CHAPTER-I

OVERVIEW OF INVENTORY MANAGEMENT

INTRODUCTION:

Management must be concerned with all aspects of the firm’s operations

including production of goods and delivery of services, sales and marketing

activities, and supporting functions, such as personal training and data processing

to handle these responsibilities, most firms make extensive use of financial data

and reports. As businesses become larger and more complex, finance assumed

the responsibility of dealing with problems and decisions associated with

managing the firm’s assets.

Inventories constitute the major element in the working capital of many

business enterprises. For instance, inventories on an average constitute 60 percent

of current assets in public limited companies in INDIA. It is, therefore, necessary

to manage inventories efficiently and effectively to avoid unnecessary

investments in them .Inventories have a direct Impact on the profits of the firm.

Profit is affected by inventories in several ways. Firstly, too much, or too little

inventory affects the firm’s rate of return on investment. Secondly, the rate at

St Mary’s School of Management Studies 1

which the inventories move through the production on distribution process also

affects the cost of doing business.

It is therefore, necessary to formulate and initiate inventory policies which

will serve as guides in determining the correct level of inventory to maintain and

the correct amount of working capital to invest in inventory. To develop adequate

inventory plan, it is necessary to have thorough knowledge of the objectives of

inventory management and inventory management techniques.

A firm neglecting the management of inventories will be jeopardizing its

long-run profitability and may fail ultimately. It is possible for a company to

reduce its levels of inventories to a considerable degree e.g., 10 to 20 percent,

without any adverse effect on production and sales, by using simple inventory

planning and control techniques. The reduction in excessive inventories carries a

favorable impact on company profitability.

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 CHAPTER-II

DEFINITION AND CLASSIFICATION OF INVENTORIES:

The American institute of Accountants has set forth a definition of inventories

which has been accepted both by accountants and finance executives. The

definition is as follows:

The term inventory designate the aggregate of those items of tangible personal

property which (1) are held for sale in the course of business,(2) are in the

process of production for sale, or (3) are to be currently consumed in the

production of goods or services to be available for sale.

The definition implies that there are four types of inventories; finished goods,

work in progress, raw material, and supplies which are consumed in the creation

and distribution goods and services.

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.

Work-in-progress inventories are semi-manufactured products. 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 final category includes materials and supplies other than raw materials which

are necessary to the normal operation.

OBJECTIVES OF INVENTORY MANAGEMNET:

The inventory management consists of achieving two conflicting objectives.

a) Maintenance of large size inventory to assure continuity of operation in
the most efficient manner.
b) Minimize the firm’s investment in inventory to maximize profitability.

Both over investment and under investment in inventories are undesirable,

because costs and benefits are associated with the levels of inventory. If the firm

minimizes the investment in inventories the cost can be reduced. Smaller the

inventory, lower the cost to the firms. But investment in large inventories

St Mary’s School of Management Studies 4

provides efficient and smooth production and sales operations. Larger the

inventory, better it is from the point of view of continuity of operations.

Thus there is a necessity to aim at a level of inventory which will reconcile

these conflicting elements. The objective of inventory management should be to

determine an optimum level of investment in inventories on the basis of trade off

between cost and benefits associated with the levels of inventory.

COST OF HOLDING INVENTORY:

The operating objective of inventory management is to minimize costs

associated with the inventory. Costs relating can be divided under two heads:

ordering costs and carrying costs. These costs are very important in deciding the

optimum level of inventory.

ORDERING COSTS:

These costs are related to ordering of inventory. Ordering costs are

payments for secretarial services, written and other forms of communication,

book-keeping. Thus ordering costs consists of clerical and stationary costs. These

costs are also called as set up costs. They are generally fixed per order placed

regardless of the number of units. The larger the number of order placed, the

higher are such costs. The ordering costs can be minimized by placing fewer

orders for a larger amount. But purchase of larger quantity of inventory would

increase the carrying cost.

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CARRYING COSTS:

Carrying costs are related to maintenance of inventory carrying costs

include expenditure for storage, handling of materials, extra heat, light, insurance

and property tax. Carrying costs also include the opportunity cost of funds i.e.

interest on investment in inventory. Large inventories cause diversion of funds

from other profitable ventures. This is the opportunity cost of funds. Carrying

costs are nearly proportionate to the value of inventory. If the level of inventory

increases, the carrying costs also increase and vice versa.

Thus the total cost of inventory i.e. ordering and carrying costs should

be compared with the benefits arising from holding of inventory to determine the

optimum level of inventory.

BENEFITS OF HOLDING INVENTORIES:

Another important element in the determination pf optimum inventory level,

relates to the benefits of holding inventories. Inventories perform certain basic

functions which are of very much importance in firm’s production and marketing

strategies. According to JOHNSON R.W. (Financial management) the basic

function of inventories 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.

The term uncoupling means that the key activities of a firm viz., purchasing,

producing and selling, which are closely interrelated, can be carried on

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independently. If inventories are not held, purchasing and production would be

completely controlled by the sales schedule. If sales increase, the need for

purchase and production will increase and vice versa. But, if inventories are held,

each activity can be carried out independently and efficiently. The following are

the benefits of holding inventory.

BENEFITS IN PURCHASING:

If the purchasing is carried on independently i.e. without up to production or

sales, the firm can purchase large quantities than is warranted by usage in

production or the sales levels. This will enable the firm to get certain advantages.

Firstly, the bulk purchasing enables the firm to get trade discounts. Secondly,

ordering costs can be minimized by placing fewer orders for a large amount.

Thirdly, large inventory serves as a hedge against increasing prices. Fourthly,

bulk purchasing also provides a hedge against labour trouble.

BENEFITS IN PRODUCTION:

The basic objective of holding finished goods inventory is to separate production

and sales activities. This enables the firm to undertake production at a rate

different and sales that of sales. If the firms demand is seasonal in nature,

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management has to courses open. First it can produce production when sales are

high and reduce production when sales or low. Second, it may produce

continuously throughout the year and build up inventory which will be sold

during the period of seasonal demand. The former involves discontinuity in

production while the latter ensure stabilized production. Many advantages

acquire from stabilized production.

a) Improved worker morale and possibly greater efficiency.

b) Reduced peak-load production and fewer overtime charges.

c) Reduction of certain costs which result from idle equipment.

d) Certain economies made possible through the purchase of raw materials.

BENEFITS IN SALES:

The maintenance of inventories enables the firm to enhance its sales

efforts. If the firm has no inventory of finished goods, its level of sales will

depend upon its current production level. The firm may not be able to meet the

demand instantaneously had the customers may switch to other firms who can

supply at short notice.

Thus, the objective of inventory management relate to the minimization of

inventory on the one hand and the need to ensure sufficient inventory to assure

continuity of production and sales operations. Thus, both the objectives of

inventory management conflict with each other. The optimum level of inventory

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should be determined in terms of trade off between costs and benefits associated

with inventory management.

IMPORTANCE OF INVENTORY CONTROL:

The importance or necessity of inventory control is well explained in terms of the

objects of inventory control which are obtained through it. A proper inventory

control lowers down the cost of production and improves the profitability of the

enterprise.

