Professional Documents
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Inventory Management With Practical Example
Inventory Management With Practical Example
FINANCIAL MANAGEMENT
Section F2
Group Members:
Aarti Purohit
Arun Koshiya
Jai Shankar Patel
Pushpa Patel
Priyanka Biswas
Reshma Dsouza
Varun Maurya
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1. INVENTORY MANAGEMENT: 3
Basic about inventory, what do we mean by inventory, Objective etc.
3. NATURE OF INVENTORY: 7
Raw material
Work in progress
Finished goods
4. TYPES OF INVENTORY: 9
Transit Inventory
Buffer Inventory
Anticipation Inventory
Decoupling Inventory
Cycle Inventory
MRO Goods Inventory
Theoretical Inventory
FIFO
LIFO
Weighted average cost method
Standard price (cost) method
WHAT IS INVENTORY?
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. In accounting inventory is considered an asset.
Inventory management is primarily about specifying the size and placement of stocked
goods. Inventory management is required at different locations within a facility or within
multiple locations of a supply network to protect the regular and planned course of
production against the random disturbance of running out of materials or goods. The
scope of inventory management also concerns the fine lines between replenishment
lead time, carrying costs of inventory, asset management, inventory forecasting,
inventory valuation, inventory visibility, future inventory price forecasting, physical
inventory, available physical space for inventory, quality management, replenishment,
returns and defective goods and demand forecasting.
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Reports can be generated from the Inventory and Asset Management Systems
that would project the amount of revenue that can be generated through the sale
of surplus equipment, or to define the number of components that have a
criticality rating of 1 so that you can project the costs associated with
maintaining duplicates of critical equipment at recovery sites. Combining the two
reports would allow you to reroute equipment being scheduled for termination to
the Recovery Facility and eliminate the additional costs associated with
purchasing duplicate
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2. WHY KEEP INVENTORY?
Why would a firm hold more inventory than is currently necessary to ensure the firm's
operation? The following is a list of reasons for maintaining what would appear to be
"excess" inventory.
Table 1
MEET DEMAND:
In order for a retailer to stay in business, it must have the products that the
customer wants on hand when the customer wants them. If not, the retailer
will have to back-order the product. If the customer can get the good from
some other source, he or she may choose to do so rather than electing to
allow the original retailer to meet demand later (through back-order).
Hence, in many instances, if a good is not in inventory, a sale is lost
forever.
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LEAD TIME:
Lead time is the time that elapses between the placing of an order (either a purchase
order or a production order issued to the shop or the factory floor) and actually receiving
the goods ordered.
If a supplier (an external firm or an internal department or plant) cannot supply the
required goods on demand, then the client firm must keep an inventory of the needed
goods. The longer the lead time, the larger the quantity of goods the firm must carry in
inventory.
Example:
HEDGE:
Inventory can also be used as a hedge against price increases and inflation. Salesmen
routinely call purchasing agents shortly before a price increase goes into effect. This
gives the buyer a chance to purchase material, in excess of current need, at a price that
is lower than it would be if the buyer waited until after the price increase occurs.
QUANTITY DISCOUNT:
Often firms are given a price discount when purchasing large quantities of a good. This
also frequently results in inventory in excess of what is currently needed to meet
demand. However, if the discount is sufficient to offset the extra holding cost incurred as
a result of the excess inventory, the decision to buy the large quantity is justified.
SMOOTHING REQUIREMENTS:
Notice how the use of inventory has allowed the firm to maintain a steady rate of output
(thus avoiding the cost of hiring and training new personnel), while building up inventory
in anticipation of an increase in demand. In fact, this is often called anticipation
inventory. In essence, the use of inventory has allowed the firm to move demand
requirements to earlier periods, thus smoothing the demand.
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ACHIEVING EFFICIENT PRODUCTION RUNS:
Maintenance of large inventories helps a firm in reducing the set up cost associated with
each production run. For example: if a set up cost is rs.200 and the run produces 200
units, the cost per unit comes toRs.1. In case, the run produce is 2ooo units, the set up
cost will stand reduce to Rs. 0.10 per unit. Thus, inventories assists the firm in making
sufficiently high run resulting in lowering down the set up cost.
Inventory example
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 up cash and if uncontrolled it will be impossible to know the actual level of stocks
and therefore impossible to control them.
