INVENTORY CLASSIFICATION

Inventory is first classified into four broad groups which are: Production inventory In-process inventory Finished goods inventory Inventory of MRO items

Production Inventory
This includes: Raw materials Parts and components that are directly used in the production process and go into the making of the final product. Two important factors that determine the size of raw material inventory are: 1. Internal factors: This includes the technology of production, the criticality of the item and the lead time required for procurement 2. External factors: The suppliers lead time to manufacture, availability of the raw materials in the market, seasonality if any, credit situation, government restriction etc. (..cont.)

Production Inventory(contd.)
Organizations, especially those in the FMCG

and engineering goods, do not always produce their output from the raw materials. Some of their components are brought from other vendors. This enables them to concentrate more on critical parts and assembling. Many of the companies are going towards this route these days, including Dell, GM, Volkswagen etc.

MRO Inventory
MRO stands for Maintenance, Repair and Operating supplies. These items are very much essential in the production process although they do not go into making the final product. They include: 1. Consumables: lubricating oils, safety items, electrical items such as lights, fans etc. 2. Spare parts: Parts of machines 3. Packing material: In the pharmaceutical industry, packing cost is substantial. In some cases, packing materials are a part of consumables.

In-Process Inventory
They are also called WIP (Work-in-process)

inventory. They comprise of the semi-finished products at various stages of production process. Typically, the output of one stage in an assembly line is the input of for the next stage.

Finished Goods Inventory

This comprises of all the final products made

by the company, ready for shipment and sale. The purpose of this inventory is to assure a constant supply to the distribution channels.

In most of the organizations, the Production inventories and MRO inventories represent the biggest segment of the total inventory system.

Classification for financial reporting

Inventories are treated as of the working capital in the Balance Sheet and they are classified as: 1. Goods in transit (GIT) or Stores in transit (SIT): This includes all materials which have already been paid for but not yet received in the stores and accounted for. 2. Stores: All materials physically held at the store, which have been accounted for. 3. Work in process (WIP): Materials issued to the shop floor which have not yet become finished goods; these are value added materials to the extent of labor and handling costs incurred. 4. Stock in trade (SITr): These include all finished goods, ready for sale.

Degree of Inventory Control implies

1. Sophistication in demand forecasting

2. Frequency of review of Inventory position

3. Frequency of reviewing Inventory replacement

policy 4. Rigor in vendor selection / review

Selective Inventory Control

It is not possible and feasible to exercise strict management inventory control over all the items. It will only be too much effort with too little benefit. Hence, the principle of management by exception is applied here. The items are classified based on certain criteria to facilitate selective inventory control. Such control minimizes waste of efforts as well as confusions.

.
The degree and character of controls should depend on: The necessity of control The relative importance of the material (An item may be important, but there may not be any necessity to control its inventory.) The particular characteristics of the material

Inventory Catalogue
It is necessary to have a list of items with details of each item as given below. (This list is called Inventory Catalogue.) An identifiable individual number or a code for each item: numeric, alpha-numeric etc. The description of the item: This should also include the dimensions, weight, identity of the mother equipment, drawing numbers, part number etc. Annual consumption of at least last three years Name of suppliers who have supplied the item in last three years Average life of the item Stock of the item

Inventory Catalogue
The inventory catalogue serves many purposes. A seasoned storekeeper can see the code

number and identify the item. It helps to identify similar items in the inventory and helps in standardization and variety reduction. In computerization of the inventory records, the catalogue number becomes the identifying number for an item. By logging in the catalogue number, the history of an item can be known.

Classification: ABC Analysis

ABC analysis is the most commonly used

method for classification. This is based on the annual consumption value. Based on Pareto Analysis which identifies vital few, trivial many. It is often seen that a small number of items account for a major portion of the total consumption expenditure and several items together are many in number but account for a small portion of annual expenditure. Actual percentages vary from one firm to another.

Classification: ABC Analysis

In general, 10% of the items account for 70% of

the cost and they are called A class items and require highest degree of control. Similarly, 70% of the items account for only 10% of the cost. And they are called C class items and should not be given much attention. The remaining items are called the B class items.

How to conduct ABC Analysis?

