Management of Inventory.ppt

7/30/2019 Management of Inventory.ppt

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Management of Inventory

Dr. Teena Shivnani

WCM / Dr. Teena 1



Meaning of Inventory

•

Inventory is one of the most visible andtangible aspects of doing business.

• In simple words, inventory is defined as

the sum total of value raw material, WIPand FG though it depends largely uponthe type of business.

• Inventory works as link betweenproduction & consumption of goods.

WCM / Dr. Teena 2



Types of Inventory

Material Inventory• Raw Material• Work in Progress• Finished goods• Consumables

• SparesLiquidity Inventory• Cash & marketable securities :- cash and

marketable securities can be thought of as aninventory of liquidity that allows separation of

collection from disbursement. Without thisliquidity inventory payment of bills would be tiedto collection of accounts, in some cases, withpayment delayed until accounts receivable are

collected.



Inventory Management

• The techniques of maintaining stock, keeping

items at desired level whether they are raw

material, WIP or finished goods.

• Inventory management means efficient control

and management of capital invested in rawmaterials and supplies, work in progress &

finished goods for the purpose of obtaining

maximum return from the investment.

WCM / Dr. Teena 4



Cont……..

•

Inventory management is mostimportant as it involves around 25% to30% of the total investment.

•

It is the role and responsibility ofpurchase and production function asalso of the manufacturing andmarketing functions.

WCM / Dr. Teena 5



Objectives

• Operating objectives

1. Regular flow of material

2. Risk minimization

3. Avoiding over stocking and under stocking

• Financial objectives1. Making possible a minimum level of investment

2. Ensure no losses

3. No duplication of purchases so maintaining thestocks likewise



Purpose and Benefits of maintaining

Inventory

• To facilitate uninterrupted production and

smooth running of business

– The transaction motive

– The precautionary motive

– The speculative motive



Risk associated with inventory

•The risk in inventory management signifies the chance thatinventories cannot be turned over into cash through normal sale

without a loss.

• These risks are due to three factors:-

1. Price decline :- it may result from an increase in the market supply

of products, introduction of new competitive product and pricereduction by competitors.

2. Product deterioration :- it may result due to holding a product too

long or it may occur when inventories are held under improper

conditions of light, heat, humidity and pressure.

3. Obsolescence :-it is due to changes in customer taste, newproduction techniques, improvement in product design,

specifications etc.



Cost of holding Inventory

The optimum level of inventory depends onthe following costs:-

1. Material Cost

2. Ordering cost3. Carrying cost

4. Stock out cost/ shortage cost

WCM / Dr. Teena 9



Material Costs

• These are the cost of purchasing the goodsplus transportation and handling charges.

• It may be calculated by adding the

purchase price (less any discount), thedelivery charges and sales tax, if any.

• Purchase Price + Delivery charges +

sales tax – Discount.

WCM / Dr. Teena 10



Ordering cost • Every time of an order is placed for stock replenishment,

certain costs are involved. The ordering cost may varydependent upon the type of item.

• Ordering cost pertain to placing an order for thepurchase of certain items of raw materials.

• This cost includes:-

1. Cost of preparation of purchase order. (typing, dispatch,postage, etc.)

2. Cost of sending reminders to get the dispatch of theitems

3. Cost of transportation of goods

4. Cost of receiving and verifying the goods5. Cost of unloading of the item.

WCM / Dr. Teena 11



Cont……..

• A large organization can fixed the ordering

cost regardless the number of order can

change.

• Ordering costs are inversely related to the

level of inventory.

WCM / Dr. Teena 12



Carrying cost

• Carrying cost constitute all the costs of holdingitems in inventory for a given period of time. They can expressed either in rupees per unitper period or as a % of the inventory value perperiod.

It includes:-• Storage & handling costs

• Interest on capital

• Taxes, depreciation and insurance.

• The cost of fund invested in inventories

• Product deterioriation and obsolescence.

WCM / Dr. Teena 13



Cont……..

•

The level of inventory and carrying cost arepositively related and move in the samedirection.

• Like ordering cost inventory carrying cost contain

both fixed & variable components.

• Mostly carrying cost vary with the inventory level but a certain portion of them such as warehouse

rent and depreciation on inventory handlingequipment are relatively fixed over the short run.

