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Meaning of Inventory
Inventory is one of the most visible and tangible aspects of doing business. In simple words, inventory is defined as the sum total of value raw material, WIP and FG though it depends largely upon the type of business. Inventory works as link between production & consumption of goods.
Types of Inventory
Material Inventory Raw Material Work in Progress Finished goods Consumables Spares Liquidity Inventory Cash & marketable securities :- cash and marketable securities can be thought of as an inventory of liquidity that allows separation of collection from disbursement. Without this liquidity inventory payment of bills would be tied to collection of accounts, in some cases, with payment delayed until accounts receivable are collected.
Inventory Management
The techniques of maintaining stock, keeping items at desired level whether they are raw material, WIP or finished goods. Inventory management means efficient control and management of capital invested in raw materials and supplies, work in progress & finished goods for the purpose of obtaining maximum return from the investment.
Cont..
Inventory management is most important as it involves around 25% to 30% of the total investment. It is the role and responsibility of purchase and production function as also of the manufacturing and marketing functions.
Objectives
Operating objectives
1. Regular flow of material 2. Risk minimization 3. Avoiding over stocking and under stocking
Financial objectives
1. Making possible a minimum level of investment 2. Ensure no losses 3. No duplication of purchases so maintaining the stocks likewise
Material Costs
These are the cost of purchasing the goods plus transportation and handling charges. It may be calculated by adding the purchase price (less any discount), the delivery charges and sales tax, if any. Purchase Price + Delivery charges + sales tax Discount.
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Ordering cost
1. 2. 3. 4. 5.
Every time of an order is placed for stock replenishment, certain costs are involved. The ordering cost may vary dependent upon the type of item. Ordering cost pertain to placing an order for the purchase of certain items of raw materials. This cost includes:Cost of preparation of purchase order. (typing, dispatch, postage, etc.) Cost of sending reminders to get the dispatch of the items Cost of transportation of goods Cost of receiving and verifying the goods Cost of unloading of the item.
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Cont..
A large organization can fixed the ordering cost regardless the number of order can change. Ordering costs are inversely related to the level of inventory.
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Carrying cost
Carrying cost constitute all the costs of holding items in inventory for a given period of time. They can expressed either in rupees per unit per period or as a % of the inventory value per period. It includes: Storage & handling costs Interest on capital Taxes, depreciation and insurance. The cost of fund invested in inventories Product deterioriation and obsolescence.
WCM / Dr. Teena 13
Cont..
The level of inventory and carrying cost are positively related and move in the same direction. Like ordering cost inventory carrying cost contain both fixed & variable components. Mostly carrying cost vary with the inventory level but a certain portion of them such as warehouse rent and depreciation on inventory handling equipment are relatively fixed over the short run.
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Example
O 1 2 3 4 5 6 OC 100 80 70 50 30 20 CC 20 30 40 50 90 110 TC 120 110 110 100 120 130
TC
CC
OC
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Techniques
Modern Technique
Traditional
Technique
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Modern Techniques
EOQ ROL Stock Levels Selective Techniques
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Traditional Techniques
Perpetual Inv. System Periodic order system
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Assumptions
1. The usage demand of the various items of inventory is equal through out the period. 2. There is no lead time involved 3. There only two distinct costs involved in computing the total costs:- (a) ordering cost (b) carrying cost 4. The cost of every order remains uniformly the same, irrespective of the size of the order. 5. The inventory carrying cost is a fixed % of the average value of inventory.
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Methods of EOQ
1. Formula Method 2. Graphic Method 3. Trail & Error Method
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Formula Method
It is also known as Square Root Formula or Wilson Formula method. The EOQ is three steps :Step 1 = calculation of EOQ EOQ = (2AO) / PC
O = Cost per Order (it is assumed to be fixed or constant) A = Annual Usage or Sales P = Price per Unit C = Carrying cost % or PC = carrying cost in amount
Example 1
The annual sales of friends electrical limited is estimated at 1800 units, the cost price per unit is Rs. 80/-. The ordering cost per order is (fixed) Rs. 60/- and the inventory carrying cost per unit is Rs. 2/-.
EOQ =
(2AO) / PC
Eoq= (2x 60x 1800) / 2 Q= 328.63 or 329/No. of order = 1800 / 329 = 5.47 orders or 6 orders Time gap between two orders = 365 / 6 = 60.83 days
WCM / Dr. Teena 25
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Example
A Ltd uses an average of 1000 bags of cement each year. They have an ordering cost per order of Rs. 60/-, order in quantities of 350 bags and have carrying costs of Rs. 10 per bag each year. Calculate total cost. Total Cost of Inventory = Cost of Purchases + Ordering Cost + Carrying cost = 1000x 60 + 1000 / 350 x 60 + 350/2 x 10 = 61921/- .
