Inventory Management

Introduction

Inventories constitute most imp part of CA


On an average they are 60% of CA in public
limited cos in India
Nature of Inventories
Raw Material
Work-in-progress
Finished goods
Supplies, Stores and spares

The level of these inventories for a firm
depend on the nature of its business.
Need to hold inventories

Transaction Motive

Precautionary Motive

Speculative Motive
Objectives of Inventory
Management
2 conflicting needs
To maintain a large size of inventories
To maintain a minimum investment in inventories

Excessive and inadequate inventory are not
desirable

Objective shd be to determine and maintain
optimum level of inventory

Major dangers of over investment
Unnecessary tie-up of firms funds and loss of
profit
Excessive carrying costs
Risk of liquidity

Consequences of under investment
Production hold-ups
Failure to meet delivery commitment
Inventory Management Techniques
How much shd be ordered?

When shd it be ordered?

Economic order Quantity (EOQ)
EOQ is that inventory level that minimises the
total of ordering and carrying costs
Ordering costs include transportation, preparation
of pur order, inspecting, etc
Ordering costs increase with the no of orders

Carrying costs include storage, insurance
deterioration and obsolescence
Carrying costs increase with the increase in the
inventory
EOQ is that order size at which annual total costs of
ordering and holding are the minimum
Three approaches to determine EOQ are trial and
error approach, formula approach and graphical
approach




Q
AO
TOC =
2
Qc
TCC=
Q
AO
2
Qc
TC + =
c
AO 2
EOQ =
1
2
3
4
Q*
C
o
s
t
s

Ordering Cost
Order Size Q
Minimum
Total Cost
Quantity discount
Dis savings + savings in ordering cost Additional
Carrying costs

Dis savings = d x P x A
Savings in ordering costs =



Additional Carrying Costs =


(

= =
' Q
A
* Q
A
O
' Q
A
O
* Q
A
O
*) Q ' Q (
2
c
2
* Q
C
2
' Q
c = =


Reorder Point
It is that inventory level at which an order shd be
placed to replenish the inventory
Reorder Point = Lead x Av usage

Safety stock
Reorder Point = lead x Av usage + Safety Stock
ABC Inventory Control System
ABC analysis tends to measure the significance
of each item of inventories in terms of its
value.
The high value items are classified as A items
and would be under the tightest control. C
items represent relatively least value and
would be under simple control. B items fall
in between these two categories and require
reasonable attention of management.

The ABC analysis concentrates on imp items
and is also known as Control by Importance
and Exception (CIE)

As the items are classified in the importance
of their relative value, this approach is also
known as Proportional Value Analysis (PVA)