ADVANCED FINANCIAL MANAGEMENT

Module-4 (7 Hours)
Inventory Management: Purpose and functions of inventories -Types of inventories (Raw-
materials, work-in-progress (WIP), finished goods & Maintenance, Repairs and Operations
(MRO). Determination of inventory control levels: ordering, reordering, danger level.
Techniques of inventory management- Economic Order Quantity (EOQ model). Pricing of
raw material - Monitoring and control of inventories- ABC Analysis. (Theory and problems)
Dr UMA K
Assistant Professor
4. Inventory Management
4.1. Introduction to Inventory Management:
1. Definition: Inventory management is the process of planning, organizing, and
controlling the procurement, storage, and utilization of inventory to ensure optimal stock
levels.
2. Purpose: It aims to balance supply and demand while minimizing costs associated with
holding, ordering, and stockouts.
3. Scope: It covers raw materials, work-in-progress (WIP), and finished goods across
various industries like manufacturing, retail, healthcare, and logistics.
4. Key Objectives:
o Ensure continuous production.
o Reduce inventory holding costs.
o Prevent stockouts and overstocking.
o Improve order fulfilment and customer satisfaction.
5. Types of Inventories:
o Raw Materials: Basic inputs for production.
o Work-in-Progress (WIP): Semi-finished goods in production.
o Finished Goods: Products ready for sale.
o MRO (Maintenance, Repair, and Operations) Inventory: Spare parts and supplies for
operations.
6. Importance of Inventory Management:
o Helps businesses maintain a smooth supply chain.
o Reduces wastage and improves profitability.
o Ensures timely availability of products to meet customer demand.
7. Methods of Inventory Control:
o Just-in-Time (JIT) Inventory System.
o Economic Order Quantity (EOQ).
o ABC Analysis.
o FIFO (First-In-First-Out) & LIFO (Last-In-First-Out).
8. Technology in Inventory Management:
o Use of ERP (Enterprise Resource Planning) systems.
o Barcode and RFID tracking for inventory accuracy.
o AI and data analytics for demand forecasting.
9. Challenges in Inventory Management:
o Demand forecasting inaccuracies.
o Supply chain disruptions.
o Managing perishable and obsolete inventory.
10. Conclusion: Effective inventory management is crucial for business success, ensuring
cost efficiency, operational smoothness, and customer satisfaction.
4.2. Meaning of Inventory Management:
1. Inventory Management refers to the process of overseeing and controlling the
ordering, storage, and usage of materials, work-in-progress (WIP), and finished goods
within an organization.
2. It ensures that the right quantity of inventory is available at the right time to meet
production and customer demands.
3. It aims to balance supply and demand while minimizing costs associated with
holding, ordering, and stockouts.
4. Effective inventory management improves operational efficiency, cash flow, and
overall business profitability.
5. It involves techniques like Just-in-Time (JIT), Economic Order Quantity (EOQ), ABC
analysis, and stock audits.
Definitions of Inventory Management:
1. According to Donald Waters: “Inventory management is the process of efficiently
supervising the constant flow of units into and out of an existing inventory."
2. According to F. Robert Jacobs & Richard B. Chase: "Inventory management is the
planning and controlling of inventories to meet the competitive priorities of the
organization."
3. According to APICS (Association for Supply Chain Management): "Inventory
management is the branch of business management concerned with planning and
controlling inventories to meet the demands of customers and production with
minimal cost."
4. According to Stevenson (Operations Management): "Inventory management
involves decisions about how much to order, when to order, and how much stock to
maintain for efficient operations."
4.2. Purpose of Inventory Management
1. Ensures Continuous Production: Maintains an uninterrupted supply of raw
materials to prevent production delays.
o Example: A car manufacturing plant keeps a stock of steel, tires, and
electronic components to ensure smooth production.
2. Meets Customer Demand: Ensures that finished goods are available to fulfill
customer orders promptly.
o Example: A retail store stocks different sizes and colors of shoes to meet
customer preferences.
