Friday, May 09, 2014


Inventory Control
The term ‘Inventory’ is used to denote (i) goods awaiting sale (the stock items of a trading concern and the finished stocks of a manufacturer); (ii) the goods in course of manufacture, known as work-in-progress, and (iii) goods to be used directly or indirectly in production, i.e., raw materials and supplies.
In a manufacturing company, normally the cost of materials constitutes fifty percent of the production cost and the cost of inventory (i.e., raw materials W.I.P., and finished good) represents about one-third of the total assets. As the costs of materials and inventory are quite formidable but at the same time controllable, there is a great need felt for proper planning, purchasing, handling and accounting for the same, and also to organize the system of inventory control in a manner that it may provide the maximum profitably to the management.

Techniques of Inventory Control
The techniques or the tools generally used to effect control over the inventory are the following:

1)      Budgetary techniques for inventory planning;
2)      A-B-C. System of inventory control; (SHORT NOTE)
3)      Economic Order Quantity (E.O.Q.) i.e., how much to purchase at one time economically; (SHORT NOTE)
4)      VED Analysis;
5)      Perpetual inventory system and the system of store verification; (SHORT AND BROAD QUESTION)
6)      Fixation of Stock Level;
7)      Control Ratios.

1)      Budgetary Techniques: For the purchase of raw materials and stocks, what we required is a purchase Budged to be prepared in terms of quantities and values involved. The sales stipulated as per sales Budget of the corresponding period generally works out to be the key factor to decide the production quantum during the budget period, which ultimately decides the purchases to be made and the inventories to be planned.

2)      A-B-C Analysis: Refer Below

3)      Economic Order Quantity: This represents the normal quantity to be placed on order when the stock has reached its re-order level. Re-ordering quantity is to be fixed taking into account the maximum and minimum stock levels. The quantity ordered must be that which, when added to the minimum stock, will not exceed the maximum stock to be carried at any point of time. The following factors govern the re-ordering quantity:
a)      Average consumption
b)      Cost of pacing order
c)       Cost of storage
d)      Interest on capital etc.

The economic order quantity can be determined by the following simple formula.

4)       VED Analysis: VED – Vital, Essential, Desirable – analysis is used primarily for control of spare parts. The spare, parts can be divided into three categories – vital, essential or desirable – keeping in view the critically to production.
5)      Perpectual Inventory System: Perpectual Inventory is a system of records maintained by the controlling department, which reflects the physical movement of stocks and their current balance. It aims at devising the system of records by which the receipts and issues of stores may be recorded immediately at the time of each transaction and the balance may be brought out so as to show the up-to-date position. The records used for perpectual inventory are:
a)      Bin Cards;
b)      Store Ledger Accounts or Stores Record cards;
c)       The forms and documents used for receipt, issue and transfer of materials.
6)      Fixation of stock level: The object of fixing stock levels for each item of material is to maintain required quantity of materials in the store and thereby the expenses may be reduced. The different stock levels are: (1) Minimum stock level (2) Maximum stock level (3) Reorder stock level
a.       Minimum stock level: It represents the minimum quantity of an item of material to be kept in the store at any time. Material should not be allowed to fall below this level. If the stock goes below this level, production may be held up for want of materials. This stock is also known as safety stock level or buffer stock.
b.      Maximum stock level: It is the stock level above which stock should not be allowed to rise. This is the maximum quantity of stock of raw materials which can be had in the stock. It is goes above, it will be overstocking.
c.       Reorder stock level: It is the point at which the storekeeper should initiate purchase requisition for fresh supply. This level lies between the maximum level and the minimum level.

7)      Control Ratios: The control ratios are mainly two –
a)      Inventory Turnover Ratio which we have studied and
b)      Input-output Ratio.
Inventory Turnover: Inventory Turnover is a ratio of the value of the materials consumed during a period to the average value of inventory held during that period.
If the inventory turnover rate in terms of value of materials is high, or if the length of the inventory turnover period is short, the material is said to be fast moving. So if the rate of consumption is fast or if the inventory turnover rate is good, it is a healthy measure of efficiency of materials control, as the capital employed is properly utilized.
 Input-output Ratio: The Input-output Ratio is the ratio of the raw material put into manufacture and the standard raw materials content of the actual output.
This ratio enables one to find out whether the usage of the materials is favourable or not. A standard ratio of input of materials and output of material should be determined and the actual ratio should be compared with the standard ratio.

ABC Analysis
It is a system of selective inventory control whereby the measure of control over an item of inventory various with its usage value.  It exercises discriminatory control over different items of stores grouped on the basis of the investment involved.  Usually the items of material are grouped into three categories viz. A, B and C according to their use value during a period.  In other words, the high use value items are controlled more closely that the items of low use value.
i. ‘A’ Category of items consists of only a small percentage i.e., about 10% of the total items of material handled by the stores but require heavy investment i.e., about 70% of inventory value because of their high prices and heavy requirement.
ii. ‘B’ Category of items comprises of about 20% of the total items of material handled by stores.  The percentage of investment required is about 20% of the total investment in inventories.
iii. ‘C’ category of items do not require much investment.  It may be about 10% of total inventory  value but they are nearly 70% of the total items handled by stores.
A’ category of items can be controlled effectively by using a regular system which ensures neither over-stoking nor shortage of materials for production. The stocks of materials are controlled by fixing certain levels like maximum level, minimum level and re-order level.  A reduction in inventory management costs is achieved by determining economic order quantities.  To avoid shortages and to minimise heavy investment of funds in inventories, the techniques of value analysis, variety reduction, standardisation etc. are used along with aforesaid techniques.
In the case of ‘B’ category of items, as the sum involved is moderate, therefore the same degree of control as applied in ‘A’ category of items is not warranted.  The orders for the items, belonging to this category may be placed after reviewing their situation periodically.  This category of items can be controlled by routine control measured.
For ‘C’ category of items, there is no need of exercising constant control.  Orders for items in this group, may be places either after six months or once in a year, after ascertaining consumption requirements.
Importance of ABC Analysis:
ABC analysis helps the management in the following ways:
(1) The investment in inventories is optimised through a close and direct control over A items. This would naturally release funds which can then be channelised into more profitable areas.
(2) The ordering and carrying costs are reduced since the management would attempt to optimise such costs so far as they relate to the bulk of the items.
(3) If the management seeks to exercise direct control over all the items of inventory, the inventory control system would become very expensive. ABC analysis therefore cuts down the cost of the system and relates its cost to the attendant benefits.
(4) With scientific control of inventories, the stock turnover rate can be maintained at comparatively high levels.
The concept of ABC analysis can be used in areas other than inventory also. This technique basically emphasises that where the items to be controlled are numerous, one should categorise them according to their importance. Close control should then be exercised on the most significant category. On the less important categories, the degree of control maybe related to the benefit from control.

Thus finally it may be concluded that ABC analysis plays an important role for a sound system of material control.