Here are certain specific advantages of inventory control:

1) Reduction in Investment in Inventory.

2) Proper and efficient use of raw material.

3) No bottleneck in production.

4) Improvement in Production and Sales.

5) Efficient and optimum use of physical as well as Financial Resources.

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 INDUSTRY PROFILE

DI pipes are generally preferred for water supply, sewerage and

transmission applications. Superiority of DI pipes lies in its ability to provide

trouble free service against increasing traffic load and much longer life compared

to other types of pipes.

Considering the growing urbanization in the country and shortage of adequate

water infrastructure, which is a priority for the country, the demand scenario for

DI pipes is positive. However, the level of competition from the domestic and

overseas manufactures particularly from CHINA is gradually increasing.

BUSINESS

Raw materials:

Raw materials accounted for 58% of the company’s turnover for the year 2005-

06. The principal raw material for the production of pipes is molten pig iron,

which is produced mainly out of iron ore and LAM coke with other raw materials

viz., limestone, dolomite etc. Although there was a reduction in the international

prices of coke, the benefit could not accrue to the company due to carry over

inventory at higher cost.

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Operations:

The production of DI pipes increased to 76,655 MT in 2005-06 compared to

62375 MT in the previous year, an increased of 23%. The production of pig iron/

molten metal from MBF was also higher at1, 11,454 Mt during 2005-06 as

against 88,887 MT in 2004-05.

OPPORTUINTIES AND THREATS:

Emerging domestic and international competition and rising prices of the pig iron

ore and coke represent a threat to the company. Capacity expansion for both pig

iron and DI pipes, technological improvements in manufacturing process and

setting up of coke oven plant and captive power plant will enable the company to

protect margins on its end product and successfully overcome the threats.

OUTLOOK:

The company is continuously moving forward to achieve operational excellence

and value addition for the stakeholders through operational synergy, higher

capacity utilization, backward integration, cost reduction and continual

improvement in shop floor operations. The commissioning of coke oven plant

and captive power plant will further strengthen the value addition chain of the

company. The growth in demand for DI pipes offers positive outlook for the

company in the coming years.

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The company is in the consolidation phase and embarking on adding balancing

facilities to expand the capacity of DI pipes from 90,000 to 1,20,000 TPA during

2006-07.

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 COMPANY PROFILE:

LANCO INDUSTRIES LIMITED (LIL) was incorporated on 1ST

November, 1991 by LANCO Group of companies to manufacture pig iron using

Korf (GERMAN) technology and cement. The unit is located at Rachagunneri

village on Tirupathi. SriKalahasthi road which is about 30 kms from Tirupathi

and 10 kms from SriKalahasthi. The installed capacity of pig iron was 90,000

TPA and with similar capacity, 90,000 TPA for cement.

Due to the poor demand and other reasons, the operation of the cement unit of the

company was suspended and the unit was reengineered for producing a different

product mix having potential south India.

As a measure of forward integration project for adding value to the pig iron

manufactured by the company. LIL floated an another company named LANCO

Kalahasthi Castings Limited (LKCL) on 4TH March 1997 to manufacturer iron

castings and spun pipes in the same campus of the company with an annual

capacity of 40,000 TPA and 35,700 TPA respectively. Accordingly LIL had an

arrangement with LKCL for supply of molten iron and pig iron to LKCL, being a

value added product, as such iron pipes manufactured by LKCL offered better

returns.

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However, due to falling pig iron prices, increase additional capacity in the

industry, competition and the technical & financial assistance, the operations of

both LIL and LKCL were affected and the company was exploring financial and

technical strategic alliance with Indian / Foreign partner.

During the same time M/s Electro steel Castings Limited, was also looking for

additional capacities for producing spun pipes. Considering synergies involved,

Lanco Industries Limited entered into a strategic alliance partnership during

December 2002, with M/sElectrosteel Castings Limited (ECL), Kolkatta a

leading manufacturer of CI Pipes and DI pipes. This was win-win situation for

both LIL and ECL. After takeover, a financial re-engineering and re-structuring

of LIL was undertaken by ECL by implementing the following:-

 Immediately after take over an amount of Rs. 2200 lakhs was infused as

share capital of the company by M/s ECL to strengthen the equity base of

the company.

 During 2002, the capacity of pig iron was increased from 90,000 TPA to

150,000 TPA.

 With effect from 1ST April, 2003 LKCL was merged with the company to

take advantage of the close synergy in the business of the two companies,

since a large part of Molten iron / pig iron is consumed by LKCL for

manufacture of DI pipes. after the merger, the share capital of LIL, the paid

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 up share value of Rs. 10/- was reduced to Rs.2.50 per share and

accordingly one share of Rs.10/- each fully paid up in LIL was issued to all

the existing shareholders for every 4 shares held by them..

 During 2003, the capacity of the DI pipes was increased to 90,000 TPA.

 During 2004, the company took the step of backward integration by setting

up 150,000 TPA coke oven plant in the same complex, which was

commissioned in June 2005.

 During 2005, the company started up of a captive power plant of 12 M/V

by using the waste heat recovered from the coke plant which is expected to

be Commissioned by March 2006.

 An additional amount of Rs.25 crores is being spent on other capital works

like revamping of bitumen coating machine, balancing equipment and

facilities for production of higher diameter DI pipes etc., to increase the

capacity of DI pipes from the present 90,000 TPA to 120,000 TPA by

2006-07.

The above has resulted in the company witnessing a profitable years a gap of 8

years during the years ended 31ST March,2003, 2004 and 2005and a dividend of

10% was declared for the years ended 31ST March 2004 and 2005 to the

shareholders.

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Step by Step Company’s growth:

1991 Incorporation of Lanco.

1994 Setting up of Mini Blast furnace with 90,000 TPA capacities.

1995 Setting up a 250 TPD Mini cement plant.

1997 Setting up of LKCL for manufacture of 40,000 TPA castings and

35,700 TPA DI pipes.

2002 Strategic Alliance with Electro steel Casting Limited.

2002 Infusion of Rs.2200 lakhs to the equity and financial restructuring.

2003 Merger of LKCL with LIL for synergy.

2003 Capacity of pig iron was increased to 90,000 TPA to 150,000 TPA.

2004 Capacity of DI pipes was increased to 90,000 TPA.

2005 Commissioning of 150,000 TPA coke oven plant.

2005 Setting up of captive power plant of 12 M/V by using the waste heat

recovered from the coke oven plant.

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 CHAPTER-III
RESEARCH METHODOLOGY
INVENTORY CONTROL:

A firm needs an inventory control system to effectively manage its inventory.

There are several inventory control systems in vogue in practice. They range

from simple systems to very complicated systems. The nature of business and the

size dictate the choice of an inventory control system .For example; a small firm

may operate a two-bin-system. Under this system, the company maintains two

bins. Once inventory in one bin is used, an order is placed, and means while the

firm uses inventory in the second bin .For a larger departmental store that sells

hundreds of items, this system is quite unsatisfactory. The departmental store will

have to maintain a self-operating, automatic computer system for tracking the

inventory position of various items and placing order.

