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Introduction: In financial parlance, inventory is defined as the sum of the

value of raw materials, fuels and lubricants, spare parts, maintenance

consumables, semi-processed materials and finished goods stock at any given

point of time. The operational definition of inventory would be the amount ofraw materials, fuel and lubricants, spare parts and semi-processed material to be

stocked for the smooth running of the plant. Since these resources are idle when

kept in stores, inventory is defined as an idle resource of any kind having an

economic value.

Inventories are maintained basically for the operational smoothness, which they

can affect by uncoupling successive stages of production, whereas the monetary

value of inventory serves as a guide to indicate the size of the investment made to

achieve this operational convenience. The materials management department is

expected to provide this operational convenience with a minimum possible

investment in inventories. The objectives of inventory, operational and financial,

needless to say, are conflicting. The materials department is accused of both

stockouts as well as large investment in inventories. The solution lies in

exercising a selective inventory control and application of inventory control

techniques.

Inventory terminology:

Inventory or stock is referred to in a variety of ways:

A Stock-keeping unit (SKU) is a separately identifiable class of item, which is

complete in the sense that a customer in that form can utilize it.

Manufacturing, wholesale and retail inventory depends on the type of firm

holding the inventory. These could be held in different forms for the same

material. For example, wholesale in bulk form, and retail in packaged form.

During manufacturing, input inventory is raw material; an inventory in-between

processing stage is referred to as work-in-process; and after the completion of

manufacturing is called as finished goods inventory.

Transit or in-transit or pipeline inventory is inventory that either waiting or in

the process of transportation. The speed of transportation and the point of time

of ownership transfer of pipeline inventory determines the time of holding, and

hence the cost of holding this inventory.

Seasonal stock refers to the material, which is purchased or manufactured in

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anticipation of seasonal demand.

Promotional stock is the additional stock kept ready for the increase in demand

due to market promotions of products.

Speculative stock is the additional stock purchased as a hedge against the

possibility of future increase in price of the material.

Dead stock is unused and / or obsolete stock, which cannot be sold.

In order to understand the concept of inventory terms are used for managing

inventory at a logistical facility, let us first view the definitions:

Inventory level is the actual inventory quantity held at a logistical facility at a

particular point of time.

Cycle inventory or base stock refers to the inventory quantity held in stock due to

the replenishment time required in the ordering process.

Replenishment time or lead-time is the time elapsed between order placement

and order receipt for an inventory item. In case inventory is to be replenished bymanufacturing, this is the time elapsed between the work order issue for

manufacturing and the completion of manufacturing.

Safety stock or buffer stock inventory is the inventory held due the differences in

demand and supply rate of material at each stage in-between supplier, purchase,

manufacture, distribution, and customer to avoid stock outs at each stage.

Average inventory is the calculated average of the inventory quantity held at alogistical facility over a period of time.

Reorder point is the pre-decided inventory level, which is reached by a falling

inventory level during utilization of inventory, at which point an order is placed

for replenishing the inventory in order to avoid a stock out.

Order quantity is the inventory quantity, which is ordered for replenishing

depleting inventory.

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Functions of Inventory

the necessity of holding inventory is due to the following functions of inventory

Specialization:

A firm can either produce all the required variety products at a plant at one

location, or, produce different products at separate plant locations. Locating

separately will enable the firm to select the location of each different product

manufacturing plant based on the particular requirements of that product, thus

achieving specialization efficiencies like geographical facilities and economies of

scale. This specialization approach creates inventory at diverse locations. Also,

pipeline inventories are created due to transport linkages required betweendifferent manufacturing plants and with distribution warehouses.

Balancing supply and demand:

Demand depends upon the requirements of customers relating to time and

quantity of products, and is not in the control of the producer. Supply, on the

other hand is under the producers control, but has to be economized and also

paced with the time and quantity requirements of customer demand. In order to

ensure that customers are not dissatisfied when they demand the required

quantity of products, it is necessary to have adequate inventory of productsavailable at all times. This is the balancing inventory required due to the different

rates of manufacturing and consumption. In case of seasonal products when

production has to take place for a longer period of time in advance of the season,

production throughout the year ensures lower investments in production

capacities while increasing inventory. An example is the production of rainwear

throughout the year for the sales which will occur only during the rainy season.

Another example of balancing is seasonal production during raw material

availability and year-round consumption, which also requires inventory. Theexample of this is seasonal availability of mango fruit and year-round

consumption of mango based products.

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Economies of scale:

Economies of scale are obtained by holding large inventories a) While

purchasing, ordering in large quantities provides cost economies and discounts;

(b) transportation economies are obtained by transporting in larger quantities;and, (c) during manufacturing, producing in economic batch quantities lower

costs.

Overcoming uncertainity :

Safety stock of inventory is required to overcome uncertainty of customer

demand on the one hand; and, purchasing, receiving, manufacturing, and order

processing delays on the other. Either of these may result in shortages of

products at the time of customer requirements if adequate safety stock ofmaterial is not provided for. If such material stock outs are not frequent

occurrences, the customer may look elsewhere leading to a last order at the very

least, or a lost customer. This uncertainty results in buffer stocks being created

between (a) supplier and purchasing, (b) purchasing and production, (c)

production and marketing, (d) marketing and distribution, (e) distribution and

intermediary, (f) intermediary and customer, in order to avoid stock outs.

Classification of Inventories :

(1) Production inventories

they represent raw materials, parts and components that are used in the process

of production. Production inventories include

Standard industrial items purchased from outside (also called bought outs)

Non-standard items (purchased items)

Special items manufactured in the factory itself (also called works made parts or

piece parts.

(2) MRO inventories

They refer to the maintenance; repairs and operation supplies, which are

consumed during process of, manufacture but do not become a part of the

product.

(3)In-process inventories

They represent items in the semi-finished condition (i.e. items in the partially

completed stage)

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(4)Goods-In-TransitThey represent such materials, which have been paid for but have not yet

been received by the stores.

Risks of Holding Inventory :The holding of inventory creates the following risks for a firm

The investments committed to a particular inventory combination are not

available for alternative uses for the benefit of the firm. The risks in these case

is due to the interest cost incurred on this inventory until the investment is

recovered, as also the opportunity cost of profit which might have been made

in alternative investment

The inventory may be pilfered or lost

The inventory may become absolute and/ or useless

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Determination of inventory is another risk for holding inventory:

Inventory Cost

In operating an inventory system manager should consider only those coststhat vary directly with the operating doctrine in deciding when and how much

to recorder; cost independent of the operating doctrine are irrelevant.

Basically, there are five types of relevant costs.

Cost of the item.

Cost of procuring the item.

Cost of carrying the item in inventory.

Cost associated with being out of stock when units are demanded but areunavailable (stock outs).

Cost associated with data gathering and control procedures for the inventory

system.

Often these five costs are combined in one way or another, but lets discuss

them separately before we consider combinations.

(1)Cost of Item

The cost, or value, of the item is usually its purchase price: the amount paid to

the supplier for the item. In some instances, however, transportation,receiving, or inspection costs, for example, may be included as part of the cost

of the item. If the cost of the item per unit is constant for all quantities

ordered, the total cost of items purchased during the planning horizon is

irrelevant to the operating doctrine. If the unit cost varies with the quantity

ordered, a price reduction called a quantity discount, this cost is relevant.

If the facility manufactures the item, the cost of the item is its direct

manufacturing cost. Again, constant unit cost mean total costs are irrelevant.

(2) Procurement Costs

Procurement costs are the placing a purchase order or the setup costs if the

item is manufactured at the facility. These costs vary directly with each

purchase order placed. Procurement costs include costs of postage, telephone

calls to the vendor, labor costs in purchasing and accounting, receiving costs,

computer time for record keeping, and purchase order supplies.

