INVENTORY MANAGEMENT

CONTENTS:

1) Executive summary2) Introduction to the concept3) Industry profile4) Company profile

a) Back ground and inception of the companyb) Nature of the business carriedc) Vision , mission and quality policyd) Product/services profilee) Area of operation – global/national/regional ownership patternf) Competitors informationg) Infrastructural facilitiesh) Achievement award i) Workflow model (end to end)

5) Mckinsey’s seven S Model a) Structureb) Skillc) Styled) Strategye) Systemf) Staffg) Shared value

6) Research methodologya) Title of the project

b) Statement of the problemc) Objectivesd) Operational definitionse) Data collectionf) Statistical tools used for research g) Sampling techniques – sampling unit, sample size and sampling

method.h) Plan of analysis i) Limitations

7) Data analysis and interpretation8) Summary of the findings9) Suggestions10) Conclusions – future growth11) Learning experience12) Annexure

a) Financial statementsb) Questionnairesc) Bibliography.

EXECUTIVE SUMMARY

EXECUTIVE SUMMARY

Title of the project

“A STUDY ON INVENTORY MANAGEMENT”

STATEMENT OF PROBLEM

A study of inventory management at ABB LTD is undertaken in order to

know the inventory performance and position of the company and to know the

strength and weakness and to assess the profitability of the company.

Inventories constitute most significant part of assets of large majority of the

companies in India. Inventory a double edged sword is usually an asset of an

organization, if not used properly it will become liability. It is therefore

absolutely very important to manage inventories efficiently and effectively in

order to overcome unnecessary investment. And “To identify the

problems/challenges involved in the Inventory Management process at ABB

ltd.”

OBJECTIVES OF THE STUDY

The main objectives of the study are:-

OBJECTIVES:

1. To study the tools and techniques of inventory management adopted at ABB Ltd.

2. To study the inventory control measures in inventory management.

3. To study the demand forecast of inventory management at ABB Ltd.

4. To study how ABC analysis and aging schedule is implemented in inventory management.

5. To determine the stock level in inventory management at ABB Ltd.

6. To identify problems related to inventory management and to find out suitable measures to overcome them.

7. To study the methods of valuation of inventory on ABB Ltd.8. To study the inventory management procedure.9. To make a comparative study of inventory management in last

5 years using ratio analysis technique.

Methodology of data collection

a) Primary data

The primary data is collected by personal interviews with officials.

b) Secondary data

Files, annual reports, periodicals, manuals and text book. Which have already

been passed through the statistical process are the secondary data used.

c) Field work

This was under taken individually to collect various information regarding the

study by visiting following sections.

Stores department

Information regarding stocking of materials receipts and issues to workshops.

Inventory control procedures in various wards inside the department were

obtained.

Accounts department

Remaining all the information was obtained from accounts department through

personal interviews with section officials.

Plan of analysis

The analysis and interpretation was collected from finance department thus

processed and tabulated is in the form of tables and graphs. The table thus

obtained by calculating average, percentage, turnover ratio, graphs and diagram

in respect of the stock of raw materials sales & inventory control procedures

and thus to draw conclusion from the analysis done.

Scope of the study

This study is to find the facts and opinions of inventory management and

control at ABB plant.

In accordance with the present trends it aims mainly at finding out the

inventory control procedures at ABB.

This study gives the brief information about the inventory management of

the indo ABB ltd

The study was done by using annual reports, inventory manual…etc.

Limitation of the study

Time restriction was only 30 days of project work in the organization.

The information, which was needed, could not be made public by the

organization.

The study are related to ABB ltd Bangalore only

The finding and suggestion cannot be generalized.

The study covered a wide concept hence wide collection and coverage of

information was not easily possible.

INTRODUCTION TO THE

CONCEPT

INTRODUCTION:

Every enterprise needs inventory for smooth running of its

activities. It server as a link between the production and

distribution process. The greater a time lag, the higher the

requirement of inventory the unforeseen fluctuation of inventory

demand and supply of goods, fluctuating inventory prices,

necessitate the need for inventory management.

The investment inventory constitutes the most significant

part of the current assets inventory of the under taking. Thus it is

very essential to have a proper control and management of

inventory.

Meaning and nature of inventory

The general meaning of inventory is stock of goods or list of goods

inventory. In accounting language it means stock of finished goods.