The main objective of inventory control is to achieve

maximum efficiently in production and sales with the

minimum investment in inventory.

FUNCTIONS:

As mentioned earlier, inventory is a necessary evil. Necessary because it aims at

absorbing the uncertainties of demand and supply by ‘decoupling’ the demand

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and supply sub-systems. Thus an organization may be carrying inventory for the

following reasons.

a) Demand and lead-time uncertainties building of safety stock (buffer stocks) so

as to enable various sub-systems to operate somewhat in a Decoupled manner.
It is obvious that the larger the uncertainty of demand and supply, the larger
Will have to be the amount of buffer stocks to be carried for a prescribed
Service level.

b) Time long in deliveries also necessitates building of inventories; if the

Replenishment lead times are positive then stocks are needed for system
Operation.

c) Cycle stocks may be maintained to get the economies of scale so that total
system cost due to ordering carrying inventory and back logging are
minimized. Technology requirement of batch processing also build up cycle
stock.

d) Stocks may build up as pipeline inventory or work-in-progress inventory due

to finiteness of production and transportation rates. This includes materials
actually being worked or moving between work centers.

e) When the demand seasonal may become economical to build inventory

during periods of low demand to case the strain of peak period of demand.

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f) Inventory may also be build up for other reasons such as quantity discounts
being offered by suppliers, discount sales anticipated increase in material
price possibility of future non-availability etc.

ESSENTIAL OF GOOD INVENTORY CONTROL SYSTEM:

1) Classification and codification of inventories by allotting proper code

Number to each item and group and regroup on some basis.

2) Standardization and simplification of inventories in order to maintain

Quality and reduce the number of items.

3) Adequate storage facility.

4) Setting different levels and reorder point for each item of inventories.
5) Fixing Economic Order Quantity.
6) Experienced personnel for handling inventories properly.
7) Intelligent and experienced Personnel.
8) Co-ordination.
9) Budgeting.
10) Internal Check.
The inventory includes stock of raw materials, semi-finished goods,
finished goods and components etc. of several descriptions. In order facilitate
prompt recording, locating and dealing, each item of inventory should be
assigned a particular code for proper identification and must be divided in
groups on basis of location, nature of item, plant etc.

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 TECHNIQUES OF INVENTORY CONTROL:

Effective inventory management requires an effective control system of

inventories. A proper inventory control not only helps in solving the acute
problem of liquidity but also increases profits and causes substantial reduction
in the working capital of the concern. The following are the important
techniques of inventory control.
♦ Setting of various stocks levels.
♦ ABC analysis.
♦ Two bin system.
♦ Establishment of system of budgets.
♦ Use of perpetual inventory records and continuous stock verification.
♦ Determination of Economic Order Quantity (E.O.Q).
♦ Review of slow and non-moving items.
♦ Use of control ratios.

SETTING OF VARIOUS STOCKS LEVEL:

Carrying of too much little of inventories is determined to the firm, if the

inventory level is too little the firm will face frequent stock outs involving heavy

ordering cost and if the inventory level is too high it will be unnecessary tie up to

capital. Therefore, an efficient inventory management requires that a firm should

maintain an optimum level of inventory costs are the minimum and at a same time

there is not stock out which may result in loss of sale or stoppage production of

various stock levels are discussed as such.

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Re-ordering level:

It is the point at which if stock of a particular material in store

approaches, the storekeeper should initiate the purchase requisition for fresh

supplies of that material.

This level is fixed somewhere between the maximum and minimum

levels in such a way that the difference of quantity of the material between the re-

ordering level and the minimum level will be sufficient to meet the requirements of

production up to the time the fresh supply of the material is received.

Re-ordering level can be calculated by applying the following formula.

Re-ordering level =Maximum Consumption x Maximum re-order period.

Or

Re-ordering level =

[
Safety stock + Average daily consumption X Average delivery period ]
Where:

Safety stock=

Annual Demand X [Maximum lead time –– Normal lead time ]

365

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Minimum level:

It indicates the lowest figure of inventory balance, which must be maintained in

hand at all times, so that there is no stoppage of production due to non-

availability of inventory.

The main consideration for the fixation of minimum level of inventory is as

follows:

1) Information about maximum consumption and maximum delivery period in

respect of each item to determine its re-order level.

2) Average rate of consumption for each inventory item.

3) Average delivery period for each item. This period can be calculated by

averaging the maximum and minimum period.

The formula used for its calculation is as follows:

Minimum Level of inventory =

Re-order level – [Normal consumption X normal re-order period ]

Maximum level:

It represents the maximum quantity of an item of material which can be

held in stock at any time. Stock should not exceed this quantity. The quantity is

fixed so that there may be no overstocking.

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

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 ♦ Amount of capital available for maintaining stores.

♦ Godown space available.

♦ Maximum requirement of the stores for production purposes at any point

of time.

♦ Rate of consumption of the material during the lead time.

♦ The time lag between indenting and receiving of the material.

♦ Possibility of loss in stores by deterioration, evaporation etc.

♦ Cost of maintaining stores.

♦ Likely fluctuation in prices.

♦ The seasonal nature of supply of material. Certain materials are available

only during specific periods of the year, so these have to be stocked

heavily during these periods.

♦ Restrictions imposed by the government or local authority in regard to

material in which there are inherent risks e.g. fire and explosion.

♦ Possibility of change in fashion and habit which will necessitate change in

requirement of materials.

Maximum level of inventory=

Reorder level + Reorder quantity ––

[Minimum consumption X minimum re-ordering period]

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Average stock level:

The average stock level is calculated by the following formula:

Average stock level = Minimum stock level + [1/2 of re-order quantity]

Danger level:

When the stock level falls below the minimum level, it reaches the danger

level, when immediate action is to be taken for replenishment of stock.

Danger level=

Average consumption X lead time for emergency purposes.

STOCK CONTROL THROUGH ABC ANALYSIS:

Manufacturing organization find it useful to divide materials into three

categories for the purposes of exercising selective control on materials.

An analysis of the material costs will show that a smaller percentage of

items of materials in the stores may contribute to a large percentage of the

value of consumption and, on the other hand, a large percentage of times

may represent a smaller percentage of the value of items consumed.

Between equal to their value of consumption.

Items falling in the first category are treated as “A” items, of the second

category as “B” items and items of the third category are taken as “C”

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items. Such an analysis of material is known as ABC analysis. This

technique of stock control is also know as stock control according to value

method or always better control method or proportional parts value analysis

method .Thus, under this technique of material control, materials are listed

in ‘A’,’B’and ‘c’ categories in descending order based on money value of

consumption. ABC analysis is measures the cost significant of each item

of material. It concentrates on important items. So it is also known as

“control by Importance and Exception” (C.I.E).

