Average Cost
 FIFO and LIFO.
 Queueing theory. [16]

Inventory Turn is a financial accounting tool for evaluating inventory and it is

not necessarily a management tool. Inventory management should be
forward looking. The methodology applied is based on historical cost of
goods sold. The ratio may not be able to reflect the usability of future
production demand, as well as customer demand.

Business models, including Just in Time (JIT) Inventory, Vendor Managed

Inventory (VMI) and Customer Managed Inventory (CMI), attempt to minimize
on-hand inventory and increase inventory turns. VMI and CMI have gained
considerable attention due to the success of third-party vendors who offer
added expertise and knowledge that organizations may not possess.

Inventory management in modern days is online oriented and more viable in

digital. This type of dynamics order management will require end-to-end
visibility, collaboration across fulfillment processes, real-time data automation
among different companies, and integration among multiple systems. [17]

Nowadays, effective materials and inventory management plays an important

role in successful organization competitiveness. Incorporating Inventory
Management Policy into the general and classical Supply Chain Network
Design (SCND) problem have significant effects on complexity of the
formulated problem. Lagrangian Relaxation (LR) provides efficient approach
for solving large instances of those problems.