(3) Carrying Costs

Carrying or holding casts are the costs of maintaining the inventory

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warehouse and protecting the inventoried items. Typical costs are insurance,

security, warehouse rental, heat, lights taxes, and losses due to pilferage

spoilage, or breakage. The cost of typing up capital inventory is also

considered a carrying cost.

(4) Stockout Cost

Stock out cost, associated with demand when stocks have been, takes the

form of lost sales or backorder costs. When sales are lost because of

stockouts, the firm loses both the profit margin on unmade sale and its

customers good will. If customers take their business elsewhere, future profit

margins may also be lost. When customers agree to come back after

inventories have been replenished, they make backorders. Backorder costs

include loss of good will and money paid to reorder goods and notifycustomers when goods arrive. As the next example shows, stockouts can and

do occur in the service industries.

(5) Cost of operating the information processing system

Whether by hand or by computer, someone must update records as stock

levels change, for system in which inventory levels are not recorded daily, the

cost is primarily incurred in obtaining accurate physical counts of inventories.

Frequently, these operating costs are more fixed than variable over a wide

quantity range. Therefore since fixed costs are not relevant to the operatingdoctrine, we will not consider them further.

(6) Cost tradeoffs

Our objective in the inventory control is to find the minimum cost operating

doctrine over some planning horizon; these costs can be expressed in a

general cost equation:

Total

Annual = cost of the items + procurement costs + carrying Costs + stock outcost

Relevant cycle stocks lost sales

Cost Buffer stocks Backorders

Fundamental approaches to managing Inventory:

Traditional Inventory management has been deciding how much to order?

And when to order? But challenges of today require inventory managers to

find answer to the question where to stock the material as this greatly

influences customer satisfaction level. High level of inventory indicates higher

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customer satisfaction level, but cost of high inventory is obviously high. Hence

the modern challenge is high customer satisfaction at minimum inventory

Reactive Approaches:

Fixed Order Quantity Approach: Q modelThe above approach also called Q model signifies that the order quantity can

be fixed at a level depending on demand, value and inventory related costs. A

stock level called Re Order Level [ROL] is fixed, which triggers ordering. Re

Order Level is the lead-time consumption or product of lead-time and demand

rate during lead-time. When we follow this approach order quantity is fixed

by calculating EOQ and ROL is fixed by calculating lead-time consumption.

Inventory cycles can be conceptualized by looking at the figure given below

and drawn in the class.

Constant monitoring is the main disadvantage of this model:

Salient Features of the above approach : Widely used technique

Requires constant monitoring of stock levels

Suitable for high value and critical items

Limited by the assumptions made cost of in transit inventory, volume

transportation rates, use of private carriage, etc

Economic Order quantity

The order quantity depends upon the cost of the inventory items, the rate and

nature of demand (whether constant or fluctuating), the replenishment time,

and the inventory carrying costs and ordering costs for the inventory items.

The EOQ can be calculated with the help of a mathematical formula.

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Following assumptions are implied in the calculation:

Constant or uniform demand- although the EOQ model assumes constant

demand, demand may vary from day to day. If demand is not known in

advance- the model must be modified through the inclusion of safe stock.

Constant unit price- the EOQ model assumes that the purchase price per unit

of material will remain unaltered irrespective of the order offered by the

suppliers to include variable costs resulting from quantity discounts, the total

costs in the EOQ model could be redefined.

Constant carrying costs- unit carrying costs may very substantially as the size

of the inventory rises, perhaps decreasing because of economies of scale orstorage efficiency or increasing as storage space runs out and new

warehouses have to be rented.

Constant ordering cost- this assumption is generally valid. However any

violation in this respect can be accommodated by modifying the EOQ model in

a manner similar to the one used for variable unit price.

Instantaneous delivery- if delivery is not instantaneous, which is generally the

case; the original EOQ model must be modified through the inclusion of a safe

stock.

Independent orders- if multiple orders result in cost saving by reducing paper

work and the transportation cost, the original EOQ model must be further

modified. While this modification is somewhat complicated, special EOQ

models have been developed to deal with it.

These assumptions have been pointed out to illustrate the limitations of the

basic EOQ model and the ways in which it can be easily modified tocompensate for them.

Fixed Order Interval Approach: P model

The time between two successive orders [order interval], T is fixed and the

maximum stock that can be stored, S is also fixed as pre-requisites for this

approach. The inventory level is not monitored as in Q model continuously

but checked in intervals of T fixed as a policy decision. On the fixed day as per

T the stock is checked and the difference between current stock level and

maximum sock S is calculated. This difference is the order quantity, which

will be ordered immediately. The order quantity arrives after the lead-time.

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Next inventory check will be only after the interval T.

Salient Features of the above approach

Widely used technique

Does not require constant monitoring of stock levels

Suitable for lower value and non critical items

Min-Max Approach a modification to EOQ model

When we follow EOQ model, an order is released when ROL is reached. Here

the assumption is stock depletion is at a specific rate D during replenishment

cycle. In reality when stock depletes in larger increments we may suddenly

find that we are suddenly way below ROL. Min-Max Approach suggests that

the actual order quantity should be the sum of EOQ and the difference

between ROL and actual stock on hand at the time ROL occurs.

Just In Time

The time-based approach to inventory management came into focus when

Toyota Motors Company came out with the concept of kanban in 1950. This

lead to the dramatic reduction in WIP quantities tying the inventory closely to

the demand from subsequent process or internal customer. Kanban is

conceptually a two-bin system, a signal being raised to warrant

replenishment.

JIT approach became a modern production system seeking to implant conceptof stockless production. JIT embraced a variety of manufacturing concepts like

reduced lot sizes, quick switch over [SMED], load leveling [response to tact

time], group technology, statistical process control [control charts],

preventive maintenance and quality circles.

QR, CR, AR, response-based techniques

Quick responseInformation regarding retail sales is communicated by the retailer to the

manufacturer via Electronic data Interface (EDI). The Manufacturer then

decides upon the most effective and efficient replenishment response. The

manufacturer then communicates the replenishment shipment schedule to

the retailer to facilitate receipt. Thus, quick response is achieved by speedier

technology-enabled information exchange.

Continuous replenishment strategy

Also known as vendor managed inventory. This approach eliminates the need

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for placing an order. Retail sales information is directly passed to the supplier,

who takes the responsibility of replenishing the right variety of inventory at

right time with advance shipping notification to the retailer

Automatic or profile Replenishment or ARAR enables the supplier to anticipate the customers requirement in advance

to make replenishment. The responsibility for inventory management is

placed squarely on the supplier. There should be information flow between

customer & supplier that makes inventory visibility possible. While this takes

away the inventory management from the customer and gives it to the

supplier, supplier gets the benefit of inventory visibility and more effective

management to reduce total costs.

Planning approaches

Fair Share Allocation

Inventory planners decide to allocate an amount of inventory to a ware house

based on the past consumption pattern of that particular facility from the

available inventory volume at the source.

In the above example, in the plant warehouse the inventory is 600 units. If we

decide to keep aside 100 units and allocate the balance, the allocation is donekeeping the daily use performance pattern of the distribution centers. The

methodology as given below.

Let A be the amount of inventory available for allocation.

Let I be the inventory in distribution center.

Let D be the daily demand,

Then a common days supply, DS, for distribution center inventories is,

A + I

DS = --------------

D

500 + 50+100+75

DS = --------------------------

10+50+15

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9.67days.

Now amount of inventory allocated to distribution center 1 is

[9.67 50/10]/10 = 4.67X10 = 46.7 units, say 47 units.

Similarly we can find allocations for distribution centers 2 & 3. We get 383 &

70 units. Fair share allocation method doesnt take into account performance

cycle times, EOQ & safety stock considerations.

