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Chapter-1

Introduction

1.1 INTRODUCTION:

If we observe closely, inventories can be found everywhere. We dont know since when ants

and squirrels have been keeping inventories of their food supplies. And we dont know how

they learned to keep an account of these inventories. Not only wildlife but also humans have

been smart enough to realize the benefits of inventories. Since the stone-ages, we have been

carrying inventories and managing them. Businesses, may it be a small mom-and-pop store or

the worlds biggest retailer Wal-Mart, maintain inventories and try managing them efficiently

to fulfill their customers demands at lowest possible costs. Bottom line for a profit-seeking

business is to increase the operating income.

Operating income = Operating revenues Operating expenses

Inventories affect both terms on the right side. Sales revenue can increase if inventories are

allocated among different products in improved ways. But they profoundly affect operating

expenses because they represent a major component of it.

Figure 1 Inventory between supply and demand

Figure presents an abstraction of the inventory. As simple as it is, a great deal cannot be

presented in such an abstraction. For instance, in the real world, demand as well as supply

processes are quite complex.

The degree of complexity in these two processes mainly differentiates strategies to manage

inventories. There can be some inventories which possess single-item and single-location

structure as in this Figure. There can also be more complex larger systems with multiple

items and/or multi-echelon structures, commonly referred to as supply chains or supply

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networks. However, the single-item and single-location systems are embedded in these more

complex multi dimensional systems and can be operationally dependent on each other.

In simplest terms, inventory management deals with the eternal issues of how much to keep

on hand and how much and how frequently to reorder. For many companies, inventory is an

essential resource needed for day-to-day operations.

Assembly and manufacturing companies need raw materials to process and combine with

purchased items to assemble into finished goods. Distribution centers and retail stores need

products to sell. Companies that are predominantly service operations need an assortment of

office and other supplies. All operations need various types of maintenance, repair, and

operating suppliesalso known as MRO or indirect items.

The pattern, timing, and level of demand for end products rarely exactly match the amount

and type of inventory a company has on hand. When demand is low, a company may have

inventory on hand that it wishes it did not have. On the other hand, there are times when

demand is high and companies wish they had more on hand. It is not really a no-win

situation. It is a situation that gave rise to what I would call the eternal issues of inventory

management, which deal with how much to keep on hand and how much and how frequently

to reorder.

Ideally, if we are always certain of the level of demand and the order lead time, there will be

no need to keep any inventory. The level of demand refers to the quantities and timing of the

need for the various products we produce. The order lead time refers to the period between

placing a replenishment order and the time it is actually received.

Alas, in our real world we all know that we often cannot determine customer demand or the

order lead time. We therefore say that we keep inventory on hand primarily to cover these

uncertainties. The reason this is a concern for us is that we want to meet customer needs in

good time and with the right quantities and at the same time meet customer needs and pro-

duce a profit for our firm. We cannot afford to be reckless in deciding what quantities of

inventory to keep on hand, because, although it may help us meet customer needs, we may

end up losing money in the process.

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1.2 THEORETICAL FOUNDATION:

One could argue that inventory management principles can be traced back at least to biblical

times as evidenced by the story of Joseph interpreting the Pharaohs dream as being seven

years of plentiful harvests followed by seven years of crop failures and his associated advice

to the Pharaoh to stockpile enough harvested grain during the plentiful years to ensure

adequate food during the subsequent famine. In terms of published professional material

probably the earliest article (laying out the principles of the economic order quantity) was by

Harris (1913) as reported by Erlenkotter (1990). Military applications and the formation of

associated research teams (e.g. the RAND Corporation in the USA and the Defense Research

Board in Canada) led to considerable research and development work after World War II. In

particular, all of K.J. Arrow, A.J. Clark, S. Karolin, H.E. Scarf, H.M. Wagner and T.M.

Whiten were affiliated with RAND. One of the earliest papers in this era was Arrow et al

(1951). Other important publications in the 1950s, with at least elements related to

inventory management, included Dvoretsky et al (1952a, 1952b, 1953) Karr and Geyser

(1956), Wagner And Whiten (1958) several articles in Arrow et al (1958a, 1958b), Gallaher

et al(1959), Simpson (1959), and Scarf (1959). It is noteworthy that much of this activity

occurred precisely during the period in which CORS originated. From the 1960s onward

there was a rapid proliferation of publications, some of which will be mentioned later, in a

wide range of outlets. Text books on inventory management began to appear in the 1960s.

Early examples included Wagner (1962), Hadley and Whiten (1963), Nadir (1966) and

Brown (1967). In addition, Elion and Limpkin (1968) published a compilation of abstracts of

papers that had appeared in the period 1953-1965.

1.3 OBJECTIVES:

To study of inventory system of KSRM.

To identify the drawbacks of the existence system.

To calculate the effectiveness of the proposed method.

To check whether it is the best method or not.

Trying to implement the scientific method of comparing with old method.

Implementation of the proposed method.

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1.4 METHODOLOGY:

To study the present approach system of KSRM

To identify the BSRM inventory record keeping system

To verify the procedure of inventory record keeping and ordering system

To check which method is followed

To design an improved system

1.5 SCOPE AND LIMITATION:

1. The Standards and Procedures Manual section relating to Inventory Management

must be created and published. This section must describe the process by which

assets are identified, entered into the Inventory Management System, tracked, and

finally deleted.

2. Financial and technical product information must be available through the Inventory

System, as needed to support the functional responsibilities of personnel within the

finance and contracts management departments.

3. All mainframe and data network based hardware and software assets must be

identified and entered into the Inventory System.

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Chapter 2

Inventory Management

2.1 INTRODUCTION:

The control and maintenance of inventory is a vital problem experienced almost by all sectors of the

economy. This topic is very important, as all organizations deal with inventories on a daily basis.

Neglecting the importance of inventory in any organization can lead to the closing down of the

company, especially if the factors of production are not well management in order to meet customers

needs or desires, the company will grind to a halt. The inventory problem consists of having sufficient

items available when desired by the customers. The stock of items must be reasonable, meaning that it

should be in a position to meet customers demand in terms of quantity and quality.

Management inventory has become a special issue when selling globally because holding goods in

non-domestic markets is virtually a necessity if customer service levels are to be maintained.

Inventory management is of great importance especially for managers who must decide how much (if

any) to hold and how to administer the rest of the logistics system more creatively in order to ensure

that customer service does not suffer as a result particular attention or the support of the entire

companys management levels in order to meet customers satisfaction.

2.2 INVENTORY MANAGEMENT:

2.2.1 Definition of inventory:

The word inventory has been defined in many ways, as indicated in the literature. Three definitions

have been chosen which seem to be more appropriate to the topic developed in this dissertation.

Inventories are stockpiles of raw materials ,suppliers, components, work in process and finished

goods that appear at numerous points throughout a firms production and logistics channel (Ballou

2004:326).According to Chase, Jacobs and Aquiline (2004:545), inventory is the stock of any item or

resource used in an organization. An inventory system is the set of policies and controls that monitor

levels of inventory and determine what levels should be maintained, when stock should be

replenished, and how large orders should be. Finally, Rycroft et al (2000:419) define inventory or

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stock as the stored accumulation of materials, a tax office will hold stocks of material resources in an

transformation system. So a company will hold stocks of materials, a tax office will hold stocks of

information and a theme park will hold stocks of customers (when it is customers which are being

processed we normally refer to the stocks of them as a queues).

2.2.2 Mission:

The mission of an Inventory System is to provide a Central Asset Repository of information

used to define assets and relate the asset to its owner, location, and relative importance. This

information will provide personnel with data needed to support their job functions, for

example:

Facilities Management will be able to plan Heating, Ventilation and Air

Conditioning (HVAC) requirements, as well as power and floor space needed

to support equipment listed in the Asset Repository for a specific location.

Financial Services will be able to budget for asset procurement, depreciate

assets over time, and prepare complete tax documents.

