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SUMMER TRAINING PROJECT REPORT


ON
INVENTORY MANAGEMENT
IN JUBILANT ORGANOSYS LTD.
GAJRAULA, (U.P.)
PROJECT REPORT SUBMITTED IN PARTIAL FULFILMENT OF
MASTER OF BUSINESS ADMINISTRATION OF
Uttar Pradesh Technical University

Under the Guidance of:


Mr. Anil Kumar Goal
(Finance Faculty)
IVS Institute of Management (Mathura)

Submitted By:
VAIBHAV AGARWAL
M.B.A. IIIrd Sem.
Roll. No. 0730870025

IVS Institute of Management Mathura


(Affiliated to Uttar Pradesh Technical University,
Lucknow)
NH-2 Delhi Mathura Highway, Akbarpur, Mathura -281406(UP)
ACKNOWLEDGEMENT

I express my sincere gratitude to Mr. N. K. Agarwal (Senior Manager, Jubilant


Organosys) under whose supervision has helped to clarify my concepts of Inventory
Management, distinguished scholars and authors, whose work I heve used in this project.

I would also like to thank to Mr. Anil Goal Faculty Finance]. No words of
appreciation are good enough for the constant encouragement, which I have received from
him.

I thank Mr. Mahesh Jain (Head Accounts and Finance, Jubilant Organosys) for his
unstinted support to the project.

Finally, I would like to thank Mr. J. L. Gupta (Factory Manager, Jubilant


Organosys) to give the opportunity to complete the project in the esteemed organization.

VAIBHAV AGARWAL
MBA IIIrd Sem
Preface

As a part of the partial fulfillment of the M.B.A. programme at IVS Institute of


Management, Akbarpur (Mathura), Summer Training was undertaken with the
international company, JUBILANT ORGANOSYS LIMITED, Gajraula (J. P. NAGAR).

This project is specially designed to understand the subject matter of Inventory Management
of the company. This project gives us information and report about company’s Inventory
Management. Throughout the project the focus has been on presenting information and
comments in easy and intelligible manner.

The purpose of the training was to have practical experience of working in a organization and
to have exposure to the various management practices in the field of Finance. This training
has also given me an on the job experience of Financial Management.

This project is very useful for those who want to know about company and Inventory
Management of the company.

Contents
PART- I

*Objective of the Study


*Introduction of Company
* Company Profile
* History
* Board of Directors
* Presence Across Value Chain
* Awards
* Products
* Guiding Principals of Company
* Structure of the Company
* Research Methodology
* Introduction of the Topic
* Conceptual Discussions

PART- II

* Data Collection
* Financial Statements
* Data Analysis and Interpretation
* Problems and Suggestions
* Conclusions
* Bibliography
OBJECTIVE
OF THE
STUDY
Objective of The Study:

Inventories constitute the principal item in the working capital of the majority of trading and
industrial companies. In inventory, we include raw materials, finished goods, work in
progress, supplies and other accessories. To maintain the continuity in the operations of
business enterprise, a minimum stock of inventory required.

However, the physical control of inventory is the operating responsibility of stores


superintendent and financial personnel have nothing to do about it but the financial control of
these inventories in all lines of activity in which they comprise a substantial part of the
current assets is a frequent problem in the management of working capital. Management of
inventory is designed to regulate the volume of investment in goods on hand, the types of
goods carried in stock to meet the needs of production and sales while at the same time, the
investment in them is to kept at a reasonable level.
INTRODUCTION
OF COMPANY
COMPANY
PROFILE

Company Profile:

Jubilant Organosys Limited is the largest specialty chemical company of India and a leading
global manufacturer in defined chemical categories viz, second largest in pyridine and its
derivatives, third largest in solid polyvinyl acetate and leading positions in acetyls and other
specialty chemicals. These include pharmaceuticals and life science chemicals, performance
chemicals, organic intermediates, agri products and a range of other specialty chemicals.
It was incorporated in the year 1978 under the companies Act, 1956. The company is a
part of Jubilant Corporation, which also includes Jubilant Enpro, Domino’s, Jubilant Biosys.
The manufacturing facilities located at Gajraula in J.P.NAGAR District, U.P.

The company estabilished an Research and Development Group in the year 1982 and
Research and Development was recognized by the Department of Science and Technology.
The groups have developed a number of products, which have been commercialized over a
period of time. The various group of the Research and Development carryout research in the
field of Polymers and Adhesives, ‘Organic chemicals, Biotechnology and Environment’.

The company differentiates itself in its manufacturing approach which is based on the use of
a renewable resource as the main feed stock, the conserve energy requirement and a complete
recycling and reuse of the final wastage at the plant. The main feed stock for jubilant's
product line is Molasses, a renewable bio-mass, occurs as a by product in the sugar mill from
which industrial alcohol is produced from the process of fermentationand distillation. This
makes the manufacturing approach inheretantly eco=efficient. Industrial alcohol is further
proccessed to produced a series of value added chemicals.

Jubilant Organosys Limited has historically, been a producer and leading manufacturer of
acetyls in India for more than two decades. Jubilant Organosys also enjoy a global position in
these products. Jubilant Organosys derive our strengths in this business from our molasses
based production process. Jubilant Organosys use renewable biomass (molasses), as
feedstock for manufacturing acetyls. Jubilant Organosys, therefore, are not impact by the cost
cycle that affects the industry worldwide.
Globally Jubilant Organosys are the;

*Largest Alcohol Distillery Outside Brazil.


*Largest Acetic Acid Manufacturer From Renewable\Green Resources.
*6th Largest in Acetaldehyde.
*8th Largest in Ethyle Acetate.
*9th Largest in Acetic Anhydride.

Jubilant Organosys owns distilleries at Gajraula and Nira. These are strategic to the business
as they are located in two largest
sugar belts of India ( U.P. & MAHARASHTRA ). Company has long term contracts with
sugar mills to meet alcohol requirements while providing easy access to feed stock.

Jubilant Organosys Limited is an integrated pharmaceutical industry player with a wide range
of products and services for global life sciences companies. Company is one of the largest
Custom Research and Manufacturing Services (CRAMS) and Drug Services Companies in
India. Jubilant Organosys have presence across the pharmaceuticals value chain right from
drug, discovery, medicinal chemistry and clinical research services to custom research and
manufacturing services for advance intermediaries and fine chemicals, Active
Pharmaceutical Ingredients and Dosage Forms.

Jubilant Organosys Limited has a strong international presence having international


subsidiaries in USA, BELGIUM and CHINA. Jubilant Pharmaceutical, Inc is a full
service clinical research organisation providing clinical research, clinical data management,
biostatics, QA/regulatory and contract staffing servicing.Our products are sold across the
globe in more than 50 countries.

Jubilant Organosys Limited is a collaborative, innovative provider of products and services


to the global life sciences industry, striving to accelerate the process of pharmaceutical drug
approval. Jubilant Organosys also enjoy leadership in Industrial products and Preformance
Polymers products in India. It is headquarted in NOIDA, with net sales of - US $ 337 million
in FY06 and more than 3300 employees.

OUR VISION
OUR
PROMI
SE
OUR VALUES
We will carefully select, We stretch ourselves to be
train and develop our cost effective and efficient
people to be creative, in all aspects of our
empower them to take operations and focus on
decisions, so that they flawless delivery to create
respond to all customers and provide the best value
with agility, confidence to our customers
and teamwork

By sharing our knowledge With utmost care for the


and learning from each environment and safety,
other and from the markets we will always strive to
we serve, we will continue excel in the quality of our
to surprise our customers processes, our products
with innovative solutions and our services
HISTORY

HISTORY
2005

Acquires Target Research Associates, Inc., renamed Clinsys Inc.; a US based


Clinical Research Organisation (CRO)

Acquires Trinity Laboratories, Inc. and its wholly owned subsidiary, Trigen
Laboratories, Inc., renamed Jubilant Pharmaceuticals, Inc., a generic
pharmaceutical company in USA having a US FDA approved formulations
manufacturing facility

Enters Clinsys Clinical Research Ltd. business by setting up wholly owned


subsidiary Jubilant Clinsys Ltd.

2004

Sets up medicinal chemistry services business through wholly owned


subsidiary Jubilant Chemsys Ltd.

Enters formulations and regulatory affairs businesses by acquiring


Pharmaceuticals Services Incorporated, N.V. and PSI Supply N.V., the
pharmaceutical companies in Europe.

2003

Sets up a new state-of-the-art Research & Development Centre in Noida, near


New Delhi equipped with all latest scientific instruments.

2002

Acquires the Active Pharmaceutical Ingredients business

2001
New corporate identity: Jubilant Organosys Ltd. reflecting changed corporate
and business profile

2000

Enters the Bio / chemo informatics arena by setting up Jubilant Biosys Ltd.

1998

Enters high value-added Pyridine derivates. Commissions Pyridine HBR and


Cyano Pyridine plants.
Forms marketing subsidiary in the USA.
Acquires acetyl plant in western India.

1997

Commissions first Multi-purpose fine chemicals plant. Plant for food polymer
commissioned.

