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c   is a list of goods and materials, or those goods and materials themselves, held
available in stock by a business. Inventory are held in order to manage and hide from the
customer the fact that manufacture/supply delay is longer than delivery delay, and also to
ease the effect of imperfections in the manufacturing process that lower production
efficiencies if production capacity stands idle for lack of materials.

  

All these stock reasons can apply to any owner or product stage.

Buffer stock is held in individual workstations against the possibility that the upstream
workstation may be a little delayed in providing the next item for processing. Whilst some
processes carry very large buffer stocks, Toyota moved to one (or a few items) and has now
moved to eliminate this stock type.

Safety stock is held against process or machine failure in the hope/belief that the failure can
be repaired before the stock runs out. This type of stock can be eliminated by programmed
like Total Productive Maintenance

Lot delay stock is held because a part of the process is designed to work on a batch basis
whilst only processing items individually. Therefore each item of the lot must wait for the
whole lot to be processed before moving to the next workstation. This can be eliminated by
single piece working or a lot size of one.

Demand fluctuation stock is held where production capacity is unable to flex with demand.
Therefore a stock is built in times of lower utilization to be supplied to customers when
demand exceeds production capacity. This can be eliminated by increasing the flexibility and
capacity of a production line or reduced by moving to item level load balancing.

Line balance stock is held because different sub-processes in a line work at different rates.
Therefore stock will accumulate after a fast sub-process or before a large lot size sub-process.
Line balancing will eliminate this stock type.
 Where these stocks contain the same or similar items it is
often the work practice to hold all these stocks mixed together before or after the sub-process
to which they relate. This 'reduces' costs. Because they are mixed-up together there is no
visual reminder to operators of the adjacent sub-processes or line management of the stock
which is due to a particular cause and should be a particular individual's responsibility with
inevitable consequences. Some plants have centralized stock holding across sub-processes
which makes the situation even more acute.

Inventory needs to be accounted where it is held across

accounting period boundaries since generally expenses should be matched against the results
of that expense within the same period. When processes were simple and short then
inventories were small but with more complex processes then inventories became larger and
significant valued items on the balance sheet. This need to value unsold and incomplete
goods has driven many new behaviors into management practice. Perhaps most significant of
these are the complexities of fixed cost recovery, transfer pricing, and the separation of direct
from indirect costs. This, supposedly, precluded "anticipating income" or "declaring
dividends out of capital". It is one of the intangible benefits of Lean and the TPS that process
times shorten and stock levels decline to the point where the importance of this activity is
hugely reduced and therefore effort, especially managerial, to achieve it can be minimized.


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Raw Materials are those basic inputs that are converted into finished product through the
manufacturing process. Raw materials inventories are those units which have been purchased
and stored for future productions.
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Inventories are Semi-manufactured product. They represent products that need more work
before they become finished products for sale.

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Finished goods inventories are those completely manufactured products which are ready for
sale. Stocks of raw materials and work-in-progress facilitate production, while stock of
finished goods is required for smooth marketing operations. Thus inventories serve as a link
between the production and consumption of goods.

The levels of three kinds of inventories for a firm depend of the nature of its business. A
manufacturing firm will have substantially high level of all three kinds of inventories, while a
retail or wholesale firm will have a very high level of finished goods inventories 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, and on the other hand, inventories of a consumer
product company will not be large because of short production cycle and fast turnover.


