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INVENTORY MANAGEMENT

Dr. Neeraj Chitkara

Assistant Professor

Samalkha Group of Institutions

Email- neer.chitkara@gmail.com

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INTRODUCTION

Inventories are assets of firm and as such they represent an investment. Because such investment requires the precious funds, managers must ensure that the firm maintains inventories at the correct level. If they become too large, the firm loses the opportunity to employ those funds more effectively. Similarly, if they are too small, the firm may lose sales. Managing the level of inventories is like maintaining the level of water in a bath tub with an open drain. The water is flowing out continuously. If the water is let in too slowly, the tub is soon empty. If the water is let in too fast, the tub overflows.

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TYPES OF INVENTORIES

The common types of inventories for most of the business firms may be classifies as finished goods, w-i-p and raw materials.

Finished GoodsThese are the goods which are either being

purchased or being produced or being processed by the firm. These are just ready for sale to customers. Inventories of finished goods arise because of the time involved in production process and the need to meet customer’s demand promptly. If the firms do not maintain a sufficient finished goods inventory, the customer who are unwilling to wait may turn to competitors. The purpose of finished goods inventory is to bring smoothness in the production and sales function.

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Work-in Progress

It refers to the raw materials engaged in various phases of production schedule. The degree of completion may be varying for different units. Some units might have been just introduced, while some others may be 40% complete or others may be 90% complete. The work-in-progress refers to partially produced goods. The value of work-in-progress includes the raw materials costs, the direct wages and expenses already incurred and the overheads, if any. The qty. and the value of work-in-progress depends upon the length and complexity of production cycle.

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Raw Materials

The raw materials include the materials which are used in the production process and every manufacturing firms has to carry certain stock of raw materials in stores. These units of raw materials are regularly issued/transferred to production department. Inventories of raw materials are held to ensure that the production process is not interrupted by a shortage of these materials. The requirement of stock of raw material is based upon many factors including speed with which raw materials can ordered and procured, uncertainty in the supply of raw materials etc. Its purpose is just to make the production and purchasing functions independent.

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OBJECTIVES OF HOLDING INVENTORY

Transaction Motive Precautionary Motive

Strikes, labour problems, natural calamities etc.

Speculative Motiveto earn extra profit due to shortage

Contractual Agreements

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BENEFITS OF HOLDING INVENTORY

For Trading Concerns Uninterrupted selling process Quality discounts

For manufacturing concerns Uninterrupted production schedule Independent sales activity

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COST OF INVENTORYThe cost of holding inventories may include the

following: Carrying Costs: This is the cost incurred in keeping or

maintaining n inventory of one unit of raw material or work-in-progress or finished goods. There are two components of it:Cost of Storage

e.g. rent of space, salary of storekeeper, cost of infrastructure, cost of insurance, cost of warehousing, handling costs etc.Cost of Financing

e.g. opportunity costs, interest on borrowings ( carrying cost is always variable cost and directly varies in the same direction in which the stock varies)

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Ordering Costs : The costs of ordering include the cost of

acquisition of inventories i.e. cost of preparation and execution of an order, cost of paper work and cost of communication with supplier, cost of inspection, checking & handling, salaries & wages of the purchase department.

1. Total annual ordering cost= Cost per order × No. of orders placed in the year

The ordering cost may have fixed components as well as variable components; fixed component is not affected by the order size whereas variable component is affected by the order size e.g. transaction\charges may be payable per unit subject to a minimum charges per trip.

The carrying cost and the ordering costs are the opposite forces and collectively they determine the level of inventory. A financial manager has to achieve a trade-off between carrying costs and the ordering costs.

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Cost of stock-outs (a hidden cost)A stock out is a situation when

the firm is not having units of an item in store but there is a demand for that either from customers or the production department. The stock out refers to demand for an item whose inventory level has already reduced to zero or insufficient level. Stock out does not appear if the item is not demanded even if the inventory level has fallen to zero.

Costs of stock outs of finished goods i.e. lost sales, cancellation of orders, adverse affect to the goodwill etc. Costs of stock outs of raw material is the hurdle in the production process.

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INVENTORY

High Levels Low Levels

Benefits

•Happy Customers•Few productions delays( always have need parts on hand)

Benefits•Low Storage costs•Less risk of Obsolescence

Costs•Expensive•High Storage Costs•Risk of Obsolescence

Costs•Shortage•Dissatisfied customers

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TECHNIQUES OF INVENTORY MANAGEMENT

Explosion process Past-usage Methods Value-volume Analysis ABC Approach VED Classification HML Classification XYZ Classification FSN Classification SDE and Golf Classification SOS Classification

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INVENTORY CONTROL MODELS

Economic Order Quantity Model Probabilistic Inventory control Just-In-Time Inventory Management System

Other Control Devices Control Account Physical Counting Visual View Two-bin-System Minimum-maximum System Periodic Order System

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INVENTORY MANAGEMENT & VALUATION

Average Cost Method First-In , First-out (FIFO) Inventory

Method Last-In, First-out (LIFO) Method`

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DETERMINATION OF STOCK LEVELS

Both the excess and shortage of materials are harmful for the firms. Hence various stock levels must be determined:

Minimum Level:This represents the quality which

must be maintained in hand at all times. The following things must be considered regarding it Lead Time, Rate of Consumption, Nature of materials etc.

Minimum Level=Re-ordering level - (Normal consumption × Normal re-order period)

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RE-ORDERING LEVEL

When the quality of materials reaches at a certain figure then fresh order is send to get materials again. Re-ordering level is fixed between minimum level and maximum level.

The following points are considered while determining re-ordering level: rate of consumption, no. of days required to replace the stock etc.

Re-ordering level= Maximum consumption × Maximum re-order period.

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MAXIMUM LEVEL

It is the quality beyond which a firm should not exceed its stock otherwise there will be overstocking. Maximum stock level depends upon the following factors:

The availability of capital for the purchase of materials.

The maximum requirement at any point of time. The availability of space for storing the materials. The rate of consumption of materials during lead time. The cost of maintaining the stores. The possibility of fluctuations in prices. The nature of materials. Restrictions imposed by govt.Maximum stock level= Re-ordering level + Re-ordering

quantity-(Minimum consumption × Minimum re-ordering period).

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DANGER LEVEL

It is the level beyond which materials should not fall in any case. If danger level arise then immediate steps should be taken to replenish the stock even if more cost is incurred in arranging the materials. If materials are not arranged immediately there is a possibility of stoppage of work.

Danger level= Average consumption × maximum re-order period for emergency purchase

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AVERAGE STOCK LEVEL;

Average stock level = Minimum stock level +1/2 of Re-order quantity