Requirements Planning Approach

Requirements planning approach include materials or manufacturing

requirement PlanNng or MRP, and DISTRIBUTION REQUIREMENTS PLANING

or DRP. MRP controls inventory management from purchasing to Completionof manufacturing with delivery of finished goods to Plant Warehouse. DRP

then takes over the inventory for distribution to the customers. MRP starts

with MASTER PRODUCTION PLANNING (MPS) which details what, how much

and when to manufacture based on forecasts and/or customer orders. On the

basis of this end-product schedule, MRP prepares a schedule of raw Materials,

Components and Sub-assemblies requirements to meet the MPS. DRP, on the

other hand, starts with Customer Requirements for the end-product at

diverse Geographical locations.

MRP DRP

Guiding factor Guided by production schedules

Guided by customer demandControl of the firm Under control of the firm

Not under control of the firm

Demand situation Operates in dependant demand situation Operates in

independent demand situation

Area of operation and coordination Coordinates scheduling and integration of

materials into finished goods Coordinates demand between outlets and

supply sources Stage of functioning Controls inventory until manufacturing

and assembly is complete. Controls and coordinates inventory after

manufacturing and assembly of finished goods and DRP. MRP plans the

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procurement of raw materials as per their requirements, right from the first

stage till the final assembly.

After the goods have been manufactured, DRP plans the distribution of

finished goods from the plant warehouse to the wholesalers and retailers till

it reaches the customer.The integrated model seeks to combine these two areas. Taking into

consideration the requirements of both MRP and DRP, it provides integrated

planning.

Adaptive Logic Approach

Certain situations may warrant the use of a reactive inventory approach;

while others may find the planning approach to be appropriate. In actual

practice one night find a system wherein different conditions exist atdifference locations and times requiring the use of both the reactive and

panning approaches under different conditions. For example, during the

product lifecycle, it is necessary to push the products through the distribution

channels during the introductory and growth phases, while allowing

customers to pull the inventories through the increased distribution channels

during the saturation/maturity phases.

Techniques Of Inventory Management:

ABC ANALYSIS

ABC analysis underlines a very important principle Vital few: trivial many.Statistics reveal that just a handful of items account for bulk of the annual

expenditure on materials. These few items, called A items, therefore, hold the

key to business. The other items, known as B and C items, are numerous in

number but their contribution is less significant. ABC analysis thus tends to

segregate all items into three categories: A, B, and C on the basis of their

annual usage. The categorization so made enables one to pay the right amount

of attention as merited by the items.

A-items: it is usually found the hardly 5-10% of the total items account for 70-75% of the total money spent on the materials. These items require detailed

and rigid control and need to be stocked in smaller quantities. These items

should be procured frequently, the quantity per occasion being small.

B-items: these items are generally 10-15% of the total items and represent

10-15% of the total expenditure on the materials. These are intermediate

items. The control on these items need not be as detailed and as rigid as

applied to C items.

C-items: these items are generally 70-80% of the total items and represent 5-

10% of the total expenditure on the materials. The procurement policy of

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these items is exactly the reverse of A items. C items should be procured

infrequently and in sufficient quantities. This enables the buyers to avail price

discounts and reduce work load of the concerned departments.

Policies of Control for A, B and c Categories.Any sound stock control system should ensure that the each item gets the

right amount of attention at the right time. ABC analysis makes this possible

with considerably less efforts due to its selective approach there are number

of ways in which ABC classification can be made use of:

Degree of Control

Some one at the senior level should be made responsible for regular

reviewing of these items. Up-to-date and accurate records should be maintainfor these items. B items should be brought under normal control made

possible by goods record keeping and periodic attention. Little control is

required for C items.

Ordering Procedure

A items should be subject to frequent review to reduce unwarranted

stockouts and possibilities of overstocking. A reasonable good analysis for

order points is required for B items butthe stocks may be reviewed less

frequently. No such computations are necessary for C items. These shouldbe bought in bulk.

Staggering of delivery schedules

Staggering of delivery schedules is one of the best strategies to reduce the

inventory investment and ensure un-interrupted inflow of materials.

Staggered deliveries tend to reduce cost of order writing but increase the cost

of inspection and receiving. Annual contract with scheduled deliveries are

desirable for A and B class of items. C class of items, however, should bepurchased in bulk on single-order-basis.

Stock records

Details records of goods ordered, received, issued and goods on hand should

be maintained for A category of items. No such detailed records are

necessary for C items. Any routine method that ensures goods and accurate

records is enough for B category of items.

Priority treatment: VIP treatment may be accorded to A items in all activities

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uch a processing of purchases orders, receiving, inspection movement on the

shop floor, etc., with an object to reduce lead time and average inventory. No

such treatment is necessary for B items. No priority is assigned to C items.

Safety StockAll items of consumption are equally important from production point of

view. Safety stock should be less for A items. The possibility of stockouts can

considerably be cut down by closer forecasting, frequent reviewing and more

progressing. C items, on the contrary, should have sufficient safety stock to

eliminate progressing and to reduce the probability of stockouts. A moderate

policy is required for B items, safety stock being neither too high nor too

low.

Value Analysis

To secure maximum benefits, it is essential to select those items for value

analysis which offer the highest scope for cost reduction. The usage

classification is a useful step in this direction. Only A and B items are

selected for detailed value analysis and the former is given priority over the

latter. C items should not be value analysed.

HML ANALYSIS:H-M-L analysis is similar to ABC analysis except for the difference that instead

of usage value, price criterion is used. The items under this analysis are

classified into three groups that are called high, medium and low. To

classify, the items are listed in the descending order of their unit price. The

management for deciding three categories then fixes the cut-off-lines. For

example, the management may decide that all items of unit price above Rs.

1000/-will of H category, those with unit price between Rs. 100/- to

Rs.1000/- will be of M category and those having unit price below Rs. 100/-will be of L category.

HML analysis helps to -

Assess storage and security requirements

To keep control over consumption at the departmental head level

Determine the frequency of stock verification

To evolve buying policies to control purchase

To delegate authorities to different buyers to make petty cash purchase

VED ANALYSIS:

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V stands for vital, E for essential, D for desirable. This classification is

usually applied for spare parts to be stocked for maintenance of machines and

equipments based on the criticality of the spare parts. The stocking policy is

based on the criticality of the items. The vital spare parts are known as capital

or insurance spares. The inventory policy is to keep at least one number of thevital spare irrespective of the long lead-time required for procurement.

Essential spare parts are those whose non-availability may not adversely

affect production. Such spare parts may be available from many sources

within the country and the procurement lead time many not be long. Hence, a

low inventory of essential spare parts is held. The desirable spare parts are

those, which, if not available, can be manufactured by the maintenance

department or may be procured from local suppliers and hence no stock is

held usually.

S-D-E ANALYSIS:

S-D-E analysis is based on the problems of procurement namely:

Non-availability

Scarcity

Longer lead time

Geographical location of suppliers, and

Reliability of suppliers, etc.S-D-E analysis classifies the items into three groups called scarce, difficult

and easy. The information so developed is then used to decide purchasing

strategies.

Scare classification comprise of items, which are in short supply, imported

or canalized through government agencies. Such items are best to procure

limited number of times a year in lieu of effort and expenditure involved in

the procedure for import.

Difficult classification includes those items, which are available indigenouslybut are not easy to procure. Also items, which come from long distance and

for which reliable sources do not exist, fall into this category. Even the items,

which are difficult to manufacture and only one or two manufacturers are

available belong to this group. Suppliers of such items require several weeks

of advance notice.

Easy classification covers those items, which are readily available. Items

produced to commercial standards, items where supply exceeds demand and

others, which are locally available, fall into this group.

The purchase department employs S-D-E analysis

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To decide on the method of buying

To fix responsibility of buyers

GOLF ANALYSIS:

This stands for Government, Open Market, Local or Foreign source of supply.For many items, imports are canalized through Government agencies such as

state trading corporation, minerals and metals trading corporation, Indian

drugs and pharmaceutical etc.

For such items the buying firms cannot apply any inventory control

techniques and hence to accept the quota allocated by the government. Open

market category is those who form bulk of suppliers and procurement is

rather easy. L category includes those local suppliers from whom items can

be purchased off-the-shelf on cash purchase basis. F category indicatesforeign suppliers since an elaborate import procedure is involved, it is better

to buy imported items in bigger lots usually covering the annual

requirements.