While the reasons for holding stock are covered earlier, most manufacturing
organizations usually divide their "goods for sale" inventory into:
Work in process, WIP - materials and components that have begun their
transformation to finished goods.
Spare parts
3. NATURE OF INVENTORY:
Inventory is defined as a stock or store of goods. These goods are maintained on hand
at or near a business's location so that the firm may meet demand and fulfill its reason
for existence. If the firm is a retail establishment, a customer may look elsewhere to
have his or her needs satisfied if the firm does not have the required item in stock when
the customer arrives. If the firm is a manufacturer, it must maintain some inventory of
raw materials and work-in-process in order to keep the factory running. In addition, it
must maintain some supply of finished goods in order to meet demand.
Sometimes, a firm may keep larger inventory than is necessary to meet demand and
keep the factory running under current conditions of demand. If the firm exists in a
volatile environment where demand is dynamic (i.e., rises and falls quickly), an on-hand
inventory could be maintained as a buffer against unexpected changes in demand. This
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buffer inventory also can serve to protect the firm if a supplier fails to deliver at the
required time, or if the supplier's quality is found to be substandard upon inspection,
either of which would otherwise leave the firm without the necessary raw materials.
Other reasons for maintaining an unnecessarily large inventory include buying to take
advantage of quantity discounts (i.e., the firm saves by buying in bulk), or ordering more
in advance of an impending price increase.
Generally, inventory types can be grouped into four classifications: raw material, work-
in-process, finished goods, and MRO goods.
RAW MATERIALS:
Raw materials are inventory items that are used in the manufacturer's conversion
process to produce components, subassemblies, or finished products. These
inventory items may be commodities or extracted materials that the firm or its
subsidiary has produced or extracted. They also may be objects or elements that the
firm has purchased from outside the organization. Even if the item is partially
assembled or is considered a finished good to the supplier, the purchaser may
classify it as a raw material if his or her firm had no input into its production.
Typically, raw materials are commodities such as ore, grain, minerals, petroleum,
chemicals, paper, wood, paint, steel, and food items. However, items such as nuts
and bolts, ball bearings, key stock, casters, seats, wheels, and even engines may be
regarded as raw materials if they are purchased from outside the firm.
WORK-IN-PROCESS:
Any item that has a parent but is not a raw material is considered to be work-in-process.
A glance at the rolling cart product structure tree example reveals that work-in-process
in this situation consists of tops, leg assemblies, frames, legs, and casters. Actually, the
leg assembly and casters are labeled as subassemblies because the leg assembly
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consists of legs and casters and the casters are assembled from wheels, ball bearings,
axles, and caster frames.
Case:
Work in process of any company will be depends on the capacity to produce the goods.
At Dulux paint Total time required to manufacture paint varies between 7-24hrs
depending on the type of goods. At one particular time only one size of product is
manufactured. Currently company has 150 kl of goods Work In Progress (WIP).
Company has capacity of 200kl WIP.
FINISHED GOODS:
A finished good is a completed part that is ready for a customer order. Therefore,
finished goods inventory is the stock of completed products. These goods have been
inspected and have passed final inspection requirements so that they can be
transferred out of work-in-process and into finished goods inventory. From this point,
finished goods can be sold directly to their final user, sold to retailers, sold to
wholesalers, sent to distribution centers, or held in anticipation of a customer order.
The levels of the above 3 kinds of inventories differ depending upon the nature of
business. For example: a manufacturer will have high level of all 3 kinds of
inventories. While a retailer or wholesaler will have level of inventories for finished
goods but will have no inventories of raw material or work-in progress . more over
depending upon the nature of business, inventories may be durable or non-durable,
valuable or inexpensive, perishable or non-perishable etc.
Inventories can be further classified according to the purpose they serve. These types
include transit inventory, buffer inventory, anticipation inventory, decoupling inventory,
cycle inventory, and MRO goods inventory. Some of these also are know by other
names, such as speculative inventory, safety inventory, and seasonal inventory.
4. TYPES OF INVENTORY:
TRANSIT INVENTORY:
Transit inventories result from the need to transport items or material from one location
to another, and from the fact that there is some transportation time involved in getting
from one location to another. Sometimes this is referred to as pipeline inventory.