1995

Gets ISO 9001 certification.

1990

Commissions Pyridine & Picoline plant.

1988

Launches its first branded product: Vamicol, an adhesive product.

1987
Introduces new products in Performance Chemicals segments: Poly vinyl
acetate emulsion for paint, textile, paper & packaging and woodworking
industry.

1985

Research & Development center gets recognition from Government of India.

1983

Commercial production of Vinyl Acetate Monomer (VAM).

1981

Initial Public Offering. Listing on leading stock exchanges of India.

1978

Incorporated as Vam Organic Chemicals Ltd.


BOARD OF
DIRECTOR
S
Board Of Directors

Shyam S Bhartia Chairman & Managing Director

Hari S Bhartia Co-Chairman & Managing Director

na Executive Director & President – Life . Sciences

S N Singh Executive Director - Chemicals

Executive Director - Manufacturing & Supply Chain

Ajay Relan Director

Abhay Havaldar Director

Bodhishwar Rai Director

Arabinda Ray Director


PRESENCE
ACROSS
VALUE
CHAIN
PRESENCE ACROSS VALUE CHAIN:
AWARD
S
AWARDS

Jubilant's rapid progress across all corporate aspects has consistently been acknowledged by
various industry bodies, government and non-government agencies in the form of awards and
certifications.

Golden Peacock award for Innovation Management - 2003

Six-sigma Quality Award at the All India CII Convention -2004

The Greentech Foundation Award for Environment Excellence

The Energy Conservation Award (Chemical sector) from the Government of India for the
Gajraula unit

Best Managed Manufacturing Plant for Single super phosphate by FAI - 2003

Best HR Practices Award by Centre for International Businesses - 2004

P C Acharya Award for Development of Indigenous Technology by ICMA - 2004

Top 5 Best Managed Workforce in India - Hewitt Award

The DSIR Award for Innovation in Chemicals & Allied Industries


GUIDING PRINCIPALS
OF JUBILANT
ORGANOSYS LTD
GUIDING PRINCIPALS OF JUBILANT ORGANOSYS LTD

1. We will conduct ourselves or business with the highest standards of honesty, integrity and
professionalism.

2. We will recognize the positive contribution that individuals & our team members to
produce business successfully.

3. We will encourage a learning environment where people can constantly grow, develop &
contribute.

4. We will strive for excellence and seek continuous improve in everything.

5. We will respect all stockholders including employees, partners and suppliers & still them
with a passion to deliver the highest quality goods services.

6. We will foster initiative &creative by empowering individuals to attain well defined


objectives.
STRUCTURE OF
THE COMPANY
STRUCTRE OF THE COMPANY

Jubilant Organosys Ltd. act upon the rules & regul- ations of the Companies Act, 1948. The
company have well defined structure .It have the following departments:

1. HR/ Personnel department

2. Accounts departments

3. Purchase departments

4. Store department

5. Quality department

6. Shipping department

7. Sales & Excise department


ORGANISATIONAL CHART OF JOL
RESEARCH
METHODOLOGY
RESEARCH METHODOGY

Research methodology is the way to systematically solve the research problem.


Objective of research study is Analysis of inventory of Jubilant Organosys Ltd. Analyzing of
inventory, we determining following inventories-

1. Raw materials inventory.


2. Work in progress inventory.
3. Finished goods inventory &
4. Supplies inventory.

In this section of inventories, we should analyze the annual investment in inventories,


Valuation of inventory after closing balance of items in inventory. In this manner, we
calculate reorder point, safety stock levels, minimum & maximum levels of inventory.

Working hypothesis of the objective is that inventories are the stock piles of goods .The all
organization on their inventories. JOL invests about 60%of total assets inventory should be
analyzed their records.

The analysis of inventory according to their data available in the company. The data
collection of inventory for analysis by the direct store department. We should record primary
and secondary data by the helps of assistants ledger books M R N etc. We went to the all
inventories as raw material , work in progress inventory, finished goods inventory by the
proper observation of data’s of the company.
The particular method for data collecting used direct interview with assistants and
telephone interview with friends to known about annual investment of inventories and other
important data.

INTRODUCTION
OF THE TOPIC
INTRODUCTION

Inventories constitute the most significant part of current assets of a large majority of companies
in India. On an average, inventories are approximately 60% of current assets in public limited
companies in India. Because of the large size of inventories maintained by firms, a considerable
amount of feuds is required to be committed to them. It is therefore, absolutely imperative to
ménage inventories efficiently and efficiently in order to avoid unnecessary investment. A firm
neglecting the management of inventories will be jeopardizing its long run profitability and may
fail ultimately. It is possible for fore a company to reduce its levels of inventories to a
considerable degree e.g. 10 to 20 percent, with out any adverse effect on production and sales, by
using simple inventory planning and control techniques. The reduction in excessive inventory
carries a favorable impact on a company’s profitability.

MEANING OF INVENTORY:-

Inventory is the physical stoke of goods maintained in an organization for its smooth sunning. In
accounting language it may mean stock of finished goods only. In a manufacturing concern, it
may includes raw materials, work-in-progress and stores etc. In the form of materials or supplies
to be consumed in the production process or in the rendering of services.
In brief, Inventory is unconsumed or unsold goods purchased or manufactured.

NATURE OF INVENTORIES :-
Inventories are stock of the product a company is manufacturing for sale and
components that make up the product. The various forms in which inventory exist in a
manufacturing company are raw materials, work in progress and finished goods.

RAW MATERIALS:-

Raw materials are those inputs that are converted into finished product though
the manufacturing process. Raw materials inventories are those units which have been purchased
and stored for future productions.

WORK IN PROGRESS:-

These inventories are semi manufactured products. They represent products that
need more work before they become finished products for sales.

FINISHED GOODS:-

Finished goods inventories are those completely manufactured products which


are ready for sale. Stock of raw materials and work in progress facilitate production. While stock
of finished goods is required for smooth marketing operation. Thus, inventories serve as a link
between the production and consumption of goods.

The level of three kinds of inventories for a firm depend on the nature of its business. A
manufacturing firm will have substantially high levels of all three kinds of inventories, while a
retail or wholesale firm will have a very high and no raw material and work in progress
inventories. Within manufacturing firms, there will be differences. Large heavy engineering
companies produce long production cycle products, therefore they carry large inventories. On the
other hand, inventories of a consumer product company will not be large, because of short
production cycle and fast turn over. Firms also maintain a fourth kind of inventory, supplies or
stores and spares.

SUPPLIES:

It includes office and plant cleaning materials like soap, brooms, oil, fuel, light, bulbs
etc. These materials do not directly enter production, but are necessary for production process.
Usually, these supplies are small part of the total inventory and do not involve significant
investment. Therefore, a sophisticated system of inventory control may not be maintained for
them.
MANAGEMENT OF INVENTORY

Inventories constitute the principal item in the working capital of the majority of
trading and industrial companies. In inventory, we include raw materials, finished goods,
work-in-progress, supplies and other accessories. To maintain the continuity in the operations
of business enterprise, a minimum stock of inventory required. However, the physical control
of inventory is the operating responsibility of stores superintendent and financial personnel
have nothing to do about it but the financial control of these inventories in all lines of activity
in which they comprise a substantial part of the current assets is a frequent problem in the
management of working capital. Management of inventory is designed to regulate the
volume of investment in goods on hand, the types of goods carried in stock to meet the needs
of production, and sales while at the same time, the investment in them is to be kept at a
reasonable level.

CONCEPT OF INVENTORY MANAGEMENT

The term inventory management is used in two ways- unit control and value control.
Production and purchase officials use this word in term unit control whereas in accounting
this word is used in term of value control. As investment in inventory represents in many
cases, one of the largest asset items of business enterprises particularly those engaged in
manufacturing, wholesale trade and retail trade. Sometimes the cost of material used in
production surpasses the wages and production overheads. Hence, the proper management
and control of capital invested in the inventory should be the prime responsibility of
accounting department because resources invested in inventory are not earning a return for
the company. Rather, on the other hand, they are costing the firm money both in terns of
capital costs being incurred and loss of opportunity income that is being foregone.

OBJECTIVES OF INVENTORY MANAGEMENT

The basic managerial objectives of inventory control are two-fold; first, the avoidance
over-investment or under-investment in inventories; and second, to provide the right quantity
of standard raw material to the production department at the right time. In brief, the
objectives of inventory control may be summarized as follows:

A. Operating Objectives:

(1) Ensuring Availability of Materials: There should be a continuous availability


of all types of raw materials in the factory so that the production may not be help up wants of
any material. A minimum quantity of each material should be held in store to permit
production to move on schedule.

(2) Avoidance of Abnormal Wastage: There should be minimum possible wastage


of materials while these are being stored in the godowns or used in the factory by the
workers. Wastage should be allowed up to a certain level known as normal wastage. To
avoid any abnormal wastage, strict control over the inventory should be exercised. Leakage,
theft, embezzlements of raw material and spoilage of material due to rust, bust should be
avoided.
(3) Promotion of Manufacturing Efficiency: If the right type of raw material is
available to the manufacturing departments at the right time, their manufacturing efficiency
is also increased. Their motivation level rises and morale is improved.

