¨Inventory control

Inventory control is a method where all stocks of goods are properly and promptly issued, accounted and preserved in the best interest of an entity that handles its inventory.




  • Objectives of inventory control:
  1. Maximum Customer service
  2. Minimum inventory investment
  3. Low cost plant operation
  • Functions of inventory control:
  1. To keep the inventories as low as possible consistent with the market conditions
  2. To minimize “out of stock” danger, which result in crash purchase at uneconomical rate
  3. To maintain a sufficient stock of finished products
  4. To maintain the proper records
  5. To forecast market and economic conditions of supply
  • Techniques of Inventory control:
  1. ABC analysis:

Means Always Better Control. ABC analysis divides an inventory into three categories- “A items” with very tight control and accurate records, “B items” with less tightly controlled and good records, and “C items” with the simplest controls possible and minimal records. ‘A’ items are very important for an organization. Because of the high value of these ‘A’ items, frequent value analysis is required. In addition to that, an organization needs to choose an appropriate order pattern (e.g. ‘Just- in- time’) to avoid excess capacity. ‘B’ items are important, but of course less important than ‘A’ items and more important than ‘C’ items. Therefore, ‘B’ items are intergroup items. ‘C’ items are marginally important. Difference among these items are shown in below table:

A items B items C items
Covers 10% of total items. Covers 20% of total items Covers 70% of total items
Consumes about 70% of total budget. Consumes about 20% of total budget. Consumes about 10% of total budget.
Requires very strict control. Requires very moderate control. Requires very loose control.
Requires either no safety stocks or low safety stocks. Requires either low safety stocks. Requires either high safety stocks.
Requires maximum follow-up. Requires periodic follow-up. Requires close follow-up.

 

  1. Economic order quantity:





In inventory management, economic order quantity (EOQ) is the order quantity that minimizes the total holding costs and ordering costs. It is one of the oldest classical production scheduling models. EOQ applies only when demand for a product is constant over the year and each new order is delivered in full when inventory reaches zero. There is a fixed cost for each order placed, regardless of the number of units ordered. There is also a cost for each unit held in storage, commonly known as holding cost, sometimes expressed as a percentage of the purchase cost of the item. We want to determine the optimal number of units to order so that we minimize the total cost associated with the purchase, delivery and storage of the product. The required parameters to the solution are the total demand for the year, the purchase cost for each item, the fixed cost to place the order and the storage cost for each item per year. Note that the number of times an order is placed will also affect the total cost, though this number can be determined from the other parameters.

Methods of determining EOQ:

  1. Tabular determination of EOQ
  2. Graphic preparation of EOQ: EOQ is the point where holding costs and ordering costs are minimum as shown in the below figure.images
  1. Algebric calculation of EOQ

EOQ = 2ab/cs

a= Annual consumption

b= Buying cost per order

c= Cost per unit material

s= Storage and other inventory carrying cost

Example

Annual requirement quantity (a) = 10000 units

Cost per order (b) = 2

Cost per unit (c)= 8

Carrying cost percentage (s) = 0.02

Solution:  √2ab/cs = √(2*10000*2)/8*0.02            = 500 units

  1.  Perpetual Inventory system:

Under the perpetual inventory system, an entity continually updates its inventory records to account for additions to and subtractions from inventory for such activities as:

  • Received inventory items
  • Goods sold from stock
  • Items moved from one location to another
  • Items picked from inventory for use in the production process
  • Items scrapped

Thus, a perpetual inventory system has the advantages of both providing up-to-date inventory balance information and requiring a reduced level of physical inventory counts.





However, the calculated inventory levels derived by a perpetual inventory system may gradually diverge from actual inventory levels, due to unrecorded transactions or theft, so you should periodically compare book balances to actual on-hand quantities, and adjust the book balances as necessary.

  1. Review of slow and non-moving items:

Slow moving items are those items which are moving at slow rate. Dormant material are those items which are moving temporarily because of seasonal production. Obsolete items are those which have become useless due to change in design, method of manufacture, product or process etc. In order to detect slow and non-moving items, the followings steps may be taken:

  1. Periodic reports
  2. Obsolete items
  3. Moving ratios

 

  1. Input-output ratio analysis

Input-output ratio (I-O ratio) is the relation between quantity of material charged to the production process and the quantity of material in the final output.

For example, 5 kg of material X is put in production and final output is 4 kg, then I-O ratio is 5*100/4= 125%.

Less the I-O ratio, more economical is the product.

  1. Setting of various levels





To ensure smooth running of production process, the materials department of an enterprise sets different levels for each item of inventory. These levels are:

  1. Maximum level
  2. Minimum level
  3. Reorder level
  4. Danger or safety stock level
  1. Maximum level: This is the maximum quantity above which stock should never be held at any time. It is fixed after considering the following factors including investment required in stores, raw materials and other items of inventory, Availability of storage space, Lead time for delivery of materials, Obsolescence rate, Consumption rate of materials, Economic Order Quantity, Storage and Insurance costs, Price advantage due to bulk purchases.

Maximum Level can be calculated as:

Maximum Level=Re-order Level ×  Re-order Quantity –( Minimum consumption × Minimum Re-order period)

  1. Minimum Level: This is the minimum level below which an item of stoeck should never be allowed to fall. Minimum level depends on the following factors including consumption rate of materials, lead time for delivery of materials.

Minimum level is computed using the following formula:

Minimum level=Re-order level – (Normal consumption × Normal reorder-period)

  1. Danger or safety level:Safety or reserve stock is fixed to avoid stock out conditions. Carefully fixed safety stock level helps in minimising stock-out and carrying costs. This level is fixed usually between minimum level and zero level. On reaching this level, the storekeeper stops issuing materials. However sometimes for preventive measures, this stock is fixed above minimum level.





Formula for calculating Danger level is:

Danger/Safety level= Ordering Level–(Average rate of consumption×Re-order period)

Or

(Maximum rate of consumption–Average rate of consumption)×Lead Time

  1. Ordering Level: Ordering Level is that level on reaching which, a fresh order is placed with the suppliers. This level depends on annual consumption of an item, lead time, expected usage during lead period, minimum Level.

Ordering level is calculated using the formula:

Ordering Level= Minimum Level + consumption during lead period

or

Maximum consumption × Lead time + Safety stock

or

Maximum consumption×Maximum re-order period

  1. Use of material budgeting:

 

In this method purchase budget for both individual and whole is prepared separately. Increase or decrease in previous months with comparison to previous year, adjustment of overbuying or underbuying during the previous months are factors to be considered.

 

  1. Establishing an effective purchase procedure: Means the sequence of steps in which a purchase transaction is carried out.

 

  1. VED analysis:





Vital essential and desirable analysis is used primarily for the control of spare parts. The spare parts can be divided into three categories:

 (i) Vital: The spares the stock out of which even for a short time will stop production for quite some time and future the cost of stock out is very high are known as vital spares.

(ii) Essential: The spare stock out of which even for a few hours of days and cost of lost production is high is called essential.

(iii) Desirable: Spares are those which are needed but their absence for even a week or so will not lead to stoppage of production.