Contracts Management will be able to negotiate vendor discounts and

enterprise agreements.

Contingency Planning personnel will be able to develop recovery plans for

mainframe and office assets contained within the Inventory System based on

the assets relative importance (as stated within the Criticality field).

Technical personnel will be able to resolve problems more quickly with the

information contained within the Inventory System, because they will have a

listing of the assets contained within a location and any support or

maintenance activities associated on the asset.

The Inventory System should be integrated within the everyday functions performed by

personnel associated with entering and maintaining asset information. The system will reduce

the effort devoted to asset management, while supplying many personnel with the

information they need to perform their functional responsibilities.

Every effort should be made to develop a central Asset Repository that covers the entire

enterprise, rather than having separate Asset Repositories for mainframe, network, and

distributed environments. Having a single repository will simplify accounting and asset

management, while allowing for the implementation of enterprise-wide asset management

standards and procedures.

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2.3CLASSIFICATION OF INVENTORY:

2.3.1 Raw material:

Material that will be processed or repackaged or assembled into final product, a bakery uses flour and

sugar as raw materials, whereas an electronic manufacturing plant uses boards and chips.

2.3.2 Under inspection:

Material which is currently undergoing some type of inspection. Another term used is MRB, which

stands for material review board. Some companies have elaborate systems for performing incoming

inspection of material.

2.3.3 Work-in-process (WIP):

Material which is currently at some incomplete stage of processing. For some companies, WIP can be

substantial. With effective planning, it is possible to reduce WIP to reduce space requirements and

eliminate chaos on the shop floor.

2.3.4 Partially completed parts:

These are subcomponents produced within the company from raw materials. These are stocked

temporarily and issued out at a later time for use in completing an end item or a sales order.

2.3.5 Finished goods:

Final products ready to be shipped out to customer. Depending on the environment, it is possible to

further classify this type of inventory among distribution centers in different geographic locations.

2.4 MAINTENANCE, REPAIR, AND OPERATING (MRO) SUPPLIES:

These materials are not directly used as part of the final product; they are used for the equipment that

processes the final product. Examples are grease, grinding wheels, drill bits, office supplies,

packaging material, and so on. Technically, they are considered used in the production process.

2.5 CLASSIFICATION BY RESPONSIBILITY:

2.5.1Consigned inventory:

There are some situations where suppliers store inventory at a customers facility for which they

receive no payment until the material is used up. The stock is owned by the supplier, not the buying

company. Consignment programs need clearly defined procedures to ensure accurate records

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2.5.2 Outside independent location inventory:

There may be inventory owned by the company that is in outside warehouses owned by other firms.

There needs to be accurate and verified records of what materials are in such warehouses.

This inventory classification is usually associated with accounting processes and the various activities

of materials, warehousing, and purchasing departments. There are other ways of classifying inventory

as we shall see in the following text.

2.6 CLASSIFICATION BY VALUE OF ANNUAL USAGEABC CLASSIFICATION

ABC classification is a way of grouping inventory into low, medium, or high value of annual usage.

The technique begins by sorting all inventory items from highest to lowest value of annual usage.

Annual usage is computed by multiplying the annual quantity used by its unit cost.

One common use of this ABC classification is for planning cycle count schedules. Cycle counting is

an inventory control technique that periodically compares physical on hand inventory against records

to determine variances and identify and eliminate the causes for said discrepancies. Items with high

value of annual usage are called A items, medium value are called B items and low value are

called C items. A items are scheduled to be cycle-counted more frequently than B which in turn

are counted more frequently than C items. The general concept is that A items are more important

since they have high value of annual usage. Another use of ABC classification is to assign

responsibility for items to various planners or buyer/planners. The assignment of a group of part

numbers to a materials planner can be based on value of annual usage and whatever other

considerations are decided by management. In some cases, items are assigned by product group. In

this case, ABC classification within product group can be used. Still another method of assigning

planning responsibility within product group is a combination of ABC classification and category

within a product.

2.7 OTHER WAYS OF CLASSIFYING INVENTORY

There are many other ways of classifying inventory. Depending on the purpose, we could classify

inventory based on any combination of the following characteristics:

Annual usage, demand

Unit price

State of obsolescence

Pattern of demandindependent and dependent demand

Hazardous handling requirement

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No usage for the past X months

Government regulation

Availability in the marketplace

Order lead time

Recyclable packaging

Weight

Bulk

Pilferage

Lot control requirements

Any of these attributes can be combined with others to develop a classification of interest. Then, a

control report to monitor that aspect of inventory can be periodically generated and analyzed. For

example, items can be marked as subject to high pilferage and can perhaps be specially monitored

using a special process or inventory report. A classification can also be set up and a system developed

that indicates possible obsolescence of an item. Such a measure could indicate the number of months

since last issued. A high number of months since last issue could be an indicator of an item that has

become obsolete.

There are many reasons for obsolescence. Sometimes, the engineering design department just decides

to stop calling out for an item without informing all concerned; or an engineering change notice is

issued, but the process of dissemination and implementation is imperfect, and no decision or action is

ever taken on the obsolete inventory.

Lot control requirements are a critical element for food and pharmaceutical ingredients. Lot control is

also required in varying extent for inventory used to produce components for aerospace equipment.

Lot numbers and heat numbers are frequently required for various inventory such as structural steel,

for example, bars, angles, tubing, pipes, plates, beams, and channels. Structural bolts, nuts, and

washers also need traceability when used for vari-ous products. All these impose procedural control

on inventory management personnel and other departments in the firm.

Weight considerations along with bulk (volume) are used for storage and logistics decisions. Sensitive

inventory such as explosives, hazardous material, or controlled substances like narcotics are subject to

many control regulations. Some of these regulations may require special certification of personnel

who handle and record inventory transactions .I do not have to limit ourselves to a ranking solely by

value of annual usage. We have to keep in mind that the purpose of cycle counting is to maintain

suitable control over important inventory items. I can therefore define the meaning of important to

include value of annual usage as well as other factors that we feel are important.

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2.8 REASONS TO CARRY INVENTORY

There are many factors in the real world that are beyond our control. We are there-fore forced to deal

with these and tackle the problems they present. We take action to minimize or eliminate the ill

effects of these outside factors on our operation. Unfortunately, many of these actions involve keeping

more inventory than we really want. The following are reasons for carrying inventory:

2.8.1Market demand:

There are items that are expected by customers to be on the shelf when they demand them. Examples

are bread, milk, fast food, furniture, music CDs, cars, etc. For this market situation, the producers and

distributors are forced to carry inventory on hand. The challenge is, of course, to be able to guess the

correct type and quantity of inventory to produce and keep on the shelf. After the quantity and type

of inventory to be produced is decided, success is governed by operations efficiency and a good

combination of market savvy and aggressive salesmanship such as the type exhibited by car and

furniture salespeople.

2.8.2 Safety stock:

Safety stock is the extra inventory above current or short-term needs that is kept on hand intentionally

to cover the possibility that demand will be higher than usual or the order lead time longer than usual.

Ideally, if we are absolutely certain of the demand and the order lead time, there would be no need for

any safety stock.

2.8.3 To cover minimum run lots:

There are many items that have to be produced in large quantities to be economically feasible.

Although it is true that all firms should continually strive to reduce run lot size, nevertheless, many

factors can make producers set minimum-size runs for their customers. When a buying firm has

requirements that are nowhere close to the minimum run lot imposed by producers, the buyer firm is

still able to purchase its inventory from distributors. The advantages of buying from distributors

include lower minimum quantities, better payment terms and, usually, more responsive technical

support. The main disadvantage, though, would usually be the higher price. Distributors are able to

meet more than the minimum order sizes of producers because of the following reasons:

2.8.4 Transportation stock:

This refers to inventory that is in transit between locations. This type of inventory is common for

finished goods that are moved through several layers and channels of distribution. The flow of these

goods is also continual; at any time there is a substantial quantity in transit.