S-OS ANALYSIS

S-OS analysis is based on seasonality of the items and it classifies the items

into two groups S (seasonal) and OS (off seasonal). The analysis identifies

items which are:

Seasonal and are available only for a limited period. For example agricultureproduce like raw mangoes, raw materials for cigarette and paper industries,

etc. are available for a limited time and therefore such items procured to last

the full year.

Seasonal but are available throughout the year. Their prices, however, are

lower during the harvest time. The quantity of such items requires to be fixed

after comparing the cost savings due to lower prices if purchased during

season against higher cost of carrying inventories if purchased throughout the

year.Non-seasonal items whose quantity is decided on different considerations.

M-N-G ANALYSIS;

M-N-G analysis based on stock turn over rate and it classifies the items into M

(moving items), N (non-moving items) and G (ghost items).

M (moving items) is those items, which are consumed from time to time. N

(non-moving items) are those items, which are not consumed in the last one

year. G (ghost items) is those items that had nil balance, both in the beginning

and at the end of the last financial year and there were no transactions

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(receipt or issues) during the year.

Analysis mainly helps to identify non-existing items for which the store keeps

bin-cards or waste computer memory or waste computer stationary while

preparing stores ledger. Stores department even might have even ear-marked

space for these non-existent items.All pending/ open purchase orders (if any) of such items should be canceled.

F-S-N ANALYSIS;

F-S-N analysis is based on the consumption figures of the items. The items

under this analysis are classified into three groups: F (fast moving), S (slow

moving) and N (non-moving).

To conduct the analysis, the last date of receipt or the last date of issuewhichever is later is taken into account and the period, usually in terms of

number of months, that has elapsed since the last movement is recorded.

Such an analysis helps to identify:

Active items which require to be reviewed regularly

Surplus items whose stocks are higher than their rate of consumption; and

Non-moving items which are not being consumed

X-Y-Z ANALYSIS;

X-Y-Z analysis is based on value of the stocks on hand (i.e. inventoryinvestment). Items whose inventory value are high are called as X items while

those inventory value are low are called Z items. And Y items are those which

have moderate inventory stocks.

Usually X-Y-Z analysis is used in conjunction with either ABC analysis or HML

analysis.

XYZ analysis helps to identify a few items, which account for large amount of

money in stock and take steps for their liquidation/retention.

XYZ when combined with FSN analysis helps to classify non-moving itemsinto XN, YN, and ZN group and thereby identify a handful of non-moving

items, which account for bulk of non-moving stock. These can be studied

individually in details to take decision on their disposal or retention.

PECULIRITIES IN INDIA

All the well-known inventory control techniques have a basic assumption:

free availability of materials as and when required in any quantity. This is

however not true of Indian conditions. We operate in a sellers market for

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most of the materials. There is a perpetual scarcity of key raw materials and

the prices fluctuate widely. However, the techniques should not be discarded

but used judiciously as a broad guideline, keeping in mind their limitations.

The Indian industry tends to stress a lot on production and machine

utilization-this focus of attention in the context of scarcity of materials leadsto hoarding of stocks. The inflation that prevails in the country prompts

hoarding

In view of the shortage of foreign exchange, strict import procedures are

enforced. The time taken for import clearance is high and the inventory of

imported materials is therefore usually very high.

In its initial stage of industrial development, the country relied solely on

foreign collaboration. Machinery and spare parts ware readily imported. The

lack of technological knowledge made the country rely on the collaboratorsfor the estimation of the requirements of spare parts. This stock of spares is

abnormally high. It is extremely evident that these spares are useless and

should be written off; however, for financial reasons they continue to exist on

inventory records.

Inventory control systems are built on the foundation laid by materials

management techniques such as ABC-VED analysis, standardization and

codification. Setting up an inventory control system without the pre-use of

these techniques is like building a castle in the air. The importance of ABC-

VED analysis is brought out in the light of the inability to measures precisecosts on the basis of which inventory levels could be set Standardization and

codification help in variety reduction and make inventory control purposeful.

Inventories, built to act as a cushion between supply and demand, serve the

following needs: it is sufficient to take care of the requirements of demand till

the next supply arrives, it is sufficient to take care of probable delays in

supply as well as probable variations in demand.

The problems that to be tackled are: the determination of the level of

inventory for placing a replenishment order, the quantity to be ordered, theamount of delay in supplies and the amount of variations in demand which

the inventory should be able to withstand. The problems can be resolved by

the cost implications. Costs, which are relevant for consideration, are

discussed in the following paragraphs.

Relevant Costs

Basically there are four costs relevant for consideration in developing an

inventory model. These are: (1) the cost of placing a replenishment order, (2)

the cost of carrying inventory, (3) the cost of under stocking, and (4) the cost

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of overstocking. The cost of ordering and the inventory carrying cost are

viewed as the supply side costs and help in the determination of the quantity

to be ordered for each replenishment. The understocking and overstocking

costs are viewed as the demand side costs and help in the determination the

amount of variations in demand and the delay in supplies, which theinventory should withstand.

Cost of ordering

Every time an order is placed for stock replenishment, certain are involved,

and, for most practical purposes, it can be assumed that the cost per order is

constant. The ordering costC o may very, dependent upon the type of items:

raw materials like steel against production components like casting. However,

it is assumed that an estimate Co can be obtained for a given range of items.This cost of ordering, Co includes:

Paper work costs, typing and dispatching an order.

Follow-up costs the follow-up required to ensure timely suppliers- includes

the travel cost for purchase follow-up, telephone, telex and postal bills.

Costs involved in receiving the order, inspection, checking and handing to the

stores.

Any set up cost of machines if charged by the supplier, either directly

indicated in quotations or assessed through quotations for various quantities.

The salaries and wages to the purchase department. This is relevant forconsideration if the purchase function is carried out at same level with the

existing staff. If the level of purchasing activity decreases significantly,

obviously a proportional amount of personnel will be transferred to other

departments.

If the level of purchasing increases, the extra load will be tackled by paying

overtime to existing staff or by recruiting new personnel. This additional cost

can be viewed as the marginal cost of orders. The ordering cost in a typical

Indian firm is around Rs. 100 per order, but experience shows that this costvaries considerably depending upon the efficiency of the purchasing

department

Some firms operate on the basis of receipt cost particularly when dealing

with staggered delivers. The mathematical models can be suitably modified to

get the economic receipt quantity instead of economic order quantity.

Cost of Inventory Carrying

This cost Cc is measured as a percentage of the unit cost of the item. This

measure, therefore, gives a basis for estimating what it actually costs a firm to

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carry stock. This cost includes: 1) interest on capital, (2) insurance and tax

charges, (3) storage costs-any labour, excluding handing of receipts of new

orders-the costs of provision of storage area and facilities like bins, racks,

etc (4) allowance for deterioration or spoilage, (5) Salaries of stores staff,

and (6) obsolescence. The inventory carrying cost varies and in a typicalIndian industry is about 30 percent. A major portion of this is accounted for

by he interest on capital, which depends on the fiscal policies of the

government. A few firms differentiate the costs as fixed and variable. In the

analysis of and use of mathematical formula, only the variable costs of

ordering should be considered as the fixed costs will be constant irrespective

of the number of orders placed or the inventory carried

Understocking CostThis cost, Ku is the cost incurred when an item is out of stock. It includes the

cost of lost production during the period of stock out and extra cost per unit,

which might have to be paid for an emergency purchase.

Overstocking Cost

This cost K o is the inventory carrying (which is calculated per year) for a

specific period of time. The time varies in different contexts- it could be the

lead time of procurement or the entire life-time of a machine. In the case of

one-time purchases, overstocking cost would be: purchase price-scrap price.Based on the above costs several scientific models have been developed and

these are discussed separately for consumables and for spares in the

following chapters. The need for using these models in India has been

stressed by various committees. For example, the report of the committee* on

public undertakings mentions: For proper inventory control, it is essential to

adopt the scientific practices and techniques that have been developed in this

regard.