(4) Avoidance of Out of Stock Danger: Information about availability of materials


should be made continuously available to the management so that they can do planning for
procurement of raw material. It maintains the inventories at the optimum level keeping in
view the operational requirements. It also avoids the out of stock danger.

(5) Better Service to Customers: Sufficient stock of finished goods must be maintained to
match reasonable demand of the customers for prompt execution of their orders.
(6)Highlighting slow moving and obsolete items of materials.

(7) Designing poorer organization for inventory management: Clear cut accountability should
be fixed at various levels of organization.

B. Financial Objectives:

(1) Economy in purchasing: A proper inventory control brings certain advantages and
economies in purchasing also. Every attempt has to make to effect economy in purchasing
through quantity and taking advantage to favorable markets.

(2) Reasonable Price: While purchasing materials, it is to be seen that right quality of material
is purchased at reasonably low price. Quality is not to be sacrificed at the cost of lower price.
The material purchased should be of the quality alone which is needed.

(3) Optimum Investing and Efficient Use of capital: The basic aim of inventory control
from the financial point of view is the optimum level of investment in inventories. There
should be no excessive investment in stock, etc. Investment in inventories must not tie up
funds that could be used in other activities. The determination of maximum and minimum
level of stock attempt in this direction.

TYPES OF INVENTORY

1. Movement Inventories:-
Movement inventories are also called transit or pipeline inventories. Their
existence owes to the fact that transportation time is involved in transferring substantial amount
of resources.

2.Buffer inventories:-
In Buffer inventories are held to protect against the uncertainties of demand
and supply. An organization generally knows the average demand for various items that it needs.
Prod.deptt. issue store inspect receive supplier
Supplies

Demand

Inventory in

Hand place
Orders
Purchase
dep’t.
Net order issue receive tender
Quantity tenders quotation evaluations

Inventory cycle

3. Anticipation Inventories.

Anticipation inventories are held for the reason that future demand for the product is anticipated.
Production of specialized times like crackers well before dewily, umbrellas and raincoats before
taints set in, fans while summers are approaching; or the piling up of inventory stocks when a
strike is on the anvil, are all examples of anticipation inventories.

CONTROL OF MATERIALS :

Rigid control over materials are necessary not only to guard against theft, but also to minimize
waste and misuse from causes such as excessive inventories, over issue, deterioration, spoilage,
and obsolescence.

There are certain prerequisites to an effective control system for materials:

1.Materials of the desired quantity will be available when needed;


2.Materials will be purchased only when a need exists and in economical qualities;
3.Purchases of materials will be made at most favorable prices;
4.Vouchers for the payments of materials purchased will be approved only if the materials have
been received in good condition;
5.Materials will be protected against loss by proper physical control;
6.Issue of materials will be properly authorized and accounted for; and
7.All materials, at all times, will be charged, as the responsibility of some individual.

The control of materials, as an element of cost of production, is illustrated with reference to the
purchase and issues procedures, inventory systems, and inventory control techniques.

IMPORTANCE OF INVENTORY CONTROL:

The importance or necessity of inventory control is well explained in the terms of the
objects of inventory control, which are obtained through it. A proper inventory control
lowers down the cost of production and improves profitability of enterprise.

ADVANTAGES OF INVENTORY CONTROL:

(1) Reduction in investment in inventory.

(2) Proper and efficient use of raw materials.

(3) No bottleneck in production.

(4) Improvement in production and sales.

(5) Efficient and optimum use of physical as well as financial resources.


(6) Ordering cost can be reduced if a firm places a few large orders in place of numerous
small orders.

(7) Maintenance of adequate inventories reduces the set-up cost associated with each
production run.

Risk and cost Associated with Inventories:

Holding of Inventories expose the firm to a number of risks and costs.

Major risks are:

(a) Price decline: They may be due to increase in market supply of the product, introduction of a
new competitive product, price-cut by the competitors etc.

(b) Product deterioration: This may due to holding a product for too long a period or improper
storage conditions.

(c) Obsolescence: This may due to change in customer’s taste, new production technique,
improvements in product design, specifications etc.

The Costs of holding inventories are as follows:


(a) Material Cost: This include the cost of purchasing the goods, transportation and handling
charges less any discount allowed by the supplier of goods.

(b) Ordering Cost: This includes the variables cost associated with placing an order for the
goods. The fewer the orders, the lower will be the ordering costs for the firm.

(c) Carrying Cost: This includes the expenses for storing and handling the goods. It comprises
storage costs, insurance costs, spoilage costs, cost of funds tied up in inventories etc.

ESSENTIALS OF INVENTORY CONTROL SYSTEM

For an efficient and successful inventory control there are certain important conditions
that are a follows:

(1) Classification and Identification of inventories: The usual inventory of


manufacturing firm includes raw-material, stores, work-in-progress and component etc. To
facilitate prompt recording the dealing, each item of the inventory must be assigned a
particular code number and it must be classified in suitable group or sub-divisions. ABC
analysis of material is very helpful in this context.

(2) Standardization and simplification of inventories: In order to facilitate


inventory control, the inventory line should be simplified. It refers to the elimination of
excess types and sizes of items. Simplification leads to reduction in classification of
inventories and its carrying costs. Standardization, on the other hand, refers to the fixation of
standards of raw material to be purchased and specification of the components and tools to be
used.

(3) Setting the Maximum and Minimum limits for each part of inventory: The
third step in this process is to set the maximum and minimum limits of each item of the
inventory. It avoids the chances of over-investment as well as running a short of any item
during the cost of producing. Reordering point should also be fixed beforehand.

(4) Economic Order Quantity: It is also a basic inventory problem to determine the
quantity as how much to order at a time. In determining the EOQ, the problem is one to set a
balance between two opposite costs, namely, ordering costs and carrying costs. This quantity
should be fixed beforehand.

(5)Adequate storage Facilities: To make the system of inventory control successful and
efficient one, it is also essential to provide the adequate storage facilities. Sufficient storage
area and proper handling facilities should be organized.

(6)Adequate Reports and Records: Inventory control requires the maintenance of adequate
inventory record and reports. Various inventory records must contain information to meet the
needs of purchasing, production, sales and financial staff. The typical information required
about any class of inventory may be relating to quantity on hand, location, quantities in
transit, unit cost, code for each item of inventory, reorder point, safety level etc. Statements
forms and inventory records should be so designed that the clerical cost of maintaining these
records must be kept a minimum.

(7)Intelligent and Experienced Personnel: An important requirement of successful


inventory control system is the appointment of qualified and experienced staff in purchase
and stores department. Mere establishment of procedures and the maintenance of records
would not give the desired results as there is no substitute for sincere and devoted as well as
experienced hands. Hence, the whole inventory control structure should be manned with
trained, qualified, experienced and devoted employees.

(8)Coordination: There must be proper coordination of all departments involved in the


process of inventory control, such as purchase, finance, receiving, approving, storage and
accounting departments. These all departments have different outlook and objects in
inventory management but financial manager has to coordinate them all.

(9)Budgeting: An efficient budgeting system is also required. Preparation of budgets


concerning materials, supplies and equipment to ensure economy in purchasing and use of
material is also necessary.

(10)Internal Check: Operating of a system of internal check is also vital in inventory


management so that all transactions involving material supplies and equipment purchase are
properly approved and automatically checked.

FACTORS AFFECTING STOCK INVESTMENT LEVEL

These factors can be put in two categories: General and Specific.

General Factors: These factors include those factors, which affect directly or indirectly level
of investment in any asset. These are as follows:

(1) Nature of Business


(2) Size and scale of Business
(3) Expected Sales Volumes
(4) Price Level Changes
(5) Availability of Funds
(6) Management view Point

Specific Factors: These factors are directly related with investment in stock.

Following are the main factors:

(1) Seasonal Character of Raw Materials: If supply of raw material used in the firm is
seasonal, the firm will require more funds for the purchase of raw material during season.
Usually, raw materials are available at cheaper rates during is production season.

(2) Length and Technical Nature of the production process: If production


process is lengthy and of technical nature, higher investment is required in raw material. In
the technical nature production process, quality control of raw material is given more
emphasis.

(3) Terms of Purchase: If some concessions or discount in price or facilities of


credit are provided by suppliers on purchase of raw materials in huge quantity then the firm
is inspired for excessive purchase of goods and hence comparatively more investment is
required in inventory.

(4) Nature of End Product: Nature of end product also influences investment in
inventory. If the end product is a durable good, high investment will be required because
durable goods can be stored for a long period. On the other hand, perishable goods cannot be
stored for a long period. Hence, investment in inventory of such products is low.

(5) Supply Conditions: If the supply of raw material is regular and there is no
possibility of interruption in future, high investment in inventories is not required.
(6) Time Factor: The lead time of raw material time token in production process and
sale of product also influence investment in inventories. Longer the period, higher will be the
investment in inventories.

(7) Loan Facilities: If raw materials are purchased on credit or loan from the bank or
other financial institution can be obtained on the security of raw material, lesser investment
would be required. In the absence of such loan facility, higher investment would be required.

