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INVENTORY MANAGEMENT

Meaning of Inventory Control Inventory refers to the stock pile of the product a firm is offering for sale and the components that make up the product. In other words, the inventory is used to represent the aggregate of those items of tangible assets which are 1. Held for sale in ordinary course of the business. 2. In process of production for such sale. 3. To be currently consumed in the production of goods or services to be available for sale. a) Raw material and supplies. b) Work in Progress. c) Finished goods. Meaning of Control:Inventory control means efficient management of capital invested in raw materials and supplies, work- in progress and finished goods. Needs or importance of holding Inventories 1. To Ensure Production. 2. Reducing order Cost. 3. Gaining Quantity Discount. 4. Avoiding Losses of Sales. 5. Full Utilization of company. 6. Lower Price. Objectives of inventory Management A. Operating objective:a. To ensure continuous supply of materials. b. To ensure uninterrupted production. c. To minimize the risks and losses. d. To ensure better customer Services. e. Avoiding of stock out danger. B. Financial Objective:a. To minimize capital investment. b. To minimize inventory costs. c. Economy in purchase. C. Dangers of excess inventory:a. Unnecessary investment of funds and reduction in profit. b. Increase in holding costs. c. Loss of liquidity. d. Deterioration in inventory. Factor affecting level of inventory 1. Nature of business. 4. Market structure. 7. Financial position. 2. Inventory turnover. 5. Economies of production. 8. Period of operating cycle. 3. Nature of type of product. 6. Inventory costs. 9. Attitude of management.

TECHNIQUES OF INVENTORY CONTROL Inventory control signifies a planned approach of finding when to shift, what to shift, how much to shift and how much to stock so that costs in buying and storing are optimally minimum without interrupting production or affecting sales. To solve these problems of inventory management various techniques are there. These techniques are divided into two categories: These Notes are prepared by ASNclasses 85, Shree Gopal Nagar, Gopalpura By Pass, 5177216, 3241216

TECHNIQUES: (1) MODERN TECHNIQUES: (a) Economic Order Quantity (EOQ) (b) Re-Order Point (ROP) (c) Fixing Stock Levels (d) Selective Inventory Control (i) ABC Analysis (ii) VED Analysis (iii) SDE Analysis (iv) FSN Analysis (2) TRADITIONAL TECHNIQUES: (a) Inventory Control Ratios (b) Two Bin System (c) Perpetual Inventory System (d) Periodic Order System 1. (a) ECONOMIC ORDER QUANTITY (EOQ) The optimal size of an order for replenishment of inventory is called economic order quantity. Economic order quantity (EOQ) or optimum order quantity is that size of the order where total inventory costs (ordering costs + carrying costs) are minimized. Economic order quantity can be calculated from any of the following three methods (a) Trial and Error Method (b) Formula Method (c) Graphic Method

Formula Method: This method is used to avoid the computational difficulties of trial and error method. It is also known as SQUARE ROOT FORMULA or WILSON FORMULA as given below: EOQ = 2RO C

Where, EOQ = Economic Order Quantity R = Annual Requirement or consumption in units O = Ordering Cost per order C = Carrying Cost per unit per year No. of orders = R/EOQ Time gap between two orders = Total Cost = = No. of days in a year No. of Orders

Purchase Cost + Carrying Cost + Order Cost (R x Unit Price) + (EOQ/2 x C) + (R/EOQ x O)

Types of Inventory Cost: (A) Ordering Cost: a. When ordering to outside party: i. Transportation Costs ii. Inspection Costs b. Ordering on Plant: i. Machine Set up Costs ii. Tooling Costs

(B) Inventory Carrying Costs/Inventory Holding Costs: (a) Costs connected directly with materials: Obsolescence These Notes are prepared by ASNclasses 85, Shree Gopal Nagar, Gopalpura By Pass, 5177216, 3241216