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2.8.5 Distribution inventory:

Distribution inventory are goods that are kept in warehouses close to concentrations of customers. The

intention is to reduce freight costs in delivering the goods to the final customers. Meantime, the

freight from the manufacturers plant can be accumulated to fill larger units such as full van loads or

railcars. The physical proximity of distribution centers makes for quick response and hence superior

customer service.

2.8.6 Anticipation stock:

This term denotes stock purposely accumulated based on some planned activity, such as a marketing

promotion or an upcoming seasonal event.

2.8.7 Hedge stock:

This is stock kept or accumulated in expectation of rising prices or supply uncertainty in the

marketplace. The reason for price fluctuations or uncertain supply often includes global economic

conditions or geopolitical turmoil. Some types of inventory that have historically been subject to

volatility are certain minerals, wood products, oil, and steel.

2.8.8Process buffer stock:

In the real world, there is always a discrepancy between the rate of demand for a product and the rate

of production. Even within a process, different work stations have different rates due to the speed of

the process itself or the current technological capabilities of the equipment.

I should be aware that there is an inventory buffer between me and my suppliers. This is due, in part,

to the reordering process. My suppliers, in turn have a buffer with their suppliers. And so on up the

supply chain.

There is also a buffer between me and my customers. This buffer is due, partly, to the ordering

process and partly to transportation factors. Finally, within my company, there are buffers between

various departments from the receiving dock through each work station on through to the finished

goods area.

2.9 TO COVER FOR INADEQUATE SYSTEMS:

I have to admit that a companys inventory system may be inadequate and may therefore provide

inaccurate information in terms of part numbers, quantities, and timing. The ineffective system

provides incorrect information that shows inventory requirements that are either overstated or

understated. Also, the timing of the need provided by the system could be wrong. Another possible

error relates to the part number.

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It is common practice among inventory and purchasing people to over order inventory and has it

delivered earlier simply because they are using planning information that is unreliable. This is an

extremely awkward situation for many reasons. Firstly, they do not know that over ordering will meet

their needs.

Secondly, the philosophy of better over order than under order is flawed, because an unreliable

inventory system rarely shows the correct requirements. The inventory order will, therefore,

invariably be either high or low. Either way, I end up with overstock or a shortage. Thirdly, both

shortages and overstock have a cost associated with them.

A shortage results in angry customers, whereas an overstock situation results in lost profits due to

higher expenses. The solution to this situation is to eliminate the causes of unreliable data.

2.10 INVENTORY SYSTEMS FEATURES:

The Inventory System in Commerce Server comes with many important features that aid in the real-

time management of inventory for items in your catalog. These features allow you to do the

following:

Display real-time inventory conditions of your products and product variants, including in

stock, out-of-stock, back-ordered, or pre-orderable.

Filter products and product variants listings to show only those products that are currently

available in stock.

Decrement inventory levels when orders are processed.

Receive notifications when inventory levels reach an out-of-stock threshold.

Integrate inventory levels with LOB applications.

Gain insight into how well products and product variants are selling.

2.11 MEASURES of INVENTORY EFFECTIVENESS:

There are many measures that indicate the degree of effectiveness of inventory management. These

different indicators focus on some aspect of inventory management.The measure is also called days of

supply or some other time period such as weeks of supply. This is computed by dividing the quantity

on hand by the average daily demand or usage. This can be done for individual part numbers or for a

particular category of items. For individual items, units of measure such as pieces, pounds, or gallons

are used. For categories of part numbers, there are often different units of measure, so it is more

meaningful to use dollar figures to compute the days.

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2.12 OTHER MEASURES:

These are measures that are tied to the customer-service aspect of inventory management:

Orders shipped on schedule.

Line items shipped on schedule.

Total units shipped on schedule.

Dollar volume shipped on schedule.

2.14 MOTIVATION FOR HOLDING INVENTORY:

2.14.1 Rationale for having inventory:

There are many reasons that motivate companies to have stock. Bloomberg, Lemay and Hanna

(2002:136-137) have identified five reasons for holding stock, namely:

Economics of scale. A firm can realize economies of scale in manufacturing, purchasing and

transportation by holding inventory. If the business buys large amounts, in gets quantity

discounts. In turn, transportation can move larger volumes and get economies of scale through

better equipment utilization.

Manufacturing can have longer production runs if more material is inventoried, allowing per

unit fixed cost reductions.

Balancing supply and demand. Some firms must accumulate inventory in advantage of

seasonal demand. A toy manufacturer sees some demand year-round, but 60 percent or more

of sales will come in the Christmas season. By manufacturing to stock, production can be kept

level throughout the year. This reduces idle plant capacity and maintains a relatively stable

workforce, keeping costs down.

If demand is relatively constant but input materials are seasonal, such as in the production of

canned fruits, then finished inventory helps meet demand when the materials are no longer

available.

Specialization, inventory allows firms with subsidiaries to specialize. Instead of

manufacturing a variety of products, each plant can manufacture a product and then ship the

finished products directly to customers or to a warehouse of storage. By specializing each

plant can gain economies of scale through long production runs.

Protection from uncertainties. A primary reason to hold inventory ie. To offset uncertainties

in demand. If demand increases and raw material stocks run out, the production line shuts

down until more material is delivered. Likewise, a shortage of work in process means the

product cannot be finished. Finally, if customer orders outstrip finished goods supply, the

resulting stock outs could lead to lost customers.

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2.15 IMPORTANCE OF INVENTORY:

Inventory plays an negligible role in the growth an survival of an organization in the sense that failure

to an effective and efficient management of inventory, will mean that the organization will lose

customers and sales will decline. Emphasizing on the importance of inventory on the balance sheet of

companies, Coyle, Brady and Langley (2003:188) state that inventory as an asset on the balance

sheet of companies has taken an increased significance because of the strategy of many firms to

reduce their investment in fixed assets, that is, plants, warehouses, office buildings, equipment and

machinery, and so on.

The research done by Holdren and Hollingshead (1999:1) in the United States of America witnesses

that much of the $700 million worth of inventory held by American businesses is financed by bank

loans with the goods pledged as security. An important industrial marketing relationship exists

between inventory managers and commercial lending officers who write these inventory loans.

Inventory mangers need to provide their lenders with sufficient information to obtain financing at the

lowest rate. Loan officers need to assess the degree of inventory risk in order to assign a proper

interest rate. Issues of risk and return of inventory loans are matters of concern for both inventory

managers and creditors.

Inventory management is an important concern for managers in all types of businesses.

The challenge is not to pare inventories to the bone to reduce costs or to have plenty around to satisfy

all demands, but to have the right amount to achieve the competitive priorities for business most

efficiently.

Finally, according to the U .S Bureau of Census (Ballou 2004:326-328), inventories are found in such

places as warehouses, yards, shop floors, transportation equipment and on retail store shelves. Having

these inventories on hand can cost between 20 and 40 percent of their value per year. Therefore,

carefully managing inventory levels makes good economic sense.

Even though many strides have been taken to reduce inventories through just-in-time, time

compression, quick response and collaborative practices applied throughout the supply channel, the

annual investment in inventories by manufacturers, retailers, and merchant wholesalers, whose sales

represent about 99 percent of GNP, is about 12 percent of U.S gross domestic product.

2.16 SYMPTOMS OF POOR INVENTORY MANAGEMENT:

A certain number of symptoms allow discovering poor inventory management. Lambert and Stock

(2001: 254-255) mention the following elements in order to diagnose poor inventory management:

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a. Increasing number of back orders.

b. Increasing dollar investment in inventory with back orders remaining constant.

c. High customer turnover rate.

d. Increasing number of orders cancelled.

e. Periodic lack of sufficient storage-space.

f. Wide variance in inventory turnover among distribution centers and among major inventory items

g. Deteriorating relationships with intermediaries as typified by dealer cancellations and declaring

orders.

h. Large quantities of obsolete items.