3. Minimizes Holding Costs: Helps optimize storage costs and prevent excessive
inventory accumulation.
o Example: An e-commerce company uses data analytics to maintain optimal
stock levels and reduce warehouse expenses.
4. Reduces Stockouts & Shortages: Prevents lost sales and customer dissatisfaction
due to unavailable products.
o Example: A pharmacy ensures it has essential medicines in stock to avoid
running out during emergencies.
5. Balances Supply and Demand: Helps manage demand fluctuations efficiently by
maintaining adequate stock levels.
o Example: An ice cream company increases production in summer to meet
peak demand.
6. Optimizes Order Quantity: Determines the right order size to reduce procurement
and carrying costs.
o Example: A bookstore orders new arrivals based on past sales data to avoid
overstocking.
 7. Improves Cash Flow: Efficient inventory management prevents excessive capital
from being tied up in unsold stock.
o Example: A smartphone company maintains only a limited inventory of older
models to focus on new releases.
8. Enhances Profitability: Reduces waste, obsolescence, and inefficiencies to improve
profit margins.
o Example: A food processing company uses the First-In-First-Out (FIFO)
method to minimize food spoilage.
9. Supports Production Planning: Ensures timely availability of materials for
uninterrupted workflow.
o Example: A textile factory maintains fabric stocks based on expected
production schedules.
10. Facilitates Seasonal Demand: Helps businesses stock up for peak seasons without
supply chain disruptions.
 Example: A toy manufacturer produces extra units before the holiday season to meet
increased demand.
Functions of Inventories
1. Raw Material Storage: Maintains essential inputs for continuous production.
o Example: A bakery stocks flour, sugar, and butter for daily baking.
2. Work-in-Progress (WIP) Management: Holds semi-finished goods in different
production stages.
o Example: An automobile factory has partially assembled cars waiting for final
assembly.
3. Finished Goods Inventory: Stores completed products ready for sale.
o Example: A furniture store keeps ready-made sofas for immediate delivery.
4. Buffer Stock: Acts as a safeguard against supply chain uncertainties.
o Example: A steel company keeps extra raw materials to avoid delays due to
supplier issues.
5. Transit or Pipeline Inventory: Accounts for goods in transit between supplier and
buyer.
o Example: An online retailer tracks shipments of smartphones from a supplier
to its warehouses.
6. Decoupling Inventory: Maintains extra stock between production stages to prevent
delays.
o Example: A paper mill stores extra pulp to continue production even if supply
is delayed.
7. Safety Stock: Provides backup in case of unexpected demand spikes or supply
disruptions.
o Example: A hospital maintains extra oxygen cylinders for emergencies.
8. Seasonal Inventory: Helps businesses stockpile goods for high-demand seasons.
o Example: A clothing brand stocks up on winter jackets before winter begins.
9. Service Inventory: Ensures parts and supplies are available for after-sales service.
o Example: An automobile company stocks spare parts for vehicle repairs.
10. Obsolete & Excess Inventory Management: Identifies slow-moving or outdated
stock to minimize losses.
 Example: A mobile store offers discounts on older phone models to clear inventory
before launching new ones.
4.3. Types of inventories (Raw-materials)
1. Raw Materials Inventory
Definition: Raw materials are the basic inputs used in the production of finished goods.
Purpose:
 Ensures continuous production without delays.
 Helps maintain a steady supply chain.
Examples:
 Manufacturing Industry: Steel used in automobile production.
 Food Industry: Wheat used in bread-making.
 Textile Industry: Cotton for fabric production.
4.4. Work-in-Progress (WIP) Inventory
Definition: WIP inventory includes semi-finished goods that are still in the production
process.
Purpose:
 Ensures smooth flow between different production stages.
 Prevents delays by keeping partially completed goods available.
Examples:
 Automobile Industry: A partially assembled car on the production line.
 Construction Industry: A building under construction.
 Furniture Industry: Wooden parts being assembled into a chair.
4.5. finished goods
Definition: Finished goods are fully manufactured products ready for sale to customers.