WCM / Dr. Teena 14



Shortage cost (costs of stock out)

• Shortage costs or costs of stock out are such costs whichthe company would incur in case of shortage of certain

items of raw material required for production or theshortage of certain items of finished goods to meet theimmediate demands of the customers.

• Shortage of inventories of raw materials may affect the

company in one or more of the following ways:-1. the company may have to pay some what higher price,

connected with immediate procurements.

2. The company may have to compulsorily resort to somedifferent production schedules, which may not be as

efficient and economical.

Stock out of finished goods, however may result in thedissatisfaction of the customers and the resultant loss of sales.

WCM / Dr. Teena 15



Relationship between OC, CC & TC

• The order quantity that minimize total

annual inventory costs, can be determinedgraphically by plotting inventory cost.

TC = OC + CC + Pur. Price

• As no. of orders ordering cost• As no. of orders carrying cost

• Total cost initial decrease till OC & CC arenot equal. When OC = CC, total cost startincreasing.

WCM / Dr. Teena 16



Example

O OC CC TC1 100 20 120

2 80 30 110

3 70 40 1104 50 50 100

5 30 90 120

6 20 110 130

WCM / Dr. Teena 17

TC CC

OC



Techniques

Modern

Technique

Traditional

Technique

WCM / Dr. Teena 18



Modern Techniques

EOQ

ROL

Stock Levels

Selective Techniques

WCM / Dr. Teena 19



Traditional Techniques

Perpetual Inv. System

Periodic order system

Two Bin System

Inventory Ratio

WCM / Dr. Teena 20



EOQ / OOQ Model

• If a firm order for its total annual requirement of material

in one lot and keeps it in stock, its ordering costs will below but carrying cost will rise.

• On the other hand in case the firm orders small quantities

at different times in more than one order, its carrying costs

would be low but ordering cost will increase.• Therefore, a firm should place an order for that quantity

where there is a trade-off between ordering cost and

carrying costs becoz at this point the total cost of inventory

would be minimum.• EOQ or OOQ is that size of the order where total inventory

costs ( OC + CC ) are minimized.

WCM / Dr. Teena 21



Assumptions1. The usage demand of the various items of inventory is equal

through out the period.2. There is no lead time involved

3. There only two distinct costs involved in computing the total

costs:- (a) ordering cost (b) carrying cost

4. The cost of every order remains uniformly the same, irrespective of the size of the order.

5. The inventory carrying cost is a fixed % of the average value of

inventory.

WCM / Dr. Teena 22





Formula Method • It is also known as “ Square Root Formula “ or “Wilson

Formula method”.

• The EOQ is three steps :-

Step 1 = calculation of EOQ

EOQ = (2AO) / PC

O = Cost per Order (it is assumed to be fixed or constant)

A = Annual Usage or Sales

P = Price per UnitC = Carrying cost % or PC = carrying cost in amount

Step 2:- No. of order = Sales or usage / EOQ

Step 3:-Time gap between two orders= 365 / no of orders

WCM / Dr. Teena 24



Example 1• The annual sales of friends electrical limited is

estimated at 1800 units, the cost price per unit isRs. 80/-. The ordering cost per order is (fixed) Rs.

60/- and the inventory carrying cost per unit is Rs.

2/-.

EOQ = (2AO) / PC

Eoq= (2x 60x 1800) / 2

Q= 328.63 or 329/-

No. of order = 1800 / 329 = 5.47 orders or 6 orders

Time gap between two orders = 365 / 6 = 60.83 days

WCM / Dr. Teena 25



Calculation of Total Cost of

Inventory

• Total Cost of Inventory = Cost of Purchases +

Ordering Cost + Carrying cost

• Cost of Purchase = Annual Consumption x

purchase price

• Ordering cost= No of order x ordering cost

• Carrying Cost = EOQ / 2 x carrying cost

WCM / Dr. Teena 26



Example

A Ltd uses an average of 1000 bags of cement each

year. They have an ordering cost per order of Rs.

60/-, order in quantities of 350 bags and have

carrying costs of Rs. 10 per bag each year.

Calculate total cost.• Total Cost of Inventory = Cost of Purchases +

Ordering Cost + Carrying cost

= 1000x 60 + 1000 / 350 x 60 + 350/2 x 10

= 61921/- .