In many instances, inventory levels can reduced by one or more of the following steps :

a. Multi-echelon inventory planning. ABC analysis is an example of such planning.

b. Lead time analysis.

c. Delivery time analysis. This may lead to a change in carriers or negotiation with

existing carriers.

d. Elimination of turnover and or obsolete items.

e. Analysis of pack size and discount structure.

f. Examination of returned goods procedures.

g. Encouragement or automation of product substitution.

h. Installation of formal re-order review system.

i. Measurement of fill rates by stock-keeping unit. (SKP)

j. Analysis of customer demand characteristics.

2.17 JUST-IN-TIME INVENTORY MANAGEMENT:

Just-in time (JIT) production system (as the Toyota Production System) was introduced by Shigeo

Shying and Taichi Ohno at the Toyota Motor plant in the mid-1970. JIT production is called by many

names: zero inventory production system (ZIPS), minimum inventory production system (MIPS),

kanban production, kaizen production, stockless production, pull through production and quick

response (QR) inventory systems. JIT manufacturing, both as a philosophy and a disciplined method

of production, has received much attention since its introduction. The JIT production philosophy is

founded upon three fundamental principles: elimination of waste,, continuous quality improvement

and encouragement of worker participations planning and execution.

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Gordon (2001:76) adds that this just-in-time manufacturing philosophy requires manufacturers to

work in concert with suppliers and transportation providers to get required items to the assembly line

at the precise time they are needed for production.

JIT is a disciplined approach to improve manufacturing quality, flexibility and productivity through

the elimination of waste and the total involvement of people. JIT is not simply reducing inventory;

rather its overall objective is increased quality. If properly developed, a number of potential benefits

can follow. To realize these benefits, certain conditions must prevail. The goals must include the

respect for people and the elimination of waste. Respect for people includes creating a stable

environment, motivation and trust, bottom round management, robotics, quality circles and

subcontractor networks. The employees, not management, operate JIT. The employees determine

problems and solve them. The employees increase product quality. If the employees do not believe in

the JIT concepts, the system will fail no matter what management tries to do. (Bloomberg, Lemay and

Hanna 2002:165-166).

Gourdin (2001:76-78) has identified a number of basic tenets, advantages and disadvantages will be

briefly discussed in order to provide basic information on just-in-time inventory management.

2.18 BASIC TENETS OF JIT

A successful JIT system is based upon the following key concepts:

Quality with JIT, the customer must receive high quality goods. One of the historical

roles of inventory has been to protect the customer against defective items; if a bad

product is received it can be discarded and a new one drawn from inventory. With a

JIT system, however, poor quality means the production line stops or the external

customer gets a defective item. There are no extra items to replace the poor ones.

Vendors as partners. Generally, firms using JIT rely on fewer vendors rather than

more. Purchases are concentrated with a limited number of suppliers in order to give

buyer leverage with respect to quality and service. Purchasers also include vendors in

the planning process, sharing information regarding sales and production forecasts so

that vendors then have a clear idea of what their customers need.

Vendor co-location with customer. Ideally, suppliers should be located in close

proximity to their customers. As the distance between vendors and buyers increases,

so does the opportunity for system disruption and stock-outs. In order to minimize this

risk, customers often demand that vendor facilities be co-located on the same site or at

least in the same geographical era as their own.

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2.19 ADVANTAGES OF JIT:

More inventory turns: Because there is less on hand, the inventory that is maintained

stays for a shorter period of time. The problem with an extremely high number of

turns is that it can raise the probability of stocking out to an unacceptable high label

while raising ordering cost as well.

Better quality: As was mentioned earlier, high quality products must be received with

a JIT system or else the entire benefit production process collapses, Customers

concentrate their purchases with a small number of vendors in exchange for receipting

high quality items and requisite service. The cost of failure on either count to the

vendor thus become very high.

Less warehousing space needed: When there is less inventory, fewer and/or smaller

warehouses are required. Under BMWs JIT production strategy, only a minimum

amount of inventory is held on the production line at its new U.S. plant. In some

cases, the time supply is a mere four hours. To ensure a reliable delivery system, the

plane employs a pull strategy whereby part orders are automatically issued once the

supply on the lines falls below a critical level.

2.20 DISADVANTAGES OF JIT:

Disadvantages of JIT are:

Risk of stock-outs. When firms eliminate inventory, the risk of stock-outs can rise.

Managers attempt to minimize this occurrence by demanding very high levels of

service from their vendors and logistics service providers. However, when co-location

of customer and vendor is not feasible, for example, the resultant variability in the

pipeline can lead to stock-outs despite management best effort to prevent them.

Increased transportation costs. Since JIT requires frequent shipments of small

quantities, transportation costs almost always rise. As long as these costs are more

than offset by the inventory savings, it is advantageous for the organization to permit

them. However, it is possible to spend more on transport than is being saved with the

JIT system, so management must ensure that movement expenses are closely

monitored.

Increased purchasing costs. As mentioned earlier, purchasing discounts are generally

associated with buying large quantities at a time. Theoreticaly, JIT means foregoing

those price-breaks in favors of obtaining smaller amounts more frequently. Managers

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must make sure that purchasing costs are not rising more than what inventory costs

are failing.

Small channel members may suffer. JIT is sometimes criticized as a system that

allows strong organizations to unload their inventory on smaller firms in the channel.

Theoretically, every company in the pipeline can utilize JIT, the reality, however, is

that channel leaders may impose such stringent delivery criteria that vendors may feel

compelled to hold inventory in order to satisfy them.

Environmental issues. In a micro sense, JIT can lead to high levels of traffic

congestion and air pollution because additional transportation is often required to

maintain customer service levels in the absence of inventory.

2.21 INVENTORY MANAGEMENT IMPROVEMENT

Gordon (2001:72) has identified six activities in order to improve inventory

management. These activities will be explained in order to provide some background

information on the improvement of inventory management in business organizations.

Top management commitment. Because lower inventories have an impact on many

different parts of the logistics systems, senior leadership must ensure that all those

activities are working together to meet customer needs without the luxury of excess

stock.

ABC analysis of all inventory items. Management must first understand that goods in

inventory are most important in terms of their contribution to the objectives of the

organization. These few items most important customers would be designated A

items and perhaps maintained at virtually 100 percent availability. The bulk of the

goods in inventory would be denoted B items that might be supported at for

instance, 80 percent levels, Finally, there could be some low-demand items classified

as C Which are maintained at very low levels or possibly not stocked at all.

Improved performance of other logistics activities, Managers should ensure that the

rest of the logistics system is functioning efficiently. It may be that inventory policies

have evolved as a way to obscure other problems that should be dealt with directly.

By reviewing transportation, order processing, and warehousing functions, for

example, management may find that order-cycle variability can be reduced by

improving those activities that would lower the need for inventory.

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Improved demand forecasting. Demand forecasting is also a way of reducing

variability, this time in terms of expected versus actual sales. Better forecasting

techniques can be utilized to more accurately predict actual sales.

Inventory management software. Software is currently available for virtually any

type of inventory management situation and allows managers to track sales by item

costs length of time in inventory and other vectors as well. Many of the more

comprehensive packages are structured around some variation of material

requirements planning (MRP) or distribution requirements planning (BRP) depending

on the nature of the inventory concerned. Briefly, MRP manages material and in-

process inventory for production while (DRP) deals with finished flow finished p

Postponement involves modifying or customizing products after the main

manufacturing process is complete. Final configuration of products can be delayed

until the distribution cycle, or even performed after delivery.

Broglie, Grassy and Minatare (2004:1) leaning on their research done on th

multiattribute classification method for spare inventory management have found that

any improvement in the management of this type of inventory is desirable and useful

in practice, leading to both improved factory performance and reduced investment in

inventories.