Deterioration Pilferage

(b) Financial Costs: Taxes Insurance Interest on Capital borrowed to acquire and maintain the inventory capital costs, storage space costs etc. (C) Stock-out Costs: (i) Lost contribution through the lost sales (ii) Lost of future sales (as customer goes elsewhere) (iii) Loss of customer Goodwill (iv) Loss of Production (v) Labour frustration and demoralization (vi) Extra costs associated with urgent often small quantity replenishment purchases. Graphic Method The economic order quantity can also be determined with the help of graph. Under this method, ordering costs, carrying costs and total inventory costs according to different lot sizes are plotted on the graph. The point at which the inventory carrying cost and the line of ordering cost intersect each other is the economic order quantity. At this point the total cost line is also minimum. Y

EOQ Costs (Rupees) Total Inventory Cost Carrying Cost

Ordering Cost O X

Assumptions: * Inventory is consumed at a constant rate. * Costs do not vary over time. * Lead time is known and constant. * Order cost, carrying cost and unit price are constant. * Carrying or holding costs are proportionate to the value of stock held. Similarly, ordering cost varies proportionately with price. 1. (b) RE-ORDER POINT After determining the optimum quantity of purchase order, the next problem regarding purchase of goods is to know the point of when the order should be placed so that the firm. Re-order level is that level of inventory at which an order should be placed for replenishing the current stock of inventory. 1. Lead Time: Lead time refers to the time between ordering a replenishment of an item of inventory and actually receiving the item into store. 2. Usage Rate: Total annual consumption No. of days in a year These Notes are prepared by ASNclasses 85, Shree Gopal Nagar, Gopalpura By Pass, 5177216, 3241216

3. Safety Stock: It is the minimum quantity of inventory which a firm decides to keep always to protect itself against the risk and losses of stoppage in production and sale due to non- availability of inventory. Formulae:

R.O.P = (Lead Time x Usage Rate) + Safety Stock or R.O.P = Maximum usage x Maximum R.O.P or Safety Stock = Usage Rate x Days of safety Usage Rate = Annual Consumption/No. of days in a year.
1. (c) Fixing Stock Levels The maximum & minimum stock levels are fixed after considering the following factors: * Availability of storage space. * Lead time i.e. time required in receiving the goods ordered. * Availability of working capital. * Average rate of consumption of material . * Cost of storage and insurance. * Risk of obsolescence and deterioration. * Maximum requirements stores at any particular point of time. * Economy in prices such as making bulk purchases during period of low prices. * Rate of consumption of material. * Re-order level.

Maximum Level = (ROL + ROQ) (Minimum Usage x Minimum ROP) Maximum Level = Safety Stock + EOQ Minimum Level = Re-order level (Normal Usage Rate x Normal Re-order period) = ROL (Normal Usage x Average ROP) Minimum Level = Safety Stock Average stock level = Maximum level + Minimum level 2 Average stock level = (Minimum level + 1/2 Re- order Quantity)
1. (d) SELECTIVE INVENTORY CONTROL (i). ABC Analysis: Always better control.

or

or

or

ABC anal ysis may be defined as a technique where inventories are analyzed to their value so that costly items are given greater attention and care by the management. Process of i. ii. iii. iv. v. Benefits: i. ii. iii. iv. ABC Analysis: Classification Ascertainment of total cost Rank determination Computation of ratio or percentage Determination of ABC category. Significant reduction in investment in inventory. Protection against stock outs. Less work load related to ordering procuring, receiving, inspection, handling and storage of inventory items. Reduction in obsolescence losses. These Notes are prepared by ASNclasses 85, Shree Gopal Nagar, Gopalpura By Pass, 5177216, 3241216

Category A B C

% of Total Value 70-80 20-25 5-10

% of Total Quantity 5-10 20-30 60-70

v.

Increase in profits.

2. VED Analysis: Vital, Essential and Desirable. 3. SDE Analysis: Scarce, Difficult and easy. 4. FSN Analysis: Fast Moving (F), Slow Moving (S), Non Moving (N). 2. (a) INVENTORY CONTROL RATIOS 1. No. of days stock in hand = Stock X 365 days Cost of Sales for the Year 2. Stock Turnover = Cost of goods sold Average Stock

2. (b) TWO BIN SYSTEM All inventory items are stored in two separate bins. In the first bin, a sufficient supply is kept to meet the current requirement over a designated period of time. In the second bin, a safety stock is maintained for use during lead time. When the stock of first bin is used, an order for further stock is immediately placed. The material in second bin is then consumed to meet stock needs until the new order is received. On receipt of new order, second bin is restored and the balance is put in the first bin. Therefore depletion of first bin provides an automatic signal to re-order.

