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It may mean raw materials, work-in-progress, maintenance materials, processed and semi- processed materials, oils, fuels and lubricants as well as finished and semi- finished goods. They may be either in solid, liquid or gaseous form, required for future use, mainly in the production process as in the case of finished goods for re-sale. In any case, it is an idle resource having an economic value awaiting conversion, consumption or re-sale. Thus inventories are held primarily for some transaction. 'Today's inventory is tomorrow's production'. In case of production inventory, generally there is a time-lag between the recognition of the need and fulfillment of that need. This time-lag; which is technically called 'leadtime', is due to the time required for ordering, processing and time needed by the vendor for actual delivery of the materials. Consequently, leadtime greatly influences holding of the volume of inventory. Had it been so that materials were readily available right on placing orders, there would have been no need for holding inventory. The second element is that inventories are held as a precautionary measure for increases in both leadtime and consumption rate. Also, there are reasons for holding inventory as a matter of speculation, because prices may subsequently go up or the material may become scarce in the future. This is however, not 'of so much importance for our purpose. Finally, inventories also serve to decouple materials from consumption at successive stages of production operations THENEED FOR CONTROL We have already seen how important it is to improve upon the return on capital, that is, profit margin. But there are obvious limitations such as competition in the business world. One way of improving the profit margin is to turn inventories into saleable products with less investment and as quickly as possible so that higher sales targets can be achieved and more profits made with less investment. In other words, a high inventory to sales turn over ratio is necessary to achieve an improvement over return on capital. The inventory-turnover ratio can be defined as the gross sales revenue to average inventory held during a year. This ratio is too low in India. While it is roughly about 3:1 in India, it is about 12 to 18 in the USA on an average. The same is about 7 in West Germany and about 6 to 8 in the UK. An RBI study on 700 Joint Stock Companies shows the following investment structure: Raw Materials and Inventories« . Rs. 600 crores Plant and Machineries «. Rs. 540 crores The above figures show higher capital outlay in raw materials and inventories than in plant and machinery. A constant attempt should be made to reduce investment in inventories. If a modest 5 per cent reduction is possible, that would mean release of 1m extra amount of investable funds for other productive purpose. The overall picture is gloomier. It has been variously estimated that in India about Rs. 15,000 crores is blocked in immovable inventory of which about Rs.2,500 crores is blocked in dead inventories. One wonders whether a developing economy can afford to block so much money in an idle resource. WHAT IS INVENTORY CONTROL The simplest language, inventory control may be said to be a planned method whereby investment in inventories held in stock is maintained in such a manner that it ensures proper and smooth flow of materials needed for production operations as 'well sales, while at the same time, the total costs of investment in inventories is kept at a minimum. From the above definition it follows that a comprehensive inventory control system must be closely coordinated with other planning and control activities, such as, (planning, capital budgeting, sales forecasting, including production planning, production scheduling and control. This impinges on a wide range of operations, operating decisions and policies for production, sales and finance. The finance controller of a company regards inventory as a necessary evil, since it drains off cash which could he used elsewhere to earn some profits. The marketing manager always wants enough of ready stock of finished goods inventories in order to give better customer service to ensure the company's goodwill and would not like to see a sales opportunity lost for want of saleable ready stock. The production manager does not want an out-of. Stock condition for which production might be held up. It will, therefore, he seen that everyone- has some objectives which arc connecting in nature. The basic problem is, therefore, to strike a balance between operating efficiency and the costs of investment and other associated costs with large inventories, with the object to keep the basic conflicts at the minimum while optimizing the inventory holding. THE TECHNIQUES Some of the techniques which will follow include methods of fixing purchase quantities, setting of order points and safety stocks. The decisions as to which item to make when and to keep inventories in balance requires application of a wide range of techniques from simple graphical methods to more sophisticated and complex quantitative techniques. Many of these techniques employ concepts and tools of mathematical and statistical methods and make use of various control theories from engineering and other fields. They arc primarily aimed at helping to make better decisions and getting people involved and follow a wise policy. As such, they are far from academic exercises only. However, making decisions more intelligently and making actions follow these decisions is not easy. Thus while these quantitative techniques have taken much out of the decisionmaking managers what was being done through bunch or intuitive judgment, real business acumen demands that these must be blended with practical business sense. It is an axiomatic truth that these techniques alone cannot turn bad judgement into good ones simply because they are exact. However, before focusing our attention on such techniques, let us first attempt to analyze different types of inventories ABC ANALYSIS ORSELECTIVE I NVENTORY CONTROL(SIC) 80 per cent of the income and wealth were concentrated in the hands of about 20 per cent of the population. This 80-20 relationship also holds good in most cases of inventories