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.