For inventory manufacturing concern it includes raw materials, work

in progress, consumables finished goods and spares etc.

1) Raw materials:

If forms a major input inventory in organization. The quantity

of raw materials required will be determined by the rate of

consumption.

2) Work in Progress :

The work in progress is that stage of stocks, which are in

between raw materials and finished goods.

3) Consumables :

These are the material, which are needed to smoothen, the

process of production. These do not directly go into

production, but act as catalyst.

4) Finished Goods :

These are the goods, which are ready to sale for the

consumers. The stock of finished goods provides as buffer

between production and market.

5) Spares:

Spares also from a part of inventory. The stocking policies

differ from industry to industry.

Inventories cost account for nearly 55 percent of the cost of

production, as it is clear from an analysis of financial statements of

large number of private and public sector organizations. So, It

essential to establish suitable procedures for proper control of

materials from the time of purchase order placed with supplier until

they have been consumed properly and accounted for.

Definition:

The term inventory refers to assets, which will be sold in future

in the normal course of business operations. The assets, which

the firm stores as inventory in anticipation of need, are raw

materials, work-in-progress/process, and finished goods.

Inventory often constitute a major element of a total working

capital and hence ft has been correctly observed, 'Good

inventory management is good financial management’.

Inventory control is a system, which ensures the provision of

the required quantity at the required time with the minimum

amount of capital.

Inventories are the second largest asset category for the

manufacturing firms next to plant and equipment.

Inventory control includes scheduling, the requirements,

purchasing, receiving and inspecting, maintaining stock records

and stock control. Inventory control is a matter of coordination.

A proper material control helps in improving the input-output

ratio.

Objective of inventory management

The main objective of inventory management are operational and

financial. The operational object means availability of materials and

spares in sufficient quantities for undisturbed flow of production.

The financial objective means investments in inventories should not

remain idle and minimum working capital should be locked in it.

THE OTHER OBJECTIVES ARE:

1) To ensure continues supply of inventories to the production.

2) To avoid over stocking and under stocking.

3) To maintain optimum level of investment in inventories.

4) To keep material cost under control, to keep low cost of

production.

5) To eliminate duplication in ordering or replacing stocks.

6) To minimize losses through, deterioration, pilferage, wastage

and damages.

7) Designing structures for good inventory management.

8) Perpetual inventory control of materials.

9) To ensure right quality of goods at reasonable prices. Analysis

of prices cost and value.

10) To facilitate data for short and long term planning and control of

inventory.

NEED FOR INVENTORY CONTROL:

If a cost accounting system is to be effective there must be a

proper control of inventory and supplies form the time orders

are placed with suppliers until they have been effectively

utilized in production.

Materials are equivalent to cash and they make up an important

part of the total cost. It is essential that materials should be

properly safeguarded and correctly accounted. Proper control of

material can make a substantial contribution to the efficiency of

a business. The success of a business concern largely depends

upon efficient purchasing, storage, consumption and

accounting.

In a large firm the planning and routing department is

responsible for arranging how and where the work is to be done

and issue instructions. It sets definite time schedules so that

necessary materials are delivered to the proper department in

proper time not too long before hand neither lest it should

interfere with other work nor after they are required as this

result in idle time.

Business firm keep inventories for different purposes. Every

firm big or small trading or manufacturing has to maintain some

minimum level of inventories. Based on some motives the

inventories are maintained.

a. Transaction motives:

Every firm has to maintain some level of inventory to meet the

day-to-day requirements of sales, production process, customer

demand etc. In this finished goods as well as raw material are

kept as inventories for smooth production process of the firm.

b. Precautionary motive:

A firm should keep some inventory for unforeseen

circumstances also like loss due to natural calamities in a

particular area, strikes, lay outs etc so the firm must have some

finished goods as well as raw-materials tc meet circumstances.

c. Speculative motive:

The firm may be made to keep some inventory in order to

capitalize an opportunity to make profit due to price

fluctuations.

REASONS AND BENEFITS OF INVENTORY:

The optimal level of maintaining inventory is a subjective

matter and depends upon the features of a particular firm,

(i) Trading firm:

In case of a trading firm there may be several reasons for

holding inventories because of sales activities that should not

be interrupted. More over it is not always possible to procure

the goods whenever there is a sales opportunity as there is

always a time gap required between purchase and sale of

goods. Thus trading concern should have some stock of finished

goods in order to under take sales activities independent of the

procurement schedule.