Purpose:
 Ensures immediate availability for customer demand.
 Reduces lead time for delivery.
Examples:
 Retail Industry: Laptops displayed for sale in an electronics store.
 Pharmaceutical Industry: Packed medicines ready for distribution.
 Apparel Industry: Shirts and jeans stored in warehouses for sale.
4.6. Maintenance, Repairs and Operations (MRO)
Definition:
 MRO inventory includes supplies and equipment needed for maintenance and repairs,
but not directly used in production.
Purpose:
 Ensures smooth operation of machinery and facilities.
 Reduces downtime and prevents equipment failure.
Examples:
 Manufacturing Industry: Lubricants and spare machine parts.
 Healthcare Industry: Cleaning supplies and medical tools.
 IT Industry: Printer cartridges and cables for office equipment.
4.7. Determination of inventory control levels: ordering, reordering, danger level.
Determination of Inventory Control Levels
Inventory control levels help businesses maintain the right stock levels to prevent shortages
and overstocking. The key inventory control levels include:
1. Ordering Level
Definition: The inventory level at which a new order should be placed to replenish stock
before it runs out.
Formula:
Ordering Level=Maximum Consumption × Maximum Reorder Period
Example:
 A factory consumes a maximum of 200 units of raw materials per day, and the
supplier takes a maximum of 10 days to deliver. Ordering Level=200×10=2000 units
 This means a new order should be placed when inventory reaches 2000 units.
2. Reorder Level
Definition: The stock level at which a replenishment order must be placed to avoid stockouts
before the new stock arrives.
Formula:
Reorder Level=Average Daily Consumption ×Lead Time
Example:
 A pharmacy sells 50 bottles of cough syrup daily, and the supplier takes 5 days to
deliver. Reorder Level=50×5=250 bottles
 The pharmacy should reorder when the stock reaches 250 bottles to prevent
shortages.
3. Danger Level
Definition: The stock level at which immediate replenishment is needed to prevent
production stoppages or stockouts.
Formula:
Danger Level=Minimum Consumption × Minimum Reorder Period
Example:
 A textile company has a minimum consumption of 100 meters of fabric per day, and
the supplier takes a minimum of 2 days to deliver. Danger Level=100×2=200 meters.
 If fabric stock falls to 200 meters, immediate action is required to avoid a production
halt.
4.9. Techniques of inventory management
1. Economic Order Quantity (EOQ)
Definition: EOQ is the optimal order quantity that minimizes total inventory costs, including
ordering and holding costs.
Formula: EOQ=2DS / H
Where: DD = Annual demand, SS = Ordering cost per order, HH = Holding cost per unit per
year
Example: A company requires 10,000 units annually. The ordering cost is Rs. 50 per order,
and the holding cost per unit is Rs.2 per year. EOQ=2(10,000) / (50)2=500,000
 The company should order 707 units per order to minimize costs.
2. Just-in-Time (JIT) Inventory
Definition: JIT minimizes inventory levels by receiving goods only when they are needed for
production or sales.
Benefits:
 Reduces holding costs.
 Minimizes wastage and obsolescence.
Example:
 Toyota follows JIT by receiving car parts from suppliers only when needed for
assembly, reducing warehouse storage costs.
3. ABC Analysis
Definition: ABC analysis classifies inventory into three categories based on value and usage
frequency:
o A-items: High value, low quantity.
o B-items: Moderate value, moderate quantity.
o C-items: Low value, high quantity.
Example: A retail store manages its inventory as follows:
o A-items: Laptops and smartphones (high-value, need strict control).
o B-items: Computer accessories (moderate value).
o C-items: Pens and stationery (low value, bulk purchases).
4. FIFO (First-In-First-Out) and LIFO (Last-In-First-Out)
Definition: FIFO: The oldest stock is used/sold first.
 LIFO: The newest stock is used/sold first.
Example:
 FIFO: A grocery store sells older dairy products first to prevent spoilage.
 LIFO: A coal supplier issues the most recently received coal first to match current
market prices.