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Chapter-3

Inventory Policy

3.1 POLICY:

A policy is a principle or rule to guide decisions and achieve rational outcomes. A policy is

an intent and is implemented a procedure or protocol. The board of or governance body

within in an organization generally adopts policies. Whereas procedure or protocol developed

and adopted by senior executive officers .Policies can assist in both subjective and objective

decision-making would usually assist senior management with decisions that must consider

the relative merits of a number of factors before making decisions and as a result are often

hard.

3.2 INVENTORY POLICY:

Inventory is the stock of any item or resource used in an organization. An inventory system is

the set of policies and controls that monitor levels of inventory and determine what levels

should be maintained, when stock should be replenished, and how large orders should be

maintained. By convention, manufacturing inventory generally refers to items that contribute

to or become part of a firms product output.

Manufacturing inventory is typically classified into raw materials, finished products,

component parts, supplies, and work-in-process. In distribution, inventory is classified as in-

transit, meaning that it is being moved in the system, and warehouse, which is inventory in a

warehouse or distribution center.

Retail sites carry inventory for immediate sale to customers. In services, inventory generally

refers to the tangible goods to be sold and the supplies necessary to administer the service.

The basic purpose of inventory analysis, whether in manufacturing, distribution, retail, or

services, is to specify (1) when items should be ordered and (2) how large the order should

be. Many firms are tending to enter into longer-term relationships with vendors to supply

their needs for perhaps the entire year. This changes the when and how many to order to

when and how many to deliver.

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3.3 INVENTORY SYSTEMS:

An inventory system provides the organizational structure and the operating policies for

maintaining and controlling goods to be stocked. The system is responsible for ordering and

receipt of goods: timing the order placement and keeping track of what has been ordered,

how much, and from whom.

The system also must follow up to answer such questions as:

Has the supplier received the order?

Has it been shipped?

Are the dates correct?

Are the procedures established for reordering or returning undesirable merchandise?

This section divides systems into

Single period systems and

Multiple period systems.

The classification is based on whether the decision is just a one-time purchasing decision

where the purchase is designed to cover a fixed period of time and the item will not be

reordered, or the decision involves an item that will be purchased periodically where

inventory should be kept in stock to be used on demand. We begin with a look at the one-

time purchasing decision and the single-period inventory model.

3.4 PURPOSES OF THE POLICY:

All firms (including JIT operations) keep a supply of inventory for the following reasons:

To maintain independence of operations:

A supply of materials at a work center allows that center flexibility in operations. For

example, because there are costs for making each new production setup, this

inventory allows management to reduce the number of setups. Independence of

workstations is desirable on assembly lines as well. The time that it takes to do the

identical operations will naturally vary from one unit to the next unit. Therefore, it is

desirable to have a cushion of several parts within the workstation so that shorter

performance times can compensate for longer performance times. This way the

average output can be fairly stable.

To meet variation in product demand:

If the demand for the product is known precisely, it may be possible (though not

necessarily economical) to produce the product to exactly meet the demand. Usually,

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however, demand is not completely known, and a safety or buffer stock must be

maintained to absorb variation.

To allow flexibility in production scheduling:

A stock of inventory relieves the pressure on the production system to get the goods

out. This causes longer lead times, which permit production planning for smoother

flow and lower-cost operation through larger lot-size production. High setup costs, for

example, favor producing a larger number of units once the setup has been made.

To provide a safeguard for variation in raw material delivery time:

When material is ordered from a vendor, delays can occur for a variety of reasons: a

normal variation in shipping time, a shortage of material at the vendors plant causing

backlogs, an unexpected strike at the vendors plant or at one of the shipping

companies, a lost order, or a shipment of incorrect or defective material.

To take advantage of economic purchase order size:

There are costs to place an order: labor, phone calls, typing, postage, and so on.

Therefore, the larger each order is, the fewer the orders that need be written. Also,

shipping costs favor larger ordersthe larger the shipment, the lower the per-unit

cost.

Many other domain-specific reasons:

Depending on the situation, inventory may need to be carried. For example, in-transit

inventory is material being moved from the suppliers to customers and depends on the

order quantity and the transit lead time. Another example is inventory that is bought

in anticipation of price changes such as fuel for jet planes or semiconductors for

computers.

3.5 INVENTORY COSTS:

3.5.1Holding (or carrying) costs: This broad category includes the costs for storage

facilities, handling, insurance, pilferage, breakage, obsolescence, depreciation, taxes, and the

opportunity cost of capital. Obviously, high holding costs tend to favor low inventory levels

and frequent replenishment.

3.5.2 Setup (or production change) costs: To make each different product involves

obtaining the necessary materials, arranging specific equipment setups, filling out the

required papers, appropriately charging time and materials, and moving out the previous

stock of material.

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If there were no costs or loss of time in changing from one product to another, many small

lots would be produced. This would reduce inventory levels, with a resulting savings in cost.

One challenge today is to try to reduce these setup costs to permit smaller lot sizes. (This is

the goal of a JIT system).

3.5.3 Ordering costs: These costs refer to the managerial and clerical costs to prepare the

purchase or production order. Ordering costs include all the details, such as counting items

and calculating order quantities. The costs associated with maintaining the system needed to

track orders are also included in ordering costs.

3.5.4 Shortage costs: When the stock of an item is depleted, an order for that item must

either wait until the stock is replenished or be canceled. When the demand is not met and the

order is canceled, this is referred to as a stock out. A backorder is when the order is held and

filled at a later date when the inventory for the item is replenished.

There is a trade-off between carrying stock to satisfy demand and the costs resulting from

stock outs and backorders. This balance is sometimes difficult to obtain be-cause it may not

be possible to estimate lost profits, the effects of lost customers, or lateness penalties.

Frequently, the assumed shortage cost is little more than a guess, although it is usually

possible to specify a range of such costs.

Establishing the correct quantity to order from vendors or the size of lots submitted to the

firms productive facilities involves a search for the minimum total cost resulting from the

combined effects of four individual costs: holding costs, setup costs, ordering costs, and

shortage costs. Of course, the timing of these orders is a critical factor that may impact

inventory cost.

3.6 FACTORS OF INVENTORY POLICY STATEMENT:

3.6.1Work-Context Factors

Boredom monotony, lack of interest, dull

Upward Communication how often employee talks to people in higher positions

Decision Influence opportunity for independent decisions and control

Growth Opportunities personal growth and development of skills, knowledge

Personal Control autonomous function

Salary appropriate compensation for work required

Task Identity completion of whole task vs. just a part

Task Responsibility accountability, responsibility of tasks

Task Significance impact on lives and work of others

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Skill Variety different activities, skills and talents used

Specialized Skills high complex skill level or expertise

Supervisor Support immediate supervisor supports work efforts

Work Load not too heavy or light

3.6.2Organizational Factors

Leadership Effectiveness leadership effective inspiring excellence, getting work done

Planning planning part of organizational processes

Clarity of Policies and Procedures clearly articulated and meaningful

Organizational Philosophy/Mission guides peoples work throughout the organization

3.6.3Alienation Factors

Meaninglessness future isnt as good as current position or profession

Cultural Estrangement low reward value to goals typically valued by organization

Powerlessness employees own behavior wont determine outcomes or reinforcement they

seek

Social Isolation exclusion or rejection

Work-Activity Estrangement position duties and tasks dont provide enjoyment or

satisfaction

Worker Alienation degree to which person disassociates from a work identity

3.7 FACTORS INFLUENCE THE LEVEL OF EACH COMPONENT OF

INVENTORY:

3.7.1 Raw Material Inventory:

1. The volume of safety stock against material shortages that interrupt production.

2. Considerations of economy in purchase.

3. The outlook for future movements in the price of materials.

4. Anticipated volume of usage and consumption.

5. The efficiency of procurement and inventory control function.

6. The operating costs of carrying the stocks.

7. The costs and availability of funds for investment in inventory.

8. Storage capacity.

9. Re-component cycle.

10. Indigenous or foreign.

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11. The lead-time of supply.

