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INVENTORY

MANAGEMENT

Origin : 13751425; Late Middle English


inventorie and inventorium in Latin.
AIM
Aim of this presentation is to introduce the
topic of Inventory Management to an already
stressed, hard-pressed and unsuspecting class
of students.
SCOPE
Part 1 Basic Concepts.

Part 2 Systems and Methods.

Part 3 Miscellaneous Aspects.

Interactive Session and Conclusion.


PART 1 BASIC CONCEPTS
INVENTORY : FIN ACCTG
The assets that are:-
Held for sale in the ordinary course of business; or
In the process of production for such a sale; or
In the form of materials or supplies to be
consumed in the production process; or
In the rendering of services.
Relevance : Trading concern & Manufacturing
unit.
Loose tools v/s spares.
TYPES OF INVENTORY

Work in
process

Vendors Raw Work in Finished Customers


Materials process goods
Work in
process
.TYPES OF INVENTORY
Raw Materials Basic inputs that are converted
into finished product through the manufacturing
process.
Work-in-progress Semi-manufactured products
that need some more work before they become
finished goods for sale.
Finished Goods Completely manufactured
products ready for sale.
Supplies Office and plant cleaning materials that
do not directly enter production but are necessary
for production process and do not involve
significant investments.
RELEVANCE : INVENTORY
Constitute significant part of current assets.
CURRENT ASSETS

Realised or consumed in the operating cycle.

Held primarily for trading.

Cash or cash-equivalent.

(An asset which is not a current asset is classified as a non current asset)
RELEVANCE: INVENTORY
Constitute significant part of current assets.
On an average, inventory forms approx 60% of
current assets in Public Limited Companies in India.
Huge financial implications.
Effective and efficient management is imperative to
avoid unnecessary investment.
Improper inventory management affects long term
profitability and may cause failure ultimately.
10 to 20% of inventory can be reduced without any
adverse effect on production and sales by using
simple inventory planning and control techniques.
INVENTORY MGT
The act or manner of managing, handling, directing or
controlling the flow of inventory.
NEED :-
Demand related:-
Meet unexpected demands.
Smooth seasonal or cyclical demands.
Pricing related:-
Hedge against price increases.
Take advantage of quantity discounts.
Process and supply surprises related:-
Internal upsets in parts of or our own processes.
External delays in incoming goods.
OBJECTIVES: INVENTORY MGT
To maintain an optimum size of inventory for
efficient and smooth production and sales
operations.

To maintain a minimum investment in inventories to


maximize the profitability.

Effort should be made to place an order at the right


time with right source to acquire the right quantity
at the right price and right quality.
SUCCESS MANTRA
Ensure a continuous supply of raw materials to
facilitate uninterrupted production.
Maintain sufficient stocks of raw materials in
periods of short supply and anticipate price
changes.
Maintain sufficient finished goods inventory for
smooth sales operation, and efficient customer
service.
Minimize the carrying cost and time.
Control investment in inventories and keep it at an
optimum level.
WHAT IF WE OVER REACT?

Unnecessary tying down of firms funds and loss


of profit.
Excessive carrying costs.
Risk of liquidity- difficult to convert into cash.
Physical deterioration of inventories while in
storage due to mishandling and improper
storage facilities.
WHAT IF ONE IS TOO COOL!

Production hold-ups loss of labour hours.


Failure to meet delivery commitments.
Customers may shift to competitors which will
amount to a permanent loss to the firm.
May affect the goodwill and image of the firm.
IN A NUTSHELL
Track inventory.
How much to order?
When to order?

IF we know the value,


all these functions will
get addressed!!

BTW,it is tough to do inventories in Afghanistan because of the tally


ban.
PART 2 SYSTEMS & METHODS
INVENTORY SYSTEMS
Factor Periodic Inventory System Perpetual Inventory System

Basis of ascertaining inventory By actual physical count On the basis of records

Calculation of inventory Directly by applying the Closing Inventory = opening


method of valuation of inventory+ purchases cost of
inventories goods sold

Calculation of cost of goods Cost of goods sold = opening Directly calculated by applying
sold inventory + purchases the method of valuation of
closing inventory inventories

Lost Goods Cost of goods sold includes Cost of closing inventory


cost of lost goods (if any) includes cost of lost goods (if
any)
METHODS OF VALUATION
An inventory valuation allows a company to provide
a monetary value for items that make up its inventory.

Methods:-
First In First Out (FIFO) Method.

Last In First Out (LIFO) Method.

Weighted Average Cost/price Method.


FIFO METHOD
Based on the assumption that the goods that are
received first are issued first.
For purpose of assigning costs and not exactly for
purpose of physical flow of goods.
Goods sold, thus, consist of earliest lots and are
valued at the price paid for such lots.
The ending inventory consists of latest lots and is
valued at the price paid for such lots.
Balance sheet shows ending inventory costed as per
approx market price.
FOR EASE OF ASSIMILATION
(QUESTION) ABC Ltd. Provides you with the following
information :
- 1.1.20 11 Opening Stock 100 units @ Re 1.
- 2.1.20 1 1 Purchased 400 units @ Rs 1.50.
- 3.1.20 1 1 Issued 450 units.
-4.1.20 11 Purchase 500 units @ Re 2.06.
- 5.1.2011 issued 300 units.

REQUIRED : Compute the value of inventory and cost of


goods sold as on 5.1.2011 assuming:-
(a) Perpetual system; and
(b) periodic system under FIFO method.
1STOCK LEDGER UNDER FIFO METHOD
DATE RECEIPTS ISSUES BALANCE

Quality Rate Amt. Quality Rate Amt. Quality Rate Amt.


