Part-I : Commerce DSBM 5.

Inventory Control

5. Inventory control

Inventory control
Definition: (S.16, W.15, S.15, W.14): Inventory control Means constant checking and evaluation of stored
inventories.

Inventory:
Definition:An inventory can be described as sum of the value of raw materials, fuels and lubricants, spare
parts, maintenance consumables, semiprocessed materials and finished good stock of a business firm at any
given point of time.

Objectives of inventory control: (S.14)

1. Maximum customer service‐ Customer service is improved if inventories are raised to a very high level
and production schedules are kept flexible to meet the changing demands.
2. Minimum inventory investment‐The inventories block the capital of a business enterprise, since they
generate storage cost or become obsolete in storage. So minimum investment is required to raise inventory.
3. Low cost plant operation‐The overall plant costs are kept low by stable production which is possible
only by having sufficient inventories.

Functions of Inventory Control

1. Low inventories: As per market condition, keep inventories as low as possible.
2. Forecast market and economic conditions of supply: With regards to availability of materials, forecast
market and economic conditions.
3. Maintain sufficient stock: Maintain sufficient stock, to meet expectations of customers and prompt
delivery of goods.
4. Proper records: Maintain proper records, to supply accurate and regulate material reports to management.
5. Minimize out of stock danger: Minimize “out of stock” danger which result in crash purchase at
uneconomical rates.

Various Inventory Control Techniques: (S.16, S.15, S.14)

Different techniques commonly used to control the inventory include:
1. ABC analysis
2. Economic order quantity
3. Perpetual inventory system
4. Review of slow & non‐moving items
5. Input‐output ratio analysis
6. Setting of various levels
7. Establishing an effective purchase procedure
8. Use of material budgeting
9. Scrap & surplus disposal
10. VED analysis

1. ABC : (S.16, W.15, S.15, W.14)

ABC is Always Better Control
● This technique is used generally in big stores where large inventory items are stored.
● The products are divided into three groups A,B & C., according to the cost of the material & money
value of consumption.
A items B items C items
it covers 10% of the total it covers 20% of the total it covers 70% of the total
inventories. inventories inventories
it consumes about 70% of it consumes about 20% of it consumes about 10% of
total budget. total budget. total budget.
it requires very strict control. it requires moderate control. it requires loose control.
it requires either no safety it requires low safety stocks it requires high safety stocks
Part-I : Commerce DSBM 5. Inventory Control
stocks or low safety stocks.
it needs maximum follow up it needs periodic follow up it needs close follow up
it must be handled by senior it can be handled by middle it can be handled by any
officers management official of the management

Advantages of ABC control :

1) The investment in inventory can be regulated & funds can be utilized in the best manner.
2) Closer & strict control on valuable items is possible.
3) It helps to maintain enough safety stock of C items.
4) This type of control helps in the maintenance of high stock turn over.
5) It reduces the inventory carrying cost.

2. EOQ (W.15, S.15):

It is Economic Order Quantity. This technique is used to find out how much of the inventory is to be
ordered. The correct quantity to buy is the quantity at which the ordering cost and the inventory carrying
cost will be minimum.

Ordering cost: (S.16): The ordering cost consists of the cost of paper work involved in placing an order,
like use of paper, typing, posting, filing etc. It also includes the cost of salaries of staff involved in this work,
the costs incidental to placing an order like follow-up, receiving, inspection.

Inventory carrying cost:(S.16):It is represented by items like rent of storage, cost of insurance and taxes,
salaries of store-keeper and losses in stores due to pilferage, wastage, breakage etc.

Methods for Determination of EOQ:

A) Tabular determination of EOQ
B) Graphic presentation of EOQ
C) Determination of EOQ by algebraic formula

A) Tabular determination of EOQ

A tabular arrangement of data relating to items of materials helps in the determination of an approximate
EOQ. This arrangement may help the company to find out the orders that need to be placed weekly, monthly
or yearly. EOQ is where the lowest total annual cost for purchasing the items is observed.

Number of orders per year: It is number of placing the order per year.

Annual order cost: It is number of order X Order cost.

Annual Inventory carrying cost: It is calculated by using formula

Annual Inventory carrying cost = Order cost X Annual usage

100 Number of orders per year

Total annual cost: It is sum of ordering cost and inventory carrying cost.

For eg. The order cost is Rs.4 per order. Inventory carrying cost is 10% of the rupee value of annual usage.
Rupee value of the annual usage is Rs. 1000.

Sr.No. Numbers of Annual ordering Annual Total Annual

orders per year cost Inventory cost
Carrying cost
1 12 48 8.33 56.33
2 6 24 16.66 40.66
3 4 16 25.00 41.00
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4 3 12 33.33 45.33
5 2 8 50.00 58.00
6 1 4 100 104.00

B) Graphic presentation of EOQ: This graph is plotted between order quantity and cost to order and carry,
The ideal point where the sum of both the costs is minimum, i.e. the point A is EOQ.