As a first step, once the items in the inventory have been properly identified, their usage record for a complete operating cycle is built. Usually, the operating cycle is one year in most of the companies. Then the items are sorted and ranked in the decreasing order of their consumption value. The value of each item is next as a percentage of the total. By computing successive cumulative percentages, one can determine which items make up the first 70% of inventory investment, the next 20% and the balance 10%. The groups are called the A, B, and C respectively.
Solve one problem as given in MS-Excel.

Importance of ABC Analysis?

ABC classification is of immense importance to the management. It provides the basis on how to allocate funds and time of personnel w.r.t. procurement as well as refinement of control over the individual inventory items. It would be a waste of time and effort to pay much attention to the C-class items. Separate policies are usually adopted for three classes. A-class items need to be monitored on day-to-day basis. Decision on C-class items are based on the objectives like, minimizing acquisition cost, maximizing service level and reliability, minimizing inventory investment, minimizing indirect costs associated with the items and utilizing personnel and their time effectively.

XYZ Analysis

XYZ classification is based on the stock value of the items. Items having a very high stock value are classified as X. Items with least stock value are classified as Z. The method of arriving at the classification is the same as for ABC classification. Only instead of taking annual consumption value into account, the annual stock value for each item should be taken into account.

VED Analysis

Certain items are important by the impact of their absence. Their absence can cause a holdup in production and result in high costs, shut down or slow down of production/productivity, a great impact on overall sale. The above items may or may not be priced high but their stockout costs are indeed very high. These items are called vital items. E stands for essential. These items are not very critical to production, their stockout costs are still expensive. D stands for desirable- it is better to avoid stockouts for these items, although a stockout for a short period will not affect the production. The classification is done on the basis of shortage costs of the material.

VED Analysis

Various forms of VED classification exist. James A.G.Krupp, Director of Corporate Materials at Echlin Inc had classified the materials in his orgn. According to its service or operating importance on a 3-point scale. 1. Critical 2. Medium 3. Non-critical (see the matrix of safety stock (SS) of VED Vs. ABC classification in MS-Excel)

FSN Analysis

Items can also be classified as fast moving, slow moving or non-moving based on their pattern of issue from the store. This denotes how soon a material is consumed/sold after it has been purchased and taken into stock. This classification helps in controlling obsolescence. F: very fast moving and used once in every week or say, every month. N: items which are not consumed/sold even once in say two to three years are classified as non-moving. Keeping too many non-moving items in the inventory is dangerous. They block useful working capital and eat into the profitability of the company. Attention needs to be paid to them to declare them as surplus or obsolete and find alternate uses of the material or else dispose them off, so far it leads to money realization as well as space saving. S: All items which are neither Fast or non-moving are termed as slow moving items.

HML Classification

This classification is based on the unit price of material. H: High price per unit of the item M: Medium price per unit of the item L: Low price per unit of the item This classification is particularly relevant when it comes to deciding the procedure to be followed for procurement.

PQR Classification

Besides value and criticality of the items, another commonly used method to classify items is based on the shelf life of the item. Shelf life of an item is defined as the useful life of the item, that is, the period in which the item can display the complete characteristics, for which it is meant. P: Items having a low shelf life, and thus requiring frequent attention R: Items having very long shelf life and thus requiring the least attention Q: all other items which are neither in P nor in R This classification is more relevant for perishable items such as confectionaries etc. Time period for PQR classification varies from one industry to another.

SDE Classification

This classification is based on the ease of obtaining an item. S: Scarce items- such items are not easily available in the market and might require source development or else it might be an item which is difficult to manufacture or there are only one or two manufacturers who have to be given orders several months in advance and so on. All these items require special efforts for procurement. D: Difficult to obtain E: Easy to obtain An item which is A as well as S needs completely different methods for inventory management.

GOLF Classification

This classification is based on the nature of the source for an item. G (Government): Items which are canalized through the State Trading Corporations, MMTC etc., come under G class. Common procedures for inventory management may not apply to them. Lead times are longer. O (Open market): For such items, there are a number of suppliers. Quality and availability is good. L (Local sources): F (Foreign sources):

SOS Classification

This classification is based on the nature of the time of availability for an item. S: Seasonal: such as jute, cotton, sugarcane etc. OS: Off-Seasonal: Items which are not seasonal

See several commonly used matrices in MS-Excel