Spare parts management

Spare parts management is an important section of any system and a part that

needs much planning and organization. The right parts much be ready when

need to prevent the process to stop and the project to be slowed down to

much. On the other hand, too many spare parts will mean a both unpractical

and expensive situation.

Spare Parts Management Indicators

There is a saying: What you cant measure, you cant improve. The saying

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are not necessarily always true, but it is interesting, because I think a

derivative of the saying is true: What you measure, is usually what you

get.

Reducing Inventory ValueIt is common for plants to have a lot of focus on reducing inventory value.

Inventory value is one of those numbers that acts like salt in a wound for

corporate accountants. No, it doesnt matter if its high or low, it always

hurt to look at the number. Most of the time we dont know if the number is

too high or too low, we just know we want the number to be lower.

Cost of Keeping Spare Parts and Materials.

The cost for keeping inventory is usually an estimated number, often calledinventory interest (or similar), that varies from 10-40% depending on

company accounting rules. The cost included storeroom, storeroom

personnel,

depreciation, etc. If you have a spare parts and materials inventory value

of 10 Million, it costs the company 1-4 Millions (10-40%) a year to keep

that spare parts and materials inventory.

The Problem

Since it is common that inventory value is the only number the plant reallycares about, it tends to get reduced. But, anyone can reduce inventory value

very easily, IF its the only thing that matters. I can tell you to scrap

all spare parts right now bringing your spare parts and materials inventory

to zero. But the consequences will be devastating to production since we

dont have any spare parts.

Measure a Counterweight

Spare parts inventory value is important, but to effectively reduce spareparts inventory value, the counterweight has to be measured as well. The

counterweight to inventory value can be stock-outs for example (times we

get the spare part needed divided by total request for spare parts). When

stock outs go over around 4-5%, you will start seeing signs of people not

trusting the storeroom. These signs are spare parts in supervisors office,

satellite stores, spare parts in crafts peoples toolboxes etc.

inventory Management:

Inventory is a list for goods and materials, or those goods and materials

themselves, held available in stock by a business. It is also used for a list of the

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contents of a household and for a list for testamentary purposes of the

possessions of someone who has died.

Origins of the word Inventory

The word inventory was first recorded in 1601. The French term inventaire,

or "detailed list of goods," dates back to 1415.Business inventory

The reasons for keeping stock

There are three basic reasons for keeping an inventory:

1. Time - The time lags present in the supply chain, from supplier to user at

every stage, requires that you maintain certain amount of inventory to use in

this "lead time"

2. Uncertainty - Inventories are maintained as buffers to meet uncertainties in

demand, supply and movements of goods.3. Economies of scale - Ideal condition of "one unit at a time at a place where

user needs it, when he needs it" principle tends to incur lots of costs in terms

of logistics. So bulk buying, movement and storing brings in economies of

scale, thus inventory.

All these stock reasons can apply to any owner or product stage.

Buffer stock is held in individual workstations against the possibility that

the upstream workstation may be a little delayed in long setup or change-over

time. This stock is then used while that change-over is happening. This stock

can be eliminated by tools like SMED.These classifications apply along the whole Supply chain not just within a

facility or plant.

Where these stocks contain the same or similar items it is often the work

practice to hold all these stocks mixed together before or after the sub-

process to which they relate. This 'reduces' costs. Because they are mixed-up

together there is no visual reminder to operators of the adjacent sub-

processes or line management of the stock which is due to a particular cause

and should be a particular individual's responsibility with inevitableconsequences. Some plants have centralized stock holding across sub-

processes which makes the situation even more acute.

Special terms used in dealing with inventory:

Stock Keeping Unit (SKU) is a unique combination of all the components that

are assembled into the purchasable item. Therefore any change in the

packaging or product is a new SKU. This level of detailed specification assists

in managing inventory.

Stockout means running out of the inventory of an SKU.

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"New old stock" (sometimes abbreviated NOS) is a term used in business to

refer to merchandise being offered for sale which was manufactured long ago

but that has never been used. Such merchandise may not be produced any

more, and the new old stock may represent the only market source of a

particular item at the present time.Typology:

1. Buffer/safety stock

2. Cycle stock (Used in batch processes, it is the available inventory excluding

buffer stock)

3. De-coupling (Buffer stock that is held by both the supplier and the user)

4. Anticipation stock (building up extra stock for periods of increased demand

- e.g. ice cream for summer)

5. Pipeline stock (goods still in transit or in the process of distribution - haveleft the factory but not arrived at the customer yet)

Inventory examples

While accountants often discuss inventory in terms of goods for sale,

organizations - manufacturers, service-providers and not-for-profits - also

have inventories (fixtures, furniture, supplies, ...) that they do not intend to

sell. Manufacturers', distributors', and wholesalers' inventory tends to cluster

in warehouses. Retailers' inventory may exist in a warehouse or in a shop or

store accessible to customers. Inventories not intended for sale to customers

or to clients may be held in any premises an organization uses. Stock ties upcash and if uncontrolled it will be impossible to know the actual level of

stocks and therefore impossible to control them.

Whilst the reasons for holding stock are covered earlier, most manufacturing

organizations usually divide their "goods for sale" inventory into:

Raw materials - materials and components scheduled for use in making a

product.

Work in process, WIP - materials and components that have begun their

transformation to finished goods. Finished goods - goods ready for sale to customers.

Goods for resale - returned goods that are salable.

Spare parts

For example:

Manufacturing

A canned food manufacturer's materials inventory includes the ingredients to

form the foods to be canned, empty cans and their lids (or coils of steel or

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aluminum for constructing those components), labels, and anything else

(solder, glue, ...) that will form part of a finished can. The firm's work in

process includes those materials from the time of release to the work floor

until they become complete and ready for sale to wholesale or retail

customers. This may be vats of prepared food, filled cans not yet labeled orsub-assemblies of food components. It may also include finished cans that are

not yet packaged into cartons or pallets. Its finished good inventory consists

of all the filled and labeled cans of food in its warehouse that it has

manufactured and wishes to sell to food distributors (wholesalers), to grocery

stores (retailers), and even perhaps to consumers through arrangements like

factory stores and outlet centers.

Logistics or distribution

The logistics chain includes the owners (wholesalers and retailers),manufacturers' agents, and transportation channels that an item passes

through between initial manufacture and final purchase by a consumer. At

each stage, goods belong (as assets) to the seller until the buyer accepts them.

Distribution includes four components:

1. Manufacturers' agents: Distributors who hold and transport a consignment

of finished goods for manufacturers without ever owning it. Accountants refer

to manufacturers' agents' inventory as "matriel" in order to differentiate it

from goods for sale.

2. Transportation: The movement of goods between owners, or betweenlocations of a given owner. The seller owns goods in transit until the buyer

accepts them. Sellers or buyers may transport goods but most transportation

providers act as the agent of the owner of the goods.

3. Wholesaling: Distributors who buy goods from manufacturers and other

suppliers (farmers, fishermen, etc.) for re-sale work in the wholesale industry.

A wholesaler's inventory consists of all the products in its warehouse that it

has purchased from manufacturers or other suppliers. A produce-wholesaler

(or distributor) may buy from distributors in other parts of the world or fromlocal farmers. Food distributors wish to sell their inventory to grocery stores,

other distributors, or possibly to consumers.

4. Retailing: A retailer's inventory of goods for sale consists of all the products

on its shelves that it has purchased from manufacturers or wholesalers. The

store attempts to sell its inventory (soup, bolts, sweaters, or other goods) to

consumers.

It is a key observation in "Lean Manufacturing" that it is often the case that

more than 90% of a product's life prior to end user sale is spent in

distribution of one form or another. On the assumption that the time is not

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itself valuable to the customer this adds enormously to the working capital

tied up in the business as well as the complexity of the supply chain.