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The price of materials and income of a concern is directly proportional to each other. So it is
necessary that a method of pricing materials should be such that it gives a realistic value
stocks.
To safe guard public interest, the Government of India has instituted statutory controls to
prevent frequent change of material valuation method for at least three years.
The following material pricing methods are generally used:
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The major benefits of holding Inventory are the basic functions which are of crucial
important in firm¶s production & marketing strategies.
The basic function of Inventory is to act as a buffer to decouple or uncouple the various
activities of a firm so that all do not have to be pursued at exactly the same rate
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If the purchasing of raw material and other goods is not tied to production/sales, i.e. a firm
can purchase, several advantages would become available. In the first place, a firm can
purchase larger quantities than is warranted by usage in production or the sales level.
In the second, firms can purchase goods before anticipated or announced price increase. This
will lead to a decline in the cost of production. Thus Inventory, serves as a hedge against
price increases as well as shortages of raw materials. This is highly desirable inventory
strategy.
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Finished goods inventor serves to uncouple production and sale. This enables production at a
rate different from that sale. That is production can be carried on at a higher or lower than the
sales rate. This would be of special advantage to firms with a seasonal sales pattern. In their
case, the sales rate will be higher than the production rate during the part of the year (peak
season) and lower during the off-season. The choice before the firm is either to produce at a
level to meet the actual demand. In brief, since inventory permits least cost production
scheduling. Production can be carried on more efficiently.
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The maintenance of inventory also helps a firm to enhance its sales effort. For one thing, if
there are no inventories of finished goods, the level of sales will depend upon the level of
current production. A firm will not be able to meet demand instantaneously. There will be a
lag depending upon the production process. If the firm has inventory, actual sales will not
have to depend on lengthy manufacturing process.

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Effective inventory management requires an effective control system for the inventories. In
managing inventories, the firm¶s objective should be in consonance with the shareholders,
wealth maximization principle. To achieve this, the firm should determine the optimum level
inventory. Efficiently controlled inventories make the firm flexible. Inefficient control results
in unbalanced inventory and inflexibility ± the firm may sometimes run out of the stock and
sometimes may pile up unnecessary stocks. This increases the level of investment and makes
the firm unprofitable. To manage inventories efficiency, answers should be sought to the
following two questions:
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The first questions, how much to order relates to the problem of determining  .'
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inventories.


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One of the major inventory management problem is to be resolved is how much inventory
should be added when inventory is replenished. If the firm is buying raw materials, is has to
decide lots in which it has to be purchased on each replenish. If the firm is planning a
production run, the issue is how much production to schedule. These problem, are called
order quantity problems, and the task of the firm is to determine the optimum or economic
order quantity.
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??This category of cost is associated with the acquisition or ordering of inventory. Firms
have to place orders with suppliers to replenish inventory of raw material. The expenses
involved are referred to as ordering costs. Included in the ordering costs are involved in
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Ordering costs increase with the number of orders; thus more frequently inventory is
acquired, the higher the firm¶s ordering costs. On the other hand, if the firms maintain
large inventorylevels, there will be few orders placed and
Ordering costs will be relatively small. Thus, ordering costs decrease with increasing size
of inventory. 


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Costs incurred for maintaining a given level of inventory are called Carrying costs. They
include: Storage. Insurance, taxes, Deterioration and Obsolescence. Carrying costs vary
with inventory size. This behavior is contrary to that of ordering costs which decline with
increase in size of inventory. The economic size of inventory would thus depend on trade-
off between carrying costs and ordering costs.
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 trail and error approach, the formula approach and the
graphic approach ± to determine the  .'4+ ,50

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The problem, how much to order is solved by determining the economic order quantity, yet
the answer should be sought to the second problem, when to order. This is a problem of
determining the re-order point. The re-order point is that inventory level at which an order
should be placed to replenish the inventory. To determine the re-order point under certainty,
we should know: ,)'.",2+" ', .'4+ 0
Lead time is the time normally taken in replenishing inventory after the order has been
placed. By certainty we mean that usage and lead time do not fluctuate. Under such a
situation, re-order point is simply that inventory level which will be maintain for
consumption during the lead time.
That is:
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It is difficult to predict usage and lead time accurately. The demand for material may
fluctuate from day to day or from week to week. Similarly, the actual delivery time may be
different from the normal lead time. If the actual usage increases or the delivery of inventory
is delayed, the firm can face a problem of stock-out which can prove to be costly for the firm.
To guard this problem, the firm may maintain a safety-stock ± some minimum or buffer
inventory as cushion against expected increased usage and delay in delivery time.