(Rs) (Rs) (Rs) (Rs) (Rs) (Rs)

1-1- _ _ _ _ _ 100 1.00 100


2011

2-1- 400 1.50 600 _ _ _ 100 1.00 100


2011 400 1.50 600

3-1- _ _ _ 100 1.00 100 50 1.50 75


2011 350 1.50 525

4-1- 500 2.06 1030 _ _ _ 50 1.50 75


2011 500 2.06 1,030

5-1- _ _ _ 50 1.50 75
2011 250 2.06 515 250 2.06 515
2a PERPETUAL SYSTEM
Closing inventory calculated as residual figures:-

- Opening inventory 100


- Add: Purchases ( 600+Rs.1,030) 1,630
- Less: Cost of good sold
(515+75+525+100) 1,215
- Ending inventory (A+B-C) 515
2b PERIODIC SYSTEM
Cost of goods sold is calculated as residual
figures:-
- Opening inventory 100
- Add: Purchase(600+1030) 1,630
- Less: Ending inventory
(250 x 2.06) 515
- Cost of goods sold (A+B-C) 1,215
LIFO METHOD
Based on assumption that goods that are received
last are issued first.
Assumption made for purposes of assigning costs
and not for actual physical flow of goods.
Flows of goods and costs may not coincide.
Goods sold, thus, consist of the latest lots and are
valued at the price paid for such lots.
The ending inventory consists of the earliest lots
and is valued as such.
Balance sheet has an inventory costed at old prices.
RETRACING OUR STEPS A BIT
(QUESTION) ABC Ltd. Provides you with the following
information :
- 1.1.20 11 Opening Stock 100 units @ Re 1.
- 2.1.20 1 1 Purchased 400 units @ Rs 1.50.
- 3.1.20 1 1 Issued 450 units.
-4.1.20 11 Purchase 500 units @ Re 2.06.
- 5.1.2011 Issued 300 units.

REQUIRED : Compute the value of inventory and cost of


goods sold as on 5.1.2011 assuming:-
(a) Perpetual system; and
(b) periodic system under LIFO method.
1STOCK LEDGER UNDER LIFO METHOD
DATE RECEIPTS ISSUES BALANCE

Quality Rate Amt. Quality Rate Amt. Quality Rate Amt.


(Rs) (Rs) (Rs) (Rs) (Rs) (Rs)

1-1- _ _ _ _ _ 100 1.00 100


2011

2-1- 400 1.50 600 _ _ _ 100 1.00 100


2011 400 1.50 600

3-1- _ _ _ 400 1.50 600


2011 50 1.00 50 50 1.00 50

4-1- 500 2.06 1030 _ _ _ 50 1.00 50


2011 500 2.06 1,030

5-1- _ _ _ 300 2.06 618 50 1.00 50


2011 200 2.06 412
2a PERPETUAL SYSTEM
Closing inventory calculated as residual figures:-

- Opening inventory 100


- Add: Purchases (600+Rs.1,030) 1,630
- Less: Cost of good sold
(600+50+618) 1,215
- Ending inventory (A+B-C) 462
2b PERIODIC SYSTEM
Cost of goods sold is calculated as residual
figures:-
- Opening inventory 100
- Add: Purchase(600+1030) 1,630
- Less: Ending inventory
(150 x 2.06) 462
- Cost of goods sold (A+B-C) 1,268
WEIGHTED AVERAGE PRICE METHOD
Based on the assumption that each issue of goods
consists of a due proportion of the earlier lots and is
valued at weighted average price.
Weighted average price is calculated by dividing the
total cost of goods in stock by the total quantity of
goods in stock.
This weighted price is used for pricing the issues
until a new lot is received when a new weighted
average price would be calculated.
This method evens out the effect of widely varying
prices of different lots that make up stocks.
FOR BETTER UNDERSTANDING
TOTAL
COST in
Units available Units sold Per unit cost
Opening inventory 100 -- 2.10 210
Sale -- 75 -- --
Purchase 150 -- 2.80 420
Sale -- 100 -- --
Purchase 50 -- 3.00 150
Total 300 175 780

1. The weighted-average cost per unit is 780/300 = 2.60.


2. Ending inventory is 125 units (300 175) at 2.60 = 325;
3. Cost of goods sold (ie 175 units at 2.60) = 455.
PART 3 MISCELLANEOUS ASPECTS
CLASSIFICATION OF INVENTORY
ABC Classification(consumption) (25/80+15/15+70/05)
XYZ Classification(value stored) (Hi,Med,Low)
HML Classification(unit-value stored) (Hi,Med,Low)
VED Classification(spare parts mainly) (Vital,Ess,Des)
FSN Classification(consumption) (Fast, Slow, Non)
SOS Classification(agriculture) (Seasonal, Non)
SDF Classification(availability) (Scarce, Difficult, Easy)
GOLF Classification (source of supply) Govt, Ordinarily
available, Local and Foreign)
EMERGING TRENDS IN INVENTORY
MANAGEMENT
Entering into long term contracts at a fixed price
to reduce uncertainties.
Just-in-time.
Kanbans Japanese technique (Only produce
when demand comes).
Internet based ordering systems.
Supply chain management.
Vendor development.
Investment in plant and machinery.
INVENTORY CONTROL RESPONSIBILITY
Purchasing naturally has vest interest in
inventories, even to the extend that in some
companies the purchasing and stores functions are
combined.
Production looks after the work in progress.
Logistics plays a major role in inventory control
Inventories are economic importance to finance
department.
The fact that materials must be moved from one
place to another is of importance to materials
department.