12. Formalities for importing.

3.7.2Work-in-process Inventory:

1. The length of the complete production process.

2. Management policies affecting length of process time.

3. Length of process in runs.

4. Action that speed up the production process, e.g. adding second or third production shifts.

5. Managements skills in production scheduling and control.

6. Volume of production.

7. Sales expectations.

8. Level of sales and new orders.

9. Price level of raw materials used, wages and other items that enter production cost and the

value added in production.

10. Customer requirements.

11. Usual period of aging.

3.7.3 Finished Goods Inventory:

1. The policy of the management to gear the production to meet the firm order in hand.

2. The policy to produce for anticipated orders and stock keeping.

3. Goods required or the purpose of minimum and safety stocks.

4. Sales policies of the firm.

5. Need for maintaining stability in production.

6. Price fluctuations for the product.

7. Durability, spoilage and obsolescence.

8. Distribution system.

9. Ability to fill orders immediately.

10. Availability of raw material on seasonal basis while customers demand spread

throughout the year.

11. Storage capacity.

3.7.4 Stores and Spares Inventory:

1. Nature of the product to be manufactured and its lead time of manufacture.

2. State of technology involved.

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3. Consumptions patterns.

4. Lead time of supply.

5. Indigenous or foreign.

6. Minimum and safety stock and ordering quantities.

7. Capacity utilization.

8. Importing formalities.

3.8 SOME OF THE IMPORTANT INVENTORY POLICIES RELATES TO :

1. Minimum, maximum and optimum stocks.

2. Safety stocks, order quantities, order levels and anticipated stocks.

3. Waste, scrap spoilage and defective.

4. Policies relating to alternative use.

5. Policies relating to order filling.

3.9 MEASURE OF EFFECTIVENESS OF INVENTORY MANAGEMENT:

1. Size of Inventory = Total inventory/Total Current assets

2. Size of Raw material Inventory = Raw material inventory/Total inventory

3. Size of Work in Process Inventory = Work in process

Inventory/Total Inventory

4. Size of Stores and Spares parts Inventory = Stores and

Spares parts inventory/Total Inventory

5. Size of Finished Goods Inventory = Finished goods inventory/Total inventory

6. Overall inventory turnover ratio = Cost of goods sold/average total inventories at cost

7. Raw material inventory turnover ratio = Annual consumption of Raw material / Average

Raw material inventory

8. Work-in-process inventory turnover ratio = Cost of manufacture/average work-in-process

inventory at cost

9. Finished Goods inventory turnover ratio = Cost of goods sold / Average finished stock

10. Stores and spare parts inventory turnover ratio = Stores and Spares consumed/Average

stock of stores and spares

11. Age of Finished Goods inventory = 365/Finished Goods inventory turnover ratio

12. Average age of raw material inventory = 365/Raw material inventory turnover ratio

13. Average age of Work-in-Process inventory = 365/Work-in-Process inventory turnover

ratio

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14. Age of Stores and spare parts inventory = 365/Stores and spare parts inventory turnover

ratio

15. Inventory holding period = 365/Inventory turnover ratio

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Chapter-4

Inventory Control

4.1 INVENTORY CONTROL:

Inventory control is concerned with the acquisition, storage, handling and use of inventories

so as to ensure the availability of inventory whenever needed, providing adequate provision

for contingencies, deriving maximum economy and minimizing wastage and losses.

Hence Inventory control refers to a system, which ensures the supply of required quantity and

quality of inventory at the required time and at the same time prevent unnecessary investment

in inventories. It is one of the most vital phases of material management. Reducing

inventories without impairing operating efficiency frees working capital that can be

effectively employed elsewhere. Inventory control can make or break a company. This

explains the usual saying that inventories are the graveyard of a business. Designing a

sound inventory control system is in a large measure for balancing operations. It is the focal

point of many seemingly conflicting interests and considerations both short range and long

range.

The aim of a sound inventory control system is to secure the best balance between too much

and too little. Too much inventory carries financial rises and too little reacts adversely on

continuity of productions and competitive dynamics. The real problem is not the reduction of

the size of the inventory as a whole but to secure a scientifically determined balance between

several items that make up the inventory. The efficiency of inventory control affects the

flexibility of the firm. Insufficient procedures may result in an unbalanced inventory. Some

items out of stock, other overstocked, necessitating excessive investment. These

inefficiencies ultimately will have adverse effects upon profits. Turning the situation round,

difference in the efficiency of the inventory control for a given level of flexibility affects the

level of investment required in inventory. The less efficient is the inventory control, the

greater is the investment required. Excessive investment in inventories increase cost and

reduce profits, thus, the effects of inventory control of flexibility and on level of investment

required in inventories represent two sides of the same coin. Control of inventory is exercised

by introducing various measures of inventory control, such as ABC analysis fixation of

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norms of inventory holdings and reorder point and a close watch on the movements of

inventories.

4.2 WHY INVENTORY CONTROL?

Control of inventory, which typically represents 45% to 90% of all expenses for business, is

needed to ensure that the business has the right goods on hand to avoid stock-outs, to prevent

shrinkage (spoilage/theft), and to provide proper accounting. Many businesses have too much

of their limited resource, capital, tied up in their major asset, inventory. Worse, they may

have their capital tied up in the wrong kind of inventory. Inventory may be old, worn out,

shopworn, obsolete, or the wrong sizes or colors, or there may be an imbalance among

different product lines that reduces the customer appeal of the total operation.

Inventory control systems range from eyeball systems to reserve stock systems to perpetual

computer-run systems. Valuation of inventory is normally stated at original cost, market

value, or current replacement costs, whichever is lowest. This practice is used because it

minimizes the possibility of overstating assets. Inventory valuation and appropriate

accounting practices are worth a book alone and so are not dealt with here in depth.

The ideal inventory and proper merchandise turnover will vary from one market to another.

Average industry figures serve as a guide for comparison. Too large an inventory may not be

justified because the turnover does not warrant investment. On the other hand, because

products are not available to meet demand, too small an inventory may minimize sales and

profits as customers go somewhere else to buy what they want where it is immediately

available. Minimum inventories based on reordering time need to become important aspects

of buying activity. Carrying costs, material purchases, and storage costs are all expensive.

However, stock-outs are expensive also. All of those costs can be minimized by efficient

inventory policies.

4.3 OTHER REASONS FOR INVENTORY CONTROL:

Helps balance the stock as to value, size, color, style, and price line in proportion to

demand or sales trends.

Help plan the winners as well as move slow sellers

Helps secure the best rate of stock turnover for each item.

Helps reduce expenses and markdowns.

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Helps maintain a business reputation for always having new, fresh merchandise in

wanted sizes and colors.

Three major approaches can be used for inventory control in any type and size of operation.

The actual system selected will depend upon the type of operation, the amount of goods.

4.4 INVENTORIES CONTROL TECHNIQUES:

ABC Analysis of Inventories

The ABC inventory control technique is based on the principle that a small portion of the

items may typically represent the bulk of money value of the total inventory used in the

production process, while a relatively large number of items may from a small part of the

money value of stores. The money value is ascertained by multiplying the quantity of

material of each item by its unit price.

According to this approach to inventory control high value items are more closely controlled

than low value items. Each item of inventory is given A, B or C denomination depending

upon the amount spent for that particular item. A or the highest value items should be under

the tight control and under responsibility of the most experienced personnel, while C or the

lowest value may be under simple physical control.

It may also be clear with the help of the following examples:

A Category 5% to 10% of the items represent 70% to 75% of the money value.

B Category 15% to 20% of the items represent 15% to 20% of the money.

C Category The remaining number of the items represent 5% to 10% of the money value.

The relative position of these items show that items of category A should be under the

maximum control, items of category B may not be given that much attention and item C may

be under a loose control.