5. Safety Stock Management
Definition: Safety stock is an extra quantity of inventory maintained to avoid stockouts due
to demand fluctuations.
Example: A hospital keeps additional oxygen cylinders as safety stock to handle
emergencies.
6. Reorder Point (ROP) System
Definition: The stock level at which a new order must be placed before inventory runs out.
Formula: ROP=Daily Usage ×Lead Time
Example:
 A pharmacy sells 100 tablets daily, and the supplier takes 5 days to deliver.
ROP=100×5=500 tablets
 The pharmacy should reorder when stock reaches 500 tablets.
7. VED Analysis (Vital, Essential, Desirable)
Definition: Used in industries like healthcare to categorize inventory based on criticality:
o Vital (V): Essential for operations (e.g., life-saving medicines).
o Essential (E): Necessary but not critical (e.g., syringes).
o Desirable (D): Can be stocked in lower quantities (e.g., vitamin supplements).
Example: A hospital prioritizes ventilators (Vital) over bandages (Desirable) for stock
management.
8. Perpetual Inventory System
Definition: A real-time tracking system where inventory updates occur automatically with
each transaction.
Example: Amazon uses barcode scanning and RFID technology to maintain real-time
inventory records in warehouses.
9. Two-Bin System
Definition: Inventory is divided into two bins:
o Bin 1: Active stock used for daily operations.
o Bin 2: Backup stock used when Bin 1 is empty, triggering replenishment.
Example: A hardware store keeps two bins of nails; when one bin is empty, a new order is
placed.
10. Drop Shipping
Definition: A business model where retailers do not keep inventory but ship products directly
from suppliers to customers.
Example: Shopify stores selling branded T-shirts without holding stock—products are
shipped from third-party suppliers.
Conclusion: Using the right inventory management techniques helps businesses optimize
stock levels, reduce costs, and enhance efficiency. Choosing the appropriate method depends
on industry needs and business size.
4.10. Economic Order Quantity (EOQ model).
Economic Order Quantity (EOQ) Model: Economic Order Quantity (EOQ) is a
fundamental inventory management technique used to determine the optimal order quantity
that minimizes the total cost of inventory. This model helps businesses balance ordering costs
and holding costs to achieve cost efficiency.
1. Meaning of EOQ: EOQ refers to the ideal order quantity a company should purchase to
minimize the combined costs of ordering and holding inventory. It ensures that stock is
replenished efficiently without overstocking or running out of inventory.
2. Importance of EOQ
 Reduces total inventory costs.
 Ensures a smooth supply chain by maintaining adequate stock.
 Prevents excessive capital investment in inventory.
 Improves cash flow by optimizing purchase frequency.
3. Formula for EOQ
EOQ= √2DS
H
Where:
 D = Annual demand for the product (units per year)
 S = Ordering cost per order (cost incurred in placing an order)
 H = Holding cost per unit per year (cost of storing one unit of inventory)
4. Components of EOQ
A. Ordering Cost (S)
 The cost incurred every time an order is placed.
 Includes administrative expenses, transportation costs, and supplier handling charges.
 Higher order quantity reduces the frequency of orders, thereby reducing ordering
costs.
B. Holding Cost (H)
 The cost associated with storing and maintaining inventory.
 Includes warehousing costs, insurance, depreciation, and obsolescence risks.
 Larger order quantities increase holding costs.
C. Demand Rate (D)
 The number of units required per year.
 Affects the frequency of ordering and stock replenishment.
5. Example of EOQ Calculation
Scenario:
A retail company sells 10,000 notebooks per year. The cost of placing an order is $50 per
order, and the annual holding cost per notebook is $2.
Step 1: Identify the given values
D=10,000 units/year
S=50 dollars/order
H=2 dollars/unit/year
Step 2: Apply the EOQ formula
EOQ= √2DS
H
EOQ= √2(10,000) (50)
2

EOQ= √500,000

EOQ==707 units (approx.)

Step 3: Interpretation
 The company should order 707 notebooks per order.
 This minimizes the combined costs of ordering and holding inventory.