The report of the INDIAN productivity Team on “Stores & Inventory control

in U.S.A, JAPAN and WEST GERMANY” gives the following example of ABC

analysis:

Category % of Items % of Value

A 15 80
B 35 15
C 50 5
Total 100 100
ABC analysis of inventory items

The significant of this analysis is that a very close control is exercised over he

items of ‘A’ group which account for a high percentage of costs while less

stringent control is adequate for category ‘B’ and very little control would suffice

for category ‘C items.

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100%

95%

Class A Class B Class C

0 15% 50% 100%

% of number of items

ABC analysis of INVENTORY ITEMS

Advantages:

A strict control is exercised on the item which represents a high percentage of

the material costs. Managerial time is spent on ‘A’ items whereas ‘C’ items and

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sometimes ‘B’ items can be handled by clerical staff with least managerial

supervision.

1) Investment in inventory is reduced to the minimum possible level

because a responsible quantity of ‘A’ items representing a significantly

portion of the material costs is purchased. To reduce investment in

materials, close control ‘A’ items contributes much more than close

control of ‘C’ items.

2) Storage a cost is reduced as a reasonable quantity of materials, which

account for high percentage of value of consumption will be

maintained in the stores.

Two bin system:

Under this system each bin is divided into two parts– one, smaller part,

should stock the quantity equal to the minimum stock or even the re-ordering

level, and the other to keep the remaining quantity. Issues are made out of the

large part; but as soon as it becomes necessary to use quantity out of the smaller

part of the bin, fresh order is placed. “Two bin systems” is supplemental to the

record of respective quantities on the bin card and the stores ledger card.

Establishment of system of budgets:

To control investment in the inventories. It is necessary to know in

advance about the inventories requirement during a specific period usually a year.

St Mary’s School of Management Studies 27

The exact quantity of various types of inventories and the time when they would

be required can be known by studying carefully production plans and production

schedules. Based on this, inventories requirement budget can be prepared. Such a

budget will discourage the unnecessary investment inventories.

Use of perpetual inventory records and continuous stock verification:

Perpetual inventory system:

Under this system a continuous record of receipt and issue of materials is

maintained by the stores department and the information about the stock of

material is always available.

CIMA defines perpetual inventory system as “the recording as they occur of

receipts, issues and the resulting balances of individual items of stock in either

quantity or quantity and value.”

In this system the entries are made in bin cards and stores ledger as and when the

receipts and issues of materials take place and ascertaining the balance after

every receipt or issue of materials. The stocks as per the dual records namely bin

card and stores ledger are reconciled on a continuous basis.

Advantages:

♦ This system avoids the disruptions to production or trading caused by the

periodic stock taking.

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 ♦ This system facilitates production planning and inventory control.

♦ Perpetual inventory system is efficiently maintained with continuous stock

taking.

♦ The perpetual inventory system avoids the necessity of stock taking by

actual at the end of financial period.

♦ Stock can be taken for the purpose preparation of profit and loss account

and balance sheet.

♦ It helps in having a detailed and more reliable check on the stocks.

♦ The stocks records are more reliable and stock discrepancies are

investigated and appropriate actions are taken immediately.

Periodic stock taking system:

Under this system the stock levels are reviewed at fixed intervals e.g. at the

end of every month or three months. All the items of stocks in the store are

reviewed periodically.

CIMA defines periodic stock taking as “a process whereby all stock items are

physically counted and then valued.” The aim of periodic stock taking is to find

is to find out the physical quantities of materials of all types are physically

counted at a given date.

St Mary’s School of Management Studies 29

 ♦ A team of stock checkers should be allocated to count all stock in one area,

to ensure that all stock is counted once, and that no omission or

duplications occur.

♦ In the office, the completed stock sheets should be collated and totaled,

and the quantities checked against the stock records.

♦ Senior staff or auditors should perform sample checks on a number of

items.

♦ All staff involved should be issued with stock taking instructions well

before the date of the actual count. Often non-stores staff ill be involved in

the count.

♦ Any stocks showing discrepancies should be recounted, and if still not

resolved should be reported to management.

♦ Stock checkers should enter amounts counted on preprinted stock sheets.

♦ A ‘cut-off’ time should be set, after which no movement of stock is

allowed until the count has been completed.

Determination of Economic Order Quantity (E.O.Q):

The total costs of a material usually consist of:

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Total acquisition cost + Total ordering cost + Total carrying cost.

Total acquisition cost through buying is usually unaffected irrespective of the

quantity of material ordered at one time unless quantity discounts are available.

The quantity of materials to be ordered at one time is known as economic

ordering quantity. This quantity is fixed in such a manner as to minimize the cost

of ordering and carrying the stock.

Carrying costs:

It is the cost of holding the materials in the store and includes:

♦ Cost of storage space which could have been utilized for some other

purpose.

♦ Cost of bins and racks that have to be provided for the storage of materials.

♦ Cost of maintaining the materials to avoid deterioration.

♦ Amount of interest payable on the money locked up in the materials.

♦ Cost of spoilage in stores and handling.

♦ Transportation costs in relation to stock.

♦ Cost of obsolescence on account of some of the materials becoming

obsolete after some time of storage either due to change in the process or

product.

♦ Insurance cost.

♦ Clerical cost etc.

St Mary’s School of Management Studies 31

Ordering cost:

It is the cost of placing orders for the purchase of materials and includes:

1) Cost of staff posted in the purchasing department, inspection section and

payment department.

2) Cost of stationery, postage and telephone charges.

E.O.Q = 2UO

Where

EOQ = economic order quantity.

U = consumption of the material concerned in units during a year.
O = Cost of placing one order including the cost of receiving the
Goods i.e. cost of getting an item into the firm’s inventory.
C = holding costs of inventory O.U per year
Y

From the above diagram it is clear that carrying costs and ordering costs

behave in opposite ways. If huge quantity is ordered at one time, ordering costs

St Mary’s School of Management Studies 32

 will be low and carrying costs will be high and vice versa if low quantity is

ordered at one time.

Assumptions:

1) There are dynamic conditions of the supply which enable a firm to ace as

many orders as it needs.

2) Prices of the item remain stable which keep carrying cost constant.

3) The quantity of the item to be consumed during a particular period is

totally known i.e. quantity to be consumed is certain.

Review of slow and non-moving items:

Sometimes, due to high value of slow moving and non-moving raw materials, it

appears that the concern has blocked huge sum of money unnecessarily in raw

materials. To overcome this problem, it is necessary to dispose –off as early as

possible, the non-moving items or make arrangements for their exchange with the

inventories required by the concern. Besides this no new requisition should be made

for the purchase of slow moving items, till the existing stock is exhausted.

Computation of inventory turnover ratio may help in identifying slow moving items.

The Pareto distribution:

St Mary’s School of Management Studies 33

 The Pareto (80/20) distribution is similar in concept to ABC method of

stock control. Its name is derived from an economist, vilfredo Pareto, who

suggested that 805 of a nations wealth is held by 20% of its population and so the

remaining 80% of the population hold only 20% of its net wealth. This 80/20

analysis has been applied to stocks that 20% of stores items account for 80% of

the value of stocks in hand. This indicates that rigorous stock control methods

should be applied to these 20% of items in order to derive maximum benefits

from stock control. The remaining 80% of items do not require such rigorous

control methods applied to them because the cost and effort might not be justified

by the saving obtainable.