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Example of Discount
In Maheshwari company the annual consumption of a particular item is 4000 units. The purchase price per unit is Rs. 10. ordering cost is 60/- per order. Carrying cost is 30% of the value of inventory. The supplier is offering a bulk discount of 1% on lots of 800 units. Advice whether the EOQ should be raised to 800 units.
WCM / Dr. Teena 29
Graphic Method
The EOQ can also be determined with the help of graph. Under this method OC, CC and TC according to different lot sizes are plotted on the graph. The point at which the line of inventory carrying cost and the line of ordering cost intersect each other is the EOQ. At this point the total cost line is also minimum.
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Example
O 1 2 3 4 5 6 OC 100 80 70 50 30 20 CC 20 30 40 50 90 110 TC 120 110 110 100 120 130
TC
CC
OC
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Lead Time
Lead time is the time lag that takes place between the placement of an order and the actual supply / delivery made in the company godown. As we have seen earlier the standard EOQ model presumes as if there is no lead time involved. It means the order can place when inventory level comes to zero. It is not possible. Therefore we should directly take account the lead time too while calculating EOQ. This can be done by introducing a slight modification in the standard EOQ analysis.
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Usage Rate
This is the rate per day at which the item is consumed in production or sold to customers. It is expressed in units. It is calculated by dividing the total consumption by no of days in a year or 360.
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Safety stock
Safety stock as the minimum quantity of inventory which a firm decides to keep always protect itself against the risk & losses. In actual practice one can neither estimate the lead time nor the daily usage so accurately and exactly. Accordingly we should always keep some safety stock with us to meet such uncertainty.
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ROL Formula
Re- Order point can computed as in case safety stock is not given = Re-Order point = Lead time X Daily usage = 5 X 20 kg. = 100 kg. is order point.
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Stock Level
For avoiding the under stocking and over stocking most of the large companies adopt a scientific approach of fixing stock levels. These levels are :Maximum Level Minimum Level Re-order Level Re-order Quantity / EOQ
1. 2. 3. 4.
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Formula
Max. stock =
ROL + ROQ (Min consumption x Min re-order period) ROL = Re-order level ROQ = Re order quantity If safety stock is given than formula will be = Max. stock = EOQ + Safety Stock
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Re-order Level
When to place a order is also an important question requiring a suitable answer. The optimum order point or order level is the level of inventory at which the EOQ of stock (it means EOQ is ordering second, third time etc) should be ordered again. ROL = Max. daily usage X Max. lead time
OR
ROL = Max consumption X Max re-order period If safety stock is given than add safety stock in above formula.
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Average stock
It represent the stock which is maintained in the stores. This level is above the minimum level and below the maximum level. AS = Min stock + Max. stock / 2 AS = Min stock + Re-order quantity
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Re-order Quantity
It is known as EOQ. Formula for calculating EOQ will be same.
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Danger level
Sometimes purchase material are not received in time and stock level goes below the minimum level. In order to meet such type of situation a danger level is fixed. Danger level is a level at which normal issue are stop and material are issued for important job only. Danger level means less than minimum stock. At this level the minimum required raw material is purchased at any price , the raw material at this level is arranged at war level.
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Formula
There are two opinion based formulas for calculation of danger level: 1st opinion= It being emergency period, these purchases are costly and hence to be bought minimum of quantity. DL =Minimum rate of consumption X Emergency delivery period 2nd opinion = emergency has no definite limit, so maximum quantity to be bought to tide over further arising problems. DL=Maximum rate of consumption X Emergency delivery period
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Example
Two material A & B are used as follows:Min = 50 units per week each Max. = 150 unit per week each Normal uses = 100 units per week each Re-order quantity = A = 600 unit B = 1000 unit Delivery period = A = 4 6 week B = 2 4 week
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Solution
ROL = Max. cons. X Max re-order time A = 150 x 6 = 900 unit B = 150 x 4 = 600 unit
Min Level = ROL (NC X Normal del. Period) = A = 900 ( 100 X 5) = 400 unit = B = 600 (100 x 3) = 300 Unit Normal Delivery Period = A = 4 + 6 / 2 = 5 days B = 2 + 4 / 2 = 3 days
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Cont..
Max. Level = ROL + ROQ ( Min consumption X Min delivery Period) A = 900+600 (50 x 4) = 1300 unit B = 600+1000 (50 x 2) = 1500 Unit Average Stock = Min st. + max. st./ 2 A = 400 + 1300 / 2 = 850 units B = 300 + 1500 / 2 = 900 Units
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Example
A company uses annually 50,000 units of an item each costing 1.20/- each. Each order cost 45/-. And inventory carrying cost 15% of the annual average inventory value. Find out = EOQ = if the company operates 250 days a year the procurement time is 10days and safety stock is 500 units find ROL, max. & Min. inventory and average stock
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Solution
EOQ = 5000 units (Calculate) Consumption per day = 50,000 / 250 days = 200 units ROL = safety stock + (Lead time x consumption per day) = 500 + (10 x 200) = 500 + 2000 = 2500 units Max. inventory = ROL + EOQ (Min consumption during lead time) 2500 + 5000 ( 10X200) = 5500 units Min inventory = ROL (Normal consumption in lead time) = 2500 (10 x 200) = 500 units Average stock = 500 + 5500 / 2 = 3000 units
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ABC Analysis
Always Better Control (ABC) is an application of the principle of Management by Exception to the field of inventory control. Under this technique all the items of inventory are classified in the following three categories i.e. A, B, C on the basis of usage rate. The A, B, & C category value will be decided by company. The value is vary according to company. Different company may have different value of A, B, & C category. This value may be change as per time also.