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After classification, the items are ranked by their value and then the cumulative percentage of

total value against the percentage of item is noted. A detailed analysis of inventory may

indicate above figure that only 10 per cent of item may account for 75 per cent of the value,

another 10 per cent of item may account for 15 per cent of the value and remaining

percentage items may account for 10 per cent of the value. The importance of this tool lies in

the fact that it directs attention to the key items.

4.5 ADVANTAGES OF ABC ANALYSIS:

It ensures a closer and a more strict control over such items, which are having a

sizable investment in there.

It releases working capital, which would otherwise have been locked up for a more

profitable channel of investment.

It reduces inventory-carrying cost.

It enables the relaxation of control for the C items and thus makes it possible for a

sufficient buffer stock to be created.

It enables the maintenance of high inventory turnover rate.

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4.6 FIXATION OF NORMS OF INVENTORY HOLDINGS:

Either by the top management or by the materials department could set the norms for

inventories. The top management usually sets monitory limits for investment in inventories.

The materials department has to allocate this investment to the various items and ensure the

smooth operation of the concern. It would be worthwhile if norms of inventories were set by

the management by objectives, concept. This concept expects the top management to set the

inventory norms (limit) after consultation with the materials department. A number of factors

enter into consideration in the determination of stock levels for individual items for the

purpose of control and economy. Some of them are:

Lead time for deliveries.

The rate of consumption.

Requirements of funds.

Keeping qualities, deterioration, evaporation etc.

Storage cost.

Availability of space.

Price fluctuations.

Insurance cost.

Obsolescence price.

Seasonal consideration of price and availability.

EOQ (Economic Order Quantity), and

Government and other statuary restriction

Any decision involving procurement storage and uses of item will have to be based on an

overall appreciation of the influence of the critical ones among them. Material control

necessitates the maintenance of inventory of every item of material as low as possible

ensuring at the same time, its availability as and when required for production. These twin

objectives are achieved only by a proper planning of inventory levels. It the level of inventory

is not properly planned, the results may either be overstocking or under stocking. If a large

stock of any item is carried it will unnecessarily lock up a huge amount of working capital

and consequently there is a loss of interest. Further, a higher quantity than what is legitimate

would also result in deterioration. Besides there is also the risk of obsolescence if the end

product for which the inventory is required goes out of fashion. Again, a large stock

necessarily involves an increased cost of carrying such as insurance, rent handling charges.

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Under stocking which is other extreme, is equally undesirable as it results in stock outs and

the consequent production holds ups. Stoppage of production in turn, cause idle facility cost.

Further, failure to keep up delivery schedules results in the loss of customers and goodwill.

These two extreme can be avoided by a proper fixation of two important inventory levels via,

the maximum level and the minimum level. The fixation of inventory levels is also known as

the demand and supply method of inventory control.

Carrying too much or too little of the inventories is detrimental to the company. If too little

inventories are maintained, company will have to encounter frequent stock outs and incur

heavy ordering costs. Very large inventories subjects the company to heavy inventory

carrying cost in addition to unnecessary tie up of capital.

An efficient inventory management, therefore, requires the company to maintain inventories

at an optimum level where inventory costs are minimum and at the same time there is no

stock out which may result in loss of sale or stoppage of production. This necessitates the

determination of the minimum and maximum level of inventories.

4.7 MINIMUM LEVEL

The minimum level of inventories of their reorder point may be determined on the following

bases:

Consumption during lead-time.

Consumption during lead-time plus safety stock.

Stock out costs.

Customer irritation and loss of goodwill and production hold costs.

To continue production during Lead Time it is essential to maintain some inventories. Lead

Time has been defined as the interval between the placing of an order (with a supplier) and

the time at which the goods are available to meet the consumer needs.

There are sometimes fluctuations in the lead-time and/ or in the consumption rate. If no

provision is made for these variations, stock out may take place-causing disruption in the

production schedule of the company. The stock, which takes care to the fluctuation in

demand, varies in lead-time and consumption rate is known as safety stock. Safety stock may

be defined as the minimum additional inventory, which serves as a safety margin or buffer or

cushion to meet an unanticipated increase in usage resulting from an unusually high demand

and or an uncontrollable late receipt of incoming inventory. It can be determined on the basis

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of the consumption rate, plus other relevant factor such as transport bottleneck, strikes or

shutdowns.

In the case of uncertainly, the probabilistic approach may be applied to determine the safety

margin. To avoid stock out arising out of such eventualities, companies always carry some

minimum level of inventories including safety stock. Safety stock may not be static for all the

times. A change in the circumstances and in the nature of industry demand, necessitates are

adjusted in its level. In this study an effort has been made to examine how the current

companies determine their minimum level for re-order inventories, safety stock, whether a

level of study is maintained throughout the year or not.

For each type of inventory a maximum level is set that demand presumably will not exceed as

well as a minimum level representative a margin of safety required to prevent out of stock

condition. The minimum level also governs the ordering point. An order to sufficient size is

placed to bring inventory to the maximum point when the minimum level is reached.

4.8 MAXIMUM LEVEL

The upper limit beyond which the quantity of any item is not normally allowed to rise is

known as the Maximum Level. It is the sum total of the minimum quantity, and ECQ. The

fixation of the maximum level depends upon a number of factors, such as, the storage space

available, the nature of the material i.e. chances of deterioration and obsolescence, capital

outlay, the time necessary to obtain fresh supplies, the ECQ, the cost of storage and

government restriction.

4.9 SEVERAL TOOLS OF INVENTORY CONTROL

The economic order quantity which enables determination of optimal size of order to

place on the basis of demand or usage of the inventory.

The technique of safety stocks to overcome problems of uncertainty.

The order point formula, which tells us, the optimal point at which to reorder a

particular item of inventory.

Together, these tools provide the means for determining an optimal average level of

inventory for the firm. Ratio analysis has a wider application as a measure of inventory

control among most manufacturing firms. Some of the important ratios are explained below:

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4.9.1 Inventory to Sales:

Total Inventory/Sales for the Period the ratio explains variations in the level of investment.

An increase in inventory levels, substantially beyond that which might be expected from an

increase in sales, may reflect such phenomena as the result of a conscious policy shift to

higher stock levels, of unintended accumulation of unsold stocks, and of inventory

speculation, or simply stocking in anticipation of an almost certain surge of orders.

4.9.2 Inventory Turnover (Cost of Goods Sold/Average Inventory)

The ratio tells us the rapidity with which the inventory is turned over into receivables

through sales. Generally, the higher the inventory turnover, the more efficient the

management of a firm is. However, a relatively high inventory turnover ratio may be the

result of too low a level of inventory and frequent stock outs. Therefore, the ratio must be

judged in relation to the past and expected future ratios of the firm and in relations of similar

firms or the industry average or both.

4.9.3 Sales to Inventory (Annual Net Sales/Inventory at the End of Fiscal Period)

The ratio indicates the volume of sales in relation to the amount of capital invested in

inventories. When inventory for affirm is larger in relation to sales (the condition which

causes it to have a lower net sales to inventory ratio than other firms) the firms rate of return

is less since it has more working capital tied up in inventories than has the firm with a higher

ratio.

4.9.4 Inventory to Current Assets (Total Inventory/Total Current Assets)

The ratio indicates the amount of investment in inventory per rupee of current assets

investment. Generally an increasing proportion of inventory is indicative of inefficient

inventory management. The ratio may also indicate the state of liquidity position of concern.

The lower the inventory to current assets lowers the liquidity as compared to other current

assets, viz., receivables, cash and marketable securities.

4.9.5 Inventories Expressed in Terms of Number of Days Sales

The ratio indicates the size of inventory in terms of number of days sales. For this purpose

first the sales per day are calculated and inventory is divided by the amount of sales per day.

The increasing inventory in terms of number of days sales may indicate either accumulation

of inventory or decline in sales. Inventory for this purpose is assumed to include finished

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goods only. While the former situation signifies poor inventory management, the later

indicates the poor performance of the marketing department.