 The total number of orders required per year: _D_ = _10,000 = 14.14 orders /Y
 EOQ 707
 The company will place around 14 orders per year to optimize costs.
6. Assumptions of the EOQ Model
 Demand remains constant throughout the year.
 Ordering cost and holding cost per unit remain fixed.
 The entire order quantity is delivered at once without shortages.
 No discounts are offered for bulk purchases.
7. Limitations of EOQ
 Ignores demand fluctuations and seasonal variations.
 Assumes fixed costs, which may change over time.
 May not be suitable for perishable goods with short shelf life.
 Not ideal for businesses with unpredictable supply chain disruptions.
8. Variants of EOQ Model
A. EOQ with Quantity Discounts
 Applies when suppliers offer bulk purchase discounts, modifying the total cost
calculation.
B. EOQ with Stockouts
 Adjusts EOQ when occasional stockouts are allowed, considering lost sales costs.
C. EOQ with Variable Demand
 Used when demand is uncertain, incorporating safety stock calculations.
Conclusion: The EOQ model is a powerful tool for businesses to optimize inventory
ordering while minimizing costs. However, it should be applied with considerations for real-
world factors like demand variability, supplier reliability, and storage limitations.
4.11. Pricing of raw material: Pricing of raw materials is a crucial factor in cost
management, affecting the overall production cost, profitability, and competitiveness of a
business. The method used to price raw materials depends on factors such as market
conditions, supply chain efficiency, and accounting practices.
1. Meaning of Raw Material Pricing: Raw material pricing refers to the methods used to
determine the cost of materials used in production.
 It includes direct costs (purchase price) and indirect costs (transportation, storage, and
handling).
 Choosing the right pricing method helps in accurate financial reporting and cost
control.
2. Factors Affecting Raw Material Pricing
A. Market Forces
 Supply and Demand: Prices fluctuate based on the availability of raw materials and
industry demand.
 Global Trade Policies: Tariffs, import/export restrictions, and government
regulations impact pricing.
 Inflation & Currency Exchange Rates: Affects costs, especially for imported
materials.
B. Procurement and Logistics Costs
 Transportation Costs: Freight charges influence the final material cost.
 Storage and Warehousing: Long-term storage increases costs due to maintenance
and depreciation.
 Bulk Purchasing Discounts: Larger orders may reduce per-unit costs through
supplier discounts.
C. Industry and Seasonal Variations
 Commodity-Based Raw Materials: Prices of materials like crude oil, steel, and
cotton fluctuate based on international market conditions.
  Seasonal Availability: Agricultural raw materials like wheat and sugarcane have
seasonal price variations.
3. Methods of Pricing Raw Materials
A. First-In, First-Out (FIFO) Method
 The oldest stock (purchased first) is used first, and its cost is recorded.
 This method is useful when prices are rising, as it results in lower cost of goods sold
(COGS) and higher profits.
Example: A company purchases raw materials as follows:
 Jan: 100 kg at Rs. 5/kg
 Feb: 100 kg at Rs. 6/kg
 Mar: 100 kg at Rs. 7/kg
If 150 kg of material is used, the cost calculation will be:
 100 kg × Rs. 5 = Rs. 500
 50 kg × Rs. 6 = Rs. 300
 Total cost = Rs. 800
This method ensures that older stock is used first, reducing the risk of material obsolescence.
B. Last-In, First-Out (LIFO) Method
 The newest stock (purchased last) is used first, and its cost is recorded.
 This method is beneficial when prices are increasing, as it results in higher COGS and
lower taxable income.
Example:
Using the same purchase data as above, if 150 kg is used, the cost calculation will be:
 100 kg × Rs. 7 = $700
 50 kg × Rs. 6 = $300
 Total cost = $1,000
LIFO results in a higher cost of goods sold and lower profits during inflation.
C. Weighted Average Cost (WAC) Method
 Averages out the cost of raw materials over multiple purchases to provide a uniform
cost per unit.
 Useful when raw material prices fluctuate frequently.
