Inventory Management

INVENTORY MANAGEMENT
What Is Inventory Management?
• Inventory management refers
to the process of ordering,
storing, using, and selling a
company's inventory. This
includes the management of
raw materials, components, and
finished products, as well as
warehousing and processing of
such items.
Nature of Inventories
• Nature of Inventories:
• Normally, Ìnventories’ consist of:
• Raw Materials : These are
materials and components that
are required as inputs in making of the
final product.
• Work-in-progress : It refers to
the goods which are in the intermediate
stages of production.
• Finished Goods : It consists of
final `Finished Products’ that are ready
for sale.
TYPES OF INVENTORY:
• Types of Inventory:
• The Àccounting Standard – 2’ [AS-2] of
“The Institute of Chartered Accountants of
India”, has classified “Inventory” into:
• 1. Raw Materials – consisting of
“Raw Material and Component”
• 2. Stores and Spares – consisting of
“Fuel and Spare Parts”
• 3. Work-In-Progress – representing
“Partly Finished Goods”
• 4. Finished Goods – referring to
“Completely Finished Goods” ready for
sale.
COST OF INVENTORY:
• Cost of Inventory:
• The Ìnventory Cost’ may be categorised as:
• 1) Material Cost:
• It refers to the “Total Cost of Material Purchased” or “Landed Cost of Material Procured” (which is Material
Cost PLUS incidental expenses.)
• 2) Ordering Cost:
• It is the `Cost of Placing an Order and Receiving’ the Material.
• `Cost of Placing an Order’ refers to the expense involved in complying with the `Purchase Procedure’ within
the organisation.
• `Cost of Receiving’ the Material represents the expenses incurred for receipt of material, testing & inspection
and storing of materials.
• 3) Carrying Cost:
• It consists of the Storage Cost, Material Maintenance Cost, Insurance Cost, Interest element of Funds parked
in Inventories, etc.
• 4) Shortage Cost:
• It refers to the situation where the quantity of material in hand is less
than the quantity actually required. Hence, there is a `Shortage of
Material’.
This can have repercussion on:
• Upsetting the Production Schedules;
• Non-compliance of Customer’s Orders in time;
• Purchase of costlier substitutes;
• Deterioration of Company’s Goodwill in the Market. Etc.
Purpose / Objective of Inventory:
• The main purpose or objectives of Ìnventory Management’ is to:
1.Prevent ùnder-stocking’ or òver-stocking’ of materials;
2.Ensure timely procurement of inventories;
3.Minimise `Total Inventory Cost’;
4.Prevent `Manipulations of Records’;
5.Avoid `Frauds’ with respect to items of inventories;
6.Provide correct & ready information (with respect to items of Ìnventories’):
1. To Management for Decision Making;
2. For Periodic Stock-taking;
3. For timely reporting of Ìnventory Value’ in Financial Statements.
Role of Inventory in Working Capital:
Inventory Management Techniques
• ABC Analysis– ABC analysis stands for Always Better Control Analysis.
It is an inventory management technique where inventory items are
classified into three categories namely: A, B, and C. The items in A
category of inventory are closely controlled as it consists of high-
priced inventory which may be less in number but are very expensive.
The items in B category are relatively lesser expensive inventory as
compared to A category and the number of items in B category is
moderate so control level is also moderate. The C category consists of
a high number of inventory items which require lesser investments so
the control level is minimum.
JUST IN TIME METHOD
• In Just in Time method of inventory control, the company keeps only
as much inventory as it needs during the production process. With no
excess inventory in hand, the company saves the cost of storage and
insurance. The company orders further inventory when the old stock
of inventory is close to replenishment. This is a little risky method of
inventory management because a little delay in ordering new
inventory can lead to stock out situation. Thus this method requires
proper planning so that new orders can be timely placed.
• Economic Order Quantity (EOQ) Model
• Economic Order Quantity technique focuses on taking a decision
regarding how much quantity of inventory should the company order
at any point of time and when should they place the order. In this
model, the store manager will reorder the inventory when it reaches
the minimum level. EOQ model helps to save the ordering cost and
carrying costs incurred while placing the order. With the EOQ model,
the organization is able to place the right quantity of inventory.
EOQ is also referred to as the optimum lot
size
Types of Stock Levels of Inventory
• The types are: 1. Minimum Level 2. Maximum Level 3.