where it may be found that about 20 per cent of the total number of items are responsible for about 80 per cent of the value. The idea of studying such, inventory value is to find out 'where the money lies'. AS this '20 per cent of items, 80 per cent of value' rule holds good in many inventory situations, high value items need more stringent control, which may be termed 'A' class items, and the remaining ones can be classified as 'B' and 'c' class items according to descending order of value. Thus, the principle of graduated control may be affected and the degree of control may be equated with the frequency of reviews. Controlling tightly means reviewing frequently, and frequency in turn tends to determine the order quantity, A items would be reviewed frequently, and because of their high value they will be ordered in small quantities in order to keep the inventory investment minimum. B items will be renewed less frequently and C items still less, The following graphical illustration will make the meaning of ABC Analysis more clear, which is based on selective control technique
000 and minimum quantity to be held in stock is 250units. the definition of costs in an inventory system may vary from time to time. MAX MINI SYSTEM Under this method. if either delivery is not received just after two months or if during the subsequent months consumption rate increases. control is exercised through various levels. (ii) Purchasing and inventory control people automatically pay attention to the items when they need it. used for day-to-day decision-making and insensitive to small variations. more bolts and nuts are ordered. period of review is fixed either at three months. order quantity is fixed but the time varies.levels of all items. say. When the delivery arrives. One is when the order should be placed. Order quantity There are twobasic control systems: 1. Of items in used (%) 20 30 50 100 Value (%) 80 15 5 100 THE TWO-BIN SYSTEM One of the earliest systems of stock control is two-bin system. This system works well for production raw materials and components for which long leadtimes are necessary 2. The bolts and nuts are issued from the first bin as and when required. indirect cost and overheads.. when requirements of all items are worked out . maximum level and minimum level are fixed. The first involves planning with due regard to production and marketing requirements. (c) Delay in postings makes the records useless for control as often even a critical item can be held up for want of posting which otherwise would have been shown that the re-order point has been touched. Order level or re-order level or the order point iv. (b) When and how much. viz. it is a deterministic system. direct cost. we have to consider the following: (a) What to order. The replenishment arrives just when the second bin is empty. Suppose you have an item in inventory for which maximum is fixed at 1. such as. This system recognizes the fact that each item in inventory possesses its own characteristics and optimum order quantity requirements. then both the bins are again filled in BIN NO 2 BIN NO 1 Use till Bin no 1 is empty Use Bin 2 When Bin 1 is empty Such a method is appropriate only when consumption rate is constant. Accounting system typically distinguishes three types of costs. Maximum level ii. 1. the stock balance will fall to the minimum and it will be replenished again to the maximum. The former is based on historical cost concept used for financial reporting and the latter is. Thus. and the other is what quantity should be covered. The following diagram shows this simple method. Maximum and minimum levels are determined for each inventory item and an order or re-order point is established in between the two levels. While delivery is awaited. and the quantity varies. Periodic review system. distribution and other charges. six months or once in a year. The bins contain. then you will run out soon. storage. depending upon the length of time being planned and other circumstances. Re-ordering is done after a period of review and order or re-order is placed when the quantity touches a certain level. .Fixed order quantity system: Under this system.total inventory is closely related to the safety stock provisioning to create an impact on inventory control. The major advantages are: (i) Each item can be procured at the most economical price and quantity. Designing of this system requires consideration of many factors. and if the leadtime is taken to be two months time. If during the past two months consumption rate has been 300 units per month on an average. (b) Re-order points and safety levels once fixed are not frequently changed after study. The second has two aspects: (i) Order point (ii) Order or re-order quantity Order quantity will be discussed along with safety stock or buffer stock since subtle influence of time in transit on . At this point. price. The order point is computed in such a manner that by the time new supplies is received.Class A B C Total No. the nuts and bolts from the second bin are issued.Periodic review system: This is a time-bound system which requires periodic reviews of the stock. mild-steel bolts and nuts.a fresh. Here. that is to say. The weakness of this system is: (a) Stock levels are actually fixed at lower levels since managers have no time to study inventory levels of individual items. Fixed order quantity system. we may conclude that in any inventory management and control system. handling. by and large. it would be better to draw a distinction between Accounting costs and operational costs. usage rate and other pertinent factors. Thus. Previous experience shows that a safety stock of 250 units is quite sufficient. As against the principles and consistency of accounting costs. Minimum level iii. Economic ordering starts with an analysis of these various components of costs. and as soon as the first bin is empty. and the order point and the order quantity: i. We know from our experience what quantity of bolts and nuts are necessary for a given period as well as we know their rate of consumption. 2. the objective underlying inventory control is to minimize the total cost of procurement. However. which is a simple method of control exercised by two simple rules. in order to devise a good inventory control system.