Inventory Management

Introduction

• Inventories constitute most imp part of CA

• On an average they are 60% of CA in public limited co’s 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 firm’s 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

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Carrying C

ost

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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 =

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• 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)