Merchandise shipped by truck or rail can sometimes take days or even weeks to go
from a regional warehouse to a retail facility. Some large firms, such as automobile
manufacturers, employ freight consolidators to pool their transit inventories coming from
various locations into one shipping source in order to take advantage of economies of
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scale. Of course, this can greatly increase the transit time for these inventories, hence
an increase in the size of the inventory in transit.
Case:
Take the case of HPCL the transports are done from refinery to the customer through
different modes of transport i.e. Pipeline, Roadways (Tankers), Shipping, etc. the time
takes to reach a goods from refinery to the customer are called Transit inventory.
BUFFER INVENTORY:
ANTICIPATION INVENTORY:
Oftentimes, firms will purchase and hold inventory that is in excess of their current need
in anticipation of a possible future event. Such events may include a price increase, a
seasonal increase in demand, or even an impending labor strike. This tactic is
commonly used by retailers, who routinely build up inventory months before the demand
for their products will be unusually high (i.e., at Halloween, Christmas, or the back-to-
school season). For manufacturers, anticipation inventory allows them to build up
inventory when demand is low (also keeping workers busy during slack times) so that
when demand picks up the increased inventory will be slowly depleted and the firm
does not have to react by increasing production time (along with the subsequent
increase in hiring, training, and other associated labor costs). Therefore, the firm has
avoided both excessive overtime due to increased demand and hiring costs due to
increased demand. It also has avoided layoff costs associated with production cut-
backs, or worse, the idling or shutting down of facilities. This process is sometimes
called "smoothing" because it smoothes the peaks and valleys in demand, allowing the
firm to maintain a constant level of output and a stable workforce.
Case:
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Lets take a case of Dulux paint, in paint industry there will be a seasonality of
demand. Which means there production will be throughout the year and distribution
will be on pick time i.e. market demand will be more in the month of March to May and
June to Nov. this will be done for smooth distribution.
DECOUPLING INVENTORY:
Very rarely, if ever, will one see a production facility where every machine in the process
produces at exactly the same rate. In fact, one machine may process parts several
times faster than the machines in front of or behind it. Yet, if one walks through the plant
it may seem that all machines are running smoothly at the same time. It also could be
possible that while passing through the plant, one notices several machines are under
repair or are undergoing some form of preventive maintenance. Even so, this does not
seem to interrupt the flow of work-in-process through the system. The reason for this is
the existence of an inventory of parts between machines, a decoupling inventory that
serves as a shock absorber, cushioning the system against production irregularities. As
such it "decouples" or disengages the plant's dependence upon the sequential
requirements of the system (i.e., one machine feeds parts to the next machine).
The more inventory a firm carries as a decoupling inventory between the various stages
in its manufacturing system (or even distribution system), the less coordination is
needed to keep the system running smoothly. Naturally, logic would dictate that an
infinite amount of decoupling inventory would not keep the system running in peak form.
A balance can be reached that will allow the plant to run relatively smoothly without
maintaining an absurd level of inventory. The cost of efficiency must be weighed against
the cost of carrying excess inventory so that there is an optimum balance between
inventory level and coordination within the system.
Case:
Take a case of Book making industry. The manager knows that paper making machine
will be not working after two days & production will be stop because of that so they will
be produce in advance the more quantity of papers and when the machine will not
working at that time binding will be done and distribution will not be affected by stopping
the production.
CYCLE INVENTORY:
Those who are familiar with the concept of economic order quantity (EOQ) know that
the EOQ is an attempt to balance inventory holding or carrying costs with the costs
incurred from ordering or setting up machinery. When large quantities are ordered or
produced, inventory holding costs are increased, but ordering/setup costs decrease.
Conversely, when lot sizes decrease, inventory holding/carrying costs decrease, but the
cost of ordering/setup increases since more orders/setups are required to meet
demand. When the two costs are equal (holding/carrying costs and ordering/setup
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costs) the total cost (the sum of the two costs) is minimized. Cycle inventories,
sometimes called lot-size inventories, result from this process. Usually, excess material
is ordered and, consequently, held in inventory in an effort to reach this minimization
point. Hence, cycle inventory results from ordering in batches or lot sizes rather than
ordering material strictly as needed.
Maintenance, repair, and operating supplies, or MRO goods, are items that are used to
support and maintain the production process and its infrastructure. These goods are
usually consumed as a result of the production process but are not directly a part of the
finished product.
