Chapter 5 Inventory Control

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CHAPTER 5 INVENTORY CONTROL

Objectives:

Learn the different kinds inventory control analysis.


Understand the meaning of inventory control and what the uses of it in the business are.

THE NEED FOR CONTROL

We have already seen how important it is to improve upon the return on capital, that is, profit
margin. But there are obvious limitations such as competition in the business world. One way of
improving the profit margin is to turn inventories into saleable products with less investment and
as quickly as possible so that higher sales targets can be achieved and more profits made with
less investment. In other words, a high inventory to sales turnover ratio is necessary to achieve
an improvement over return on capital.

WHAT IS INVENTORY CONTROL

The simplest language, inventory control may be said to be a planned method whereby
investment in inventories held in stock is maintained in such a manner that it ensures proper
and smooth flow of materials needed for production operations as 'well sales, while at the same
time, the total costs of investment in inventories is kept at a minimum. From the above definition
it follows that a comprehensive inventory control system must be closely coordinated with other
planning and control activities, such as, (planning, capital budgeting, sales forecasting, including
production planning, production scheduling and control. This impinges on a wide range of
operations, operating decisions and policies for production, sales and finance. The finance
controller of a company regards inventory as a necessary evil, since it drains off cash which
could he used elsewhere to earn some profits. The marketing manager always wants enough of
ready stock of finished goods inventories in order to give better customer service to ensure the
company's goodwill and would not like to see a sales opportunity lost for want of saleable ready
stock. The production manager does not want an out-of. Stock condition for which production
might be held up. It will, therefore, he seen that everyone- has some objectives which arc
connecting in nature. The basic problem is, therefore, to strike a balance between operating
MODULE INVENTORY MANAGEMENT AND CONTROL

efficiency and the costs of investment and other associated costs with large inventories, with the
object to keep the basic conflicts at the minimum while optimizing the inventory holding.
● Inventory control keeps track of inventories. TOO MUCH, TOO LITTLE or BADLY
BALANCED inventory is avoided as everything has a cost.

● Too much, leads to undue carrying charges in form of taxes, insurance, storage,
obsolescence, depreciation and undue blockage of capital.

● Too little, involves frequent ordering, loss of quantity discounts, higher transportation
costs, it may not fulfill the future/emergency requirement.

● In today’s dynamic world, situations are changing fast. Too little may become too much
very fast.

● To maintain the balance of too much and too little is critical task and can be done by
implementing inventory control.

FACTORS AFFECTING INVENTORY CONTROL

● The decision on inventory leads an impact on the whole organization. The number of
factors can be divided in the following categories.

1. Characteristic of Manufacturing System

2. Amount of Protection against shortages

3. Organizational factors

4. Other factors.

1. Characteristic of Manufacturing system The nature of production process, production


planning, and plant layout have an effect on inventory policy.

1. Degree of specialization of product.

2. Process Capability and flexibility.

3. Production capacity and storage.

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MODULE INVENTORY MANAGEMENT AND CONTROL

4. Quality reqts., shelf-life, obsolescence.


5. Nature of production system.

2. Amount of protection against shortage Due to fluctuation in demand of the product,


there should be protection at supply end. Buffer stocks help to do achieve this.

1. Change in size and frequency of orders.

2. Unpredictability of sales.

3. Structure of distribution pattern.

4. Costs associated with failure to meet demand

5. Accuracy of demand forecast.

3. Organizational Factors:

These are certain factors, which are related to policies, traditions and
environment of org.

1. Organizational structure.

2. Amount of capital available for stock.

3. Rate of return on capital on the opportunity cost.

4. Storage and warehousing policies.

4. Other factors.

These are related to overall environment of organizations in the specific region.

1. Inflation.

2. Strike situations.

3. Wars or some other natural calamities like floods, earthquakes, etc.

4. Differences between input and output.

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MODULE INVENTORY MANAGEMENT AND CONTROL

TYPES OF INVENTORY ANALYSIS


ABC inventory Control System:

Large numbers of
firms
have to maintain
several
types of inventories. It
is
not desirable to keep
the
same degree of
control
on all the items. The
firm
should pay maximum
attention to those
items
whose value is
highest.
The firm should,
therefore, classify
inventories to identify
which item should
receive the most effort in
controlling. The firm
should be selective in its approach to control investment in various types of inventories. This
analytical approach is called the ABC analysis and tends to measure the significance of each
item of inventories in terms of its value. The high value items are classified as ‘An items’ and
would be under the tightest control. ‘C items’ represent resp. least value and would be under
simple control. ‘B items’ fall in between this two categories and require reasonable attention of
management. The ABC analysis concentrates on imp items and is 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).

