Inventory management techniques

The inventory of an industrial organization consists of hundreds and even thousands

of items having widely varying costs,usage and lead time together with procurement
and/or technical problems. It is neither desirable nor possible to exercise the same
degree of control over all these items. The management should pay more attention
to items whose usage value is high and less attention to items having low usage
value. The organization should,therefore , be selective in its approach towards
inventory control and the techniques used are called selective inventory control
techniques.

Inventory Control Methods

In order to control the consumption of materials, within a given production house,

cost accountants resort to different inventory control methods. Some effective
inventory control methods are explained in the following paragraphs.
According to the second International Accounting Standard (IAS 2), inventories are a
list of all items in stock and are valued at a price lower than the net realizable cost.
Indeed producer's logic is very realistic because, a stock is always valued less than
net realizable and in addition to that, over consumption of stock, uncontrolled
wastage, delayed stock supply and unaccounted stock, add to the production
expenditure. Thus the basic motive of implementing inventory control methods is:

 To minimize wastage and over consumption

 To keep a good and even flow of the intake and issue of stock

The art of costing probably originated during the world wars, when war profiteers
realized that controlling an expenditure even before it is incurred, is much more
profitable and saves a lot of resources. This nature of cost accounting has proved to
be advantageous as it overcomes the demerits of financial accounting, which aims at
just recording transactions, after they have taken place.

The various techniques applied for inventory management are as follows:

1. Selective inventory control
2. Setting of various stock levels
3. Systems of inventory control
4. Economic ordering quantity (EOQ)
5. Re-order point and safety stock
6. Application of computers to inventory management
7. Just-in-time inventory management
8. Materials requirement planning (MRP)
9. Inventory audit.

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Selective inventory control

Effective inventory management requires the understanding and knowledge of the

nature of inventories, and to gain this understanding the following analysis and
classification techniques are available.
1. ABC analysis
2. HML analysis
3. XYZ analysis
4. VED analysis
5. FSN analysis
6. SDE analysis
7. GOLF analysis
8. SOS analysis
The motive behind these analyses and their clasiifications is to tackle the important
aspects more rigorously. Moreover, an equally critical analysis of all items will be
very expensive and will have a diffused effect regardless of priorities.

Classification of inventories

Technique Basis Main use

Value of To control raw material,
ABC ( Always Better Control) conception components and work-in-
progress inventories in the
normal course of business
Unit price of Mainly to control purchases
HML(High,Medium,Low) the material
Value of the To review the inventories and
XYZ items in their uses at scheduled
storage intervals
Criticality of the To determine the stocking
VED(Vital,Essential,Desirable) component levels of spare parts
Consumption To control obsolescence
FSN(Fastmoving,slowmoving,non- pattern of the
moving) components
Problems faced Lead time analysis and
SDE(Scarce, Difficult, Easy to in procurement purchasing strategies
obtain)
Source of the Procurement strategies
GOLF( Government, Ordinary, material
Local, Foreign sources)
Nature of Procurement/holdingstrategies
SOS(Seasonal,Off-Seasonal) supplies for seasonal items like
agricultural products

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ABC Analysis

Any stock is segregated into different sections. These items are classified into 3
sections, A, B and C. The logic of segregating these items into sections is that
section A consists of limited number of items that are very expensive. Section B has
items that are not expensive and the number of units that is to be ordered is also not
very large. The section C consists of numerous items, that have a low monetary
value. The logic behind such segregation is that every section is viewed differently
by the cost accountant, due the difference in order time, reorder time and delivery
period. For example, though the unites in section A are less, their monetary value is
also high and so is their delivery period. The ABC analysis is a simple and probably
the most effective of all stock control methods.
It contemplates to classify all the inventory items into three categories based on their
usage values. Items of high usage value but small in number are classified as “A”
items and would be under strict control of top level management. “C” items are large
in number but require little capital and would be under simple control. Items of
moderate value and size are classified as “B” items and would attract reasonable
attention of the middle level management. ABC analysis ( Always Better Control
analysis) is also known as „ control by importance and exception” and “proportional
value analysis”.
It has been found that normal inventory items in most organizations show the
following distribution patterns

A : 5 to 10 % of the total number of items accounting for 70 to 80 % of the annual

usage value.
B : 10 to 20 % accounting for about 15 to 20 % of tha annual usage value, and
C: 70 to 80 % of the number of items accounting for 5 to 15 % of the annual usage
value.

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HML analysis

In this analysis,items are classified on the basis of unit cotst rather than their usage
value as in ABC analysis. Accordingly, they are classified as H-high , M-Medium ,L-
low. This analysis helps in keeping control over materials consumption at
departmental level.

XYZ analysis

This analysis is based on the closing inventory values of different items. X items
have high inventory values while Z items have low tied-up capital. Y items lie in
between. This analysis helps to reduce the capital investment in high value items.