WCM / Dr. Teena 27



Calculation of TC in case of Discount

• Reduced the cost price by discount amount

• Calculate new carrying cost becoz as purchase

price is changed CC will also change.

• Consider the minimum quantity of discount as

new EOQ.

• Calculate the total cost according to formula.

WCM / Dr. Teena 28



Example of Discount

• In Maheshwari company the annual

consumption of a particular item is 4000

units. The purchase price per unit is Rs. 10.

ordering cost is 60/- per order. Carrying

cost is 30% of the value of inventory. Thesupplier is offering a bulk discount of 1%

on lots of 800 units.

• Advice whether the EOQ should be raisedto 800 units.

WCM / Dr. Teena 29



Graphic Method

• The EOQ can also be determined with the help of graph. Under this method OC, CC and TC

according to different lot sizes are plotted on the

graph.

• The point at which the line of inventory carrying

cost and the line of ordering cost intersect each

other is the EOQ. At this point the total cost line

is also minimum.

WCM / Dr. Teena 30



Example

O OC CC TC1 100 20 120

2 80 30 110

3 70 40 1104 50 50 100

5 30 90 120

6 20 110 130

WCM / Dr. Teena 31

TC CC

OC



Trial & Error Method

• Under this method, annual consumption of

goods are divided into imaginary different lot

sizes and total inventory cost (CC & OC) for

each lot size is calculated.

• The lot size , where TC is minimum is chosen

as EOQ or most profitable quantity to be

purchased.

WCM / Dr. Teena 32



Re-Order Point / ROL

• It is a level of inventory at which an order should be placed for replenishing of current stock of

inventory.

• This can well done by ensuring that the order is

placed when sufficient balance of stock is still left

to take care of the lead time.

• But for this we may have to know the rate of

usage of material & lead time exactly.

WCM / Dr. Teena 33



Lead Time• Lead time is the time lag that takes place

between the placement of an order and theactual supply / delivery made in the companygodown.

• As we have seen earlier the standard EOQ modelpresumes as if there is no lead time involved. It

means the order can place when inventory levelcomes to zero. It is not possible.

• Therefore we should directly take account thelead time too while calculating EOQ.

• This can be done by introducing a slightmodification in the standard EOQ analysis.

WCM / Dr. Teena 34



Usage Rate

• This is the rate per day at which the item is

consumed in production or sold to customers.

• It is expressed in units.

• It is calculated by dividing the total

consumption by no of days in a year or 360.

WCM / Dr. Teena 35



Safety stock

• Safety stock as the minimum quantity of

inventory which a firm decides to keep alwaysprotect itself against the risk & losses.

• In actual practice one can neither estimate the

lead time nor the daily usage so accurately andexactly.

• Accordingly we should always keep some safetystock with us to meet such uncertainty.

WCM / Dr. Teena 36



Uncertainty & Inventory Management

•

Inventory is related to consumption of materialor selling of FG. But on both the aspect may have

uncertainty.

• To face the uncertainty, always maintain safety

stock in the organization. As the level of uncertainty is high, it require more safety stock

and viva versa.

•

Uncertainty safety stock• Uncertainty safety stock

WCM / Dr. Teena 37



ROL Formula• Re- Order point can computed as in case safety stock

is not given =

Re-Order point = Lead time X Daily usage

= 5 X 20 kg. = 100 kg. is order point.

• Re- Order point can computed as in case safety stockis given =

Re- Order point = ( lead time X daily usage ) + safetystock

WCM / Dr. Teena 38



Stock Level

•For avoiding the under stocking and overstocking most of the large companies adopt a

scientific approach of fixing stock levels. These

levels are :-

1. Maximum Level

2. Minimum Level

3. Re-order Level

4. Re-order Quantity / EOQ

WCM / Dr. Teena 39



Maximum stock Level

This is the level above which stock level should not

normally be allowed to rise. The maximum level

is fixed after taking into account such factors

as:-

1. Rate of consumption of material2. Space availability

3. Cost of storing above normal stock

4. Amount of capital needed and available forpurchasing of stock

5. Re-order quantity

WCM / Dr. Teena 40



Formula

• Max. stock =

ROL + ROQ – (Min consumption x Min re-order period)

ROL = Re-order level

ROQ = Re –

order quantity

If safety stock is given than formula will be =

Max. stock = EOQ + Safety Stock

WCM / Dr. Teena 41



Minimum Level / safety stock

• It is that level below which stock should not

normally be allowed to fall.• This is essential safety stock and is not normally

touched.