Similarly, a firm may have several incentives being offered in

terms of quantity discounts or lower price etc by the supplier of

goods. There is trading concern inventory helps in a de-inking

between sales activity and also to capitalize a profit of

opportunity due to purchase made at a discount will result in

lowering the total cost resulting in higher profits for the firm.

(ii) Manufacturing firm:

A manufacturing firm should have inventory of not only the

finished goods, but also of raw materials and work-in-progress

for following reasons.

(a) Uninterrupted production schedule:

Every manufacturing firm must have sufficient stock of raw

materials in order to have the regular and uninterrupted

production schedule. If there is stock out of raw materials in

order to have the regular and uninterrupted production

schedule. If there is stock out of raw material at any stage of

production process then the whole production may come to a

half. This may result in custom dissatisfaction as the goods

cannot be delivered in time more over the fixed cost will

continue to be incurred even ff there is no production.

Further work-in-progress would let the production process run

smooth. In most of manufacturing concerns the work in

progress is a natural outcome of the production schedule and it

also helps in fulfilling when some sales orders, even if the

supply of raw-materials have stopped.

(b) Independent sales activity:

Inventory of finished goods is required not only in trading

concern but manufacturing firms should also have sufficient

stock of finished goods. The production schedule is a time

consuming process and in most of the cases goods cannot be

produced just after receiving orders. Therefore, every firm has

to maintain minimum level of finished goods in order to deliver

the goods as soon as the order is received.

Costs involved in inventory:

Every firms maintains inventory depending upon requirement

and other features of firm for holding such inventory some cost

will be incurred there are as follows:

(a) Carrying Cost;

This is the cost incurred in Keeping or maintaining an inventory

of one unit of raw materials, work-in -process or finished goods.

Here there are two basic cost involved.

(i) Cost of storage:

It includes cost of storing one unit of raw materials by the firm.

This cost may be for the storage of materials. Like rent of

spaces occupied by stock, stock for security, cost of

infrastructure, cost of insurance, and cost of pilferage,

warehousing costs, handling cost etc.

(ii) Cost of financing:

This cost includes the cost of funds invested in the

inventories .It includes the required rate of return on the

investments in inventory in addition to storage cost etc. The

Carrying cost include there fore both real cost and opportunity

cost associated with the funds invested in the inventories.

The total carrying cost is entirely variable and rise in directly

proportion to the level of inventories carried.

Total carrying cost = (carrying Cost per unit) x (Average

inventory)

(b) Cost of ordering:

The cost of ordering includes the cost of acquisitions of

inventories. It is the cost of preparation and execution of an

order including cost of paper work and Communicating with the

supplier.

The total ordering cost is inversely proportion to annual

inventory of firm. The ordering cost may have a fixed

component, which is not affected by the order size: and a

variable component, which changes with the order size.

Total Ordering Cost = (No.Of orders) x (cost per order).

(c) Cost of stock out:

It is also called as Hidden cost. The stock out is the situation

when the firm is not having units of an item in stores but there

is a demand for that Item either for the customers or the

production department .The stock out refers to zero level

inventory .So there is a cost of stock out in the sense that the

firm face a situation of lost sales or back orders .The stock outs

are quite often expensive. Even the good will of firm also be

effected due to customers dissatisfaction and may lose

business in case of finished goods, where as in raw materials or

work in process can cause the production process to stop and it

is expensive because employees will be paid for the time not

spend in producing goods.

The carrying cost and the ordering cost are opposite forces and

collectively. They determine the level of inventors in a firm.

Total cost =(cost of items purchased) +(Total Carrying

and ordering cost)

Valuation of Inventory:

The methods of valuing inventory are combination of the actual

cost and replacement cost plans. The chief advantage of the

cost or net realizable value rule is that it is conservative. Hence

the methods of Valuation of inventory are quite independent of

system of mincing.

In balance sheet closing stock is shown under current assets

and is also credited to manufacturing or trading accounts. The

inventories are valued on the basis as follows.