VED Analysis:

VED–– vital, essential and desirable–– analysis is used primarily for

control of spare parts. The spare parts can be divided into three categories––

vital, essential or desirable keeping in view the criticality of production.

The spares, the stock-out of which even for a short time will stop production for

quite some time and where the cost of stock out is very high, are known as vital

spares, the spares, the absence of which cannot be tolerated for more than a few

hours or a day and the cost of lost production is high and which are essential for

the production to continue, are known as essential spares. The desirable spares

St Mary’s School of Management Studies 34

are those spares which a are needed but their absence for even week or so will

lead to stoppage of production.

Some spares, though negligible in monetary value, may be vital for the

production to continue and require constant attention. Such spares may not

receive the attention they deserve if they are maintained according to ABC

analysis because their value of consumption is small. So, in their cases, VED

analysis is made to get the effective result.

Input – Output Ratio:

Input-Output ratio is used in material control, which indicates the relation

between the quantity of material used in the production and the quantity of final

output. For example, if 500 units of material is introduced into the process or

operation and the yield of final product is 400 units, the Input-output ratio is

calculated as follows:

Input – Output Ratio = Input Units / Output x100

St Mary’s School of Management Studies 35

Advantage Analysis :

The advantage of analysis of input-output ratios is given below:

♦ It helps in material planning by estimation of output and its raw material

requirement.

♦ The standard input-output ratio act as guide in control of materials used in

the process by minimization of waste, scrap, spoilage and defectives.

♦ It acts as a performance indicator of particular production cost centers.

♦ It helps the management in investigation and analysis of any variation is

material usage by establishing relation between input and output.

♦ The cost-benefit analysis of use of different substitutes of raw material is

possible by comparing each of the input-output ratios.

St Mary’s School of Management Studies 36

Stock turnover ratio:

The stock turnover ratio indicates the movement of average stock holding of

each item of material in relation to its consumption during the accounting period.

The stock turnover ratio is calculated by applying the following formula.

Cost of materials used during the period

Average stock of materials used during the period

By comparing the number of days in the case of two different materials, it

is possible to know which is fast moving and which is slow moving. On this

attempt should be made to reduce the amount of capital locked up, and prevent

over-stocking of the slow moving items.

<<<O>>>

St Mary’s School of Management Studies 37

 SCOPE AND METHODOLOGY

Scope:

Raw materials contribute a single largest expenditure item, which account

for nearly 70% of the total value. The important of the inventory management

lies in the fact that in significant contribution made in reducing material cost

through proper control will go a long way in improving the profitability and

R.O.I.

Fixed assets constitute capital already suck and the only scope for

improving the R.O.I. lies in the efficient management of materials. So the

inventory control assumes greater importance.

Holding inventory is inevitable for keeping the production wheels

running. It also acts as lubricant and spring for production, distribution system.

But holding costs are involved in inventory control tool guide in formulating an

inventory policy for various raw materials, which goes in the production process.

The study has been conducted to know the most suitable and economies

maintenance of inventory for LANCO INDUSTRIES LIMITED.

St Mary’s School of Management Studies 38

Methodology:

Objectives of the study.

Generally the objective of the present case study to analyze the inventory

Management Analysis in particular this analysis aims at.

 To analyze the stock control in Lanco Industries by adopting ABC

Technique.

 To estimate the EOQ for the Lanco Industries.

 To calculate the stock control levels of Inventory.

 To present analysis of Inventory Ratios.

 To suggest necessary measures for an effective Inventory Management

System for the Lanco Industries.

St Mary’s School of Management Studies 39

DATA BASE:

The present case study is based on secondary data sources of data collected from

Lanco Industries for six years i.e., from 2000-06 keeping the objectives in view

the data has been collected . from the Lanco Industries and it reports on Financial

results for the above period. Besides the Financial Manager was also interviewed

personally to collect some of the data which are not available in the reports.

Tools of Analysis:

The analysis of the case study is primarily descriptive in nature. The analysis is

made by adopting ABC technique, EOQ Model and Control Levels. Besides the

description is also presented through graphical representations for easy

understanding.

St Mary’s School of Management Studies 40

 Chapter IV

DATA ANALYSIS AND ITERPRETATION

DATA ANALYSIS:

Analysis the inventory handling using the following techniques.

♦ ABC analysis (control mechanism).

♦ EOQ

♦ Control levels.

Control Mechanism:

Usually the firm has to maintain several types of inventories. It is not

desirable to keep same degree of control on all items the firm should play

maximum attention to these whose is the highest value.

The firm should receive the most effort in controlling. The firm should be

selective in it approach to control inventory handling in various types of

inventories.

St Mary’s School of Management Studies 41

 This analytical approach is called the ABC analysis, and tends to

measure the significance of each item ate inventories in terms of its value.

ABC Analysis:

ABC analysis or classification which is said to be “always better

control”. Thus ABC analysis firstly organized in the “General Electric Company”

of USA.

In this, the items are classified in the importance of their relative value.

This is also known as proportional value analysis (PVA) or annual usage value

analysis. (AUV).

In this, the higher value items are classified as “A items” and would be

under the highest control.

“C items” represents relatively least value and would be under simple

control.

“B items” fall in between these two categories and require reasonable

alteration of management.

Rules of implementing ABC techniques:

♦ Classify the item of inventories.

♦ Determine the price per unit of each item.

♦ Find the total cost of each item.

St Mary’s School of Management Studies 42

 ♦ Rank the items in accordance with total costs, allotting first rank to the

item with highest total cost and so on (i.e. arrange in descending order).

♦ Find out the total number of items and calculate the percentage of each

item.

♦ Calculate the percentage of Total cost of each item to total cost of all

items.

♦ Combine items on the basis of their relative value to form three categories

A, B, C.

“A” items having high consumption value (e.g.–15%).

“B” items having low consumption value (e.g. – 55%).

“C” items having moderate consumption value (e.g. – 30%).

Determination of optimum ordering quantity:

Determination of the quantity for which order should be placed is one of the

important problems concerned with efficient inventory management. Economic

order quantity refers to the size of the order which gives maximum economy in

purchasing any item of raw materials of finished product. It is fixed mainly after

taking into account the following costs:

St Mary’s School of Management Studies 43

Inventory carrying cost:

It is the cost of holding the materials in the store and includes:

♦ Cost of storage space which could have been utilized for some other

purpose.

♦ Cost of bins and racks that have to be provided for the storage of materials.

♦ Cost of maintaining the materials to avoid deterioration.

♦ Amount of interest payable on the money locked up in the materials.

♦ Cost of spoilage in stores and handling.

♦ Transportation costs in relation to stock.

♦ Cost of obsolescence on account of some of the materials becoming

obsolete after some time of storage either due to change in the process or

product.

♦ Insurance cost.

♦ Clerical cost etc.

