How to take stock of your inventory?
Inventory is the term used for the goods available for sale and raw materials used to produce goods available for sale. Inventory also includes spare parts, packing materials, tools & gauges and every material, which contributes towards the manufacturing of goods and packing of the end product till it is in finished condition.
t is generally categorized under raw and packaging materials, semi-finished, goods in work-in-progress condition, finished goods, inventories in transit and consignment inventory.
Inventory control, also known as stock control, refers to the process of managing a company’s warehouse inventory levels. The inventory control process involves managing items from the moment they are ordered; throughout their storage, movement and usage; to their final destination or disposal. Many systems, processes, and technologies have been developed over the years to help companies streamline the supply chain processes involved in inventory control systems. Accounting control of inventories is concerned with the proper recording of the receipt and consumption of the material as well as the flow of goods through the plant into finished stock and eventually, to customers.as the flow of goods through the plant into finished stock and eventually, to customers.It is also concerned with the safeguarding of the undertaking’s property in the form of raw materials, work-in-progress and semi-finished products. Operating control of inventories is concerned with maintaining inventories with the optimum level keeping in view the operational requirements and financial resources of the enterprise.
Importance and advantages of an Inventory Control System:
(i) Reducing risk of production shortages
(ii) Reducing order cost
(iii) Minimise the blockage of financial resources
(iv) Avoiding lost sales
(v) Achieving efficient production scheduling
(vi) Gaining quantity discounts
(vii) Taking advantage of price fluctuations
(viii) Tiding over demand fluctuations
(ix) Deciding timely replenishment of stocks
Methods of Inventory
ControlInventory control is concerned with the periodic review of materials in stock. It detects materials not required for planned production, among other purposes and if the obsolete materials continue
to occupy storage space until they are removed from stores.
The inventory control methods give us a means for determining an optimal level of inventory as well as an estimate of how much should be ordered and when. There are several methods suggested for inventory controls.
The following are some of the most important systems used:
(a) ABC System: A firm using ABC system segregates its inventory into three groups — A, B and C. The ‘A’ items are those in which it has the largest rupee investment. This group consists of the 20 per cent of items accounting for 90% of the firm’s rupee investment. The ‘B’ group consists of the items accounting for the next largest investment, i.e., the 30 per cent of the items accounting for about 8 per cent of the firm’s rupee investment. The ‘C’ group typically consists of a large number of items accounting for small rupee investment. This group consists of approximately 50 per cent of all the items of inventory but only about 2 per cent of the firm’s rupee investment.
The common procedure for categorization of items into ‘A’, ‘B’ and ‘is:The common procedure for categorization of items into ‘A’, ‘B’ and ‘is:
- The categorization can be made by comparing the cumulative percentage of items with the cumulative percentage of usage value.
- All the items are to be ranked in the descending order of their annual usage value.
- The cumulative percentage of items to the total number of items is also marked in another column.
- The cumulative totals of annual usage values of these items along with their percentages to the total annual usage value are to be noted along-side.
(b) Budgetary Control System: Budgetary control is a tool of management used to plan, carry out and control the operations of business. It establishes pre-determined objectives and provides the basis for measuring performance against these objectives. Under this system, the number of units of the materials to produce a finished product and the level of inventory to be maintained and the quantities to be purchased during the period is all pre-determined.
When these plans are projected in advance, they are called budgets. Control over inventories is exercised on the basis of budgeted figures. Successful inventory budgeting depends upon the sales forecast. The budget on control system has the advantage of the co-ordination on the inventory consumption level and the expected consumption.
This system integrates and ties together all activities of the enterprise — right from the planning to control. Control helps to eliminate or reduce unproductive activities and minimizing waste. It is an effective method of controlling activities of the business unit since it provides standards against which actual performance is measured.
(c) Minimum-Maximum System: This is one of the oldest methods used in most businesses for controlling inventories. It is essential that proper control should be exercised on the level of the inventory to be maintained. Efficient management of inventory demands that both over and under investment in stock be avoided.
If higher levels of inventories are maintained, the stock level will be influenced by obsolescence, change in fashion and improvements in technicalities. Too much capital tied up in inventories results in a lower rate of return and the possibility of substantial loss from decline in market value.
Too small a quantity is likely to reduce the value of the business and proper servicing of the customers. According to this, a maximum level of inventory based upon the demand and the minimum level to prevent out-of-stock conditions for each item of stock are established. An order is placed when the minimum level is reached, which will bring the quantity to the maximum level.