Cost of raw materials in stock may include freight charges

and carrying cost. But such cost should not exceed market

price,

Work -in -process is generally valued at cost, which includes

cost of materials, labor. And the proportionate factory

overhead, as it is reasonable according to degree of

completion,

Cost of finished goods wound normally to be total or full

cost it includes prime cost plus appropriate amount of the

overhead. Selling and distribution cost is deducted on the

other hand work in progress may be valued at work in

progress may be Valued at work cost, marginal cost, prime

cost or, even at direct materials.

ISSUE PRICING METHODS:

There are two categories:

(i) Cost prices:

(a) FIFO (First in First out)

(b) LIFO (last in first out)

(c) Specific price

(d) Base stock price

(e) HIFO (highest in first out)

(ii) Derived from cost prices:

(a) Simple average price

(b) Weighted average price

(c) Periodic simple average price

(d) Periodic weighted average price

(e) Moving simple average price

(f) Moving weighted average price

(iii) Notional prices:

(a) Standard price

(b) Inflated price

(c) Re-use price

(d) Replacement price

First in First out (FIFO)

This is the price paid for the material first taken into stock from

which the material to be priced could have been drawn.

Under this method stocks of materials may not be used up in

chronological order but for pricing purpose it is assumed that

items longest in stock are used up first. The method is most

suitable for use where in material is slow-moving and

comparatively high unit cost.

Advantages:

i. Price is based on actual cost and not on basis of

approximations such as no profits or losses arises by

reasons of adopting this method.

ii. The resulting stock balance generally represents fair

commercial valuation of stock.

iii. It is based on traditional principles.

Disadvantages:

i. The number of calculations in the stores ledger involved

tends to be complicated with increase in clerical error.

ii. The cost of consecutive similar jobs will differ if the

price changes suddenly,

iii. In times of rising prices, the charge to production is

unduly low as the cost of replacing the material will be

higher.

Last in first out (LIFO)

This is the price paid for the material last taken into stock from

which the materials to be priced could have been drawn. This

method also ensure material being issued at the actual cost. Its

use is based on the principle that costs should be as closely as

possible related to current price level. Under this method

production cost is calculated on basis on replacement cost.

Advantages:

i. Production is charged at the most recent prices so that it is

based on the principle that cost should be related to current

price levels.

ii. It obviates the necessity for continuously ascertaining the

replacement price.

iii. Neither profit nor loss is usually made by using this method.

iv. In the times of rising prices there is no wind fall profit as

would have been obtained under FIFO method.

Disadvantages:

i. Needs more clerical work.

ii. Compassion among similar jobs is very difficult.

iii. Stock valves relating to prices of the oldest cost on hand

may be entirely out of the current replacement prices.

Weighted average price:

This is the price which is calculated by dividing the total cost of

material in the stock from which the material to be priced have

been drawn, by the total quantity of material in the stock. This

method differs from all other methods because here issue

prices are calculated on receipts of materials and not on issue

of materials. Thus as soon as new lot is received a new price is

calculated and issues are then taken.

Advantages:

i. This method is advantageous where the price varies

widely as its use even out the effect of these wide

variations.

ii. The basis of price calculations is a simple one involving

only the division of total amount of material in stock by

quantity in stock.

iii. Calculation of new prices arises only when receipt of

stocks are received.

iv. Stock records under this method give a fair indication of

the stock values, which can be used in financial

analysis.

Disadvantages:

This method is completed than simple average because it takes

into consideration the total quantities and total costs in stock.

i. Profit or loss may be incurred as in simple average

price,

ii. As LIFO or FIFO this method calls for many calculations,

iii. In order to calculate the accurate value of issues the

average price must normally be calculated to four to

five decimal places.

Standard price:

It is the predetermination of fixed price on basis of a

specification of all factors affecting price like the quantity of

materials in hand and to be normally purchased and rate of

discount compared with existing price including or excluding

freight and ware housing expense.

A standard price for each material is set and the actual price

paid is compared with standard. It is paid exceeds the standard

a loss will be realized if not profit will be obtained.

Advantages:

i. This method is easy to operate.

ii. Comparing the actual prices with the standard price will

determine the efficiency of purchase department.

iii. The effect of price variations is eliminated from job

costs.

iv. It reduces classical costs by eliminating detailed cost

records.

v. In times of inflation or price fluctuations is very difficult

to fix a standard price.

vi. This method also incurs a profit or loss on issues and

closing stock.