4.9.6 Sundry Creditors to Inventory (Sundry Creditors/Inventory)

The ratio reveals the extent to which inventories are procured through credit purchases.

Inventories for this purpose are assumed to include raw materials and stores and spares only.

If the ratio is less than unity, it reveals that the credit available is lower than the total

inventory required. It also explains the extent of inventory procured through cash purchases.

Indirectly it emphasizes the inventory financing policy of the firm. If the ratio is more than

one, it explains that the entire inventory is purchased on credit.

4.9.7 Inventory to Net Working Capital (Inventory/Net Working Capital)

The ratio explains the amount of inventory per rupee of equity/long-term financed portion of

current assets. A higher ratio may mean greater amount of net working capital investment in

inventory.

4.10 PROCESS OF CONTROLLING INVENTORY:

Controlling inventory does not have to be an onerous or complex proposition. It is a process

and thoughtful inventory management. There are no hard and fast rules to abide by, but some

extremely useful guidelines to help your thinking about the subject. A five step process has

been designed that will help any business bring this potential problem under control to think

systematically thorough the process and allow the business to make the most efficient use

possible of the resources represented. The final decisions, of course, must be the result of

good judgment, and not the product of a mechanical set of formulas.

STEP 1: Inventory Planning

Inventory control requires inventory planning. Inventory refers to more than the goods on

hand in the retail operation, service business, or manufacturing facility. It also represents

goods that must be in transit for arrival after the goods in the store or plant are sold or used.

An ideal inventory control system would arrange for the arrival of new goods at the same

moment the last item has been sold or used. The economic order quantity, or base orders,

depends upon the amount of cash (or credit) available to invest in inventories, the number of

units that qualify for a quantity discount from the manufacturer, and the amount of time

goods spend in shipment.

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STEP 2: Establish order cycles

If demand can be predicted for the product or if demand can be measured on a regular basis,

regular ordering quantities can be setup that take into consideration the most economic

relationships among the costs of preparing an order, the aggregate shipping costs, and the

economic order cost. When demand is regular, it is possible to program regular ordering

levels so that stock-outs will be avoided and costs will be minimized. If it is known that every

so many weeks or months a certain quantity of goods will be sold at a steady pace, then

replacements should be scheduled to arrive with equal regularity. Time should be spent

developing a system tailored to the needs of each business. It is useful to focus on items

whose costs justify such control, recognizing that in some cases control efforts may cost

more the items worth. At the same time, it is also necessary to include low return items that

are critical to the overall sales effort.

If the business experiences seasonal cycles, it is important to recognize the demands that will

be placed on suppliers as well as other sellers. A given firm must recognize that if it begins to

run out of product in the middle of a busy season, other sellers are also beginning to run out

and are looking for more goods. The problem is compounded in that the producer may have

already switched over to next seasons production and so is not interested in (or probably

even capable of) filling any further orders for the current selling season. Production resources

are likely to already be allocated to filling orders for the next selling season. Changes in this

momentum would be extremely costly for both the supplier and the customer.

On the other hand, because suppliers have problems with inventory control, just as sellers do,

they may be interested in making deals to induce customers to purchase inventories off-

season, usually at substantial savings. They want to shift the carrying costs of purchase and

storage from the seller to the buyer. Thus, there are seasonal implications to inventory control

as well, both positive and negative. The point is that these seasonable implications must be

built into the planning process in order to support an effective inventory management system.

STEP 3: Balance Inventory Levels

Efficient or inefficient management of merchandise inventory by a firm is a major factor

between healthy profits and operating at a loss. There are both market-related and budget-

related issues that must be dealt with in terms of coming up with an ideal inventory balance:

Is the inventory correct for the market being served?

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Does the inventory have the proper turnover?

What is the ideal inventory for a typical retailer or wholesaler in this business?

To answer the last question first, the ideal inventory is the inventory that does not lose

profitable sales and can still justify the investment in each part of its whole. An inventory

that is not compatible with the firms market will lose profitable sales. Customers who cannot

find the items they desire in one store or from one supplier are forced to go to a competitor.

Customer will be especially irritated if the item out of stock is one they would normally

expect to find from such a supplier. Repeated experiences of this type will motivate

customers to become regular customers of competitors.

STEP 4: Review Stocks

Items sitting on the shelf as obsolete inventory are simply dead capital. Keeping inventory up

to date and devoid of obsolete merchandise is another critical aspect of good inventory

control. This is particularly important with style merchandise, but it is important with any

merchandise that is turning at a lower rate than the average stock turns for that particular

business. One of the important principles newer sellers frequently find difficult is the need to

mark down merchandise that is not moving well.

Markups are usually highest when a new style first comes out. As the style fades, efficient

sellers gradually begin to mark it down to avoid being stuck with large inventories, thus

keeping inventory capital working. They will begin to mark down their inventory, take less

gross margin, and return the funds to working capital rather than have their investment stand

on the shelves as obsolete merchandise. Markdowns are an important part of the working

capital cycle. Even though the margins on markdown sales are lower, turning these items into

cash allows you to purchase other, more current goods, where you can make the margin you

desire.

Keeping an inventory fresh and up to date requires constant attention by any organization,

large or small. Style merchandise should be disposed of before the style fades. Fad

merchandise must have its inventory levels kept in line with the passing fancy. Obsolete

merchandise usually must be sold at less than normal markup or even as loss leaders where it

is priced more competitively. Loss leader pricing strategies can also serve to attract more'

consumer traffic for the business thus creating opportunities to sell other merchandise as well

as well as the obsolete items. Technologically obsolete merchandise should normally be

removed from inventory at any cost.

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Stock turnover is really the way businesses make money. It is not so much the profit per unit

of sale that makes money for the business, but sales on a regular basis over time that

eventually results in profitability. The stock turnover rate is the rate at which the average

inventory is replaced or turned over, throughout a pre-defined standard operating period,

typically one year. It is generally seen as the multiple that sales represent of the average

inventory for a given period of time.

Turnover averages are available for virtually any industry or business maintaining inventories

and having sales. These figures act as an efficient and effective benchmark with which to

compare the business in question, in order to determine its effectiveness relative to its capital

investment. Too frequent inventory turns can be as great a potential problem as too few. Too

frequent inventory turns may indicate the business is trying to overwork a limited capital

base, and may carry with it the attendant costs of stock-outs and unhappy and lost

customers.Stock turns or turnover, is the number of times the "average" inventory of a given

product is sold annually. It is an important concept because it helps to determine what the

inventory level should be to achieve or support the sales levels predicted or desired.

Inventory turnover is computed by dividing the volume of goods sold by the average

inventory. Stock turns or inventory turnover can be calculated by the following equations:

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If the inventory is recorded at cost, stock turn equals cost of goods sold divided by the

average inventory. If the inventory is recorded at sales value, stock turn is equal to sales

divided by average inventory. Stock turns four times a year on the average for many

businesses. Jewelry stores are slow, with two turns a year, and grocery stores may go up to 45

turns a year.

If the dollar value of a particular inventory compares favorably with the industry average, but

the turnover of the inventory is less than the industry average, a further analysis of that

inventory is needed. Is it too heavy in some areas? Are there reasons that suggest more

inventories are needed in certain categories? Are there conditions peculiar to that particular

firm? The point is that all markets are not uniform and circumstances may be found that will

justify a variation from average figures.

In the accumulation of comparative data for any particular type of firm, a wide variation will

be found for most significant statistical comparisons. Averages are just that, and often most

firms in the group are somewhat different from that result. Nevertheless, they serve as very

useful guides for the adequacy of industry turnover, and for other ratios as well. The

important thing for each firm is to know how the firm compares with the averages and to

deter- mine whether deviations from the averages are to its benefit or disadvantage.

STEP 5: Follow-up and Control