Examples of MRO goods include oils, lubricants, coolants, janitorial supplies, uniforms,
gloves, packing material, tools, nuts, bolts, screws, shim stock, and key stock. Even
office supplies such as staples, pens and pencils, copier paper, and toner are
considered part of MRO goods inventory.
o In the Railways, we do not have a system of working out these costs. But
it is necessary that for a given stores organization, total number of
purchases are ascertained and average cost per purchase order worked
out. When we work out the costs, we may find that some costs are fixed
while some are variable. We should be interested in knowing the variable
costs.
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Limited Tender Purchase Rs.300 to Rs.600 "
o These are just approximate and may vary considerably depending upon
various factors. It is repeated that every Railway should establish these
costs from time to time so that they can be used in designing proper
inventory models.
2) Carrying Costs:
The very fact that the items are required to be kept in stock means additional
expenditure to the organization. The different elements of costs involved in holding
inventory are as follows:
(a) Interest on capital / cost of capital / opportunity costs : When materials are kept in
stock money representing the value of materials is blocked. In a developing economy,
capital is extremely scarce and as such, the real value of capital is much higher than the
nominal rate of interest which the organization like Railways may be paying. The
,money which is blocked up is not available to the organization to do more business or
to use it for alternative productive investment. This opportunity to earn more profits
which we loose can be expressed as opportunity cost.
(c) The cost of storage, handling and stock verification : There are additional costs
because of the clerical work involved in handling of materials in the ward, in stock
verification, in preservation of materials as well as the costs because of various
equipments and facilities created for the purpose of materials. A part of this cost is of a
fixed nature. The major portion of the cost including the cost of staff, however, can be
treated as variable costs at least in the long run. This cost can be roughly 3 to 5% of the
inventory holding.
(d) Insurance Costs : Materials in stocks are either insured against theft, fire etc., or we
may have to employ watch & ward organization and also fire fighting organizations.
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Cost of this may also be 1 to 2%. The average inventory carrying costs can, therefore,
be as follows:
Whenever an item is out of stock and as such cannot be supplied, it means that some
work or the other is delayed and this, in turn, leads to financial loss associated with such
stoppage or delay of work.
o For example, if a locomotive remains idle for want of spare parts, the
earning capacity of the locomotive is lost for the duration of this period. On
the other hand, the spare parts required will have to be purchased on
emergency basis or have to be specially manufactured resulting in
additional costs.
o Stock out costs can vary from item to item and from situation to situation
depending upon the emergency action possible. No attempt therefore, is
normally made to evaluate a stock out cost of an item. Nevertheless, it is
important to understand the concept of stock out costs, even though the
actual quantification is not possible. We should have a rough grading of
the items depending upon the possible stock out costs.
4) Systems Costs :
These are the costs which are associated with the nature of the control systems
selected. If a very sophisticated model of the relationship between stock out costs,
inventory holding cost and cost of ordering is used and operated with the help of a
computer, it may give the theoretical minimum of the other costs but the cost of such
control system may be sufficiently high to offset the advantages achieved.
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6. INTEGRATED INVENTORY MANAGEMENT SYSTEM
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7. PRICING OF RAW MATERIALS:
Several methods are used for pricing inventories used in production. The important
ones are :
First-in first-out(FIFO)method
Last-in first-out(LIFO)method
Weighted average cost method
Standard cost(price)method
FIFO method:
This method assumes that the order in which materials are received in the stores is the
order in which materials are issued from the stores. Hence, the materials which is
issued first is priced on the basis of the cost of material received earliest, so on and so
forth. The advantages of this method seemed to be: 1. The pricing of material is
perhaps consistent with the practice of issuing oldest material first followed in many
manufacturing organization. 2. The value of material in stock is fairly closed to the
current cost. The disadvantages of this method are: 1. Issue of material at different
prices complicates stores accounting. 2. Comparision of job cost becomes difficult
when similar jobs may be charged with different prices for the same material. 3. In this
period of rising prices, the charge to production is low. This tends to inflate reported
profits, increase tax burden & push up dividends-as a consequence, the firm is sapped
financially.
LIFO method:
This method is the opposite of FIFO method: It assumes that the material which is
acquired last is issued first. Hence material issues are priced on the basis of the cost of
most recent material purchases.
