Chapter 29 Inventory Management

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Chapter 26

INVENTORY MANAGEMENT


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OUTLINE

Introduction

Need for inventories

Order quantityEOQ model

Order point

Pricing of raw materials and valuation of stocks

Monitoring and control of inventories

Criteria for judging the inventory system

Inventory management in practice


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INTRODUCTION

There are three types of inventories: raw materials, work in

process and finished goods that are held by manufacturing firms

whereas only finished goods by distribution firms

The proportion of inventories to total assets generally varies

between 15 and 30 percent


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NEED FOR INVENTORIES

Process or movement inventories are required because

it takes time to complete a process/operation and to

move products from one stage to another.

Organisation inventories are maintained to widen the

latitude in planning and scheduling successive

operations.


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ECONOMIC ORDER QUANTITY

There are three kinds of cost with respect to EOQ model:

a. Ordering cost: Expenses on requisitioning, set up and

receiving and placing in storage

b. Carrying cost: Expenses on interest on capital locked in

inventory, storage, insurance, obsolescence and taxesc. Shortage cost: Arise when inventories are short of

requirements for meeting the needs of production or the

demand of customers

Minimization of overall costs of inventory management

would require a consideration of trade offs among these

costs


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ASSUMPTIONS OF THE EOQ MODEL

a. The demand for a given period, usually one year, is knownb. The demand is even throughout the period

c. Inventory orders can be replenished immediately

d. Two costs associated with inventories: cost of ordering and

cost of carrying

e. Cost per order is constant regardless of the sizef. Cost of carrying is a fixed percentage of the average value of

inventory


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ORDER QUANTITYEOQ MODEL

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Q =PC

Q = economic order quantity

F = cost per order

U= annual usage/demand

F = cost per order

C= percent carrying cost

P = price per unit

- Refer illustration on Page 765


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BEHAVIOUR OF INVENTORY

RELATED COSTS

CostsTotal costs

Carrying costs

Ordering costs

Quantity ordered


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QUANTITY DISCOUNTS AND ORDER QUANTITY

The standard EOQ analysis is based on the assumption that theprice per unit remains constant irrespective of the order size

When quantity discounts are available, the price per unit is

influenced by the order quantity

Refer Page 765 & 766


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ORDER POINT

If the usage rate of materials and the lead time for

procurement are known with certainty, then the

ordering level would simply be:

Lead time in daysfor procurement

When the usage rate and lead time are likely to vary, the

reorder level should be:

Normal consumption + Safety stock

x Average daily usage


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PRICING OF RAW MATERIALS

The important methods of pricing inventories used in

production are:

FIFO (First in First Out) Method The material which is

issued first is priced on the basis of the cost of material

received earliest, so on and so forth.

Weighted Average Cost Method Material issued are priced

at the weighted average cost of materials in stocks


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TREATMENT OF FIXED

MANUFACTURING COSTS

Direct Costing Fixed manufacturing overhead costs are

treated as period costs and not product costs. Hence, they

are not reflected in inventory valuation.

Absorption Costing Fixed manufacturing costs are treated

as product (or inventoriable) costs.


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GRAPH OF CUMULATIVE PERCENTAGE OF ITEMS

AND CUMULATIVE PERCENTAGE OF USAGE

20

40

60

80

100

25 40 60 80 100Cumulative

percentage of items

Cumulative usage of

items (percentage)

A B C


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JUST-IN-TIME (JIT) INVENTORY CONTROL

The JIT control system implies that the firm should

maintain a minimal level of inventory and rely onsuppliers to provide parts and components just-in-time

to meet its assembly requirements.

This may be contrasted with the traditional inventory

management system which calls for maintaining a

healthy level of safety stock to provide a reasonable

protection against uncertainties of consumption and

supplythe traditional system may be referred to as a

just-in-case system.


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PROGRAMME OF INVENTORY

MONITORING AND CONTROL

Exercise of vigilance against imbalances of raw materials and

work-in-process which tends to limit the utility of stocks.

Vigorous efforts to expedite completion of unfinished production

jobs to get them into saleable condition.

Active disposal of goods that are surplus, obsolete, or unusable. Shortening of the production cycle.

Change in design to maximise the use of standard parts and

components which are available off-the-shelf.

Strict adherence to production schedules.

Special pricing to dispose of unusually slow-moving items.

Evening out of seasonal sales fluctuations to the extent possible.


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INVENTORY MANAGEMENT IN INDIA

The most commonly used tools of inventory management

in India are ABC analysis, FSN (fast moving, slow

moving, and nonmoving analysis), and inventory

turnover analysis.

Inventory management in India can be improved by

effective computerisation, review of classifications,

improved coordination, development of long-term

relationships, and disposal of obsolete/surplus

inventories, and adoption of challenging norms.


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SUMMING UP

Inventories represent a very significant proportion of total assets. A distinction may be drawn between process or movement

inventories and organisation inventories.

According to EOQ model, the optimal order quantity is:

Q =

The reorder point may be determined by the following formula:

Reorder Point = S (L) + SR(L) FIFO method and weighted average cost method are commonly used

for pricing inventories. ABC analysis advocates a selective approach to inventory control.

The most commonly used tools of inventory management in India

are: ABC analysis, FSN analysis and inventory turnover analysis.

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Chapter 29 Inventory Management