Inflated price:

This is the price, which includes a charge designed to cover

the cost

of contingencies or related costs

This price includes not only the cost involved in bringing

the material

to the purchases premises but also the loss due to

evaporation and

Breakage etc. as well as carrying costs.

MATERIAL PURCHASING AND PURCHASING PROCEDURE

Purchase of material is one of the important function of material

management. At times more than 50% of the total product cost is

material.

Functions of Purchase Department

1. Deciding the items to be purchased based on demand.

2. Selection of sources of supply.

3. Collection the price information.

4. Placing the ordered.

5. Follow-up the ordered.

6. Checking the invoices.

7. Maintenance of purchase records.

8. Maintenance of vendors relations.

PURCHASE PROCEDURE

Purchasing procedure start with the initiation of purchase

requisitions and ends with the receipt of materials in the stores.

CENTERIZED PURCHASING

It is most important and relevant to large organizations operating

deferent plants may or may not be located at different places. For a

single place organization decentralization might be feasible on a

very limited place. But where as M & M Ltd., is a multiple plants

operating organization.

In Mahindra and Mahindra Centralized purchasing procedure is

following to purchase of materials.

Centralized purchasing avoids duplications of efforts and

working at cross purpose from one plant to another.

Centralized purchasing permits consolidation of order of

materials commonly used for two or more plants. The

ultimately results in greater buying power, favorable

contracts and trade agreements.

Easier to maintain the quality of purchased parts / items

through centralized testing and inspection. It is also

possible to conduct testing and inspection facilities.

Centralized purchasing permits to avail facilities like

quantity discounts and cash discounts thus its helps to

reduce cost.

It is beneficial to vendor also in case the size of order

constituted major proportion of his total production capacity

INVENTORY MANAGEMENT TECHNIQUES

Based on the classification

Based on order quantity

Based on the records

ABC analysis VED analysis

HML analysis

Aging schedule

Determination Determination Economic Inventory Inventory

ABC ANALYSIS:

ABC analysis classifies various inventory into three sets or

groups of priority and allocates managerial efforts in proportion

of the priority the most important item are classified into class-

A, those of intermediate importance are classified as "class-B"

and remaining items are classified into class-C'.

The financial manager has to monitor the items belonging to

monitor the items belonging to different groups in that order of

priority and depending upon the consumptions.

The items with the highest value is given top priority and soon

and are more controlled then low value item. The re-rational

limits are as follows.

Determination Determination Economic Inventory Inventory

Category % of Items % of total materials

A 5-10 70-85

B 10-20 10-20

C 70-85 5-10

Procedure:

(i) Items with the highest value is given top priority and

soon.

(ii) There after cumulative totals of annual value of

consumption are expressed as percentage of total

value of consumptions,

(iii) Then these percentage values are divided into three

categories.

ABC analysis helps in allocating managerial efforts in proportion

to importance of various items of inventory.

ECONOMIC ORDER QUANTITY:

After various inventory items are classified on the basis of the

ABC analysis the management becomes aware of the type of

control that would be appropriate for each of the three

categories of the inventory items.

The determination of the appropriate quantity to be purchased

in each lot to replenish stock as a solution to the order quantity

problems necessitates resolution of conflicting goals. Buying in

a higher average inventory level will assure.

(i) Smooth production / sale operation and

(ii) Lower ordering or setup costs. But it will involve higher

carrying costs. On the other hand small orders would reduce

the carrying cost of inventory by reducing the average

inventory level but the ordering costs would increase, as there

is a likelihood of interruption in operations due to stock-outs. A

firm should not place either too high or small orders on the

basis of a trade off between benefits derived from the

availability of inventory and the cost of carrying that level of

inventory, appropriate or optimum level of order to be placed

should be determined. The optimum level of inventory is

popularly referred to as the economic order quantity or

economic lot size. It may be defined as that level of inventory

order that minimizes the total lost associated with inventory

management. It is based on some assumptions, which are

restrictive.

a. The firm knows with certainty the annual usage of a

particular item of inventory.

b. Rate at which the firm uses inventory is steady over time.

c. The orders placed to replenish inventory stocks are

received at exactly that point in time when inventories

reach zero.

d.