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ABC Analysis
ABC analysis may be defined as a technique where inventories are analyzed according to their value so that costly items are given greater attention and care by management. Classification can be done on the basis of value of stock not on the basis of quantity of stock. A Category items are of high value . B category items are of moderate value C category items are of low.
Category
A B C
% of Total Value
70 80 % 20 25 % 5 10%
WCM / Dr. Teena
% of Total Quantity
5 -10 % 20 30 % 60 70 %
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Objective of ABC
The main purpose of ABC analysis is to indicate the degree of control required for inventory items of each category. A category items will require tight control. B category items will require less control. C category items require general control.
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Example
No of units were = 100 Value of total 100 unit were = 100000 no of item value A 20 80,000 B 30 15000 C 50 5000
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1
Ite Units m (1) s
A B C 8000 15000 5000
2
Unit Cost (2)
5.50 1.70 30.40
Total Cost ( 1 X 2)
44,000 25,500 1,52,000
Ite TC in m Descending s order C G A F B D E 1,52,000 1,28,000 44,000 36,000 25,500 11,250 3,250
D E F G
TOTAL COST
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VED Analysis
Virtual , Essential, Desirable items. In this model item will be divided in V, E, D category according to their importance. The organization may focus more on virtual and less focus on desirable items.
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E
Require average attention in all three category.
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SDE Analysis
SDE ( Scarce, Difficult and Easy) analysis evaluates the importance of the inventory items on the basis of availability. Scarce (S) items are those items which are in short supply and mostly such items constitute important items. Difficult (D) items refer to such items which cannot be procured easily. Easy (E) items are the items which are easily available in the market.
WCM / Dr. Teena 64
FSN Analysis
FSN (Fast, Slow, Non moving) in this technique inventory are grouped according to the movement into the following categories. Fast (F) moving = these are stored in large quantities and a close watch on the movement of such items is kept. E.g Raw Material Slow (S) =these are not frequently require by the production dept. E.g. production equipments Non-moving (N) =these are rarely required by the production dept. A smaller number of items are kept in stores.
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Inventory systems
Records pertaining to quantity and value of inventory in hand can be maintained according to any of the following systems:1. Periodic inventory system 2. Perpetual inventory system 3. Just in Time Inventory System
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First in First out (FIFO) :- under this method, it is assumed that the materials / goods first received are the first to be issued/ sold. Last in first out (LIFO) :- this method is based on the assumption that last item of material / goods purchased are first to be issued / sold. IMPORTANT:- In both method if opening balance of stock is there then this balance qty & its price always shown in balance column only.
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Receipt Jan. 1 Balance 50 units @ 4/Jan. 5 Job no. 10, 40 units @ 3/Jan. 8 job no. 12, 30 units @ 4/Jan. 15 job no. 11, 20 units @ 5/Jan. 26 job no 13, 40 units @ 3/ISSUE:- Jan. 10 , 70 units Jan. 12, 10 units Jan. 20, 20 units Jan. 24, 10 units
24 April 2013 Material Control / Dr. Teena 71
FIFO Method
Date 1st Jan 5th Jan 8th Jan Qty -40 30 P --3 4 Amt --120 120 Qty ------P ------Amt -------Qty 50 50 40 50 40 30 20 30 10 30 10 30 20 20 20 10 20 70 (total) P 4 4 3 4 3 4 3 4 3 4 3 4 5 4 5 5 5 --Amt 200 200 120 200 120 120 60 120 30 120 30 120 100 80 100 50 100 270 (total)
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------20
------5
-----100
50 20 10 ---
4 3 3 ----
200 60 30 ----
20th Ja
---
---
----
10 10 10 ---
3 4 4 ---
30 40 40 ---
--40
--3
--120
24 April 2013
Average Method
Qty P Amt Qty P Amt Qty P Amt 200 2.00 400 300 2.40 720 250 2.20
(Ave. P)
1220
720
24 April 2013
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Amt 400
300
2.40
720
250 2.24
500
560 250
2.24
(w.a.p.) = 1120 /500
1120
560
2.24
250
2.60
650
500
2.42
(w.a.p) = 1210 / 500
1210
200
2.42
2.42 2.42
726 726
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24 April 2013