The advantages associated with this method are: 1. The cost of production reflects the
current cost of materials better. 2. In a period of rising prices, reported profits are
depressed, dividends are kept low, & working capital is conserved. The disadvantages
of this method are: 1. Issue of material at different prices complicates stores accounting.
2. The pricing of materials is not consistent with the commonly followed practice of
issuing the oldest material first. 3. Comparison of job cost becomes difficult when
similar jobs may be charged for the same material at different prices.
Weighted Average Cost Method:
Under this method, material issues are priced at a weighted average cost of materials in
stock. To get an up-to-date weighted average cost figure, a new weighted average cost
is calculated each time a delivery is received.
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The merits of this method are: (i) It tends to smooth out price fluctuations. (ii) It provides
a fairly acceptable figure for stock values. The limitations of this method may be the
tedium involved in calculating the weighted average cost each time a new delivery is
obtained.
Standard Price (cost) Method:
Under this method a standard price is predetermined. When materials are purchased
the stock amount is debited with the standard price. The difference between the actual
price & standard price is carried to a variance account. Material issued are charged as
per the standard price.
The advantages of this method are: (i) All material issued are priced identically. The
possibility of jobs using the same material being charged with different cost-a problem
with the FIFO or LIFO method does not exist. (ii) Stock accounting is fairly simplified.
There is no need for specific prices attributable to specific issues of materials. The short
comings of this method are: (i) Determining the standard price may be somewhat
difficult, particularly when prices tend to increase somewhat unpredictably or are
characterized by wide fluctuations. (ii) the issue of how variance should be treated may
be thorny.
The first question, how much to order relates to the problem of determining economic
order quantity (EOQ) and answered with an analysis of costs of maintaining certain
level of inventories. The second question, when to order, arises because of uncertainty
and is a problem of determining the reorder point.
1) Ordering Costs:
The term ordering costs is used in case of raw materials (or supplies) and includes the
entire costs incurred in the following activities:
Requisition
Purchase
Ordering
Transporting
Receiving
Inspecting
Storing (store placement)
Ordering costs increase in proportion to the number of orders placed. The clerical and
staff costs, however, do not have to vary in proportion to the number of orders placed,
and one view is that so long as they are committed costs, they need not be reckoned in
computing ordering cost. Alternatively, it may be argued that as the number of order
increases, the clerical and staff costs tend to increase. If the number of orders are
drastically reduced, the clerical and staff force release now can be used in other
departments. Thus, these costs may be included in the ordering costs. It is more
appropriate to include clerical and staff costs on a prorata basis. Ordering costs
increase with the number of orders, thus the more frequently inventory is acquired, the
higher the firms ordering costs. On the other hand, if the firm maintains a large
inventory levels, there will be few orders placed and ordering costs will be relatively
small. Thus, ordering costs decrease with the increasing size of inventory.
2) Carrying Costs:
Costs incurred for maintaining a given level of inventory are called carrying costs. They
include storage, insurance, taxes, deterioration and adolescence. The storage costs
comprise cost of storage space (warehousing cost), stores handling costs and clerical
and staff service costs (administrative costs) incurred in recording and providing special
facilities such as fencing, lines, racks etc. Carrying costs vary with inventory size. This
behavior is contrary to that of ordering costs which decline with increase in inventory
size. The economic size of inventory would thus depend on tradeoff between carrying
costs and ordering costs.
3) Reorder point:
The reorder point is that inventory level at which an order should be placed to replenish
the inventory. To determine the reorder point under certainty, we should know:
Lead time
Average usage
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Economic order quantity
Lead time:
Lead time is the time normally taken in replenishing the inventory after the order has
been placed. By certainty we mean that uses and lead time do not fluctuate. Under
such a situation reorder point is simply that inventory level which will be maintained for
consumption during the lead time .i. e ,
Reorder point = Lead * Average usage.
4) Safety stock:
The demand for material may fluctuate from daytoday or from weektoweek. Similarly,
the actual delivery time may be different from the normal lead time. If the actual usage
increases or the delivery of inventory is delayed, the firms can a problem of stockout
which can prove to be costly for a firm. Therefore, in order to guard against the stock
out, the firm may maintain a safety stock. It is the minimum or buffer inventory as
cushion against expected increased usage and/or delay in delivery time.