Ordering cost:

It is the cost of placing orders for the purchase of materials and includes:

1) Cost of staff posted in the purchasing department, inspection section and

payment department.

2) Cost of stationery, postage and telephone charges.

St Mary’s School of Management Studies 44

Derivation of economic order quantity (EOQ):

Given

E.O.Q = 2UO

Where: EOQ = economic order quantity.

U = consumption of the material concerned in units during a year.
O = Cost of placing one order including the cost of receiving the
goods i.e. cost of getting an item into the firm’s inventory
C = holding costs of inventory O.U per year
Q = ……………..? (In units)

Calculation of Economic Order Quantity (EOQ) for the following items:

Assumptions:

♦ Demand does not vary.

♦ Lead time does not fluctuate and is instantaneous.
♦ The rate at which the inventories or makes sales is constant throughout the
year.

St Mary’s School of Management Studies 45

 The above assumptions may also be called as limitations of EOQ model.
There is very likelihood of a discrepancy between actual and estimated demand
for a particular item of inventory. Similarly, the assumptions as to constant usage
or sale of inventories and instantaneous replenishment of inventories are also of
doubtful validity. On account of these reasons, EOQ may sometimes give wrong
estimate about Economic ordering quantity.
Economic Order Quantity (EOQ) for the raw materials which is used in LANCO

S.No. Items Order Carrying Monthly

Cost Cost Consumption
1 Graphite 10 1.00 29 nos
2 Quickset-510 59 2.00 549 kgs
3 Quickset-520 29 1.00 583 kgs
4 Sieved sand 29 3.00 1014 mt
5 Silica sand 32 3.00 230 mt
6 HSD 20 0.30 86 ltr
7 LDO 25 0.70 310 ltr
8 Raw material 20 1.00 4 mt
9 Ino pipe 10 1.00 29 mt
10 Scrap 60 5.00 935 mt

INDUSTRIES LIMITED

S.No. Items Economic order Quantity

1 Graphite 580

St Mary’s School of Management Studies 46

 2 Quickset-510 32391
3 Quickset-520 33814
4 Sieved sand 1835
5 Silica sand 4907
6 HSD 11467
7 LDO 22143
8 Raw linseed oil 160
9 Ino pipe 870
10 Scrap 22940

Determination of stock levels

Reorder level: re-order level is the level of inventory at which the firm should

place an order to replenish the inventory. In case, the order is placed at this level,

the new goods will arrive before the runs out of goods to sell.

In order to determine reorder level, information is required about two

things. (a) The lead time and (b) the usage rate.

The term lead time refers to the time normally taken in receiving the

delivery of inventory after the order has been placed in case there is no

St Mary’s School of Management Studies 47

uncertainty about the usage rate and the lead time, the order level can be

determined by simply applying the formula.

Re-order level = Average usage X lead time + safety stock.

Safety stock level:

The actual usage as well as the lead time may be different from the normal usage

or the normal lead time. In order to guard against such a contingency the firm

maintains a safety stock the minimum buffer stock as a cushion against possible

increase in usage or delay in delivery time. The level of safety stock can be

calculated by applying the following formula.

Safety stock = Average usage X period of safety stock.

Maximum inventory:

It is the quantity of materials beyond which a firm should not exceed its stocks. If

the quantity exceeds maximum level limit then it will be over-stocking. A firm

should avoid over-stocking because it will result in high material costs. Over-

stocking will mean blocking of more working capital, more space for storing the

materials, more wastage of materials, and more chances of losses from

obsolescence. This can be calculated by using the following formula.

Maximum inventory = Economic Order Quantity + safety stock.

St Mary’s School of Management Studies 48

Calculated the re-order level, safety stock level and maximum inventory for

the following raw materials.

1) Calculation of safety stock level of inventories.

Safety stock = Average usage X period of safety.

For example:

Graphite avg. usage is 6000 lbs and period of safety is 1 week.

Safety stock = Average usage X period of safety.

= 29 X 30 days.

= 870.

For other raw materials.

S.NO Items Safety stock

1 Graphite 870
2 Quickset-510 549
3 Quickset-520 583
4 Sieved sand 1014
5 Silica sand 230
6 HSD 344
7 LDO 1240
8 Raw materials 60

St Mary’s School of Management Studies 49

 9 Inopipe 29
10 Scarp 935

Calculation of re-order level of inventories:

Re-order level = average usage X lead time + safety stock

For example for aluminum alloy.

= 29 X 30 days + 29 =1740.

For other items:

S.NO Items Re-order level

1 Graphite 1740
2 Quickset-510 1098
3 Quickset-520 1166
4 Sieved sand 2028
5 Silica sand 460
6 HSD 688
7 LDO 2480
8 Raw linseed oil 120
9 Ino pipe 2538
10 Scarp 1870

3) Calculation of maximum inventory:

Maximum inventory = Economic Order Quantity + safety stock.

For example: calculation of maximum inventory for shell sand

When EOQ = 1121 kgs and safety stock 5500 kgs/ weeks.

Maximum inventory = EOQ + safety stock.

= 1121 +5500

St Mary’s School of Management Studies 50

 = 6621.

Maximum
Items EOQ Safety stock inventory
Graphite 580 870 1450
Quickset-510 32391 549 32940
Quickset-520 33814 583 34397
Sieved sand 1835 1014 2849
Silica sand 4907 230 5137
HSD 11467 344 11811
LDO 22143 1240 23383
Raw linseed oil 160 60 220
Ino pipe 870 29 899
Scrap 22940 935 23875

ABC plan:

ABC analysis is the important method used for selecting inventory control. ABC

analysis is a versatile tool use as a cost reduction Technique.

Statement–– I indicates the result of treating all items alike. In this case four

orders are placed for A-class, B-class, C-class items.

Statement–– II indicates how more attentive is paid for A-class item, less

attention paid for B-class item and annual orders are placed for C-class .items.

The result is without increasing ordering cost the average inventory can be

reduced by 40% and the inventory carrying cost by 40%.

St Mary’s School of Management Studies 51

 Thus a production Manger while focusing his attention on A-class item, by

relaxing control on class B items, and annual orders placed for C-class items, can

effectively bring to the inventory carrying cost as well as reducing the inventory

from the working capital for effective control of inventory.

Normally fixed order quantity system that is the cure system is use for

ordering A-class item Replenishment system or the system is used for ordering

B-class items and annual orders are placed for C-class item. By this method the

production manager can effectively control inventory management through

Method or Exception (MOE).

How to do ABC–– analysis?

ABC–– Analysis is drawn with the 0% of items on X axis. This is done by

findings out % of cost, cumulative % of cost, % of item and cumulative % of an

item. By joining all the points, which is possible, to get the curve, where there is

curvature change drop a perpendicular to cut in the X-axis.

Similarly next portion of the curve, where the curvature change drop a

perpendicular line. Then ABC is segregated.

From the following details, draw the plan of ABC selective control for

LANCO INDUSTRIES LIMITED.