Fig: 5.1: Graphic determination of EOQ

C) Determination of EOQ by algebraic formula : EOQ can also calculated by using the following
formula

Where, a=Annual consumption

b=Buying cost per order
c=Cost per unit of material
s=Storage & other inventory carrying cost

3. Perpetual Inventory system:

This is a method of recording the store balance after every receipt and issue to facilitate regular checking
and to prevent closing down for stock taking. All errors detected are adjusted in Bincard and store ledger
under proper authority.
It includes:
A) Bin card
B) Store ledger
c) Continuous stock taking

A) Bincard: This is ready reference document maintained by store keeper, to keep record of all items of
materials and goods in his store. It shows quantities of each material received, issued and in stock. Each
Part-I : Commerce DSBM 5. Inventory Control
receipt, issue or return is recorded in bincard in a chronological card and latest balance is shown after each
receipt and issue.

Format of Bincard:
Name of organization
Description of Material: Bin No.:
Code No. : Normal quantity to order:
Stores ledger folio No.: Maximum stock level:
Re-order stock level:

Date Receipt Issue Balance quantity

G.R. No. Quantity S.R. No. Quantity

B) Store ledger: It is kept in the cost accounting department. For easy removal and insert, store ledger is
generally maintained in form of loose leaf cards.

Format of Store ledger:

Name of organizatio
STORES LEDGER ACCOUNT
Description of Material: Maximum stock.
Code No. : Minimum stock:
Bin No.: Re-order level:
Location: Ordering quantity:
Unit:

Date Receipt Issue Balance Stock verifird

G.R Qt Rat Amt S.R Qty. Rate Amt Qty. Rate Amt Date Initial Remarks
. y e .
No. No.
G.R. No.: Good Receipt Number, S.R. No.: Stock receipt Number

C) Continuous stock taking: Under this system, only limited number of items is verified on a day. Each item
gets checked for certain number daily or at frequent intervals in a year. It is verified with bincard and store
ledger. In case of any difference between this is found, it has to be pointed to the management.

Advantages: (S:15)
1. It helps in detection & immediate rectification of errors.
2. It ensures a reliable checking of the store items.
3. Timely action can be taken on shortages.
4. It serves as moral check on staff.
5. Overstocking & under stocking is avoided.
6. Helps in completion of profit & loss account & balance sheet.

4. Review of slow and non-moving items:

Proper inventory control affects significantly on total cost of production. So, proper system must be
enforced to detect and control slow moving, obsolete and dormant materials.

Slow moving materials: W.14

Part-I : Commerce DSBM 5. Inventory Control
Slow moving materials are those items which are moving at slow rate. Slow moving materials are to be
valued at cost, replacement price or net realisable value, whichever is less.

Dormant materials : W.14

Dormant materials are those items which are moving temporarily because of seasonal production.

Obsolete items : W.14

Obsolete items are those which have become useless due to change in design, method of manufacture
,product or process etc.

In order to detect, slow and non moving, the following steps may be taken:
1. Periodic report: A monthly or quarterly report of non-moving items of stock is prepared, includes its
purchase, consumption and balance in hand and report send to the management.

2. Obsolete items: A well designed information system has to devised to locate obsolete items, these can be
utilized and its further purchase can be stopped.

3. Moving ratio: In order to differentiate slow moving items, dormant and dead stocks, moving ratio should
be calculated periodically. These ratio show the turnover of these items for presentation to the management.

5. Input-Output Ratio Analysis

Input-output ratio is ratio between quantity of material charged to the production process and quantity of
material in the final output.
E.g. 2kg of material A is put in production process and the content of this material in the final product is
1.6kg.
Input-output Ratio = 2/1.6 X 100 = 125%.

Advantages:
1. It determines the efficiency of the manufacturing department.
2. It helps in the comparison of actual consumption of material with the standard consumption.
3. It indicates whether the use of material is favourable or unfavourable.
4. The cost of raw material in the finished product can be find out by multiplying the cost of raw material
per unit by the input-output ratio.
E.g. A drug and pharmaceutical company uses chemical ‘A’ as a raw material at Rs. 100/kg. The I-O ratio
125%. Due to non-availability of this raw material, two other substitutes are available as followes.
Recommend which of the following material can be used.

Material Rate Per Kg I-O Ratio

A1 Rs. 150/- 110%
A2 Rs. 120/- 140%

The cost of the material = Input/Output X Rates per unit in the finished product.

A1 = 110/100 X 150 = Rs. 165/kg

A2 = 140/100 X 120 = Rs. 168/kg

Taking into consideration, the cost of raw material chemical A1 is recommended because it is more
economical.