When asked, the cashier/owner of the store told that they maintain stocks of FMCG as
well as pharmaceuticals as per the requirement of the locality. The consumption of
FMCG is informed to be very high.
The store has installation of computerized inventory management system.
A database of inventories is automatically maintained by the system.
It keeps track of what comes in and what goes out.
As soon as the inventory reaches the reorder point, the system automatically
reminds them to order that particular commodity.
They, then place the required order using telephonic communication.
Three most selling FMCG goods have been identified and have been studied for the
inventory management:
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Min. Average Max.
Shampoo
Sunsilk 5 20 25
Garnier 5 35 40
Head and shoulder 5 25 30
Dove 5 30 35
Soap
Lux body wash 10 90 100
Lux 10 90 100
Life boy 10 80 90
Dettol 10 110 120
Dove 10 90 100
Toothpaste
Close-up 5 50 55
Colgate 5 60 65
Pepsodent 5 40 45
Ordering Costs:
It is nil for this store as the supplier charges no delivery costs to them.
Carrying costs:
Was not disclosed. The store owner looked more haphazard, when asked about it.
Reorder point:
The Computerized inventory management system automatically reminds to place an
order when the inventory reaches the min. point.
Lead time:
It was informed to be 48 hrs.
Safety stock:
The store does not have any such concept, instead it does have a minimum and a
maximum limit. It just tries to maintain the max. limit of the stock.
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9. INVENTORY CONTROL SYSTEM:
A firm needs a inventory control system to effectively manage its inventory.There are
several inventory control system in practice.They are from simle system to vaery
complicated systems. For eg: a small firm may operate a two bin system. Under this
system the company maintains two bins. Once inventory in one bin is used an order is
placed , and mean while the firm use inventory in the second bin for a llarge department
store the sells hundreds of items, this system is quite unsatisfactory. The departmental
store will have to maintain a self operating , automatic computer system for tracing the
inventory position of various item and placing order.
Classify the items of inventories, determining the expected use in units and the
price per unit for each item.
Determine the total value of each item by multiplying the expected units by its
units price.
Rank the items in accordance with the total value, giving first rank to the item
with highest total value and so on.
Compute the ratios (percentage) of nos. of units of each item to total units of all
items and the ratio of total value of each item to total value of all items.
Combine items on the basis of their relative value to form 3 categories- A, B and
C.
Paretos law applied to inventories
The relationship between the percentage of items and the percentage of AUV
(annual usage value) follows a pattern
A about 20 % of items account for about 80 % of the AUV
B - about 30 % of items account for about 15 % of the AUV
C - about 50 % of items account for about 5 % of the AUV
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An example:
A small firm inventories only ten items, but decides to setup an ABC inventory system
With 20 % A items, 30 % B items, and 50 % C items. The company records provide the
information shown below.
Part 1 2 3 4 5 6 7 8 9 10
No
Unit 1100 600 100 1300 100 10 100 1500 200 500 5510
Usag
e
Unit 20 400 40 10 600 250 20 20 20 10
Cost
AUV 2200 24000 400 1300 6000 250 200 3000 400 500 38250
0 0 0 0 0 0 0 0 0 0 0
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Just-In-Time(JIT) systems:
Japanese firms popularize the just-in time (JIT)system in the world. In a JIT system
material or manufactured components and parts arrive to the manufacturing sites or
stores just few hours before they are put to use. The delivery of material is synchronized
with the manufacturing cycle and speed. JIT system eliminates the necessity of carrying
large inventories, and thus , saves carrying other related cost to the manufacturer. The
system requires perfect understanding and co-ordination between the manufacturer and
the suppliers in terms of the timing of delivery and quality of the material. Poor quality
material and components could halt the production. The JIT inventory system
complements the total quality management (TQM). The success of the system depends
on how well a company manages its suppliers. The system puts tremendous pressure
on suppliers. They will have to develop adequate systems and procedures to
satisfactory meet the needs of manufacturers.
Example:
One truck transportation company obtains much of its business by catering to
companies that must deliver parts to other companies just in time. The Toyota
Company in Japan has developed a scheduling discipline for internal control of in
process material movement, called kanban, which substantially reduces WIP
Inventories and hence reduces the associated costs.
Outsourcing:
A few years ago there was a tendency on the parts of many companies to manufacture
all components in house. Now more companies are adopting the practice out sourcing.
