INVENTORY MANAGEMENT
Inventory management refers to management
of raw materials and related items and considers what to purchase, how to
purchase, from where to purchase, when to purchase, where to store, when to use
for production, etc. Inventories are stock of the product of a company manufacturing
for sale and components that makeup the product. The following are the various
forms in which inventories exist in manufacturing concern:
- Raw materials – Those units which have been purchased and stored for future productions
- Work in Process – Those units which are semi manufactured products
- Finished Goods – Those units which are completely manufactured and are ready for sale
- Supplies or stores – Those units which are needed for smooth running of production process
- Spares – Includes small spares and parts
Inventory Holding
Motives:
« Transactions motive – To facilitate
smooth production and sales operations
« Precautionary motive – To guard
against the risk of unpredictable changes in demand and supply of forces and
other factors
« Speculative motive – To take
advantage of price fluctuations
Objectives of Inventory
Management:
« To
facilitate smoother and uninterrupted production process
« To
maintain sufficient stock of raw materials in periods of short supply and
anticipate price changes
« To
maintain optimum inventory to maximize profitability
« To meet
the seasonal demands of the products
« To maintain sufficient finished goods inventory for smooth sales operation and efficient customer service
Over investment in inventory causes
« Unnecessary
tie-up of the firm’s funds and loss of profit
« Excessive
carrying costs
« Risk of Liquidity
Inadequate level of inventory causes
« Production
hold-ups
« Failure
to meet delivery commitments, in turn loss of profit
Inventory Management Techniques:
1. Techniques based on order quantity:
A. Economic Order Quantity Method - EOQ:
EOQ refers to the level of inventory at which the total cost of inventory comprising ordering cost and carrying cost is at minimum.
Ordering cost: This includes entire cost of acquiring raw materials such as requisitioning, purchase ordering, transporting, receiving, inspecting and storing. Ordering costs increases with increase in number of orders and decreases with increasing size of inventory.
Carrying cost: This includes the costs incurred for maintaining a given level of inventory such as storage (warehousing), insurance and taxes, handling costs, administrative costs, deterioration and obsolescence. Carrying costs increases with increasing size of inventory and decreases with increase in number of orders.
The optimum inventory is determined at a level where the ordering costs and carrying costs is at minimum.
Formula:
EOQ= √(2*A*O/C)
Where
A = Annual demand in units
O = Ordering cost per unit
C = Carrying cost per unit
A. Determination of stock level:
Stock level refers to the level of stocks maintained by the business concern at all times. Different level of stock can be determined based on the volume of the stock.
Minimum level: The level at which the stock needs to be maintained at all times. Below this level, the work will stop due to shortage of material.
Minimum level of Stock = Reorder level – (Average rate of consumption * Average reorder period)
Maximum level: The maximum limit of quantity of inventories the business concern needs to be maintained above which it will become overstocking.
Maximum level of Stock = (Reorder level + Reorder Qty) – (Minimum rate of consumption * Minimum reorder period)
(OR) = EOQ = Safety Stock + Order Qty
Lead time: The time normally taken on receiving delivery after placing orders with suppliers.
Re-order level: The level when business makes fresh order, usually between maximum and minimum level of stock.
Reorder level or Ordering level = Maximum rate of consumption * Maximum reorder period
(OR) = Safety stock + Lead time consumption
Danger level: The level below the minimum level which leads to stoppage of production process.
Danger level = Average consumption * Maximum reorder period for emergency purchase
Safety stock: Extra inventories that can be drawn down when actual lead time and usage rates are greater than expected.
Safety Stock = (Annual Demand/365) *(Maximum Reorder period – Average reorder period)
Average stock level = Minimum stock level + ½ of re-order quantity maximum level
1. Techniques based on the classification of inventories:
i. ABC Analysis:
It is the inventory management techniques that divide inventory into three categories based on the value and the volume of the inventories.
|
Category |
Volume (%) |
Value (%) |
|
A |
10 |
70 |
|
B |
20 |
20 |
|
C |
70 |
10 |
ii. FNSD Analysis:
F – Fast moving inventories; N – Normal moving inventories
S – Slow moving inventories; D – Dead moving inventories
It is the inventory management technique in which inventories are classified according to their period of holding and this method helps to identify the movement of the inventories (aging schedule of inventories).
iii. VED Analysis:
V – Vital items; E – Essential items; D – Desirable items
This technique ideally suited for spare parts in the inventory management which is classified based on the usage of the inventories.
iv. HML Analysis:
H – High Value; M – Medium Value; L – Low Value
This technique is based on the value of the inventories