(8) Price Level Fluctuations: If there are expectations of price rise in future then
raw materials may be store in high quantity and so more investment would be required. On
the contrary, if the prices of raw materials are expected to go down in future, then
comparatively lesser investment would be required.

(9) Other factors: Price control, rationing, change in taxation and export policy of
governments etc. also influence investment in inventories.
TECHNIQUES OF
INVENTORY
CONTROL
TECHNIQUES OF INVENTORY CONTROL

In managing inventories, the firm’s objective should be in consonance with the wealth
maximization principle. To achieve this, the firm should determine the optimum level of
investment in inventory. To deal with the problems of inventory management effectively, it
becomes necessary to be conversant with the different techniques of inventory control.
Although the concepts involved in inventory management are production-oriented and are
not strictly financial it is important that the financial manager understand them since they
have certain built-in financial costs. The different techniques of inventory control may be
summarized as follows:

(1) Inventory level Technique

The main objective of stock control is to determine and maintain the optimum level of stock so
that there is neither shortage of any material nor unnecessary investment in inventory. For
this purpose, determination of maximum and minimum limits of inventory and ordering level
is necessary.

(2) Maximum stock Limit: This represents the quantity of inventory above which it
should not be allowed to be kept. The main object of fixing this limit is to ensure that
unnecessary working capital is not blocked in stores. The quantity is fixed keeping in view
the disadvantages of overstocking.
The disadvantages of overstocking are:

1. Capital is blocked up unnecessarily in stores so there will be loss of interest.


2. More godown space is needed so more rent will have to be paid.
3. There are chances of deterioration in quality because large stocks will require more time
for use is the factory.
4. There is the possibility of loss due to obsolescence.
5. There is danger of depreciation in market values.

The maximum stock level is fixed by taking into account the following
factors:

(1) Amount of capital available for maintaining stores.

(2) Godown space available.

(3) Rate of consumption of the material.

(4) The time lag between indenting and receiving of the material.

(5) Length and technical nature of the production process.

(6) Possibility of loss in stores by deterioration, evaporation etc.


There are certain stores, which deteriorate in quality if they are stored
for longer period.

(7) Cost of maintaining stores.


(8) Likely fluctuation in prices. For instance, if there is a possibility of a substantial increase
in prices in the coming period, a comparatively large maximum stock level will be fixed. On
the other hand, if there is the possibility of decrease in price in the near future, stocks are kept
at a much reduced level.

(9) The seasonal nature of supply of material. Certain materials are available only during
specific periods of year. So these have to be stocked heavily during these periods.

(10)Restrictions imposed by the government or local authority in regard to materials which


there are inherent risks, e.g. fire and explosion.

(11)Risk of obsolescence, i.e., possibility of change in fashion and habit which will
necessitate change in requirements of materials.

The following formula may be applied to calculate the maximum stock:

(1) Maximum Stock = Minimum Inventory + Lot size

(2) Maximum Stock = Reorder Level - Minimum consumption during Minimum lead time +
Lot size
Minimum Stock Limit (Safety or Buffer stock)

This represents the quantity below which stock should not be allowed to fall. It is
maintained to save from the situation of stock out in the event of abnormal increase in
material usage rate and/or delivery period. In fact determination of this quantity is significant
because of uncertainty in respect to material usage rate and delivery period. The main
purpose of this level is to ensure that production is not held up due to shortage of any
material. This level is fixed for all items of stores and following factors are taken into
account for the fixation of this level:

(a) Lead time i.e. time lag between intending and receiving the material.

(b) Rate of consumption of the material during the lead time.

(c) Re-order Level

The following formula is applied to calculate Minimum Stock:

Minimum Stock = Re-order Level - Normal usage during Normal Lead time

But if normal usage and normal lead time is not known then average usage will be treated as
normal usage and average re-order will be treated as normal re-order period.
Re-ordering Level (Ordering Level)
It is the point at which if the stock of the material in stores reaches, the storekeeper should
initiate the purchase requisition for fresh supply of material. This level is fixed somewhere
between maximum and minimum level is such a way that the difference of quantity of the
material between the reordering level and the minimum level will be sufficient to meet
requirements of production up to the time of fresh supply of the material. It is fixed after
taking into consideration the following factors:

(a) Rate of material usage: Generally this rate is found out as usage rate per day, pre week
or per month. The quantity of production fluctuates according to demand of the product
which results in variation in usage rate.

Hence, the following three factors:

(i) Maximum usage rate: It implies quantity of material required at maximum capacity
production.

(ii) Minimum usage rate: It implies quantity of material required at capacity production in most
unfavorable business conditions.

(iii) Normal or average Usage Rate: It implies quantity of material required at capacity
production under normal business conditions.

(b) Ordering Period: The time taken in preparing the order for purchase of material is called
ordering period. In some concerns this period may be significant but in large concerns this
period is significant because before placing the order the purchase manager has to trace out
the best suppliers, after that only he places the order.

© Delivery, Lead or Procurement Time: The time taken from the date of placing the order
to the date of delivery by the suppliers is called procurement time. The maximum, minimum
and average procurement time should also be determined.

(D) Minimum Stock Level: This is the level of stock below which stocks should normally
not be allowed to fall.

Calculation of Re-order Point:

After taking into account the above facts re-order quantity is ascertained. For this purpose,
the following formula is applied:

Situation1:

When rate of usage and lead time are known with certainty;
Re-order point = Rate of usage x lead time.

Situation2:

When rate of usage is known with certainty and lead time is also known but is variable:
(i) Re-order point = Minimum Inventory + Average usage during Normal lead Time.

(ii) Re-order point = Rate of usage x Maximum Lead Time.


Situation3:
When rate of usage and lead time is known but variable and lead time is known with
certainty:

(i) Re-order point = Minimum Inventory + Average usage


during lead time.

(ii) Re-order point = Maximum Usage rate x Lead time.

Situation4:

When the rate of usage and lead time are known and are variable;

(i) Re-order point = Minimum Inventory + Average usage during lead period.

(ii) Re-order point = Maximum Usage rate x Maximum Lead time.

Danger Level

This means a level at which normal issues of the material are stopped and issues made only
under specific instructions. The purchase officer will make special arrangements to procure
the materials reaching at their danger levels so that the production may not stop due to
shortage of materials. It is determined as follows:

Danger level = Average Consumption x Maximum Re-order period for Emergency


Purchase

ECONOMIC ORDER QUANTITY TECHNIQUE

One of the major inventory management problems to be resolved is how much inventory should
be added when inventory is replenished. If the firm is buying raw materials, it has to decide lost
in which it has to be purchased on replenishment. If the firm is planning a production run, the
issue is how much production to schedule (or how much to make). These problems are called
order quantity problems, and the task of the firm is to determine the optimum or economic
order quantity (or economic lot size). Determining an optimum inventory level involves two
type of costs: (a) ordering costs and (b) carrying costs: The economic order quantity is that
inventory level that minimize the total of ordering and carrying costs.

Ordering costs: the term ordering costs is used in case of raw materials (or supplies) and
includes the entire costs of acquiring raw materials. They include costs incurred in the following
activities: requisitioning, purchase ordering, transporting, receiving, inspecting and storing (store
placement). Ordering costs increase in proportion to the number of order placed.
Ordering costs increase with the number of order; thus the more frequently inventory is acquired,
the higher the firm’s ordering costs. Ordering costs decrease with increasing size of inventory.
Carrying costs: Costs incurred for maintaining a given level of inventory are called carrying
costs. They include storage, insurance, taxes, deterioration and obsolescence. The storage costs
comprise cost of storage space (warehousing cost), stores handing costs and clerical and staff
service costs (administrative costs).

Table: Ordering and Carrying Costs

Ordering Costs Carrying Costs


(1)Requisitioning (1) Warehousing
(2)Order placing (2) Handling
(3) Transportation (3) Clerical and staff
(4) Receiving inspecting and storing (4) Insurance
(5) Clerical and staff (5) Deterioration
Obsolescence

Carrying costs vary with inventory size. The economic size of inventory would thus depend on
trade-off between carrying costs and ordering costs.

Ordering and Carrying Costs trade-off: The optimum inventory size is commonly
referred to as economic order quantity. It is that order size at which annual total costs of
ordering and holding are the minimum. We can follow three approaches-the trial and error
approach, the formula approach and the graphic approach-to determine the economic order
quantity (EOQ).
Trail and Error Approach: The trail and error, or analytical, approach to resolve the order
quantity problem can be illustrated with the help of a simple example. Let us assume the
following data for a firm.

Estimated annual requirements, A 1,200 units


Purchasing cost (per order), (Rs) 50
Ordering cost (per order), (Rs.) 37.50
Carrying cost per unit, (Re) 1

Average inventory - (1200 + 0)/2 = 600 units


Average value - Rs 30,000 (600*Rs50)
If we choose the multiple order than we order 100units on monthly basis
Average inventory - (100+0)/2 = 50units)
Average value - 50 * Rs 50 = 2, 500
Many other possibilities can be worked out in the same manner.

