Inventory Management Bcom Notes

Inventory Management Bcom Notes:-

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Inventory Management

MEANING AND TYPES OF INVENTORY

The inventory means and includes the goods and services being sold by the firm and the raw materials or other components being used in the manufacturing of such goods and services. i.e., Raw material, work-in progress, finished goods and stores and supplies.

Need or Purpose to Hold Inventory: (1) Achieving Efficient Production Runs, (2) Reducing Ordering Costs, (3) Benefits of Quantity Discount, (4) Avoding Lost Sales and Reduction in risk of production shortages.

Inventory Management Bcom Notes

Risk and Costs of Holding Inventories: (1) Capital Costs, (2) Storage and Handling Costs, (3) Risk of Price Decline, (4) Risk to Obsolescence, (5) Risk of Deterioration in Quality.

Meaning of Inventory Management/Inventory Control: Inventory management is a scientific method of determining what, when and how to purchase and how much to have in stock for a given period of time. Infact, the inventory management seeks to maximise the wealth of shareholders by designing and implementing such policies which attempt to minimise the cost of procuring and maintaining the inventories.

OBJECTS OF INVENTORY MANAGEMENT

(1) To ensure continuous supply of materials, spares and finished goods so that production should not suffer at any time and the customers demand should also be met.

(2) To avoid both over-stocking and under-stocking of inventory.

Inventory Management Bcom Notes

(3) To maintain investments in inventories at the optimum level as required by the operational and sales activities.

(4) To keep material cost under control so that they contribute in reducing cost of production and overall costs.

TECHNIQUES OF INVENTORY MANAGEMENT

The techniques of inventory control/inventory management are as follows:

Determination of Economic Order Quantity.
Determination of Stock Levels.
Selective Inventory Control Techniques.
Inventory Turnover Ratio.

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

It is also known as the Economic Lot Size. E.O.Q. model helps in determining the optimum inventory level that should be ordered each time. Determination of EOQ involves two types of costs viz. Ordering Cost and Carrying Cost. (Inventory Management Bcom Notes)The EOQ is that inventory level for which if order is placed, the total of ordering and carrying costs will be minimum. At EOQ level the ordering cost approximately equals the cost of carrying inventory. Therefore, determination of E.O.Q. is a trade-off between two type of inventory costs: (i) Ordering costs and (ii) Carrying Costs.

Inventory Management Bcom Notes

E.O.Q. can be determined by the following formula:

Normal Usage	50 units per week each
Minimum Usage	25 units per week each
Maximum Usage	75 units per week each
Recorder Quantity	300 units
Recorder period	4 to 6 weeks

Calculate: (a) Reorder Level, (b) Minimum Level, (c) Maximum Level, (d) Average Stock Level

Inventory Management Bcom Notes

Solution.

(a) Recorder Level = Maximum Rate of Usage × Maximum Lead Time = 75 ×6 = 450 units

(b) Minimum Level = Reorder Level – (Normal Usage × Normal Lead Time)

(c) Maximum Level = Reorder Level – (Minimum Usage Rate × Minimum Lead Time) + Reorder Quantity = 450 – (25 × 4) + 300 = 650 units

(d) Average Stock Level = Minimum Level + ½ of Reorder Quantity = 200 + [3×1/2] = 350 units

2. DETERMINATION OF STOCK LEVELS

(I) Re-order Level: Re-order level is that level of material stock at , which it is necessary to take the steps for procurement of further lots of material. This is the level falling in between the two existences of maximum level and minimum level and is fixed in such a way that the requirements of production are met properly till the new lot of material is received. The re-order level depends upon:

Inventory Management Bcom Notes

(a) Minimum Stock Level or Safety Stock: Safety stock is a buffer to meet some unanticipated increase in usage. This represents the quantity which must be maintained in hand at all times.

(b) Procurement Time or Lead Time: The term lead time’ refers to the time normally taken in receiving the delivery of inventory after the order has been placed. (c) Daily Usage Rate of Inventory: The rate at which the inventory is being used up is called the usage rate.

Formula Computation Re-order Level:

(1) When safety stock, daily usage rate and lead time are given:

Re-order Level = Safety Stock + [Daily usage Ratex Lead Time]

= SS + [r × t_p]

Illustration 3: Given: Annual demand 13,000 units, lead time 6 weeks, Safety Stock 500 units. What will be re-order point assuming sales are even. (Meerut, 2013BP) Re-order Point = 500+ [(13,000 52) × 6] = 2,000 units

Inventory Management Bcom Notes

(2) When Maximum usage rate and Maximum procurement time are given:

Re-order Level = Maximum usage Rate × Maximum Procurement Time

(II) Minimum Stock Level: Minimum stock level is the lower limit below which the stock of any inventory item should not normally be allowed to fall. This level is also called safety stock or buffer stock level.(Inventory Management Bcom Notes)

Minimum Stock Level = Reorder Level – [Average or Normal Usage Rate × Average or Normal Lead Time]

(III) Maximum Stock Level: Maximum stock level represents the upper limit beyond which the quantity of any inventory item is not normally allowed to rise to ensure that unnecessary working capital is not blocked in stock items.

Inventory Management Bcom Notes

Maximum Stock Level = Minimum Level + Reorder Quantity

(Reorder Level + Reorder Qty.) – (Minimum Usage Rate × Minimum Lead Time)

(IV) Average Stock Level: The average stock level can be expressed in the formula given below:

Average Stock Level = [Maximum Stock Level + Minimum Stock Level] / 2

= Minimum Level + [Recorder Qty. / 2]

Illustration 4.

3. SELECTIVE INVENTORY CONTROL TECHNIQUES

In practice, all items of inventory cannot, and need not, be controlled with equal attention. An effective inventory management calls for an understanding and knowledge of the nature of inventories. Some inventory items may be very important while some may to be too small or may be too unimportant to warrant a tight and intensive control. The managements often lay down priorities for different items for the extent and nature of control required in respect of each of them. For this purpose, items may be severally classified on different bases. Important selective inventory control techniques are as follows:

Inventory Management Bcom Notes

(i) ABC Analysis Technique: This technique assumes the basic principle of “Vital Few Trivial Many” while considering the inventory structure of any organisation and is popularly known as “Always Better Control”.

This technique classifies the various inventory items according to their importance. ‘A’ class consists of only small percentage of total number of itmes handled but are most important in nature. ‘B’ class items include relatively less important items. ‘C’ Class items consist of a very large number of items which are less important.

Category	% of total value	% of total quantity
A	70 to 75	5 to 10
B	15 to 25	15 to 25
C	5 to 10	70 to 75

(ii) VED Analysis: In this analysis, the items are classified on the basis of their criticality to the production process or other services. In the VED classification of materials, V stands for Vital items without: which the production process would come to a standstill. E in the system denotes Essential items whose stock out would adversely affect the efficiency of the production system. Although the system would not altogether stop for want of these items, yet their non-availability might cause temporary losses in, or dislocation of, production. The D items are the Desirable items which are required but do not immediately cause a loss of production.(Inventory Management Bcom Notes)