Formula:
WAC=Total Cost of Inventory
Total Quantity of Inventory
Example: Using the same purchase data:
WAC=(100×5)+(100×6)+(100×7)
100+100+100

=500+600+700 = 1800 = 6 per kg

300 300
If 150 kg is used, the cost will be: 150×6=900
D. Standard Cost Method
 Predetermined cost based on past data and estimates is used for pricing raw materials.
 Any difference between actual and standard cost is recorded as a variance.
Example:
 A company sets the standard cost of steel at $50 per ton.
 If the actual cost is $55 per ton, a variance of $5 per ton is recorded.
E. Specific Identification Method
 Each unit of raw material is individually tracked, making it ideal for expensive or
unique materials.
Example: A jewellery manufacturer buys:
  5 diamonds at Rs. 500 each
 10 diamonds at Rs. 600 each
If 3 diamonds from the Rs. 600 batch are used, the recorded cost will be Rs. 1,800 (3 × 600).
4. Practical Considerations in Raw Material Pricing
A. Industry-Specific Pricing
 Manufacturing: Uses FIFO for better cost management.
 Retail & E-commerce: Uses WAC for consistent pricing.
 Construction: Uses LIFO during price hikes to reduce tax liabilities.
B. Impact on Financial Statements
 Different pricing methods affect profitability, taxation, and valuation of inventory.
 FIFO results in higher profits during inflation, while LIFO reduces taxable income.
C. Impact on Decision-Making
 Businesses choose pricing methods based on cost control strategies, tax benefits, and
financial reporting requirements.
5. Conclusion
Pricing raw materials correctly ensures cost efficiency, accurate financial reporting, and
competitive pricing in the market. The choice of pricing method depends on factors like
industry requirements, price fluctuations, and tax considerations.

4.12. Monitoring and control of inventories: Monitoring and Control of Inventories:

Efficient inventory monitoring and control are essential for optimizing stock levels, reducing
costs, and ensuring smooth business operations. Effective inventory management prevents
stockouts, overstocking, and obsolescence while improving profitability.
1. Meaning of Inventory Monitoring and Control
 Inventory Monitoring: The process of tracking stock levels, movements, and usage
patterns in real time.
 Inventory Control: The strategies and techniques used to manage inventory
efficiently, ensuring the right quantity of stock is available at the right time.
 Helps in cost reduction, improves cash flow, and enhances customer satisfaction.
2. Objectives of Inventory Monitoring and Control
 Maintain optimal stock levels to prevent shortages or excess inventory.
 Reduce carrying costs like warehousing, insurance, and depreciation.
 Minimize wastage due to spoilage, theft, or obsolescence.
 Improve production efficiency by ensuring raw materials are available when needed.
 Enhance order fulfilment and customer satisfaction by reducing delays.
3. Techniques for Monitoring and Controlling Inventories
A. Perpetual Inventory System; A real-time tracking method where inventory updates
occur instantly with each transaction.
 Uses barcodes, RFID (Radio Frequency Identification), and automated software
for accurate stock monitoring.
Example: Amazon uses RFID and barcode scanning to track product movements in its
warehouses.
 Supermarkets like Walmart update stock levels instantly when an item is scanned at
checkout.
B. Periodic Inventory System
 Stock is checked at fixed intervals (weekly, monthly, or quarterly) rather than in real
time.
 Useful for businesses that do not require continuous stock tracking.
Example: A clothing retailer conducts physical stock counts every month to verify inventory
accuracy.
C. ABC Analysis (Inventory Classification); Inventory is classified based on value and
usage frequency:
o A-items: High-value, low-quantity items (strict control).
o B-items: Moderate value, moderate quantity.
o C-items: Low-value, high-quantity items (less control).
Example: A car manufacturer classifies engine parts (A-items) as critical and monitors
them closely, while screws (C-items) are stocked in bulk with minimal monitoring.
D. Just-in-Time (JIT) Inventory System
 Raw materials and stock are ordered only when needed, minimizing storage costs.