1200
1000

800
Q/2
600

stock 400
200
50
0 2 4 6 8 10 15
Time
Inventory level over time
Order- formula approach: The trial error, or analytical, approach is somewhat tedious to
calculate the EOQ. An easy way to determine EOQ is to use the order-formula approach. Let
us illustrate this approach.

Suppose the ordering cost per order, O, is fixed. The total order costs will be number of
orders during the year multiplied by ordering cost per order. If a represents total annual
requirements and Q the order size, the number of orders will be A/Q and total order costs will
be:

Total ordering cost = (Annual requirement * Per order cost)


Order size

TOC = AO/ Q

Let us further assume the carrying cost per unit, c, is constant


The total carrying costs will be the product of the average inventory units and the carrying cost
per unit.

If Q is the order size and usage is assumed to be steady, the average inventory will be.

Average inventory = order size = Q


2 2

And total carrying costs will be:

Total carrying cost = Average inventory


* Per unit carrying cost
TCC = Qc
2
The total inventory cost, then, is the sum of total carrying and ordering costs:
Total cost = Total carrying cost + Total order cost

TC = Qc + AO
2 Q

Equation (4) reveals that for a large order quantity, Q, the carrying cost will increase, but the
ordering costs will decrease. On the other hand, the carrying costs will be lower and ordering
cost will be higher with the order quantity. Thus, the total cost function represents a trade-off
between the carrying costs and ordering costs for determining the EOQ.

To obtain the formula for EOQ, Equation (4)is differentiated with respect to Q and setting the
derivative equal to zero, we obtain:

Economic order quantity = 2* quantity required * ordering cost


Carrying cost
EOQ = 2AO
C
Graphic approach:

The economic order quantity can also be found out graphically. Figure illustrates the EOQ
function. In the figure, costs-carrying, ordering and total- are plotted on vertical axis and
horizontal axis is used to represent the order size. We note that total carrying costs increase as
the order size increasers, because, on an average, a larger inventory level will be maintained, and
ordering costs decline with increase in order size means less number of orders. The behaviors of
total costs line is noticeable since it is a sum of two types of cost which behave differently with
order size. The total costs decline in the first instance, but they start rising when the decrease in
average ordering cost is more than offset by the increase in carrying costs. The economic order
quantity occurs at the point Q* where the total cost is minimum. Thus, the firm’s operating profit
is maximized at point Q*.

Minimum total
Cost
Carrying cost
Costs ordering cost

Q* order size (Q)


Economic order quantity

Optimum productions run:

The use of the EOQ approach can be extended to production runs to determine the optimum
size of manufacture. Two costs involved are set-up costs and carrying costs. Set-up costs include
costs on the following activities: preparing and processing the stock orders, preparing drawings
and specifications, tooling machines set-up, handling machines, tools, equipment and materials,
over time etc. Production runs but carrying costs will increase as large stocks of manufactured
inventories will be held. The economic production size will be the one where the total of set-up
and carrying costs is minimum.

Reorder Point:

The problem, how much to order, is solved by determining the economic order quantity, yet
answer should be sought to be second problem, when to order. This is a problem of determining
the 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 known: (a)
lead time (b) average usage, and (c) economic order quantity. Lead time is the normally taken is
replenishing inventory after the order has been placed. By certainty we mean that usage 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. That is:

Reorder point = Lead * Average usage

Safety stock:

The demand for inventory is likely to fluctuate from time to time. In particular, at certain
points of time the demand may exceed the anticipated level. In other words, a discrepancy
between the assumed (anticipated/expected) and the actual usage rate of inventory is likely to
occur in practice.
The effect of increased usage and/or slower delivery would be shortage of inventory. That is, the
firm would disrupt production schedule and alienate the customers. The firm would, therefore, be
will advised to keep a sufficient safety margin by having additional inventory to guard against
stock-out situation. Such stocks are called safety stocks. This would act as a buffer/cushion
against a possible shortage of inventory. Safety stock may, thus, be defined as minimum
additional inventory to serve as safety margin/buffer/cushion to meet unanticipated
increase in usage resulting form unusually high demand and/or uncontrollable late receipt
of incoming inventory.

The carrying costs are the costs associated with the maintenance of inventory. Since the firm is
required to maintain additional inventory, in excess of the normal usage, additional carrying
costs are involved.
The stock-out and carrying costs are counterbalancing. The larger the safety stock, the larger the
carrying costs and vice versa. Conversely, the larger the safety stock, the smaller the stock-out
costs.

max. inventory
average usage
EOQ

avg. inventory----------------------------------------------------

re-order point-----------------------------------------------------
max.usage
safety stock -------------------------------------------------------

weeks lead time

re-order point under safety stock

VED Analysis: The VED analysis is used generally for spare parts. The requirement and
urgency of spare parts is different from that of materials. A-B-C analysis may not be properly
used for spare parts. The demand for spares depends upon the performance of the plant and
machinery. Spare parts are classified as: Vital (V), Essential (E) and Desirable (D). The vital
spares are a must for running the concern smoothly and these must be stored adequately. The
non-availability of vital spares will cause havoc in the concern. The E types of spares are also
necessary but their stocks may be kept at low figures. The stocking of D types of spares may be
avoided at times. If the lead time of these spares is less, then stocking of these spares can be
avoided.
The classification of spares under three categories is an important decision. A wrong
classification of any spare will create difficulties for production department. The classification of
spares should be left to the technical staff because they know the need, urgency and use of these
spares.
Assumptions: In applying EOQ formula, it is assumed that:

(i) Total demand is known with certainty.

(ii) The usage rate of material is steady.

(iii) Orders for replenishment on inventory are placed exactly when inventories reach
ordering level.

(iv) The ordering cost per order and holding cost per unit are constant.

EOQ and Total Inventory Cost: At EOQ level total inventory cost is minimum. Total
inventory cost is the sum of material purchase cost, ordering cost and carrying cost

As per the formula:


Total Inventory Cost (TIC) = Material Purchase Cost + Total Ordering Cost + Total
Carrying Cost

= (R x P) + (R/Po x Cp) + (Qo/2 x Ch)

Discount Offer and Economic Order Quantity:


Sometimes supplier offers different discounts on orders of large quantity. In such a situation,
at fist we should calculate EOQ and find out TIC without considering discount offer. Then
we should calculate TIC of each alternative offer. That quantity will be EOQ at TIC is the
lowest.

PERPETUAL INVENTORY CONTROL TECHNIQUE

Perpetual inventory system implies maintenance of up-to-date stock records and in its
broad sense it covers both continuous stock taking as well as up-to-date recording stores
books. According to Weldon, It may be defined as “a method of recording stores balances
after every receipt and issue to facilitate regular checking and to obviate closing down for
sock-taking”. The basic object of this system is to make available details about the quantity
and value of stock of each item at all times. The system thus provides a rigid control over
stock of each item of store can regularly be verified with the stock records in the bin cards
kept in the stores and stores ledger maintained in cost office.

Advantages of Perpetual Inventory system:

1. Saving in time: The long and costly work of stocktaking


is avoided. Hence, interim and final financial accounts can be prepared with greater
convenience.

2. Arrangement of proper verification: In this system a


detailed and more reliable checking of the store is exercised because of the continuous and
random checking.
3. Verification of Errors: Errors are easily located and
rectified. This gives an opportunity for preventing a recurrence in many cases.

4. Double control: Due to separate records in Bin card and


stores ledger, double control is maintained.

5. Optimum size of material: Overstocking and under


stocking can be avoided because perpetual inventory system covers verification of stock with
regards to maximum, minimum and other levels.

6. Lack of misuse of Material: Under this system, effective


control on issue of material is possible, thus misuse of material can be avoided.

7. Moral Check on Stores staff: Due to continuous


checking, this system serves as a moral check on the stores staff. They are discouraged from
committing dishonesty.

8. Loss of stock due to obsolescence: It is detected at an


early stage and so timely action can be taken to prevent recurrence.

THE SELECTIVE INVENTORY CONTROL OR ABC SYSTEM OF CONTROL

Most manufacturing firms find themselves confronted with virtually thousands of


different inventory items. Most of these items are relatively inexpensive, while other items
are quite expensive and account for a large portion of the firm’s investment. Some inventory
items, although not expensive, turnover slowly and therefore, they require a high average
investment. The firm should classify them into A.B.C category items. Category A will
include more expensive items (in cost of product) with high investment and it will require
more intensive control.

The ‘B’ group will consist of the items accounting for the next largest investment.

The ‘C’ group will consist of a large number of items of inventory accounting for small
investment.

The ‘A’ items require intensive inventory control and most sophisticated inventory control
techniques should be applied to these items.

The ‘B’ items can be controlled using less sophisticated technique, and their level can be
viewed less frequently than ‘A’ items.

The ‘C’ items can receive the minimum attention: they will probably be ordered in large
quantities in order to obtain them at the lowest price.

Though the ABC technique is a good technique but it cannot be universally applied. Certain
items of inventory may be inexpensive but may be critical to the product in process and
cannot be easily obtained. Therefore, they may require special attention.