The following steps are involved in implementing the ABC analysis:

∙ Classify the items of inventories, determining the expected use in units and the price per
unit for each item.

∙ Determine the total value of each item by multiplying the expected units by its unit’s price.
∙ Rank the items in accordance with the total value, giving first rank to the item with highest
total value and so on.

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MODULE INVENTORY MANAGEMENT AND CONTROL

∙ Compute the ratios (percentage) of nos. of units of each item to total units of all items and
the ratio of total value of each item to total value of all items.

∙ Combine items on the basis of their relative value to form 3 categories- A, B and C.

Pareto’s law applied to inventories


The relationship between the percentage of items and the percentage of AUV (annual
usage value) follows a pattern

∙ A – about 20 % of items account for about 80 % of the AUV

∙ B - about 30 % of items account for about 15 % of the AUV

∙ C - about 50 % of items account for about 5 % of the AUV

An example:
A small firm inventories only ten items, but decides to setup an ABC inventory system With 20
% A items, 30 % B items, and 50 % C items. The company records provide the information
shown below.

Part No 1 2 3 4 5 6 7 8 9 10

Unit 1100 600 100 1300 100 10 100 1500 200 500 5510
Usage

Unit 20 400 40 10 600 250 20 20 20 10


Cost

AUV 22000 240000 4000 13000 60000 2500 2000 30000 4000 5000 382500

Part No. AUV in Cumulative Cumulative Cumulative Class


Descending AUV % AUV % of items
order
2 240000 240000 62.75 10 A

5 60000 300000 78.43 20 A

8 30000 330000 86.27 30 B

1 22000 352000 92.03 40 B

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MODULE INVENTORY MANAGEMENT AND CONTROL
4 13000 365000 95.42 50 B

1 5000 370000 96.73 60 C

3 4000 374000 97.77 70 C

9 4000 378000 98.82 80 C

6 2500 380500 99.48 90 C

7 2000 382500 100 100 C

Table: ABC Analysis

Just-In-Time (JIT) systems:

Japanese firms popularize the just-in –time (JIT) system in the world. In a JIT system material or
manufactured components and parts arrive to the manufacturing sites or stores just few hours
before they are put to use. The delivery of material is synchronized with the manufacturing cycle
and speed. JIT system eliminates the necessity of carrying large inventories, and thus, saves
carrying other related cost to the manufacturer. The system requires perfect understanding and
co-ordination between the manufacturer and the suppliers in terms of the timing of delivery and
quality of the material. Poor quality material and components could halt the production. The JIT
inventory system complements the total quality management (TQM). The success of the system
depends on how well a company manages its suppliers. The system puts tremendous pressure
on suppliers. They will have to develop adequate systems and procedures to satisfactory meet
the needs of manufacturers.

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MODULE INVENTORY MANAGEMENT AND CONTROL

Example:

One truck transportation company obtains much of its business by catering to companies that
must deliver parts to other companies “just in time”. The Toyota Company in Japan has
developed a scheduling discipline for internal control of in process material movement, called
kanban, which substantially reduces WIP
Inventories and hence reduces the associated costs.

Outsourcing:

A few years ago there was a tendency on the parts of many companies to manufacture all
components in house. Now more companies are adopting the practice out sourcing. Out
sourcing is a system of buying parts and components from outside rather than manufacturing
them internally. Many companies develop a single source of supply, and many others help
developing small and middle size suppliers of components that they require.

Example:

Tata motors has, developed number of ancillaries are able to maintain the high quality of the
manufactured components. The car manufacturing company, Maruti, which is now controlled by
Suzuki of Japan has the similar system of supply.

Computerized inventory Control Systems:

More and more companies, small or large size, are adopting the computerized system of
controlling inventories A computerized inventory control system enables a company to easily
track large items of inventories. It is an automatic system of counting inventories, recording
withdrawals and revising the balance. There is an in-built system of placing order as the
computer notice that the reorder point has become reached. The computerized inventory
system inevitable for large retail stores. Which carry thousands of items. The computer
information system of the buyer and supplier are linked to each other. As soon as the supplier’s
computer receives an order from the buyer’s system, the supply system process is activated.

🖰 For more information refer to the link provided:

https://www.camcode.com/asset-tags/what-is-inventory
control/https://cleartax.in/s/abc-analysis

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❖ To know more information about - CHAPTER 5- Inventory Control


PLEASE CLICK THE LINK: https://www.youtube.com/watch?v=f92gYBNwPqY

❖ To know more information about - CHAPTER 5-What are Common Inventory Problems
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References

https://www.tradegecko.com/inventory-management/inventory-control

https://en.wikipedia.org/wiki/Inventory_control

https://www.netsuite.com/portal/resource/articles/inventory-management/what-areinventory
management-controls.shtml
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