Danger Level 4. Average Stock Level.
• Stock Level: Type # 1. Minimum Level:
• This represents the quantity which must be maintained in hand
at all times. If stocks are less than the minimum level, then the
work will stop due to shortage of materials.
• Following factors are taken into account while deciding
minimum stock level:
Following factors are taken into account
while deciding minimum stock level:
• (i) Lead Time:
• A purchasing firm requires some time to process the order and
time is also required by the supplier/vendor to execute the order.
The time taken in processing the order and then executing it is
known as lead time. It is essential to maintain some inventory
during this period to meet production requirements.
• (ii) Rate of Consumption:
• It is the average consumption of materials items in the industry.
The rate of consumption will be decided on the basis of past
experience and production plans.
• (iii) Nature of Material:
• The nature of material also affects the minimum level. If a material is
required only against special orders of the customer then minimum
stock will not be required for such materials. Wheldon has given the
following formula for calculating minimum stock level:
Minimum stock Level = Re-ordering Level – (Normal Consumption x
Normal Reorder Period)
• (iv) Re-ordering Level:
• When the quantity of materials reaches a certain level then fresh order
is sent to procure materials again. The order is sent before the materials
reach minimum stock level.
• Reordering level is fixed between minimum level and maximum
level. The rate of consumption, number of days required to
replenish the stocks, and maximum quantity of materials
required on any day are taken into consideration while fixing
reordering level.
• Re-ordering level is fixed with following formula:
• Reordering Level = Maximum Consumption Rate x Maximum
Reorder period.
Stock Level: Type # 2. Maximum Level:
• It is the quantity of materials beyond which a firm should not
exceed its stocks. If the quantity exceeds maximum level limit
then it will be termed as overstocking. A firm avoids
overstocking because it will result in high material costs.
Overstocking will lead to the requirement of more capital, more
space for storing the materials, and more charges of losses from
obsolescence.
Maximum stock level will depend
upon the following factors:
• 1. The availability of capital for the purchase of materials in the
firm.
• 2. The maximum requirements of materials at any point of time.
• 3. The availability of space for storing the materials as inventory.
• 4. The rate of consumption of materials during lead time.
• 5. The cost of maintaining the stores.
• 6. The possibility of fluctuations in prices of various materials.
• 7. The nature of materials. If the materials are perishable in
nature, then they cannot be stored for long periods.
Wheldon has suggested the
following formula for calculating
maximum stock level:
• Maximum Stock Level = Reordering Level + Reordering
Quantity – (Minimum Consumption x Minimum Reordering
period)
Stock Level: Type # 3. Danger Level:
• It is the level below which stocks should not fall in any case. If
danger level approaches then immediate steps should taken to
replenish the stocks even if more cost is incurred in arranging
the materials. Danger level can be determined with the
following formula:
• Danger Level = Average Consumption x Maximum reorder
period for emergency purchases.
Stock Level: Type # 4. Average Stock
Level:
• The Average stock level is calculated such as:

• Average Stock Level = Minimum stock Level + 1/2 of Reorder
Quantity.
• From the following information, calculate minimum
stock level, maximum stock level and re-ordering level:
• (i) Maximum Consumption = 200 units per day
• (ii) Minimum Consumption = 120 units per day
• (ii) Normal Consumption =160 units per day
• (iv) Reorder period = 10-15 days
• (v) Reorder quantity = 1,600 units
• (vi) Normal reorder period = 10 days.
• Reordering Level = Maximum Consumption x Maximum
Reorder period
• = 200 units X 15 = 3,000 units Minimum Stock Value =
Reordering Level – (Normal Consumption x Nominal
Reordering Period)
• = 3,000 – (160 X 10) = 3,000 – 1,600 = 1,400 units
• Maximum Stock Level = Reordering Level + Reorder Quantity –
(Minimum Consumption x Reorder period) = 3,000 + 1,600 –
(120 X 10) = 3,000 + 1,600 – 1,200 = 2,400 units.
VALUATION OF INVENTORIES :
The value of materials has a direct bearing on the income of a concern , so it is necessary
that a method of pricing materials should be such that it gives a realistic value of stocks.
The traditional method of valuing materials cost price or market price whichever is less .

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INVENTORY MANAGEMENT

What Is Inventory Management?

• The types are: 1. Minimum Level 2. Maximum Level 3.

• The Average stock level is calculated such as:

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