• In case of stock falling below this level there is arisk of stoppage in production.

• Min level = ROL – ( Normal consumption X Normal

re-order period)• If safety stock is given than Min. stock will be =

safety stock

WCM / Dr. Teena 42



Re-order Level

• When to place a order is also an important question

requiring a suitable answer.• The optimum order point or order level is the level of

inventory at which the EOQ of stock (it means EOQ isordering second, third time etc) should be ordered

again.• ROL = Max. daily usage X Max. lead time

OR

• ROL = Max consumption X Max re-order period

• If safety stock is given than add safety stock in aboveformula.

WCM / Dr. Teena 43



Average stock

• It represent the stock which is maintainedin the stores. This level is above the

minimum level and below the maximum

level.• AS = Min stock + Max. stock / 2

• AS = Min stock + ½ Re-order quantity

WCM / Dr. Teena 44





Formula



Formula

• There are two opinion based formulas forcalculation of danger level:-

• 1st opinion= It being emergency period, thesepurchases are costly and hence to be boughtminimum of quantity.

DL =Minimum rate of consumption X Emergency

delivery period

• 2nd opinion = emergency has no definite limit, somaximum quantity to be bought to tide over

further arising problems.DL=Maximum rate of consumption X

Emergency delivery period

WCM / Dr. Teena 47

E l



Example

• Two material A & B are used as follows:-

Min = 50 units per week eachMax. = 150 unit per week each

Normal uses = 100 units per week each

Re-order quantity = A = 600 unit

B = 1000 unit

Delivery period = A = 4 – 6 week

B = 2 – 4 week

WCM / Dr. Teena 48





E l



Example

• A company uses annually 50,000 units of an item

each costing 1.20/- each. Each order cost 45/-. Andinventory carrying cost 15% of the annual average

inventory value.

• Find out = EOQ

= if the company operates 250 days a

year the procurement time is 10days and safety

stock is 500 units find ROL, max. & Min. inventory

and average stock

WCM / Dr. Teena 51

So ution



So ution• EOQ = 5000 units (Calculate)

• Consumption per day =

50,000 / 250 days = 200 units

• ROL = safety stock + (Lead time x consumption per day)

= 500 + (10 x 200)

= 500 + 2000 = 2500 units

• Max. inventory = ROL + EOQ – (Min consumption during lead

time)2500 + 5000 – ( 10X200)

= 5500 units

• Min inventory = ROL – (Normal consumption in lead time)

= 2500 – (10 x 200) = 500 units

• Average stock = 500 + 5500 / 2 = 3000 units

WCM / Dr. Teena 52



Inventory Control Models

• ABC Analysis

• VED Analysis

• SED Analysis

• FSN Analysis.

WCM / Dr. Teena 53

A C A l i



ABC Analysis

• Always Better Control (ABC) is an application of

the principle of “ Management by Exception” to

the field of inventory control.

• Under this technique all the items of inventory

are classified in the following three categoriesi.e. A, B, C on the basis of usage rate.

• The A, B, & C category value will be decided by

company. The value is vary according tocompany. Different company may have differentvalue of A, B, & C category. This value may bechange as per time also.

WCM / Dr. Teena 54

ABC Analysis



ABC Analysis

Category % of Total Value % of Total Quantity

A 70 – 80 % 5 -10 %

B 20 – 25 % 20 – 30 %

C 5 – 10% 60 – 70 %

WCM / Dr. Teena 55

•ABC analysis may be defined as a technique whereinventories are analyzed according to their value so

that costly items are given greater attention and careby management.

•Classification can be done on the basis of value of

stock not on the basis of quantity of stock.A Category items are of high value .B category items are of moderate valueC category items are of low.



Objective of ABC

• The main purpose of ABC analysis is to

indicate the degree of control required for

inventory items of each category.

• A category items will require tight control.

• B category items will require less control.

• C category items require general control.

WCM / Dr. Teena 56

80 20 l i ABC M d l



80 -20 rule in ABC Model

•

Maximum value is contribute by very fewitems.

• Managers should focused on this A

category. Same way calculate B & Ccategory.