St Mary’s School of Management Studies 52

S.NO Items Units Unit cost
1 Graphite segment 29 7701
2 Quickset-510 549 65
3 Quickset-520 583 185
4 Raw linseed oil 4 49762
5 Sieved sand 1014 310
6 Silica sand 230 350
7 Black paint for production 11549 72
8 Black paint (pipe) 13577 49
9 H.B.Red & Brown paint 518 88
10 Ino pipe 29 66212
11 HSD 86 30805
12 LDO 310 30988
13 Furnace oil (lv) 136 23295
14 Furnace oil 27 19116
15 SCRAP 935 16900

The system of ABC analysis suffers from a serious limitation. The system

analysis the items according to their values and not according to their importance

in the production process. For example, an item of inventory may not be very

costly and hence it may have been put in category C. however, the item may be

very important to the production process because of its scarcity. Such as items as

a matter of fact requires the almost attention of the management though it is not

admissible to do as per the system of ABC analysis. Hence, the system of ABC

analysis should not be followed blindly.

St Mary’s School of Management Studies 53

NOTES:

1. For the ABC analysis, the major 20 items used in the LANCO

INDUSTRIES LIMITED are taken into consideration.

2. The quantity based on monthly requirement.

3. The cost/unit is taken as on the basis of current market price.

St Mary’s School of Management Studies 54

 Ranking of Items according to their usage value
% of
Unit Total Total Cost Ran-
S.No. Items Units Cost Cost king
1 Graphite segment 29 7701 223329 0.62 10
2 Quickset -510 549 65 35685 0.10 15
3 Quickset-520 583 185 107855 0.30 12
4 Raw linseed oil 4 49762 199048 0.55 11
5 Sieved sand 1014 310 314340 0.87 9
6 Silica sand 230 350 80500 0.22 13
7 Black paint for 11549 72 831528 2.30 6
production
8 Black paint (PIPE) 13577 49 665273 1.83 7
9 H.B.Red & brown 518 88 45584 0.12 14
paint
10 Ino pipe 29 66212 1920148 5.3 5
11 HSD 86 30805 2649230 7.33 4
12 LDO 310 30988 9606280 26.57 2
13 Furnace oil (lv) 136 23295 3168120 8.76 3
14 Furnace oil 27 19116 516132 1.43 8
15 Scrap 935 16900 15801500 43.69 1

St Mary’s School of Management Studies 55

Ran- Item % of Cumula % of Category
King Nos Total Value Cumulative tive Total
items (in Rs) Value % Value
1 15801500 15801500 43.69
2 3 15% 9606280 25407780 26.57 80% A
3 3168120 28575900 8.92
4 2649230 31225130 7.46
5 1920148 33145278 5.40
6 5 35% 831528 33976806 2.34
7 665273 34642079 1.87 15% B
8 516132 35158211 1.45
9 314340 35472551 .88
10 223329 35695880 0.62
11 199048 35894928 0.56
12 7 50% 107855 36002783 0.30 5% C
13 80500 36083283 0.22
14 45584 36128867 0.12
15 35685 36164552 0.10
15 100 36164552 100
ABC Plan

The following conclusions are drawn from ABC Analysis:

S.NO Consumption value % of Cumulative % of Cumulative

Cost % of cost Item % of item
1 15801500 44.51 44.51 6.667 6.667
2 9606280 25.37 69.87 6.667 13.333
3 3168120 8.92 78.77 6.667 20.001
4 2649230 7.46 86.23 6.667 26.666
5 1920148 5.40 91.63 6.667 33.335
6 831528 2.34 93.93 6.667 40.002
7 665273 1.87 95.78 6.667 46.669
8 516132 1.45 97.23 6.667 53.336
9 314340 .88 98.11 6.667 60.003
10 223329 .62 98.73 6.667 66.670

St Mary’s School of Management Studies 56

 11 199048 0.56 99.28 6.667 73.337
12 107855 .30 99.58 6.667 80.004
13 80500 .22 99.80 6.667 86.671
14 45584 0.12 99.90 6.667 93.338
15 35685 0.10 100.00 6.667 100.00
36164552 100.00 100.00

45
Conclusions:
1) 15% of items account for 80% of total value.

2) 35% of items account for 15% of total value

40
St Mary’s School of Management Studies 57
 3) 50% of items account for 5% of total value.

1) The basic raw materials scrap, LDO and furnace (LVF) account for 80% of

total cost where as only 15% in terms. So, more attention should be paid

for these two items. If there is any delay in getting the raw materials, it

automatically effects the production. So, adequate raw materials are to be

kept as buffer stock to smooth running of organization. Due to strong

negotiations with the vendors. If we reduce the price of these raw materials

up to some extent, it amounts to huge savings and there by increase its

profitability.

2) The raw material HSD, Inopipe, black paint, black paint (production), and

furnace oil accounts for 35% of total cost where as 15% in terms of total

items. So, some attention should be paid for these three items. These items

are also important for production. If there is any delay in getting the raw

materials, it automatically effects the production.

3) Except A and B categories, remaining all the items fall into category. Here,

the percentage of total value should only account for only 5% where as

50% in terms of percentage of total items.

The result is without increasing ordering cost the average inventory can

be reduced by 40% and the inventory carrying cost by 40%.Thus a production

Manger while focusing his attention on A-class item, by relaxing control on class

St Mary’s School of Management Studies 58

B items, and annual orders placed for C-class items, can effectively bring lower

the inventory carrying cost as well as reducing the inventory from the working

capital for effective utilization of inventory.

Classification of items according to ABC, VED categories:

ABC analysis is the technique of exercising selective control over

inventory items. The technique is based in this assumption that a firm should

not exercise the same degree of control on items which are more costly as

compared to those items which are less costly. According to this approach, the

inventory items are divided into three categories.–– A, B and C.

Category A may include more costly items, while category B may consist

of less costly items and category C of the least costly items. Thus A, B and C

analysis concentrates on important items and exception (CIE). This approach

is also known as “proportional value analysis (PVA), since the items are

classified in importance of their relative value.

St Mary’s School of Management Studies 59

 Though, no definite procedure can be laid down for classifying the

inventories in A, B and C categories as nature and varieties of items, specific

requirements of the business etc.

VED analysis is used generally for space parts. The requirements and

urgency of spare parts is different from that of materials. A-B-C analysis may

not be properly used for space parts. The demand for spares depends upon

performance of the plant and machinery. Spare parts are classified as Vital

(V), Essential (E) and desirable (D). The vital spares are must for running the

concern smoothly and these must be stored adequately. The non-availability if

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 type

of spares may be avoided at times, if the lead time of these spare 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.
S.NO Items VED ABC
1 Graphite segment V A
2 Quickset-510 V A
3 Quickset-520 V A
4 Raw linseed oil V B
5 Sieved sand V B
6 Silica sand V B

St Mary’s School of Management Studies 60

 7 Black paint for production D B
8 Black paint (pipe) D B
9 H.B.Red & brown paint D C
10 Ino pipe E C
11 HSD E C
12 LDO E C
13 Furnace oil (LV) E C
14 Furnace oil E A
15 Scrap E C

ANALYSIS OF INVENTORY RATIOS:

Ratios are significant both in vertical and horizontal analysis in vertical

analysis ratio analysis are important to form a judgment whether performance

of the corporation at a time is good, questionable or poor. Like wise, use of

ratios in horizontal analysis indicates whether the financial condition of the

corporation is improving or deteriorating and whether the profitability or

efficiency is showing an upward or downward trend.