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As in the case of other current assets, the decision making in investment in inventory involves
a basic trade of between risk and return. The risk is that if the level of inventory is too low,
the various functions of the business do not operate independently. The return results because
lower level of inventory saves money. As the size of the inventory increase, the storage and
other costs also rise. Therefore, as the level of inventory increases, the risk of running out of
inventory decreases but the cost of carrying inventory is one which requires to be monitored
and managed not only in terms of monetary value but also in terms of number of physical
units
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Carrying of too much and too little of inventories is detrimental to the firm. If the inventory
level is to little, the firm will face frequent stock outs involving heavy ordering cost and if the
inventory level is to high it will be unnecessary tie up of Capital. Therefore, an efficient
inventory management requires that a firm should maintain an optimum level of inventory
where inventory costs are the minimum and at the same time there is no stock out which may
result in loss of sale or stoppage of production.

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This represents the quantity which must be maintained in hand at all times, If stock are less
than the minimum level then the work will stop due to shortage of materials.

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When the quantity of materials reaches at a certain figure then fresh order is sent to get
materials again. The order is sent before the materials each minimum level. Re-ordering level
or ordering level is fixed between minimum level and maximum level. The rate of
consumption, number of days required replenishing the stock, and maximum quantity of
materials required on any day are taken into account while fixing re-ordering level.

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It is the quantity of materials beyond which a firm should not exceed its stock. If the quantity
exceeds maximum level limit then it will be overstocking. A firm should avoid overstocking
because it will result in high material costs. Overstocking will mean blocking of more
working capital, more space for storing the materials, more wastage of materials and more
chances of losses from obsolescence.
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Determination of the quantity for which the order should be placed is one of the important
problems concerned with efficient inventory management.

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It is the cost of placing an order and securing the supplies. It varies from time to time
depending upon the number of order placed and the number of items ordered. The more
frequently the orders are placed, and fewer the quantity purchases on each order the greater
will be the ordering cost.

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It is cost of keeping items in stock. It includes interest of investment, obsolescence losses,
store-keeping cost, insurance premium, etc. The larger the value of inventory, the higher will
be the inventory carrying cost.
 Q= 2U x P
S

Where

Q = Economic ordering quantity

U = Quantity (unit) purchased in a year (month)

P = Cost of placing an order

S = Annual (Monthly) cost of storage of one unit.




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A Rolls manufacture, purchases 1,600 units of a certain component from B. His annual
usage is 1,600 units. The order placing cost is Rs. 100 and the cost of carrying one unit
for a year is Rs. 8. Calculate the economic Ordering Quantity.

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Q= 2U* P
S

= 2*1,600*100
8

= 40,000

= 200 units.










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Rs. Rs.
1,600 1 1,600 100 800 6,400 6,500
2 800 200 400 3,200 3,400
3 533 300 267 2,136 2,436
4 400 400 200 1,600 2,000
5 320 500 160 1,280 1,780
6 267 600 134 1,072 1,672
7 229 700 115 920 1,620
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9 178 900 89 712 1,612
10 160 1000 80 640 1,640

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A B C Analysis is the technique of exercising selective control over inventory items. The
technique is based on this assumption that a firm should not exercise the same degree of
control on item which is more costly as compared to those items which are less costly.
The firm should be selective in its approach to control investment in various types of
inventories. This analytical approach is called ABC analysis and tends to measure the
significance of each item of inventories in terms of its value. The high value items are
classified as µAn item¶ and would be under the tightest control. µC items¶ represent
relatively least value and would be under simple control.
µB items¶ fall in between these two categories and require reasonable attention of
management. The ABC analysis concentrates on important items is also known as
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importance of their relative, this approach is also known as  !!+ !
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VED Analysis is used generally for spare parts. The requirements and urgency of spare parts
is different from that of materials.

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SED Analysis evaluates the importance of the inventory item on the basis of its availability.


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Inventory turnover ratios are also calculated to minimize the investment in inventories.

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For Ex.
If the cost of raw material consumed during January, 2006 is Rs. 10,000 and the average
inventory held during the month is Rs. 2,000, the inventory turnover to

10,000/2,000 = 5.