Lead Time Safety Buffer Stock BIN I

Re-order Level

BIN

Re-order Point

2. (c) PERPETUAL INVENTORY SYSTEM Perpetual inventory system is defined as the method of recording stores balance after each receipt and issue to facilitate regular checking of stock. It is also known as continuous stock checking. The application of perpetual inventory control system involves (i) Attaching Bin cards with Bins. (ii) Continuous stock taking to compare the actual stock. Under this system, statement of material, follow up actions, monitoring etc. can be smoothly carried out. 2. (d) PERIODIC ORDER SYSTEM Under this system, all stock levels are reviewed after every fixed time intervals like weekly, monthly, quarterly etc, depending upon the criticality of the item. Critical items may require a short review cycle and on the other hand, lower cost and non moving items may require long review cycle.

These Notes are prepared by ASNclasses 85, Shree Gopal Nagar, Gopalpura By Pass, 5177216, 3241216

INVENTORY MANAGEMENT (QUESTIONS)


Q.1. Calculate the economic order quantity from the following particulars: Annual requirement =1,600 units; Cost of materials per unit =Rs 40 Cost of placing and receiving one order= Rs. 50 Annual carrying cost of inventory, 10% of inventory value. Q.2. Compute EOQ and the total variable cost from the following information: Annual demand = 5,000 units; Units Price = Rs. 20 Order Cost = Rs. 16; Storage Rate = 2% Per annum Interest Rate = 12% Per annum; Obsolescence Rate = 6% Per annum Q.3. Shrinath Enterprises require 90,000 units of a certain item annually. The cost per unit is Rs. 3, the cost per purchase order Rs. 300 and the inventory carrying cost Rs.6 per unit year. 1. What is the economic order Quantity? 2. What should the firm do, if the supplier offers discount as below: Order Quantity Discount % 4500- 5999 2 6000 and above 3 Q.4. A Manufacturing company will require 50,000 units of a product during the next year. The cost of processing an order is Rs. 20 and the carrying cost per unit is 50 paise per year. Lead time of an order is 5 days and the company will keep a safety stock of two days usage. You are required to calculate: 1. Economic order Quantity 2.Re-order Point 3. Minimum Inventory 4.Maximum Inventory and 5. Average Inventory. [Assume 250 days in a year.] Q.5. Shriram enterprises manufacture a special product ZED. The following particulars collected for the year 2000: 1. Monthly demand of ZED- 1,000 units 2. Cost of placing an order Rs. 100 3. Annual carrying cost per units Rs. 15 4. Normal usages 50 units per week 5. Minimum usages 25 units per week 6. Maximum usages 75 units per week 7. Re-order period 4 to 6 weeks. 8. Computer from the above: a. Re-order Quantity d. Maximum Level b. Re-order level e. Average stock level c. Minimum Level

Q.6. Two components X and Y are used as follow: Normal usage 600 units per week each. Maximum usage 900 units per week each Minimum usage 300 units per week each Re-order quantity- X = 4,800 units; Y = 7,200 units Re-order period- X = 4 to 6 weeks; Y = 2 to 4 weeks a. Re-order Quantity b. Re-order level c. Minimum Level d. Maximum Level e. Average stock level Q.7. Annual demand for a particular item of inventory is 10,000 units. Inventory carrying cost per year is 20% and ordering cost is Rs. 40 per order. The price quoted by the supplier is Rs. 4 per unit. However the supplier is willing to give discount of 5% for orders of 1,500 or more. Is it worthwhile to avail of the discount offer? These Notes are prepared by ASNclasses 85, Shree Gopal Nagar, Gopalpura By Pass, 5177216, 3241216

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