Reduction and elimination of these inventory 'wait' states is a key concept in

Lean.

High level inventory management

It seems that around about 1880[2] there was a change in manufacturing

practice from companies with relatively homogeneous lines of products to

vertically integrated companies with unprecedented diversity in processes

and products. Those companies (especially in metalworking) attempted to

achieve success through economies of scale - the gains of jointly producing

two or more products in one facility. The managers now needed informationon the effect of product mix decisions on overall profits and therefore needed

accurate product cost information. A variety of attempts to achieve this were

unsuccessful due to the huge overhead of the information processing of the

time. However, the burgeoning need for financial reporting after 1900 created

unavoidable pressure for financial accounting of stock and the management

need to cost manage products became overshadowed. In particular it was the

need for audited accounts that sealed the fate of managerial cost accounting.

The dominance of financial reporting accounting over management

accounting remains to this day with few exceptions and the financialreporting definitions of 'cost' have distorted effective management 'cost'

accounting since that time. This is particularly true of inventory.

Hence high level financial inventory has these two basic formulas which relate

to the accounting period:

1. Cost of Beginning Inventory at the start of the period + inventory purchases

within the period + cost of production within the period = cost of goods

2. Cost of goods - cost of ending inventory at the end of the period = cost of

goods soldThe benefit of these formulae is that the first absorbs all overheads of

production and raw material costs in to a value of inventory for reporting. The

second formula then creates the new start point for the next period and gives

a figure to be subtracted from sales price to determine some form of sales

margin figure.

Manufacturing management is more interested in inventory turnover ratio or

average days to sell inventory since it tells them something about relative

inventory levels.

Inventory turn over ratio (also known as inventory turns) = cost of goods

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sold/Average Inventory=Cost of Goods Sold/((Beginning Inventory + Ending

Inventory)and its inverse

Average Days to Sell Inventory=Number of Days a Year/Inventory Turn Over

Ratio=365 days a year/Inventory Turn Over Ratio

This ratio estimates how many times the inventory turns over a year. Thisnumber tells us how much cash/goods are tied up waiting for the process and

is a critical measure of process reliability and effectiveness. So a factory with

two inventory turns has six months stock on hand which generally not a good

figure (depending upon industry) whereas a factory that moves from six turns

to twelve turns has probably improved effectiveness by 100%. This

improvement will have some negative results in the financial reporting since

the 'value' now stored in the factory as inventory is reduced.

Whilst the simplicity of these accounting measures of inventory is very usefulthey are in the end fraught with the danger of their own assumptions. There

are in fact so many things which can vary hidden under this appearance of

simplicity that a variety of 'adjusting' assumptions may be used.

These include:

Specific Identification

Weighted Average Cost

Moving-Average Cost

FIFO, and LIFO.

Inventory Turn is a financial accounting tools for evaluating inventory and itis not necessary a management tool. Inventory management should be

forward looking. The methodology applied is based on historical cost of goods

sold. The ratio may not be able to reflect the usability of future production

demand as well as customer demand.

Business models including Just in Time (JIT) Inventory, Vendor Managed

Inventory (VMI) and Customer Managed Inventory (CMI) attempt to minimize

on-hand inventory and increase inventory turns. VMI and CMI have gained

considerable attention due to the success of third party vendors who offeradded expertise and knowledge that organizations may not possess.

Accounting perspectives

The basis of Inventory accounting:

Inventory needs to be accounted where it is held across accounting period

boundaries since generally expenses should be matched against the results of

that expense within the same period. When processes were simple and short

then inventories were small but with more complex processes then

inventories became larger and significant valued items on the balance

sheet[3]. This need to value unsold and incomplete goods has driven many

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new behaviors into management practice. Perhaps most significant of these

are the complexities of fixed cost recovery, transfer pricing, and the

separation of direct from indirect costs. This, supposedly, precluded

"anticipating income" or "declaring dividends out of capital". It is one of the

intangible benefits of Lean and the TPS that process times shorten and stocklevels decline to the point where the importance of this activity is hugely

reduced and therefore effort, especially managerial, to achieve it can be

minimized.

Accounting for Inventory:

Each country has its own rules about accounting for inventory that fit with

their financial reporting rules.

So for example, organizations in the U.S. define inventory to suit their needs

within US Generally Accepted Accounting Practices (GAAP), the rules definedby the Financial Accounting Standards Board (FASB) (and others) and

enforced by the U.S. Securities and Exchange Commission (SEC) and other

federal and state agencies. Other countries often have similar arrangements

but with their own GAAP and national agencies instead.

It is intentional that financial accounting uses standards that allow the public

to compare firms' performance, cost accounting functions internally to an

organization and potentially with much greater flexibility. A discussion of

inventory from standard and Theory of Constraints-based (throughput) cost

accounting perspective follows some examples and a discussion of inventoryfrom a financial accounting perspective.

The internal costing/valuation of inventory can be complex. Whereas in the

past most enterprises ran simple one process factories, this is quite probably

in the minority in the 21st century. Where 'one process' factories exist then

there is a market for the goods created which establishes an independent

market value for the good. Today with multi-stage process companies there is

much inventory that would once have been finished goods which is now held

as 'work-in-process' (WIP). This needs to be valued in the accounts but thevaluation is a management decision since there is no market for the partially

finished product. This somewhat arbitrary 'valuation' of WIP combined with

the allocation of overheads to it has led to some unintended and undesirable

results.

Financial accounting

An organization's inventory can appear a mixed blessing, since it counts as an

asset on the balance sheet, but it also ties up money that could serve for other

purposes and requires additional expense for its protection. Inventory may

also cause significant tax expenses, depending on particular countries' laws

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regarding depreciation of inventory, as in Thor Power Tool Company v.

Commissioner.

Inventory appears as a [[current asset]] on an organization's balance sheet

because the organization can, in principle, turn it into cash by selling it. Some

organizations hold larger inventories than their operations require in orderinflating their apparent asset value and their perceived profitability.

In addition to the money tied up by acquiring inventory, inventory also brings

associated costs for warehouse space, for utilities, and for insurance to cover

staff to handle and protect it, fire and other disasters, obsolescence, shrinkage

(theft and errors), and others. Such holding costs can mount up: between a

third and a half of its acquisition value per year.

Businesses that stock too little inventory cannot take advantage of large

orders from customers if they cannot deliver. The conflicting objectives ofcost control and customer service often pit an organization's financial and

operating managers against its sales and marketing departments. Sales

people, in particular, often receive sales commission payments, so unavailable

goods may reduce their potential personal income. This conflict can be

minimized by reducing production time to being near or less than customer

expected delivery time. This effort, known as "Lean production" will

significantly reduce working capital tied up in inventory and reduce

manufacturing costs (See the Toyota Production System).

The role of a cost accountant on the 21st-century in a manufacturingorganization

By helping the organization to make better decisions, the accountants can

help the public sector to change in a very positive way that delivers increased

value for the taxpayers investment. It can also help to incentives progress and

to ensure that reforms are sustainable and effective in the long term, by

ensuring that success is appropriately recognized in both the formal and

informal reward systems of the organization.

To say that they have a key role to play is an understatement. Finance isconnected to most, if not all, of the key business processes within the

organization. It should be steering the stewardship and accountability

systems that ensure that the organization is conducting its business in an

appropriate, ethical manner. It is critical that these foundations are firmly

laid. So often they are the litmus test by which public confidence in the

institution is either won or lost.

Finance should also be providing the information, analysis and advice to

enable the organizations service managers to operate effectively. This goes

beyond the traditional preoccupation with budgets how much have we

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spent so far, how much have we left to spend? It is about helping the

organization to better understand its own performance. That means making

the connections and understanding the relationships between given inputs

the resources brought to bear and the outputs and outcomes that they

achieve. It is also about understanding and actively managing risks within theorganization and its activities.