6. Setting of various levels:

In order to maintain inventory control, it is important to decide various levels of materials as maximum
level, minimum level and reorder level. These levels are not permanent but can be changed by considering
the factors like rate of consumption, storage place, amount of capital needed and available, nature of
material, market trend, fashion habits, Government restrictions, risk and lead time.
Part-I : Commerce DSBM 5. Inventory Control
Types of stock levels:
1) Maximum stock level
2) Minimum stock level
3) Re‐order level/ Safety stock/ Buffer stock
4) Danger level

Maximum stock level: W.14

Maximum stock level represents the upper limit beyond which the quantity of any item is not normally
allowed to rise. It can be calculated by using formula:
Maximum Level = Reorder level + Reorder quantity –Minimum consumption

Minimum consumption = Minimum consumption per week X Minimum reorder period

Minimum Stock Level/ safety stock: W.14

This is the lower limit below which the stock of any item should not normally be allowed to fall. The main
purpose of determining this limit is to protect against the possibility of a particular item going out of stock
and there is further danger of stoppage of its production and supplies. It can be calculated by using formula:

Minimum Level = Reorder level – (Normal consumption per week x Average delivery time) or Normal
reorder period

Importance of Safety stock: The main purpose of determining this limit is to protect against the possibility of
a particular item going out of stock and there is further danger of stoppage of its production and supplies.

Re order level: W.14

Re order level is fixed between the minimum and maximum stock levels.
Reorder level = Minimum consumption X Maximum re-order period.

Danger Level
This is generally below the minimum stock level. At this point, urgent action must be taken to prevent stock
out. Normal stock level should never be fall below minimum stock level. It can be calculated by using formula:
Danger level = Average rate of consumption X Emergency supply time

7. Establishing an Effective Purchase procedure

It means sequence of steps followed for purchase transaction and includes:
1. Realisation of need of item and filled the requisition form.
2. Identify the sources.
3. Select appropriate supplier.
4. Place the order to selected supplier.
5. The received goods checked thoroughly.
6. Check the invoice and make the payment.
7. Record the purchase transaction.
Every organisation prepares their purchase policies and procedure in its purchase manual in view the
objectives of company. Good purchase policies and inventory control are linked with each other.

Advantages:
1. It acts as a guide for future action.
2. It provides authentic records about the inventory which is needed for inventory control.
3. The purchase order is a legal document which helps in case of any legal problems.

8. Use of Material Budgeting

In this method. Purchase budget is prepared for both whole and individual item. During the preparation of
material budget, the following factors are to be considered:
Part-I : Commerce DSBM 5. Inventory Control
1. Increase or decrease in the sales of the previous month in comparison with the corresponding monthly
sales in the previous year.
2. Adjustment of over buying or under buying during the previous month.
A separate Purchase journal is maintained and it covers when any purchase made, it is subtracted from the
balance of the purchase budget. By referring purchase budget, concerned person know the whether buying is
too much or too little.

9. Scrap and surplus

Definition: scrap (W.14, S.15, W.15, W.16) Scrap is the residue incidentally obtained from manufacturing
processes.
Definition: surplus (W.14, W.15)
Surplus items are those items which are not required by the organisation.

Types of scrap : W.14, S.15, W.16

1) Legitimate scrap : The scrap which can be predetermined or anticipated in advance due to
manufacturing operations .E.g. Material obtained in the form of granules and powder in granulation process
during tablet manufacturing.
2) Administrative scrap: This scrap results when material etc. becomes obsolete due to change in design.
3) Defective scrap: The scrap results from substandard raw material and poor workmanship in handling
such materials.

Procedure followed for disposal of scrap and surplus (S.15, W.15, W.16)
There are two methods for disposal of scrap and surplus materials;
 Scrap and surplus material is sold if it cannot be recycled into useful material for subsequent production
of the basic product.
 It can be processed into useful raw materials for subsequent production of basic products.

Scrap control can be done by S.15

1) By providing proper attention during designing of the product.
2) By selecting the right material and equipment during production
3) By selecting right type of personnel with proper training.

10.VED Analysis: (W.16, S.14)

This system is based on utility of items. In a drug store VED analysis is useful in controlling & maintaining
the stock of various types of formulation of a particular group of drugs. The different brands of medicicine
are classified into following categories-
V=vital.
E = essential
D-desirable.

There should be maximum Stock of vital items, followed by essential items & then desirable items.
e.g Acetyl salicylic acid brands available are Disprin, Micropyrine and Anacin, hence divide as follows:
V- Vital =Disprin = Higher quantity of prescription
E - Essential =Micropyrine = Moderate quantity of prescription
D - Desirable = Anacin = very less prescription

Q. State how inventory carrying cost of business can be reduced. (W.15-Q-1-c-2mks)

Inventory carrying cost includes
 Rent on storage
 Cost of insurance and taxes
Part-I : Commerce DSBM 5. Inventory Control
 Salaries of the store keeper
 Losses in store due to pilferage, wastage breakage etc.

To reduce the inventory carrying cost the above factors has to be considered and necessary action has to be
taken so as to minimize the above cost