These types of items must be treated as “A” class items even though, using the broad
framework, they would be “B” or “C” class items.

Although, not perfect, the ABC system is an excellent method for determining the degree of
inventory control efforts required to expand each item of inventory.
The following points should be kept in mind for ABC analysis:

(1) Where items can be substituted


for each other, they should be preferably treated as one item.
(2) More emphasis should be given
to the value of consumption and not to price per unit of the item.
(3) All the items consumed by an
organization should be considered together for classifying as A, B or C instead of taking item as
spare, raw materials, semi-finished and finished items and then classifying as A, B and C.
There can be more then three classes and the period of consumption need not necessarily be
one year

Application of ABC Analysis:


ABC analysis can be effectively used in Material Management.
The various stages where it can be applied are:
(1) Information of items which
require higher degree of control.
(2) To evolve useful re-ordering
strategy.
(3) Stock records.
(4) Priority treatment to different
items.
(5) Determination of safety stock
items.
(6) Stores layout.
(7) Value analysis.

(2) Just-in-time (JIT) System:


Japanese firms popularized the just-in-time (JIT) system in the
world. In a JIT system material or the manufactured components and part 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 and other related costs of manufacturer. The
system requires perfect understanding and coordination between the manufacturer and supplier
in terms of the timing of delivery and quality of the material. Poor quality material or
complements 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
system and procedures to satisfactory meet the needs of manufacturers.
System of Accounting for Material Issued/Inventory Systems

Either the periodic inventory system or the perpetual inventory system may be used to
account for materials issued to production and ending materials inventory.

Periodic Inventory System

Under the periodic inventory system, the purchase of materials is


recorded in Purchase of Raw Materials Account. The opening/beginning inventory, if any, is
recorded in a separate Materials Inventory- Opening Account. The materials available for use
during a period equal purchases plus opening inventory. A physical count is made of the
materials on hands at the end of the period to arrive at the closing/ending materials inventory.
The cost of materials for the period is determined as shown in Exhibit:

Cost of Materials Issued

Materials inventory-opening
+ Purchases
= Materials available for use
- Materials inventory-closing (based on physical count)
= Cost of materials issued
The entire book inventory is verified at a given date by an actual count of materials on hand.
This physical inventory is usually taken near the end of the accounting year/period. This method
provides for the recording of the purchases on a daily basis but does not provide for a continuous
inventory-taking. Neither a physical count is made of the quantity of goods on hand, nor the
value of the inventory in determined by using an appropriate pricing method and attaching costs
to units counted. It is assumed that goods not on hand at the end of the period have been sold.
There is no system and accounting period, and they can be discovered only at the end.

INVENTORY TURNOVER RATE TECHNIQUE

One important technique of inventory control is to use inventory turn over ratios. These
ratios are calculated to asses the efficiency in use of inventories. Following control ratios can
be computed for inventory analysis:

(i) Inventory Turnover Ratio = Cost of goods sold/ Average Inventory

Where Average Inventory = (Opening Inventory + Closing Inventory)/2

Inventory Turnover Ratios ca be calculated separately for raw materials and finished goods.

(A) Raw Material Turnover Ratio = Raw Material Consumed/ Average stock of Raw
material.

(B) Finished Goods Turnover Ratio = Cost of Goods Sold/ Average Stock of Finished
Goods

Average Age of inventory of inventory Turnover in Days = Days during the period/
Inventory Turnover Ratio
(ii) Average inventory to total cost of production = (Average Inventory/ total cost of
production) x 100

(iii) Slow Moving Stores to Total Inventory = Average Cost of Slow Moving
Stores/Average Inventory

(iv) Inventory Performance Index = (Actual Material Turnover Ratio/ Standard


Material Turnover Ratio) x 100

These ratios provide a broad framework for the control and provide the basis for future
decisions regarding inventory control. The ratios provide a tough indication of when
Inventory levels are going to be high. Even if it appears from the ratio that the levels are too
high there might be a perfectly good reason why the level of Inventory is being maintained.
The ratios also indicate the situation and trend. However, the limitation of ratios should be
kept in mind. They are not an end themselves, but only tools of sound Inventory
Management.

FINANCIAL MANAGER’S ROLE IN INVENTORY MANAGEMENT

Inventory represents a large investment by manufacturing concern: therefore, great


emphasis must be placed on its efficient management. Though, the operative responsibility
for Inventory management lies with the inventory manager, the financial manager must also
be concerned with all types of inventories- raw materials, work-in-progress and finished
goods. He must monitor Inventory levels and see that only an optimum amount is invested in
Inventory. He should be familiar with the Inventory control techniques and ensure that
Inventory is managed well.
He should try to resolve the conflicting view points of all the departments in order to have
efficient inventory management. He has to act as a careful inspector levels. He should
introduce the policies which reduce the lead time, regulate usage and thus, minimize safety
stock. All these techniques of Inventory management lead to the goal of wealth
maximization.
VALUATION OF INVENTORIES

OBJECTIVE:

A primary issue in accounting for inventories is the determination of the value at which
inventories are carried in the financial statements until the related revenues are recognized.
This statement deals with the determination of such value, including the ascertainment of
cost of inventories and any write-down thereof to net realizable value.

1. This statement should be applied in accounting for inventories other than:

(a) Work-in-progress arising under construction contacts, including directly related service
contracts.

(b) Work-in-progress arising in the ordinary course of business of service providers.

(c) Shares, debentures and other financial instruments held as stock-in-trade.

(d) Producer’s inventories of livestock, agricultural and forest products and mineral oils, ores
and gases to the extent that they are measured at net realizable value in accordance with well
established practices in those industries.

2. The inventories referred are measured at net realizable value at certain stages of
production. This occurs, for example, when agricultural crops have been harvested or mineral
oils, ores and gases have been extracted and sale is assured under a forward contract or a
government guarantee or when a homogenous market exists and there is a negligible risk of
failure to sell. These Inventories are excluded from the scope of this statement.

DEFINITIONS

The following terms are used in this statement with the meanings specified:

Inventories are assets:

(a) Held for sale in the ordinary course of business.


(b) In the process of production for such sale, or
(c) In the form of materials or supplies to be consumed in the production process
or in the rendering of services.

1. Inventories encompass goods purchased and held for resale, for example, merchandise
purchased by a retailer and held for resale, computer software held for resale, or land and
other property held for resale. Inventories also encompass finished goods produced, or work-
in-progress being produced, by the enterprise and include materials, maintenance supplies,
consumables and loose tools awaiting use in the production process. Inventories do not
include machinery spares which can be used only in connection with an item of fixed asset
and whose use is expected to be irregular; such machinery spares are accounted for in
accordance with Accounting Standard (AS) 10, Accounting for Fixed Assets.

2. Inventories should be valued at lower of cost net realizable value.

3. Cost of Inventories
The cost of inventories should comprise all costs of purchase, costs of conversion and other
costs incurred in bringing the inventories to their present location and condition.
4. Costs of Purchase
The costs of purchase consist of the purchase price including duties and taxes (other than
those subsequently recoverable by the enterprise from the taxing authorities), freight, inwards
and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty
drawbacks and other similar items are deducted in determining the costs of purchase.

5. Costs of Conversion
The costs of conversion of inventories include costs directly related to the units of
production, such as direct labour. They also include a systematic allocation of fixed and
variable production overheads that are incurred in converting materials into finished goods.
Fixed production overheads are those indirect costs of production that remain relatively
constant regardless of the volume of production, such as depreciation and maintenance of
factory buildings and the cost of factory management and administration. Variable
production overheads are those indirect costs of production that vary directly, or nearly with
the volume of production such as indirect materials and indirect labour.

6. The allocation of fixed production overheads for purpose of their inclusion in the costs of
conversion is on based on the normal capacity of the production facilities. Normal capacity is
the production expected to be achieved on an average over a number of periods or seasons
under normal circumstances, taking into account the loss of capacity resulting from planned
maintenance. The actual level of production may be used if it approximates normal capacity.
The amount of fixed production overheads allocated to each unit of production is not
increased as a consequence of low production or idle plant. Unallocated overheads are
recognized as an expense in the period in which they are incurred. In periods of abnormally
high production, the amount of fixed production overheads allocated to each unit of
production is decreased so that inventories are not measured above cost. Variable production
overheads are assigned to each unit of production on the basis of the actual use of the
production facilities.

7. A production process may result in more than one product being produced simultaneously.
This is the case, for example, when joint products are produced or when there is a main
product and a by- product. When the costs of conversion of each product are not separately
identifiable, they are allocated between the products on a rational and consistent basis. The
allocation may be based, for example, on the relative sales value of each product either at the
stage in the production process when the products become separately identifiable, or at the
completion of production. Most by- products as well as scrap or waste materials, by their
nature, are immaterial. When this is the case, they are often measured at net realizable value
and this value is deducted from the cost of the main product. As a result, the carrying amount
of the main product is not materially different from its cost.

8. Other costs are included in the costs of inventories only to the extent that they are incurred
in bringing the inventories to their present location and condition. For example, it may be
appropriate to include overheads other than production overheads or the costs of designing
product for specific customers in the cost of inventories.