FIFO vs. LIFO accounting:

When a dealer sells goods from inventory, the value of the inventory is

reduced by the cost of goods sold (CoG sold). This is simple where the CoG has

not varied across those held in stock; but where it has, then an agreed method

must be derived to evaluate it. For commodity items that one cannot track

individually, accountants must choose a method that fits the nature of the

sale. Two popular methods which normally exist are: FIFO and LIFOaccounting (first in - first out, last in - first out). FIFO regards the first unit that

arrived in inventory as the first one sold. LIFO considers the last unit arriving

in inventory as the first one sold. Which method an accountant selects can

have a significant effect on net income and book value and, in turn, on

taxation. Using LIFO accounting for inventory, a company generally reports

lower net income and lower book value, due to the effects of inflation. This

generally results in lower taxation. Due to LIFO's potential to skew inventory

value, UK GAAP and IAS have effectively banned LIFO inventory accounting.

Standard cost accountingStandard cost accounting uses ratios called efficiencies that compare the

labour and materials actually used to produce a good with those that the same

goods would have required under "standard" conditions. As long as similar

actual and standard conditions obtain, few problems arise. Unfortunately,

standard cost accounting methods developed about 100 years ago, when

labor comprised the most important cost in manufactured goods. Standard

methods continue to emphasize labor efficiency even though that resource

now constitutes a (very) small part of cost in most cases.Standard cost accounting can hurt managers, workers, and firms in several

ways. For example, a policy decision to increase inventory can harm a

manufacturing managers' performance evaluation. Increasing inventory

requires increased production, which means that processes must operate at

higher rates. When (not if) something goes wrong, the process takes longer

and uses more than the standard labor time. The manager appears

responsible for the excess, even though s/he has no control over the

production requirement or the problem.

In adverse economic times, firms use the same efficiencies to downsize, right

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size, or otherwise reduce their labor force. Workers laid off under those

circumstances have even less control over excess inventory and cost

efficiencies than their managers.

Many financial and cost accountants have agreed for many years on the

desirability of replacing standard cost accounting. They have not, however,found a successor.

Theory of Constraints cost accounting:

Eliyahu M. Goldratt developed the Theory of Constraints in part to address the

cost-accounting problems in what he calls the "cost world". He offers a

substitute, called throughput accounting, that uses throughput (money for

goods sold to customers) in place of output (goods produced that may sell or

may boost inventory) and considers labour as a fixed rather than as a variable

cost. He defines inventory simply as everything the organization owns that itplans to sell, including buildings, machinery, and many other things in

addition to the categories listed here. Throughput accounting recognizes only

one class of variable costs: the truly variable costs like materials and

components that vary directly with the quantity produced.

Finished goods inventories remain balance-sheet assets, but labour efficiency

ratios no longer evaluate managers and workers. Instead of an incentive to

reduce labour cost, throughput accounting focuses attention on the

relationships between throughput (revenue or income) on one hand and

controllable operating expenses and changes in inventory on the other. Thoserelationships direct attention to the constraints or bottlenecks that prevent

the system from producing more throughput, rather than to people - who

have little or no control over their situations.

National accounts

Inventories also play an important role in national accounts and the analysis

of the business cycle. Some short-term macroeconomic fluctuations are

attributed to the inventory cycle.

Distressed inventoryinventory Management.

Inventory is a list for goods and materials, or those goods and materials

themselves, held available in stock by a business. It is also used for a list of the

contents of a household and for a list for testamentary purposes of the

possessions of someone who has died.

Origins of the word Inventory

The word inventory was first recorded in 1601. The French term inventaire,

or "detailed list of goods," dates back to 1415.

Business inventory

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The reasons for keeping stock:

There are three basic reasons for keeping an inventory:

1. Time - The time lags present in the supply chain, from supplier to user at

every stage, requires that you maintain certain amount of inventory to use in

this "lead time"2. Uncertainty - Inventories are maintained as buffers to meet uncertainties in

demand, supply and movements of goods.

3. Economies of scale - Ideal condition of "one unit at a time at a place where

user needs it, when he needs it" principle tends to incur lots of costs in terms

of logistics. So bulk buying, movement and storing brings in economies of

scale, thus inventory.

All these stock reasons can apply to any owner or product stage.

Buffer stock is held in individual workstations against the possibility thatthe upstream workstation may be a little delayed in long setup or change-over

time. This stock is then used while that change-over is happening. This stock

can be eliminated by tools like SMED.

These classifications apply along the whole Supply chain not just within a

facility or plant.

Where these stocks contain the same or similar items it is often the work

practice to hold all these stocks mixed together before or after the sub-

process to which they relate. This 'reduces' costs. Because they are mixed-up

together there is no visual reminder to operators of the adjacent sub-processes or line management of the stock which is due to a particular cause

and should be a particular individual's responsibility with inevitable

consequences. Some plants have centralized stock holding across sub-

processes which makes the situation even more acute.

Special terms used in dealing with inventory:

Stock Keeping Unit (SKU) is a unique combination of all the components that

are assembled into the purchasable item. Therefore any change in thepackaging or product is a new SKU. This level of detailed specification assists

in managing inventory.

Stockout means running out of the inventory of an SKU.

"New old stock" (sometimes abbreviated NOS) is a term used in business to

refer to merchandise being offered for sale which was manufactured long ago

but that has never been used. Such merchandise may not be produced any

more, and the new old stock may represent the only market source of a

particular item at the present time.

Typology

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1. Buffer/safety stock2. Cycle stock (Used in batch processes, it is the available inventory

excluding buffer stock)

3. De-coupling (Buffer stock that is held by both the supplier and the user)

4. Anticipation stock (building up extra stock for periods of increaseddemand - e.g. ice cream for summer)

5. Pipeline stock (goods still in transit or in the process of distribution -

have left the factory but not arrived at the customer yet)

Inventory examples

While accountants often discuss inventory in terms of goods for sale,

organizations - manufacturers, service-providers and not-for-profits - also

have inventories (fixtures, furniture, supplies, ...) that they do not intend to

sell. Manufacturers', distributors', and wholesalers' inventory tends tocluster in warehouses. Retailers' inventory may exist in a warehouse or in

a shop or store accessible to customers. Inventories not intended for sale

to customers or to clients may be held in any premises an organization

uses. Stock ties up cash and if uncontrolled it will be impossible to know

the actual level of stocks and therefore impossible to control them.

the reasons for holding stock are covered earlier, most manufacturing

organizations usually divide their "goods for sale" inventory into:

Raw materials - materials and components scheduled for use in making a

product. Work in process, WIP - materials and components that have begun their

transformation to finished goods.

Finished goods - goods ready for sale to customers.

Goods for resale - returned goods that are salable.

Spare parts

For example:Manufacturing

A canned food manufacturer's materials inventory includes the

ingredients to form the foods to be canned, empty cans and their lids (or

coils of steel or aluminum for constructing those components), labels, and

anything else (solder, glue, ...) that will form part of a finished can. The

firm's work in process includes those materials from the time of release to

the work floor until they become complete and ready for sale to wholesale

or retail customers. This may be vats of prepared food, filled cans not yet

labeled or sub-assemblies of food components. It may also include finished

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cans that are not yet packaged into cartons or pallets. Its finished goods

inventory consists of all the filled and labeled cans of food in its warehouse

that it has manufactured and wishes to sell to food distributors

(wholesalers), to grocery stores (retailers), and even perhaps to

consumers through arrangements like factory stores and outlet centres.Logistics or distribution

the logistics chain includes the owners (wholesalers and retailers),

manufacturers' agents, and transportation channels that an item passes

through between initial manufacture and final purchase by a consumer. At

each stage, goods belong (as assets) to the seller until the buyer accepts

them. Distribution includes four components:

1. Manufacturers' agents: Distributors who hold and transport a

consignment of finished goods for manufacturers without ever owning it.Accountants refer to manufacturers' agents' inventory as "materiel" in

order to differentiate it from goods for sale.