Class of items A B C
X Efforts to be made Efforts to be made Steps to be taken
for reducing stocks for converting for disposing of the
to the Z category stocks to the Y surplus stocks
category
Y Efforts to be made - Control may be
for converting further tightened
stocks
Z - Stock levels may -
be reviewed twice
a year

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VED analysis
The VED analysis popularly known as Vital,Essential and Desirable analysis is used
primarily for the control of spare parts. On the basis of the critical nature or relative
importance, spare parts may be classified into 3 categories, namely vital(V),
essential (E) and desirable (D). the vital items have extreme criticality, the desirable
items are not critical and essential falls somewhere in between vital and desirable.

Systems of inventory control

The main systems of inventory control are:

1. Perpetual inventory ( automatic inventory) system
2. Double bin system

Perpetual inventory system

The control of inventories while in storage is effected through what is known as the
perpetual inventory. Thus the two main functions of the perpetual inventory are:

1. Recording store receipts and issues so as to determine at any time the stock in
hand, in terms of quantity or value, or both, without the need for a physical count
of the stock
2. Continuous verification of the physical stock with reference to the balance
recorded in the stores records, at any frequency, as convenient to the
management.

The perpetual inventory system consists of:

1. Bin cards
2. Stores ledger
3. Continuous stock taking

Double Bin System

The double bin system is used to establish a connection between the order and
reorder procedures. As mentioned above, from the point of view of a producer,
uneven supply of stock and odd consumption is not very healthy. Such unevenness
is sorted by two-bin system. In such a system, the stock is sorted into two bins, or
piles. The first stock (bin 1), is the larger of the two and is used up between the time
period that lasts from purchase of stock till the reorder. The second stock (bin 2), can
be used from the time when the reorder is placed till the order is actually received.
The second stock, has a considerable amount of stand by that can be used for
emergencies

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Order Cycling System

This system is based upon a review timetable. According to this system, a review of
the entire inventory is done at regular intervals, such as 30 days, 60 days or 90 days.
After the review is done, the cost accountant views stock items with low quantities
that will not last up to the next review interval. The purchase order for such a stock
item is placed immediately. The order cycling system is not exactly foolproof and one
requires a rather experienced cost accountant to efficiently conduct it.

There are many other methods such as FIFO and LIFO (issuance inventory
valuation methods) that are considered to be very effective inventory control
methods. In addition to that, you might also refer to some established mathematical
formulas such as economic ordering quantity. These are the basic inventory control
methods, that can be implemented by you for any kind of stock or item.

Inventory management techniques followed in industry

ABC analysis:

Levis used ABC analysis method of inventory management.

A: jeans fall under this category which contributes to 70 to 80 % in value

B: t-shirts and shirts fall under this category which contributes to 20 to 25 % in value
C:caps,belts,shoes etc., fall under this category which contributes to 10 to 15 % in
value

VED :

Shahi exports follows VED

V: Fabric is the vital inventory

E: Trims are essential inventory
D: Spare and lubricants are desirable inventory

FSN:

Cannimara Public library,Chennai follows FSN

F: Newspapers are fast moving

S: issue books are slow moving
N: reference books are non moving

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Perpetual inventory system:

Multiplex departmental stores use perpetual inventory system. On day to day basis
stocks are replenished.

Periodic inventory system:

More supermarket uses periodic inventory system. How much ever is consumed,
checked and placed the order. Time period is fixed and quantity keeps on changing.

Double bin system:

Kirana stores uses double bin system. Larger quantities of goods are stored in a
larger bin. Required quantity is transferred in a smaller bin for sale. When it gets
over, the goods are refilled from larger bin.

Inventory management technique used in book store(Landmark)

Book sales are highly seasonal. Most of the sales occur between the months of
January and April. During a month, sales peak in the first week.Sales are usually
higher on Sunday, Monday and Tuesday, and peak hours are between 5 and 10
p.m. Transactions range from 100 to 150 a day. Wholesale orders, mostly received
over the phone, account for about 15% of total sales. During school vacations sales
are minimal.
Occasionally, sales promotion events are held, but only to attract more customers
rather than to compensate for weak sales. Customers are given receipts for
purchases made. One copy of the receipt is left in the cash memo. From this copy,
transactions are fed daily into the computerized cash register. Two types of reports,
X and Z are generated (AZed report, indicates the total sales on any day of the year,
and the type and number of items sold). ZED reports are generated daily from these
entries of the cash register; at the end of the year these reports are used for
accounting purposes. Information like number of items sold, department wise sales,
number of customers, return entries, any advance payments, and credits given is
available on these forms. In the beginning of the year the stock of the store is
checked, the sales are found from the ZED reports, at the end of the year the stock
is rechecked and the whole exercise gives the annual revenue generated and level
of pilferage.

Inventory Reordering & Recording: As much as 70 percent of purchases are

made on credit. Items have to be picked by the store purchaser from the suppliers
outlet. The whole process of inventory management starts with reordering.
Whenever a stockout occurs for an item, demand is registered in a demand book.

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Purchase orders are checked by the owner before allowing the purchaser to make
purchases. A new item is added to the list of purchases if salesmen receive repeated
demands (2-3 times) from customers. The purchaser calls twice a day to find if there
is some new entry on the demand register, and if so, checks for the new item in the
market. Items are purchased from two or three main vendors.Vendor selection
depends mostly upon the price; the one who offers the lowest price becomes the
supplier as long as his price remains the lowest. When purchases arrive,the
purchase invoice goes to the purchase book, while the purchased item goes to the
stock room where they are repriced and are issued for shelf display. The size of the
purchase order is decided in the light of past experience. Sometimes text books are
stocked just before the start of the new educational year, to avoid disappointed
customers.