(d) The Economic Order Quantity Approach: The Economic Order Quantity (EOQ) refers to the optimal order size that will result in the lowest total of order and carrying costs for an item of inventory given its expected usage, carrying cost and ordinary cost. By calculating an EOQ, the firm attempts to determine the order size that will minimize the total inventory costs.
Finding Economic Order Quantity
The EOQ model assumes that the finished goods are sold at a constant rate over time. The important decision in inventory management is to balance the cost of holding inventories with the cost of placing inventory replenishment orders. When the holding costs and ordering costs are balanced, the inventory costs are minimized and resulting order quantity is called the EOQ.
Total inventory cost = Ordering cost + Carrying cost
Total ordering cost = Number of orders x Cost per order = ` U/Q x F
Where u = Annual usage Q = Quantity ordered f = fixed cost per order
Total carrying cost = Average level of inventory x price per unit x carrying cost.Total carrying cost = Average level of inventory x price per unit x carrying cost.Total carrying cost = ` Q/2 x P x C = ` QPC/2where Q = Quantity ordered P = Purchasing Price per unit C = Carrying cost
Inventory Level and Order Point for Replenishment
From Fig. 1, it can be noticed that the level of inventory will be equal to the order quantity (Q units) to start with. It declines to level 0 by the end of period 1. At that point, an order for replenishment will be made for Q units. In view of zero lead time, the inventory level jumps to Q and the same procedure follows in the subsequent periods. As a result of this, the average level of inventory will remain at Q/2 units, the simple average of the two end points Q and Zero.
From the above, we know that as order quantity increases, the total ordering costs will decrease, while the total carrying cost will increase in proportion to the magnitude of the order quantity.
From Fig. 2, it can be seen that the total cost curve reaches its minimum at the point of intersection between the ordering cost curve and the carrying cost line. The value of Q corresponding to it will be the economic order quantity Q0.
Inventory Storage & Preservation
Inventory Storage & PreservationStorage and preservation are an important part of the storekeeping function. When materials remain idle in the store, these materials should be taken care of and looked after properly. Otherwise, these materials may perish due to natural chemical reactions like rusting by moisture, melting by heat, etc., and also may get affected by insects, rats, etc. Materials should be stocked in the appropriate place according to the nature of the materials. For example: Stationery, electrical, civil engineering, cleaning and similar items may be stocked in the steel racks. Medicine items may be stocked in the fridge. Perishable items may be stored in the cold rooms. Explosive, film, fuse items may be stored in the AC room. Attractive items may be stored in shelves under lock and key.
Daily and periodical cleaning should be carried out. Daily and periodical verification of stock should be carried out to ensure the correctness of stock. Proper method of handling should be followed to avoid damages to the materials.Preservation materials should be applied to protect the items. Hazardous materials should be segregated and stocked in a separate storehouse away from other storehouses. Safety precautions should be taken and safety appliances should be provided. There should be separate entry and exit for movement of materials.Management of Movement of materials & goodsProper planning and execution is key for materials management in a stores environment. There should be perfect coordination between Procurement, Stores, Production and Accounts departments to ensure efficient Materials Management. The Stores are copied of every purchase order raised and the tentative dates of supply of materials. This helps the Stores Management in organising space for storage.
All materials’ receipt and issue documents should be updated in the operating system on a real-time basis to ensure accuracy of inventory. Stores Management also controls the movement of materials to and from the subcontractors. They should also keep full control on the inventory level at the sub-contractor’s location. In respect of finished goods inventory, receipt recordings are against the final QC cleared note of Production department and issue is against the Invoice to Customer or Delivery order. In respect of a trading unit, GIN from Source Vendor forms the inward document and Sales Invoice forms the issue document.
Inventory or Stocks is a critical element in the Current Assets presented in the company’s financials. Many efficiency ratios are linked to inventory movements.Companies, as a yearly exercise, generate aging report of inventory and identify the dead and non-moving inventory for which provision is made in the accounts and plans for its disposals. Inventory is also one of the key elements in cash flow statements. It is also used as collateral in securing loans from banks. In such cases, the companies have to submit the inventory status as of month-end to the banks. The companies should also insure the inventory adequately.
Management of Inventory is a critical function in every organisation. It is always in the radar of every management, which runs the business efficiently.
CA TS Krishnan
Director, TSMT Consulting