• In C category item will many but

contributing to very small value of stock.

So the management can ignore C category.

WCM / Dr. Teena 57



Process of ABC Calculation

1. Calculate TC of all the products

2. Arrange total cost in descending order.

3. Cumulative total cost

4. Calculate % of value on total cost as per A,B,C

5. Now break up the cumulative TC as per ABC

WCM / Dr. Teena 58

E l



Example

•

No of units were = 100• Value of total 100 unit were = 100000

• no of item value

• A 20 80,000• B 30 15000

• C 50 5000

WCM / Dr. Teena 59



e.g. of calculation ABC Category

• Dinesh limited is considering a selective

control for its inventories. Prepare ABC Plan.:-

WCM / Dr. Teena 60

Items Units Unit Cost

A 8000 5.50B 15000 1.70

C 5000 30.40

D 7500 1.50

E 5000 0.65

F 7000 5.14

G 2500 51.20



1

Ite

m

s

Units

(1)

Unit Cost

(2)

Total Cost

( 1 X 2)

A 8000 5.50 44,000

B 15000 1.70 25,500

C 5000 30.40 1,52,000

D 7500 1.50 11,250

E 5000 0.65 3,250

F 7000 5.14 36,000

G 2500 51.20 1,28,000

TOTAL COST 4,00,000

WCM / Dr. Teena 61

Ite

m

s

TC in

Descending

order

Cumulative

TC

Cate.

C 1,52,000 1,52,000

G 1,28,000 2,80,000 A

A 44,000 3,24,000

F 36,000 3,60,000 B

B 25,500 3,85,500

D 11,250 3,96,750

E 3,250 4,00,000 C

2

VED Analysis



VED Analysis

•Virtual , Essential, Desirable items.

• In this model item will be divided in V, E, D

category according to their importance.

• The organization may focus more on virtualand less focus on desirable items.

WCM / Dr. Teena 62

VED & ABC M t i



VED & ABC Matrix

V E D

A It require more attention,

Becoz A & V both arehere. Value is high as well

as importance is more.

Require averageattention in allthree category.

B

CIt require noattention due toD & C category.

WCM / Dr. Teena 63

SDE Analysis



SDE Analysis

•

SDE ( Scarce, Difficult and Easy) analysis evaluatesthe importance of the inventory items on the

basis of availability.

• Scarce (S) items are those items which are in

short supply and mostly such items constituteimportant items.

• Difficult (D) items refer to such items which

cannot be procured easily.

• Easy (E) items are the items which are easily

available in the market.

WCM / Dr. Teena 64

FSN Analysis



y• FSN (Fast, Slow, Non moving) in this technique

inventory are grouped according to the movement

into the following categories.

• Fast (F) moving = these are stored in large quantities and a close watch on the movement of such items is

kept. E.g Raw – Material

• Slow (S) =these are not frequently require by theproduction dept. E.g. production equipments

• Non-moving (N) =these are rarely required by theproduction dept. A smaller number of items arekept in stores.

WCM / Dr. Teena 65

I



Inventory systems

• Records pertaining to quantity and value of inventory in hand can be maintained

according to any of the following systems:-

1. Periodic inventory system

2. Perpetual inventory system

3. Just in Time Inventory System

WCM / Dr. Teena 66

Periodic inventory system



Periodic inventory system

• In case of this system the quantity and value of

inventory is found out only at the end of theaccounting period after having a physicalverification of the units in hand.

• The system does not provide the informationregarding the quantity and value of material inhand on a continuous basis. In this systemfollowing formula will be followed:-

opening stock + purchases – closing stock

WCM / Dr. Teena 67

Perpetual inventory system



Perpetual inventory system

• It is also known as an automatic inventory system• “It is a method of recording inventory balances after

every receipt and issue to facilitate regular checking

and to obviate closing down for stocktaking.”

• In case of this system the stores’ ledgers give balance

of goods on a continuous basis.

• The basic objective of this system is to make

available the details about the quantity and value of stock of each item at all times.

WCM / Dr. Teena 68



Perpetual Inventory Techniques

1. FIFO Method

2. LIFO Method

3. Average price Method

4. Weighted Price Method

5. Base Stock Method

WCM / Dr. Teena 69



• First in First out (FIFO) :- under this method, it

is assumed that the materials / goods firstreceived are the first to be issued/ sold.