Financial ratios become meaningful to judge financial condition and

profitability performance of the corporation only when the is comparison. In

fact analysis of ratio involves two types of comparison. First, a comparison of

present ratio with past and expected future ratios for the same corporation.

The analyst can determine the composition of change and determine whether

there has been an improvement or deterioration in the financial position of the

St Mary’s School of Management Studies 61

 corporation over the period of time. The second method of comparison

involves comparing the ratios of the company or with industry averages at the

same point of time. Such a comparison would provide considerable insight

into the relative financial condition and performance of the company.

The ratios which related to inventory are:

1) Inventory turnover ratio.

2) Inventory to current assets ratio.

3) Inventory to working capital ratio.

1) Inventory turnover Ratio:

Inventory turnover ratios are calculated to indicate inventories have been

used efficiently or not. The purpose is to ensure the blocking of turnover ratio

also know as stock velocity ratio. It is normally calculated as sales/ average

inventory or cost of goods sold/ average inventory cost. Inventory conversion

period may also be calculated to find the average time taken for clearing the

stocks.

Inventory turnover ratio= Cost of goods sold

Average inventory at cost.

St Mary’s School of Management Studies 62

 Or

= Net sales

Average inventory.

Particulars of the inventory turnover ratio

Cost of Opening Closing Average
Year goods sold Stock stock Stock
2003-04 66031920 140792572 132645579 1367190755
2004-05 11006393 132645579 139643054 1316443165
2005-06 10781700 139643054 96856628 118249841
2006-07 648180 96856628 58408917 776327725
2007-08 1365000 58408917 180942000 1196754585
2008-09 27609000 180942000 91179000 136060500

Inventory turnover ratio: = cost of goods sold

Average inventory at cost
For 2000-01= 66031920
1367190755
= 4.8

For the years

Year 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

St Mary’s School of Management Studies 63

Inventory
Turnover
4.8 0.83 9.12 8.34 0.11 20.29
Ratio

Inventory turnover ratio

25

20
values

15
Inventory turnover ratio
10

years

Conclusion:
It is seen from the graph that Inventory Turnover Ratio did
not show any particular trend during the years 2003-04 to 2008-09. ITR is
found highest during the year 2008-09 and lowest during the years 2003-04
and 2007-08.

St Mary’s School of Management Studies 64

2) Inventory to current assets: In it closing stock figure is divided by the

current assets depicts the proportion of current assets represented by the

inventories.

Inventory to current assets = inventory

Current assets

Particulars of inventory to current assets ratio:

Year Current assets Inventories
2003-04 701438780 374211066
2004-05 762313599 391778580
2005-06 704243441 275255565
2006-07 383396159 119325831
2007-08 984020000 529405000
2008-09 1452079000 707518000
Inventory to current assets = Inventory
Current assets
For 2000-01 = 374211066/ 701438780 = 0.53.
For the years
Year 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
Current
assets ratio
0.53 0.51 0.39 0.31 0.53 0.48

St Mary’s School of Management Studies 65

 Current assets to invemntory ratio

0.6
0.5
values

0.4
0.3
0.2
0.1
0
2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
years

Current assets ratio

Conclusion:
From the above graphical analysis it can be concluded that the ratio of
inventories to the total current assets has decreased during 2003-04 to 2006-07.
Later during 2007-08 it has increased and again declined during 2008-09.

St Mary’s School of Management Studies 66

3)Inventory to working capital:

In it the closing stock figure is divided by the working capital which depicts

the proportion of working capital represented by the inventories.

Inventory to working capital = inventory

Working capital
Where, working capital = current asset –– current liabilities.
Particulars of inventory to working capital
Year Inventory Working capital
2003-04 374211066 349927421
2004-05 391778580 329537680
2005-06 275255565 350578744
2006-07 119325831 100538999
2007-08 529405000 478763000
2008-09 707518000 643034000

Inventory
For 2000-01, inventory to working capital ratio= Working Capital
= 374211066
349927421
= 1.07.

For the years.

Year 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
values 1.07 1.19 0.78 1.19 1.11 1.10

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 inventory to working capital

1.4
1.2
values

1
0.8
values
0.6
0.4
0.2
0
2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
years

Conclusion:
The above graphical representation reveals that Inventory-
working capital ratio has declined from 1.07 during 2003-04 to 0.78
during 2005-06. Though the ratio has increased to 1.19 during 2006-07,
again it has declined to 1.11 and further to 1.10 during the years 2007-
08 and 2008-09 respectively.

St Mary’s School of Management Studies 68

 CHAPTER-V

SUMMARY OF FINDINGS, SUGGESTIONS AND

CONCLUSIONS

FINDINGS

♦ First three items constituted 15% of items and accounted for 80% of total

value of items.

♦ 4 to 8 items constituted 35% of total items accounted for 15% of total

value of items.

♦ The remaining items constituted 50% of items accounted for the 5% of

total value of items.

♦ The estimation of EOQ indicates a proper balance between the ordering

cost and carrying cost.

♦ It is observed that Lanco has maintaining a fair level of safety stock. This

ensures that production has been continuously made without any shortage

of raw material.

♦ The calculations of Inventory Ratios show that:

St Mary’s School of Management Studies 69

 ♦ Inventory Turnover Ratio for Lanco Industries has been fluctuating widely

during the period of study.

♦ Inventory to current Assets Ratio shows that there is no proper ratio

between these two.

♦ Inventory to Working Capital the same trend is found with Inventory

Turnover Ratio.

St Mary’s School of Management Studies 70

 SUGGESTIONS

♦ The Financial Manager should keep on eye on the Management of A items.

♦ Financial Manager has to design proper Inventory policy keeping the A

items in view.

♦ Though EOQ is well for the company some more attention much be paid

on to have a good balance between the ordering cost and carrying cost.

♦ The inventory turnover ratio must be improved. The variations and the

ratio must be kept in a proper way. So that fluctuations may not occur.

♦ The Inventory to current Assets ratio must be properly maintained.

♦ The ratio of Inventory to Working Capital is found good for Lanco

Industries.

St Mary’s School of Management Studies 71

 BIBLIOGRAPHY

PANDEY.I.M. Financial Management, 8th edition,

Vikas publishing (pvt) ltd., New Delhi.

Prassanna Chandra Financial Management Theory and Practice

6th edition. Tata Mc Graw- hill publishing

Company Ltd. New Delhi.

Pradeep kumar Elements of Financial Management,.

Kedar nath ram nath & co Meerut.

M.Y. khan & P.K. jain Financial Management text ,Problems & cases,
4th edition TATA MC grawhill Publishing
CO.ltd New Delhi.

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St Mary’s School of Management Studies 73