 Reduces waste but requires efficient supply chain coordination.
Example: Toyota follows JIT by receiving car parts just before assembly, reducing excess
inventory.
E. Safety Stock Management
 Maintaining a buffer stock to prevent stockouts due to demand fluctuations or supply
delays.
Example: A hospital keeps extra oxygen cylinders in stock to handle emergencies.
F. Reorder Point (ROP) System; Determines when to place a new order before stock runs
out.
Formula: ROP=Daily Usage × Lead Time
Example: A pharmacy sells 100 tablets daily, and the supplier takes 5 days to deliver.
ROP=100×5=500
 The pharmacy should reorder when stock reaches 500 tablets.
G. Economic Order Quantity (EOQ) Model: Calculates the ideal order quantity to
minimize total inventory costs.
Formula: EOQ=2DSH
Where:
 D = Annual demand
 S = Ordering cost per order
 H = Holding cost per unit
Example: A manufacturer requires 10,000 units per year, with a per-order cost of $50 and a
holding cost of $2 per unit. EOQ=2(10,000) (50)2=707 units
 The company should order 707 units per order for cost efficiency.
H. Two-Bin System: Inventory is divided into two bins:
o Bin 1: Active stock for daily use.
o Bin 2: Backup stock used when Bin 1 is empty, triggering a reorder.
Example: A factory stores lubricants in two bins. When one bin is emptied, a new order is
placed.
I. Vendor-Managed Inventory (VMI): Suppliers monitor and replenish stock based on
agreed inventory levels.
Example: Walmart allows suppliers like Procter & Gamble to manage the inventory of
their products directly in stores.
4. Tools and Technologies for Inventory Monitoring
A. Inventory Management Software: Automates stock tracking and provides real-time data.
 Examples: SAP, Oracle NetSuite, QuickBooks, Zoho Inventory.
Example: A warehouse uses SAP software to track incoming and outgoing stock, reducing
errors.
B. RFID and Barcode Scanning
 RFID tags store product information and enable automated tracking.
 Barcodes are scanned to update stock records instantly.
Example: Amazon’s warehouses use RFID scanners to track product movements
efficiently.
C. Cloud-Based Inventory Systems: Enables real-time inventory tracking from any
location. Reduces manual errors and improves accessibility.
Example: An e-commerce company uses Zoho Inventory to manage global stock levels
remotely.
5. Common Inventory Control Issues and Solutions
A. Overstocking: Leads to high storage costs and risk of obsolescence.
 Solution: Use JIT or EOQ methods to optimize stock levels.
B. Stockouts; Causes production delays and lost sales.
 Solution: Implement Safety Stock and Reorder Point systems.
C. Inventory Theft and Fraud: Leads to financial losses and inaccurate stock records.
 Solution: Use RFID tracking and security cameras for monitoring.
D. Inaccurate Inventory Records: Results from human errors or outdated systems.
 Solution: Implement Perpetual Inventory Systems with automated tracking.
Conclusion: Effective inventory monitoring and control ensure cost efficiency, reduced
wastage, and improved business operations. Using modern inventory management
techniques like JIT, EOQ, ABC Analysis, and RFID tracking helps businesses optimize
stock levels and maximize profitability.
4.13. ABC Analysis. (Theory and problems): ABC Analysis is an inventory classification
technique that helps businesses prioritize stock management based on value and usage
frequency. It follows the Pareto Principle (80/20 rule), which states that 80% of the total
inventory value comes from only 20% of the items.
This method helps businesses focus on high-value items while efficiently managing low-
value items.
1. Meaning of ABC Analysis
 ABC Analysis categorizes inventory into three groups:
o A-items: High-value, low-quantity items (tight control required).
o B-items: Moderate-value, moderate-quantity items (moderate control).
o C-items: Low-value, high-quantity items (less control needed).
 This technique ensures cost-effective inventory management by optimizing stock
monitoring efforts.
2. Objectives of ABC Analysis
 Prioritize inventory control by focusing on high-value items.