9. Interest and other borrowing costs are usually considered as not relating to bringing the
inventories to their present location and condition and are, therefore, usually not included in
the cost of inventories.

10. Exclusions from the cost of Inventories


In determining the cost of inventories in accordance with paragraph 3. It is appropriate to
exclude certain costs and recognize them as expenses in the period in which they are
incurred. Examples of such costs are;
1. Abnormal amounts of wasted materials, labour, or other production costs.

2. Storage costs, unless those costs are necessary in the production process prior to a further
production stage.

3. Administrative overheads that do not contribute to bringing the inventories to their


present location and condition, and

4. Selling and distribution costs.

11. The cost of inventories of items that are not ordinarily interchangeable and goods or
services produced and segregated for specific projects should be assigned by specific
identification of their individual costs.

12. Specific identification of cost means that specific costs are attributed to identify items of
inventory. This is an appropriate treatment for items that are segregated for a specific project,
regardless of whether they have been purchased or produced. However, when there are large
numbers of items of inventory which are ordinarily interchangeable, specific identification of
costs is inappropriate since, in such circumstances, an enterprise could obtain predetermined
effects on the net profit or loss for the period by selecting a particular method of ascertaining
the items that remain in inventories.

13. The cost of inventories, other than those dealt with in paragraph 11, should be assigned
by using the first-in, first-out (FIFO), or weighted average cost formula. The formula used
should reflect the fairest possible approximation to the cost incurred in bringing the items of
inventory to their present location and condition.

14. A variety of cost formulas is used to determine the cost of inventories other than those for
which specific identification of individual costs is appropriate. The formula used in
determining the cost of an item of inventory needs to be selected with a view to providing the
fairest possible approximation to the cost incurred in bringing the item to its present location
and condition.

The FIFO formula assumes that the items of inventory which were purchased or produced
first are consumed or sold first, and consequently the items remaining in inventory at the end
of the period are those most recently purchased or produced. Under the weighted average
costs formula, the cost of each item is determined from the weighted average of the cost of
similar items at the beginning of a period and the cost of similar items purchased or produced
during the period. The average may be calculated on a periodic basis or as each additional
shipment is received, depending upon the circumstances of the enterprise.

15. Techniques for the measurement of the cost of inventories, such as the standard cost
method or the retail method, may be used for convenience if the results approximate the
actual cost. Standard costs take into account normal levels of consumption of materials and
supplies, labour, efficiency and capacity utilization. They are regularly reviewed and if
necessary, revised in the light of current conditions.

16. The retail method is often used in the retail trade for measuring inventories of large
numbers of rapidly changing items that have similar margins and for which is impracticable
to use other costing methods. The cost of the inventory is determined by reducing from the
sales value of the inventory the appropriate percentage gross margin. The percentage used
takes into consideration inventory which has been marked down to below its original selling
price. An average percentage for each retail department is often used.
17. The cost of inventories may not be recoverable if those inventories are damaged, if they
have become wholly or partially obsolete, or if their selling prices have declined. The cost of
inventories may also not be recoverable if the estimated costs of completion or the estimated
costs necessary to make the sale have increased.

The practice of writing down inventories below cost to net realizable value is consistent with
the view that assets should not be carried in excess of a amounts expected to be realized from
their sale or use.

18. Inventories are usually written down to net realizable value on an item-by-item basis. In
some circumstances, however, it may be appropriate to group similar or related items. This
may be the case with items of inventory relating to the same product line that have similar
purposes or end uses and are produced and marketed in the same geographical area and
cannot be practicably evaluated separately from other items in that product line. It is not
appropriate to write down inventories based on a classification of inventory, for example,
finished goods, or all the inventories in a particular business segment.

19. Estimates of net realizable value are based on the most reliable evidence available at the
time the estimates are made as to the amount the inventories are expected to realize. These
estimates take into consideration fluctuations of price or cost directly relating to events
occurring after the balance sheet date to the extent that such events confirm the conditions
existing at the balance sheet date.

20. Estimates or net realizable value also take into consideration the purpose for which the
inventory is held. For example, the net realizable value of the quantity of inventory held to
satisfy firm sales or service contracts is based on the contract price. If the sales contracts are
for less than the inventory quantities held, the net realizable value of the excess inventory is
based on general selling prices.

Contingent losses on firm sales contracts in excess of inventory quantities held and
contingent losses on firm purchase contracts are dealt with in accordance with the principles
enunciated in Accounting Standard (A.S) 4, contingencies and events occurring after the
balance sheet date.

21. Materials and other supplies held for use in the production of inventories are not written
down below cost if the finished products in which they will be incorporated are expected to
be sold at or above cost. However, when there has been a decline in the price of materials and
it is estimated that the cost of the finished products will exceed net realizable value, the
materials are written down to net realizable value. In such circumstances, the replacement
cost of the materials may be the net available measure of their net realizable value.
An assessment is made of net realizable value as at each balance sheet date.

22. Disclosure.

The financial statements should disclose:

The accounting policies adopted in measuring inventories, including the cost formula used,
and The total carrying amount of inventories and its classification appropriate to the
enterprise.

24. Information about the carrying amounts held in different classifications of inventories
and the extent of the changes in these assets is useful to financial statement users. Common
classifications of inventories are raw materials and components, work in progress, finished
goods, stores, spares and loose tools.
DATA
COLLECTIO
N
DATA COLLECTION

In analysis of inventory of JOL, We collect the data by the different sources. We collect the
primary and secondary data.

SECONDARY DATA – The secondary data are those data the already in presence for
specific purpose we use the secondary data about inventory to looks old records of the
company .For the daily information about the items We show the MRN, ledger register and
daily issue slip of materials the purchase register and other documentary evidence used for
the findings.

In the analysis of inventory the secondary data are not sufficient .then We collect primary
data.
PRIMARY DATA –
Primary data are those data that are originated very first time or
fresh data .with the help of primary data formulated the research objectives. Primary data
are the accurate attainable reliable and useful data.

1. Inventory control techniques used by the company


2. Inventory systems as perpetual and periodic systems.
3. Stock levels etc.
4. Companies website

FINANCIAL
STATEMENTS

Profit & Loss Account

FY FY FY FY FY
Particulars
2006 2005 2004 2003 2002
Gross Sales 16242.9 12737.0 9456.7 7853.9 6598.2
Excise 1189.4 1034.3 864.7 719.5 649.4
Net Sales 15053.5 11702.7 8592.0 7134.4 5948.8
Domestic
9102.1 7501.0 6304.7 5161.1 4766.3
Sales

International
5951.4 4201.7 2287.3 1973.3 1182.5
Sales

Other Income 196.9 166.4 99.5 39.3 44.1


Total Income 15250.4 11869.1 8691.5 7173.7 5992.9

Expenditure
Cost of
8158.9 6177.7 4443.7 3649.1 3118.5
materials
Manufacturin 1597.0 1394.4 1171.0 929.6 841.4
g expenses
Selling,
general and
3127.1 2054.0 1426.7 1313.3 1153.3
administrative
expenses
Total
12883.0 9626.1 7041.4 5892.0 5113.2
Expenditure

PBIDTA 2367.4 2243.0 1650.1 1281.7 879.7

Depreciation 513.4 381.4 326.2 237.5 255.8


PBIT 1854.0 1861.6 1323.9 1044.2 623.9
Interest 172.7 220.4 357.6 402.5 411.1
PBDT 2194.7 2022.6 1292.5 879.2 468.6
PBT 1681.3 1641.2 966.3 641.7 212.8
Tax 392.4 431.6 179.0 160.6 -19.4
PAT 1288.9 1209.6 787.3 481.1 232.2

Share of
Profit / (Loss) 0.00 0.00 -8.9 -0.3 0.00
in Associate
Minority
7.8 -17.7 4.0 0.00 0.00
Interest
PAT after
share of
profit / loss
1296.7 1191.9 782.4 480.8 232.2
in associate
and minority
interest
Cash Flow

FINANCE -CONSOLIDATED CASH FLOW - Jubilant Organ. (Curr:


Rs in Million)

2006.3 200503 200403 200303


Cash Flow Summary

Cash and Cash


Equivalents at Beginning 375.74 227.50 106.27 101.47
of the year
Net Cash from Operating
141.82 1116.70 843.14 436.00
Activities
-
Net Cash Used in - -
4607.43 1122.8
Investing Activities 2595.00 786.68
0
Net Cash Used in
5438.34 1477.90 60.37 691.60
Financing Activities
Net Inc/(Dec) in Cash and
0.00 148.60 4.35 0.00
Cash Equivalent
Cash and Cash
Equivalents at End of the 1364.9 375.70 227.45 106.27
year
Financial Ratios

FY FY FY FY FY
Ratio
2006 2005 2004 2003 2002
Debt : Equity Ratio 0.87 0.74 2.01 2.79 3.09
Current Ratio 2.33 1.79 2.31 2.40 2.51
Working Capital Days 90 61 80 85 84

TURNOVER RATIOS
Assets 0.90 1.21 1.21 1.16 1.23
Inventory 4.83 6.04 6.54 5.28 5.77
Debtors 6.07 6.63 6.05 8.75 7.74
Interest Cover Ratio 10.74 8.45 3.70 2.59 1.52
Earning Before Interest
Tax and Depreciation 15.73 19.17 19.21 17.97 14.79
Margin (%)
Profit Before Interest and
12.32 15.91 15.41 14.64 10.49
Tax Margin (%)
Profit Before Depreciation
14.58 17.28 15.04 12.32 7.88
and Tax Margin (%)
Net Profit (after minority
8.56 10.34 9.16 6.74 3.90
interest) Margin (%)
Return on Capital
15.17 24.56 22.14 20.61 27.59
Employed (%)
Return on Net Worth (%) 19.38 33.87 43.99 37.18 17.63
DATA ANALYSIS
AND
INTERPRETATIO
N
INVENTORY TURN OVER RATIO-

Total sales
Inventory turn over ratio =
Average inventory

The sales of JOL in year 2007 is 720 million & its investment on inventory is 126
million .

