Inventory Management and Control

Inventory Management and Control
In dictionary meaning of inventory is a “detailed list of goods, furniture etc.” Many understand the word
inventory, as a stock of goods, but the generally accepted meaning of the word ‘goods’ in the accounting
language, is the stock of finished goods only. In a manufacturing organization, however, in addition to
the stock of finished goods, there will be stock of partly finished goods, raw materials and stores. The
collective name of these entire items is ‘inventory’. The term ‘inventory’ refers to the stockpile of
production a firm is offering for sale and the components that make up the production.
The inventory means aggregate of those items of tangible personal property which
(i) Are held for sale in ordinary course of business.

(ii) Are in process of production for such sales.
(iii) They are to be currently consumed in the production of goods or services to be available for
sale.
Inventories are expandable physical articles held for resale for use in manufacturing a
production or for consumption in carrying on business activity such as merchandise, goods
purchased by the business which are ready for sale. It is the inventory of the trader who dies
not manufacture it.
Objectives of Inventory Management

The primary objectives of inventory management are:
(i) To minimize the possibility of disruption in the production schedule of a firm for want of raw
material, stock and spares.
(ii) To keep down capital investment in inventories.
The effective inventory management should
(i) Maintain sufficient stock of raw material in the period of short supply and anticipate price
changes.
(ii) Ensure a continuous supply of material to production department facilitating uninterrupted
production.
(iii) Minimize the carrying cost and time.
(iv) Maintain sufficient stock of finished goods for smooth sales operations.
(v) Ensure that materials are available for use in production and production services as and
when required.
(vi) Ensure that finished goods are available for delivery to customers to fulfil orders, smooth
sales operation and efficient customer service.
(vii) Minimize investment in inventories and minimize the carrying cost and time.
Problems faced by management:
(i) To maintain a large size inventories for efficient and smooth production and sales
operation.
(ii) To maintain only a minimum possible inventory because of inventory holding cost
and opportunity cost of funds invested in inventory.
(iii) Control investment in inventories and keep it at the optimum level.
Inventory management, therefore, should strike a balance between too much inventory
and too little inventory. The efficient management and effective control of inventories help
in achieving better operational results and reducing investment in working capital. It has a
significant influence on the profitability of a concern.
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 phase 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.
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.
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. 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:
1. Lead time for deliveries.
2. The rate of consumption.
3. Requirements of funds.
4. Keeping qualities, deterioration, evaporation etc.
5. Storage cost.
6. Availability of space.
7. Price fluctuations.
8. Insurance cost.
9. Obsolescence price.
10. Seasonal consideration of price and availability.
11. EOQ (Economic Order Quantity), and
12. Government and other statuary restriction
EOQ (Economic Order Quantity)

The EOQ refers to the order size that will result in the lowest total of order and carrying costs for an
item of inventory. If a firm place unnecessary orders it will incur unneeded order costs. If a firm places
too few order, it must maintain large stocks of goods and will have excessive carrying cost. By calculating
an economic order quantity, the firm identifies the number of units to order that result in the lowest
total of these two costs. The constraints and assumption followed:
1. Demand is known-- Using past data and future plans a reasonably accurate prediction of demand can
often be made. This is expressed in unit sold in a year.
2. Sales occur at a constant rate-- This model may be used for goods that are sold in relatively constant
amount throughout the year. A more complicated model is needed for firms whose sales fluctuate in
response to their seasonal cyclical factors.
3. Cost of running of goods are ignored-- Cost associated with storage, delays or lost sales are not
considered. These costs are considered in the determination of safety level in the re-order point
subsystem.
4. Safety stock level is not considered-- The safety stock level is the minimum level of inventory that the
firm wishes to hold as a protection against running out. Since the firm must always be above this level
the EOQ need not be considered the safety stock level.
Total Ordering Cost (TOC) = (A/Q)*O
Average Inventory= Q/2
Total Carrying Cost (TCC) = (Q/2)*C
Total Inventory Cost= TOC+TCC
Total Cost= (AO/2) + (QC/2)
Where A=total annual demand
Q=Quantity order in units
O=Order cost per order
C=Carrying cost per unit
The basic formula is
EOQ = 2(U)(OC)/ CC%PP
Where 2=mathematical factor that occurs during the deriving of the formula, U-Units sold per year, a
forecast provided by the marketing department. OC=Cost of placing each order for more inventory
provided by cost accounting. CC% = Inventory carrying cost expressed as a percentage of the average
value of the inventory, an estimate usually provided by cost accounting. PP = Purchase price per each
unit of inventory supplied by the purchasing department.
Quantity Discount and Order Quantity

The standard EOQ analysis is based on the assumption that the price per unit remains constant
irrespective of the order size. When quantity discount are available which is often the case, price per
unit is influenced by the ordered quantity. This violates the applicability of the EOQ formulas. However
the EOQ framework can still be used as a starting point for analyzing the problem.

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Inventory Management and Control

(i) Are held for sale in ordinary course of business.

Objectives of Inventory Management

The effective inventory management should

Inventories Control Techniques

1. Lead time for deliveries.

2. The rate of consumption.

4. Keeping qualities, deterioration, evaporation etc.

10. Seasonal consideration of price and availability.

11. EOQ (Economic Order Quantity), and

12. Government and other statuary restriction

EOQ (Economic Order Quantity)

Total Ordering Cost (TOC) = (A/Q)*O

Average Inventory= Q/2

Total Carrying Cost (TCC) = (Q/2)*C

Total Inventory Cost= TOC+TCC

Total Cost= (AO/2) + (QC/2)

Where A=total annual demand

Q=Quantity order in units

O=Order cost per order

C=Carrying cost per unit

The basic formula is

EOQ = 2(U)(OC)/ CC%PP

Quantity Discount and Order Quantity

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