 Reduce storage costs by minimizing excessive stock of low-value items.
 Improve cash flow by allocating funds efficiently.
 Enhance decision-making in procurement, stocking, and replenishment.
3. Categories of ABC Analysis
A. A-Category Items (High-Value, Low-Quantity)
 Represents 10-20% of inventory but accounts for 70-80% of total value.
 Requires strict monitoring, accurate forecasting, and frequent stock reviews.
 Examples:
o A car manufacturer treats engine parts as A-category items due to their high
cost.
o A hospital categorizes MRI machines as A-items since they are expensive
and limited in number.
B. B-Category Items (Moderate-Value, Moderate-Quantity)
 Represents 20-30% of inventory and accounts for 15-25% of total value.
 Needs moderate monitoring and periodic stock reviews.
 Examples:
 o A manufacturing company classifies packaging materials as B-items.
o A supermarket considers cleaning supplies as B-items—moderately priced
but essential.
C. C-Category Items (Low-Value, High-Quantity)
 Represents 50-70% of inventory but accounts for only 5-10% of total value.
 Requires minimal monitoring and bulk stocking.
 Examples:
o A stationery supplier treats paper clips and pens as C-items.
o A retail store classifies low-cost grocery items like salt and sugar as C-
items.
4. Steps to Conduct ABC Analysis
Step 1: Gather Inventory Data: Collect information on all stock items, including quantity,
cost per unit, and total annual usage value.
Step 2: Calculate Annual Consumption Value
Annual Consumption Value=Annual Demand × Unit Cost
 Determines the financial impact of each item on inventory.
Example: A company has the following inventory data:
Item Annual Demand Cost per Unit Annual Consumption Value (Rs)
X 1,000 100 100,000
Y 5,000 20 100,000
Z 20,000 2 40,000
Step 3: Rank Items by Value
 Arrange inventory in descending order based on annual consumption value.
 Identify which items contribute the most to total inventory cost.
Step 4: Classify Inventory into A, B, and C Categories
 A-Items: Top 20% of items contributing to 70-80% of total value.
 B-Items: Next 30% contributing to 15-25% of value.
 C-Items: Remaining 50% contributing to 5-10% of value.
Example Classification:
 A-category: X, Y (High annual consumption value).
 B-category: Z (Moderate value).
 C-category: Items with lower annual value.
5. Benefits of ABC Analysis
 Optimized Inventory Control: Ensures tighter control over high-value items.
 Cost Reduction: Reduces unnecessary stocking costs.
 Better Supplier Negotiation: Focuses purchasing efforts on high-value items.
 Efficient Resource Allocation: Helps in production planning and budgeting.
 Improved Decision-Making: Supports setting reorder levels and lead times.
6. Limitations of ABC Analysis
 Ignores Demand Variability: A low-cost item with high demand may still require
frequent restocking.
 Requires Regular Updates: Inventory values change over time, requiring continuous
monitoring.
 May Overlook Non-Monetary Factors: Critical low-cost items may be as important
as expensive ones.
7. Applications of ABC Analysis
A. Manufacturing Industry: Focuses on high-value components (A-items) to reduce
stockouts. Manages semi-finished products (B-items) efficiently.
Example: A-category: Steel sheets for automobile production.
 B-category: Lubricants for machinery maintenance.
C-category: Nuts and bolts for assembly.
B. Retail Industry: Helps in stocking essential and profitable products efficiently.
Example:
 A-category: High-priced electronics (laptops, smartphones).
 B-category: Clothing and footwear.
 C-category: Low-cost stationery and accessories.
C. Healthcare Industry: Ensures strict monitoring of expensive medical equipment and
drugs.
Example:
 A-category: Life-saving medicines, surgical equipment.
 B-category: General medicines, syringes.
 C-category: Bandages, cotton, gloves.
8. Conclusion: ABC Analysis is a valuable inventory management tool that helps
organizations prioritize stock control, optimize costs, and improve efficiency. By
categorizing items based on their financial impact, businesses can allocate resources
effectively and streamline inventory operations.

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