EOQ can be illustrated by

(i) Trial and error approach,

(ii) Mathematical approach.

Trial and Error approach:

In this approach the procedure of procuring the inventory is

assumed the smaller the lot the lower is average inventory and

vice versa and high average inventory would involve high

carrying costs. This approach is used for determination of EOQ

uses different permutations and combinations of lots of

inventory purchases so as to find out the least ordering and

carrying cost combinations. The carrying cost and acquisition

cost for different sizes of order to purchase inventories are

computed and the order size with lowest total cost of inventory

is EOQ.

Mathematical Approach:

The EOQ quantity can use a short-cut method calculated by

following

EOQ=

Where,

A = Annual usage of inventory

B = Buying cost per order

C = carrying cost per unit

Limitations:

While using EOQ it should be noted that it suffers from

shortcomings, which are mainly due to the restrictive nature of

the assumptions on which it is based.

The important limitation is assumption of a constant

consumption usage and, the instant replenishment of inventory

is of doubtful validity

There may be unusual and unexpected demand for stocks to

meet such [contingencies the firm has to keen additional

inventories like safety stocks. Another weakness is to assume

known annual inventories is open to question and there is

likelihood of a discrepancy between the actual and expected

demand leading to wrong estimate of EOQ.

VED ANALYSIS:

Vital Essential and Desirable analysis is done mainly for

control of spare parts keeping in view of the criticality to

production.

Vital spares are spare the stock-out of which even for a short

time will stop production for quite sometime. Essential spares

are spares the absence of which cannot be tolerated for more

than a few hours a day. Desirable spares are those, which are

needed, but their absence for even a week or so will lead to

stoppage of production.

THE RE-ORDER LEVEL:

The re-order level is the level of inventory at which the fresh

order for that item must be placed to procure fresh supply. The

re-order level depends upon

a) Length of time between the placement of an order

and receiving the supply.

b) The usage rate of the item. The inventory is

constantly being used up. The rate at which the

inventory is being used up. The rate at which the

inventory is being used up is called the usage

rate.

The reorder level can be determined as follows:

R = M+tu

R = Reorder level

M = Minimum level of inventory

T = Time gap / delivery time

U = Usage rate

The reorder level and inventory patterns have be shown as

follows:

The figure shows that if the usage rate is constant, the orders

are made at even intervals for the same amounts each time

and the inventory goes to zero just before an order is received.

Safety Stock:

The safety stock protects firm from Trade offs due to

unanticipated demand for the items level of inventory

investment is however increased by the amount of safety stock.

Safety level is ascertained in inventory as a part because there

is always an uncertainty involved in time lag usage rate or

other factor.

Usually smaller the safety level greater the risk of stock-outs. If

stock-levels are predictable then there is a chance of stock out

occurring. However stock inflows and outflows are

unpredictable or lesser predictable it becomes to carry

additional safety stock to prevent unexpected stock outs so

usage rate is estimated if cost is low then no safety stock is

needed.

JUST-IN-TIME INVENTORY:

The basic concept is that every firm should keep a minimum

level of inventory on hand, relying suppliers to furnish stock

just in time as and when required. JIT helps in emphasizing

sufficient levels of stocks to ensure that production will not be

interrupted. Although the large inventories may be bad idea

due to heavy carrying JIT is a modern approach to inventory

management and the goal is essentially to minimize such

inventories and there by maximizing the turnover.

JIT system significantly reduces inventory-carrying cost by

requiring that the raw materials be procured just in time to be

placed into production. Additionally the work in process

inventory is minimized by eliminating inventory is minimized by

eliminating inventory buffers between different production

departments.

If JIT is to be implemented successfully there must be a high

degree of coordination and co-operation between the supplier

and manufacturer and among different production centers. JIT

does not appear to have any relation with EOQ however it is in

fact alters some of the assumptions of EOQ model. The average

inventory level under the EOQ model is defined as

Average inventory= 1/2 EOQ + safety level JIT attacks this

equation in two ways.

(i) By reducing the ordering cost

(ii) By reducing the safety stock.

The basic philosophy in JIT is that the benefits, associated with

reducing inventory and delivery time to a bare minimum

through adjustment in the EOQ model; will more than offset the

costs associated with the increased possibility of stock-outs.