Inventory Process: When any item is issued from the stock, three copies are made
to record the issuance and delivery of these items. One remains with the stock room
record,while two are sent to the shopping hall, from where one of these copies is
signed (as a proof of receiving the items) and returned back to the stock room, while
the other is retained at the store. The ZED report is checked daily and if there is any
doubt, the audit roll at the till is used to remove it. The items which are not to be
selected by the customer are picked up by the salesman while the rest are picked by
the customer right off the shelf. Some of the products are repriced in the back room.
Return claims are honoured if they are backed by a sales receipt. The returned
product goes back to the shelf.

Inventory Checking: Inventory is checked twice a year and on each occasion two
days are spent for the purpose. There is no permanent staff for inventory checking.
At the time of the biannual check, all employees are involved in this work. There is
an average inventory shortage of 2% per month in spite of a guard who is employed
to keep a watchful eye on customers. According to the owners, kids are generally
responsible for shoplifting. Once, one of the employees was caught. He was later
removed from his job.

Managerial & Inventory Control: The owner had decided to develop the existing
system over a period of 2 to 3 years, so that regular business procedures were not
disrupted. The existing system focuses on cash and sales flow. The owner expects
that a formal organized system will yield positive results not only for sales and
revenues but also for store image. Development of an effective inventory control
system is being seriously considered these days.

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Inventory management technique used in departmental store
(.more- aditya birla group)

Sales are seasonal in nature. They are typically higher during winter months
(October to December); on Thursdays and on Saturdays during a typical week and
between 5 and 8 p.m.on a typical day. On average there are over a thousand
business transactions a day. Only a few of these are on credit. All sales are
documented in cash registers. There are four automated cash registers which
maintain daily sales records.

Inventory Reordering & Recording: The process of reordering a product initiates

at the salesman level. On finding a shelf partially depleted, the salesman checks the
inventory for that product in the stock room. If there is nothing stored, he writes a
purchase order which is handed over to the department head. The department head
accumulates all such orders from his department and gives them to the store
purchaser. The store purchaser groups all purchase orders received from various
departments into 'Store' and 'Market' purchases. Store purchases are conducted via
telephone and are delivered at the store by the manufacturer, while market
purchases are made by a market purchaser who is always accompanied by one of
the directors. These two spend most of their time in the market. Intelligent purchases
of this team result in high profit items being purchased. According to the owner, most
of the store's profits are earned through intelligent purchases made by market
purchase teams.

Inventory Process: Purchase documentation is handled by the accounts staff.

When a purchase consignment arrives at the store, it is checked against the invoice.
Supplies received from local suppliers are returned if found damaged, but imported
items or those received from Karachi have to be destroyed and the loss has to be
borne. All products are labelled with prices in a back-room. Most of the inventory is
stocked in godowns, with only a part placed on the display shelves. Customers pick
items and bring it to the department's cash counter, where payment is made and a
receipt in triplicate is made. A red coloured copy of the receipt is left in the
department's cash memo which is a record of the sale of the product at that
department's counter, while a white coloured original copy is issued to the customer.
At the same time the purchased item is sent along with a blue coloured carbon copy
to the main counter on the ground floor. The customer is handed over the item after
matching his receipt with its copy at the ground floor counter before the exit. When a
customer brings a claim of a damaged product it is first inspected and then the
refund is made. For this purpose, suitable adjustment is made in the cash register
and the product is replaced on the shelf or sent back to the manufacturer.

Inventory Checking: Store wide inventory checking takes place once a year but
inventory of high cost products is checked regularly. Three weeks are required for

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the annual inventory checking, and another three days to rearrange the products
back on shelves. In addition to inventory checking, store pilferage is checked by
three employees who keep a vigilant eye to catch shoplifters. Despite these
measures a monthly inventory shortage of one percent on the average remains
unaccounted for.

Inventory Control: Items for promotion and mark-downs are selected on the basis
of the approaching expiry dates, especially if there is a large quantity already in
stock. Sometimes the store is stuck with a product as a result of changes in fashions
and trends (especially in the dresses and cloth department). The placement and
display of such slow moving items are improved in order to attract customers. There
is, however, no regular procedure to monitor the volume of sales of a particular
product. The owner believes that formal' organized inventory control management
system would streamline the process and "cleanup the mess in inventory
management". He expects that an improved system will speed up the sales
transaction, improve store image and even increase revenue. As a matter of fact the
owner is looking for some specialist who could develop a system to manage
inventory and improve the control system. The owner considers checking purchases
and performance of salesmen to be the key strategic control issues.

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References :

1. http://www.buzzle.com/articles/inventory-control-methods.html

2. http://cmer.lums.edu.pk/upload/Current_Practices_in_Retail_Inventory.pdf

3. http://www.purchasing-procurement-center.com/inventory-management-
techniques.html

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