Out sourcing is a system of buying parts and components from outside rather than
manufacturing them internally. Many companies develop a single source of supply, and
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many others help developing small and middle size suppliers of components that they
require.
Example:
Tata motors has, developed number of ancillaries are able to maintain the high quality
of the manufactured components. The car manufacturing company, Maruti, which is now
controlled by Suzuki of Japan has the similar system of supply.
In many organizations, however, the opportunities to reduce inventory costs are often
not addressed at all or are not completely exploited. If your organization needs help
taking money out of inventory there are strategies you can employ today that will
provide payoff.
Some of these strategies address having less active inventory, others how you
purchase active inventory, and still others require transferring inventory or relying on
vendors for better inventory management. Regardless of which you choose to explore,
proactive inventory management policies will make a difference in your operations. Here
are some of the most common techniques for lowering inventory levels .
7. Think Postponement: For parent products from which multiple SKUs can be
manufactured, only partially completing manufacturing, placing semi-finished product in
inventory, and then completing manufacturing of the final SKUs to order reduces total
inventory. In a similar manner, component products from which final SKUs may be
assembled can be purchased to inventory and then the final SKUs assembled to order,
providing that the time for assembly doesn't exceed the customer lead time.
8. Rationalize SKUs: Removal of inappropriate product from the product line can
be a controversy-ridden process, but may reduce inventory significantly if handled in a
constructive manner, as follows:
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Develop activity-based costs for each SKU and separate them into three
groups:
o Those with selling prices that cover their variable cost but do not
completely cover their fixed cost
o Those with selling prices that do not cover their variable cost
11. Purchase Minimums: Compare the total cost of ownership for purchased
products as quoted prices with no minimums to reduced prices with minimums to
determine if the reduced prices really provide savings.
15. Don't Stock It: Manufacturing or purchasing to order when the acquisition and
customer lead time relationships and order quantity relationships allow it is a very direct
way to reduce inventory, providing that the acquisition capacity exceeds the potential
short-term demand rate.
18. Extend Payment Terms: When negotiating long- term purchase agreements,
getting the best payment terms at a given unit price is the most direct way to increase
the portion of inventory funded by the vendor. If improving payment terms can be
coupled with increased turnover, then the improvement in working capital effectiveness
is significant.
21. Consider Liquidation: Although there will always be a short-term price to pay
on the P&L and the balance sheet, when it is absolutely clear that the value to be
gained through liquidation-whether through sale at reduced price, sale as distressed
product, salvage, or charitable donation-is greater than the most optimistic estimate of
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future gross margin from conventional product sales, then liquidation is the best
decision.
23. Get Help From Friends: Collaborative Planning and Replenishment (CPFR) is
an open set of pre-defined business processes and IT/communications standards
created to facilitate collaboration between supply chain partners. CPFR can reduce
inventories through inventory balance, forecast, demand and other data visibility and
associated collaboration in the planning area.
There are numerous ways to take better control of inventory and decrease its
associated costs. The key to managing inventory successfully is to continuously
measure your performance and look for new ways to improve. These 25 strategies
should get your organization thinking about what it can do to lower inventory costs.
Many of these strategies may seem challenging to implement. This is when it is wise to
seek outside help for insight on how to put these strategies to work for you.
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Since demand for paints in Indian market is very seasonal, company has to keep
huge finished goods inventory to satisfy festive season demand at the same time
company has to keep same production level trough out the year. Keeping huge
inventory will increase the cost of final product, therefore company keep all finished
good inventory in its own warehouse. Company has a great distribution channel with
180 Depos all over India. All Depos have storage capacity to maintain supply and satisfy
the demand. On an average thane plant keeps 3 crore finished goods inventory.
Finished goods are transported to depots. Transport is outsourced and paid on per km
per kl basis. 60 days credit period is given to transporters and 21 days credit period is
given to distributors.
At site level company holds 4.35 crore of inventory (both raw material and
finished good) per month. 5.5 Crore inventory per month turnover vise. Globally
company has reported 90 crore inventory till 2007, now it has been reduced to 48 crore.
References:
Financial Management, 9th edition by I.M. Pandey.
http://en.wikipedia.org/wiki/Inventory_control_system
http://en.wikipedia.org/wiki/Inventory
http://rapidlibrary.com
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