• Last in first out (LIFO) :- this method is based

on the assumption that last item of material /goods purchased are first to be issued / sold.

IMPORTANT:- In both method if openingbalance of stock is there then this balance qty& its price always shown in balance columnonly.

WCM / Dr. Teena 70

• Receipt



Receipt

Jan. 1 Balance 50 units @ 4/-

Jan. 5 Job no. 10, 40 units @ 3/-Jan. 8 job no. 12, 30 units @ 4/-

Jan. 15 job no. 11, 20 units @ 5/-

Jan. 26 job no 13, 40 units @ 3/-

ISSUE:- Jan. 10 , 70 units

Jan. 12, 10 units

Jan. 20, 20 units

Jan. 24, 10 units

24 April 2013 Material Control / Dr. Teena 71



Average Price Method



• The average price is calculated by adding all the

different prices of material in stock and dividedby the number of prices used in that total.

• In this method Ave. price is calculated for only

issue.• In the balance column ave. price is not written,

in it amt and qty. is calculated on the basis of previous qty & amt – issue qty & issue amt.

• this method can be combination of FIFO & Ave.method.

• Ave. Price = Prices of the stock / 2WCM / Dr. Teena 73

Average Price Method

Average Method



Average Method

Qty P Amt Qty P Amt Qty P Amt

200 2.00 400 200 --- 400

300 2.40 720 500 -- 1120

250 2.20(Ave. P)

550 250 -- 570

250 2.60 650 500 -- 1220

200 2.5(A.P.)

500 300 -- 720

7424 April 2013 Material Control / Dr. Teena

Weighted Average Price Method



• This method is based on the presumption that oncethe material or goods are put into a common bin,they lose their identity. Hence, the inventory consistsof no specific batch of goods.

• The inventory is thus priced on the basis of averageprices paid for the goods, weighted according to thequantity purchased at each price.

• In this method once stock is received then we haveto calculated weighted price. On this calculated pricewe have to show balance price and further issue tillwe are not receive any other quantity of stock. Itmeans as we receive stock we have to calculatedWeighted price.

24 April 2013 Material Control / Dr. Teena 75

Weighted Average Price Method

Weighted Average Method



g g

Qty P Amt Qty P Amt Qty P Amt

200 2.00 400 200 2/-(w.a.p.) =

200 /400

400

300 2.40 720 500 2.24(w.a.p.) =

1120 /500

1120

250 2.24 560 250 2.24 560

250 2.60 650 500 2.42(w.a.p) =

1210 /

500

1210

200 2.42 484 300 2.42 726

300 2.42 726

7624 April 2013 Material Control / Dr. Teena

Base Stock Method



• This method is based on the contention that

each enterprise maintain at all times a

minimum quantity of materials or FG in its

stock. This quantity is termed as “base stock”.

• The base stock is deemed to have been

created out of the first lot purchased and

therefore, it is always valued at this price andis carried forward as a fixed assets.

WCM / Dr. Teena 77

Base Stock Method

( )



Just in Time (JIT) Inventory System

• JIT inventory system as its name suggestsmeans at the extreme there is zero inventory

and goods are produced or ordered only when

they are needed.• In other words, RM are received just in time to

go into production, manufactured parts are

completed just in time to be assembled intoproducts and products are completed “Just in

Time” to be shipped to customers.

WCM / Dr. Teena 78

Two Bin System



Two Bin System

• Under this method all inventory items are storedin two separate bins.

• In the first bin, a sufficient supply is kept to meetthe current requirement over a designatedperiod of time.

• In the second bin a safety stock is maintained foruse during lead time.

• When the stock of first bin is used an order for

further stock is immediately placed. The materialin second bin is then consumed to meet stockneeds un till the new order is received.

WCM / Dr. Teena 79

Stock Turnover Ratio



Stock Turnover Ratio• This ratio establishes a relationship between cost of

goods sold and average stock.• Cost of goods sold= O/S + purchases + direct

Expenses – C/S OR Net sales – G/P

• Average stock = O/S + C/S / 2

Stock ratio = cost of goods sold / average stock

• If cost of goods sold and average stock is not given,

then sales and closing stock are used.

Stock ratio = net sales / Average stock or C/S

Documents

Management of Inventory.ppt