2. Transportation: The movement of goods between owners, or between

locations of a given owner. The seller owns goods in transit until the buyer

accepts them. Sellers or buyers may transport goods but most

transportation providers act as the agent of the owner of the goods.

3. Wholesaling: Distributors who buy goods from manufacturers and other

suppliers (farmers, fishermen, etc.) for re-sale work in the wholesale

industry. A wholesaler's inventory consists of all the products in itswarehouse that it has purchased from manufacturers or other suppliers. A

produce-wholesaler (or distributor) may buy from distributors in other

parts of the world or from local farmers. Food distributors wish to sell

their inventory to grocery stores, other distributors, or possibly to

consumers.

4. Retailing: A retailer's inventory of goods for sale consists of all the

products on its shelves that it has purchased from manufacturers or

wholesalers. The store attempts to sell its inventory (soup, bolts, sweaters,or other goods) to consumers.

It is a key observation in "Lean Manufacturing" that it is often the case that

more than 90% of a product's life prior to end user sale is spent in

distribution of one form or another. On the assumption that the time is not

itself valuable to the customer this adds enormously to the working capital

tied up in the business as well as the complexity of the supply chain.

Reduction and elimination of these inventory 'wait' states is a key concept

in Lean.

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High level inventory management

It seems that around about 1880[2] there was a change in manufacturing

practice from companies with relatively homogeneous lines of products to

vertically integrated companies with unprecedented diversity in processesand products. Those companies (especially in metalworking) attempted to

achieve success through economies of scale - the gains of jointly producing

two or more products in one facility. The managers now needed

information on the effect of product mix decisions on overall profits and

therefore needed accurate product cost information. A variety of attempts

to achieve this were unsuccessful due to the huge overhead of the

information processing of the time. However, the burgeoning need for

financial reporting after 1900 created unavoidable pressure for financialaccounting of stock and the management need to cost manage products

became overshadowed. In particular it was the need for audited accounts

that sealed the fate of managerial cost accounting. The dominance of

financial reporting accounting over management accounting remains to

this day with few exceptions and the financial reporting definitions of

'cost' have distorted effective management 'cost' accounting since that

time. This is particularly true of inventory.

Hence high level financial inventory has these two basic formulas which

relate to the accounting period:1. Cost of Beginning Inventory at the start of the period + inventory

purchases within the period + cost of production within the period = cost

of goods

2. Cost of goods - cost of ending inventory at the end of the period = cost of

goods sold

The benefit of these formulae is that the first absorbs all overheads of

production and raw material costs in to a value of inventory for reporting.

The second formula then creates the new start point for the next periodand gives a figure to be subtracted from sales price to determine some

form of sales margin figure.

Manufacturing management is more interested in inventory turnover ratio

or average days to sell inventory since it tells them something about

relative inventory levels.

Inventory turnover ratio (also known as inventory turns) = cost of goods

sold/Average Inventory=Cost of Goods Sold/((Beginning Inventory +

Ending Inventory)and its inverse

Average Days to Sell Inventory=Number of Days a Year/Inventory Turn

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Over Ratio=365 days a year/Inventory Turn Over Ratio

This ratio estimates how many times the inventory turns over a year. This

number tells us how much cash/goods are tied up waiting for the process

and is a critical measure of process reliability and effectiveness. So a

factory with two inventory turns has six months stock on hand whichgenerally not a good figure (depending upon industry) whereas a factory

that moves from six turns to twelve turns has probably improved

effectiveness by 100%. This improvement will have some negative results

in the financial reporting since the 'value' now stored in the factory as

inventory is reduced.

Whilst the simplicity of these accounting measures of inventory is very

useful they are in the end fraught with the danger of their own

assumptions. There are in fact so many things which can vary hiddenunder this appearance of simplicity that a variety of 'adjusting'

assumptions may be used.

These include:

Specific Identification

Weighted Average Cost

Moving-Average Cost

FIFO, and LIFO.

Inventory Turn is a financial accounting tools for evaluating inventory and

it is not necessary a management tool. Inventory management should beforward looking. The methodology applied is based on historical cost of

goods sold. The ratio may not be able to reflect the usability of future

production demand as well as customer demand.

Business models including Just in Time (JIT) Inventory, Vendor Managed

Inventory (VMI) and Customer Managed Inventory (CMI) attempt to

minimize on-hand inventory and increase inventory turns. VMI and CMI

have gained considerable attention due to the success of third party

vendors who offer added expertise and knowledge that organizations maynot possess.

Accounting perspectives

the basis of Inventory accounting

Inventory needs to be accounted where it is held across accounting period

boundaries since generally expenses should be matched against the results

of that expense within the same period. When processes were simple and

short then inventories were small but with more complex processes then

inventories became larger and significant valued items on the balance

sheet [3]. This need to value unsold and incomplete goods has driven

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much new behaviour into management practice. Perhaps most significant

of these are the complexities of fixed cost recovery, transfer pricing, and

the separation of direct from indirect costs. This, supposedly, precluded

"anticipating income" or "declaring dividends out of capital". It is one of

the intangible benefits of Lean and the TPS that process times shorten andstock levels decline to the point where the importance of this activity is

hugely reduced and therefore effort, especially managerial, to achieve it

can be minimized.

Accounting for Inventory

each country has its own rules about accounting for inventory that fit with

their financial reporting rules.

So for example, organizations in the U.S. define inventory to suit their

needs within US Generally Accepted Accounting Practices (GAAP), therules defined by the Financial Accounting Standards Board (FASB) (and

others) and enforced by the U.S. Securities and Exchange Commission

(SEC) and other federal and state agencies. Other countries often have

similar arrangements but with their own GAAP and national agencies

instead.

It is intentional that financial accounting uses standards that allow the

public to compare firms' performance, cost accounting functions internally

to an organization and potentially with much greater flexibility. A

discussion of inventory from standard and Theory of Constraints-based(throughput) cost accounting perspective follows some examples and a

discussion of inventory from a financial accounting perspective.

The internal costing/valuation of inventory can be complex. Whereas in

the past most enterprises ran simple one process factories, this is quite

probably in the minority in the 21st century. Where 'one process' factories

exist then there is a market for the goods created which establishes an

independent market value for the good. Today with multi-stage process

companies there is much inventory that would once have been finishedgoods which is now held as 'work-in-process' (WIP). This needs to be

valued in the accounts but the valuation is a management decision since

there is no market for the partially finished product. This somewhat

arbitrary 'valuation' of WIP combined with the allocation of overheads to

it has led to some unintended and undesirable results.

Financial accounting :

an organization's inventory can appear a mixed blessing, since it counts as

an asset on the balance sheet, but it also ties up money that could serve for

other purposes and requires additional expense for its protection.

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Inventory may also cause significant tax expenses, depending on particular

countries' laws regarding depreciation of inventory, as in Thor Power Tool

Company v. Commissioner.

Inventory appears as a [[current asset]] on an organization's balance sheet

because the organization can, in principle, turn it into cash by selling it.Some organizations hold larger inventories than their operations require

in order inflating their apparent asset value and their perceived

profitability.

In addition to the money tied up by acquiring inventory, inventory also

brings associated costs for warehouse space, for utilities, and for insurance

to cover staff to handle and protect it, fire and other disasters,

obsolescence, shrinkage (theft and errors), and others. Such holding costs

can mount up: between a third and a half of its acquisition value per year.Businesses that stock too little inventory cannot take advantage of large

orders from customers if they cannot deliver. The conflicting objectives of

cost control and customer service often pit an organization's financial and

operating managers against its sales and marketing departments. Sales

people, in particular, often receive sales commission payments, so

unavailable goods may reduce their potential personal income. This

conflict can be minimized by reducing production time to being near or

less than customer expected delivery time. This effort, known as "Lean

production" will significan