Then inventory turn over ratio = 720/126


= 5.71

JOL used Rs. 6 million worth inventory for operation. It could generates additional
sales, sales

Sales = 6 million * 5.71


= 34.26 million

If JOL increases investment more on their inventories , then company increases their sales.

Inventory turn in year 2006-

Total sales in 2006 = 670 million


Investment on inventories = 118 million
Turn over ratio = 670/118
= 5.67

Inventory turn over in year 2005-

Total sales in 2005 = 620 million


Investment on inventories = 110 million

Turn over ratio = 620/ 110


= 5.63

Inventory turn ratio in year 2004

Total sales in 2004 = 615 million


Investment on inventories = 100 million

Turn over ratio = 615 / 100


= 6.15
Investment of inventories & sales on wards 2004-

year Investment on total sales in million


inventories in million
2004 100 615
2005 110 620
2006 118 670
2007 126 720

Jubilant Organosys Ltd. increases investment on their inventories.


Every year, then total sales increases year by year.

720

Sales EMBED Excel.Chart.8 \s


670

645

615
2004 2005 2006 2007

Years

VALUE UNDER FIFO METHOD -


Date Qty Cost Value Qty Cost Value Qty Cost Val
Jan
1 1000 2.10 210
0
9 1000 2.21 2210 1100 - 232
0
12 2000 2.10 4200 9000 - 190
27 1000 2.31 2310 1000 - 213
0
Feb
10 4000 2.10 8400 6000 - 129
16 2000 2.41 4820 8000 - 177
March
3 2000 2.41 4820 1000 - 225
0
17 4000 2.10 8400 6000 - 141
29 4000 2.29 9160 1000 - 233
0
Apr
4 2000 2.14 4280 1200 - 276
0
18 4000 @ 9340 6000 - 182
0
23 2000 2.04 4080 1000 - 223
0
May
12 1000 2.40 2400 9000 - 199
24 3000 2.00 6000 1200 - 259
0
Jun
10 1000 2.40 2400 1100 - 235
0
30 2000 2.02 4040 1300 - 275
0
Total 1900 2.19 4170 1600 - 3514
0 0 0 0

Where @ is 1000 2.21 2210


1000 2.31 2310
2000 2.41 4820
Total 4000 - 9340

Interpretation -

The FIFO method of valuation of inventory is based on the assumption that the inventory
consumed in chronological order . that is received first are issued / consumed first and value
fixed accordingly . From the table with an opening inventory of 10000 units at rs 2.10, the
first 10000 units issued are charged to the cost of goods sold at this opening inventory rate rs
2.10 . the April 18 issue or consignment of 4000 units is costed on the basis of first received
of the year . January 9 ,1000 units at rs 2.21, January 27 1000 units at rs 2.31 , and February
16 ,2000 units at rs 2.41. the 1000 each issued on May 12 and June 10 are costed on the basis
of the 2000 units received on March 3 . therefore the cost of the 13000 inventory on June 30
is composed of the received of March
29 April 4 and 23 ,May 24 and June 30 and the value is the sum of the cost of these receipts.

Valuation under perpetual inventory system-

Date Receipts Issues Balance


Q R A Q R A Q A
1Jan - - - - - - 200 1400
6Jan - - - 100 7 700 100 700
8Jan 1100 8.50 9350 - - - 1200 10050
9Jan - - - 200 8.50 1700 1000 8350
15Jan - - - 400 8.50 3400 600 4950
25Jan 300 9 2700 - - - 900 7650
27Jan - - - 300 8.50 2550 300 240
300 9 2700 0
31Jan 400 9.20 3680 - - - 700 6080

The value of inventory after 31 January is 6080 /rs


Interpretation :-
The value of inventory under periodic & perpetual inventory system is different. The
value of inventory under perpetual system is more than periodic system.

DETERMINATION OF STOCK LEVELS

Data of concentrate at JOL is as follows –


Maximum consumption = 65 units per day
Minimum consumption = 55 units per day
Normal consumption = 59 units per day
Re-order period = 10-15 days
Re-order quantity = 878 units
Normal re-order period = 12 days

Re-order level = Maximum consumption * Maximum


Re-order period

Re-order level = 65 units * 15 days


= 975 units

Minimum stock level = re-order level – (normal consumption *


Normal re-order period)
= 975 - (59 units * 12 days)
= 267 units

Maximum stock level = (re-order level + re-order quantity )


- ( min. consumption – order period)
= ( 975 units + 878 units ) - (55 units * 15 days)
= 1028 units

Average stock level = minimum stock level + ½ of Re-ordering


Quantity

= 267 units + ½ * 878 units


= 267 units + 439 units
= 706 units

Interpretation of result : -

1. After calculation the re-order level of JOL is 975 units but the actual re-order quantity is
878 units.
2. The minimum stock level of JOL is 267 units.
3. The maximum stock level of JOL is 1028 units.
4. The average stock level must be 706 units.

Calculation of expected stock out cost –

Safety stock stock prob. Of expected total


stock out(units) out stock stock out expt.
level cost(40/unit) out cost SOC

500 0 0 0 0 0
400 100 4000 0.01 40 40
250 250 10000 0.01 100
150 6000 0.02 120 220

100 400 16000 0.01 160


300 12000 0.02 240 580
150 6000 0.03 180
50 450 18000 0.01 180
350 14000 0.02 280
200 8000 0.03 240 780
50 2000 0.04 80

0 500 20000 0.01 200


400 16000 0.02 320
250 1000 0.03 300 1180
100 4000 0.04 160
50 2000 0.10 200

Expected stock out cost == stock out cost * probability of stock out .

PROBLEMS
AND
SUGGESTIO
NS
PROBLEMS FACED BY THE ORGANITION

JOL faces the following problems-

1. Jubilant Organosys Ltd. faces the problem of competition.

2. Organization facing the problem of proper skilled employees in the production


department.

3. There is no proper sequence &acknowledgement board for certain items in store


department .It is not good when external auditing held in company.

4. Organization have no record of wastage items. It is not good for operating profit of the
company.

5. In organization store assistants have no proper knowledge about engineering goods &
raw materials.
6. There is no proper staff in HR/ Personnel department for listening grievances of
employees. So employees get rid of the organization without any notice. It is not good for
any organization.

SUGGESTIONS TO THE ORGANISATION:


.
1. The organizations give proper knowledge & training for unskilled employees about their
work.

2. In store department items should placed their proper sequence & acknowledgement.

3. There should be proper record of wastage. It is good for the company.

4. Store manager give the proper knowledge about engineering & raw materials.

5. Organization should have proper staff in HR/Personnel department.

6. Personnel manager should listen grievances of the employees personnel .So employees
could not left the organization.
CONCLUSIO
N

CONCLUSION

The goal of the wealth maximization is affected by the efficiency with which inventory is
managed. Inventories constitutes about 60% of current assets of companies in India. The
manufacturing companies hold inventories in the form of raw materials , work in progress
and finished goods. Inventories facilitate smooth production and sales operation (transaction
motive), to guard against the risk of unpredictable changes in usage rate and delivery time
( precautionary motive ) , & to take advantage of price fluctuations (speculative motive ).
Inventories represent investment of a firm’s funds. The objectives of the
inventory management should be the maximization of the value of the firm. therefore the
firm should consider:

1. cost 2. return 3. risk factors

In inventory maintenance two types of costs are involved carrying cost & ordering cost .the
firm should minimize the total cost ( carrying plus ordering cost ).The firm follows inventory
control techniques as A-B-C technique EOQ & JIT techniques for better holding inventories.
BIBLIOGRAPHY

1. Advanced Accountancy
Ninth Edition
S N Maheshwari , S K Maheshwari
Vikas Publishing House Pvt. Ltd.
2. Financial Management
Ninth Edition
I M Pandey
Vikas Publishing House Pvt. Ltd

3. Management Accounting
Third Edition
M Y Khan, P K Jain
Tata Mc-Graw Hill Publishing Company Ltd.

4. Purchase , Sales Boucher & Other Documents of the Company


Moon Beverage Ltd. Sahibabad