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2. B THEORETICAL BACKGROUND

Meaning and Definition of Inventory

The inventory represents an essential component for the assets of the enterprise

and the economic analysis gives them special importance because their accurate

management determines the achievement of the activity object and the financial results.

The efficient management of inventory requires ensuring an optimum level for them,

which will guarantee the normal functioning of the activity with minimum inventory

expenses and funds which are immobilized.

Every enterprise needs inventory for smooth running of its activities. It serves as a

link between production and distribution processes. There is, generally, a time lag

between the recognition of a need and its fulfillment. The greater the time lag, the

higher will be the requirements for inventory. The unforeseen fluctuation in demand and

supply of goods also necessitate the need for inventory. It also provides a cushion for

future price fluctuation.

The inventory means aggregate of those items of tangible personal property which

(i)Are held for sale in ordinary course of business.(ii)Are in process of production for such sales.(iii)They are to be currently consumed in the production of goods or services to be

available for sale.

Inventories are expandable physical articles held for resale for use inmanufacturing a production or for consumption in carrying on business activity such as

merchandise, goods purchased by the business which are ready for sale. The inventory is

of the trader, who does not manufacture it.

Thus in the study of inventory the raw materials, stores and spare parts,consumables,finished goods and work-in-process have been included as inventories.Firm also

manufactures inventory to supplies.

Supplies included office and plant cleaning materials It is therefore quite natural that

inventory which helps in maximize profit occupies the most significant place among

current assets.

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A Study on Effectiveness and Application of Inventory Control Techniques

Taking the form of tangible current assets, the inventory is found in all the production

stages and is successively transformed from raw materials in elements of unfinished

production (work-in-process), then in finished goods destined for sale.

Factors Influences the Level of each Component of Inventory

Raw Material Inventory:

1.The volume of safety stock against material shortages that interrupt production.2.Considerations of economy in purchase.3.The outlook for future movements in the price of materials.4.Anticipated volume of usage and consumption.5.The efficiency of procurement and inventory control function.6.The operating costs of carrying the stocks.7.The costs and availability of funds for investment in inventory.8.Storage capacity.9.Re-component cycle.10.Indigenous or foreign.11.The lead-time of supply.12.Formalities for importing.Work-in-process Inventory:

1.The length of the complete production process.2.Management policies affecting length of process time.3.Length of process in runs.4.Action that speeds up the production process, e.g. adding second or third production

shifts.

5.Managements skills in production scheduling and control.6.Volume of production.7.Sales expectations.8.Level of sales and new orders.9.Price level of raw materials used, wages and other items that enter production cost and

the value added in production.

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Finished Goods Inventory:

1.The policy of the management to gear the production to meet the firm order in hand.2.The policy to produce for anticipated orders and stock keeping.3.Goods required or the purpose of minimum and safety stocks.4.Sales policies of the firm.5.Need for maintaining stability in production.6.Price fluctuations for the product.7.Durability, spoilage and obsolescence.8.Distribution system.9.Ability to fill orders immediately.10.Availability of raw material on seasonal basis while customers demand spread

throughout the year.

11. Storage capacity.

Stores and Spares Inventory:

1.Nature of the product to be manufactured and its lead-time of manufacture.2.State of technology involved.3.Consumptions patterns.4.Lead time of supply.5.Indigenous or foreign.6.Minimum and safety stock and ordering quantities.7.Capacity utilization.8.Importing formalities.Some of the important inventory policies relates to :

1.minimum, maximum and optimum stocks;2.safety stocks, order quantities, order levels and anticipated stocks;3.waste, scrap spoilage and defective;4.policies relating to alternative use;5.policies relating to order filling;Pricing of Raw Materials

When issues are made out of various lots purchased at varying prices, the problem arises

as to which of the receipt price should be adopted for valuing the materials requisitions.

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1. First In First Out Method(FIFO)

2.Last In First Out Method(LIFO)

3.Highest In First Out Method(HIFO)

4.Base Stock Method

5.Simple Average Method

6.Weighted Average Method

1. First In First Out

Materials received first will be issued first. The price of the earliest consignment is taken

first and when that consignment is exhausted the price of the next consignment is adopted

and so on. This method is suitable in times of falling prices, because the material charge

to production will be high while the replacement cost of materials will be low.

FIFO method of costing is used to introduce the subject of materials costing. The FIFO

method of costing issued materials follows the principle that materials used should carry

the actual experienced cost of the specific units used. The method assumes that materials

are issued from the oldest supply in stock and

that the cost of those units when placed in stock is the cost of those same units when

issued. FIFO is one method used to determine Cost of Goods Sold for a business.

Merits of FIFO Method:

This method is suitable during the period of decreasing of prices. Itis simple to understand and easy to calculate.

A stock is valued at the current purchase price, the value of closing stock represent

current market price.

De-merits of FIFO Method:

This method is not suitable during the period of increasing prices.

If this method is adopted during increase in price this method leads to tax liability.

2. Last In First Out LIFO Method:

Materials received last will be issued first. The price of the last consignment is taken first

and when that consignment is exhausted the price of the second last consignment is

adopted and so on. In timing of rising prices this method will show a charge to

production, which is closely related to current price levels provided that the last purchase

is made recently. This method is the opposite of the FIFO method. It assumes that the

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material which is purchase last is issued first. Hence, material issues are priced on the

basis of the cost of most recent purchases.

Merits of LIFO Method:

This method is suitable during the period of increasing of prices It

is simple to understand and easy to calculate

No under or over recovery of cost as material are issued at actual cost price.

As a stock is valued at the current purchase, the value of the closing stock represents

current market prices.

De-merits of LIFO Method:

This method is not suitable during the period of decreasing prices.

If this method is used at the time of decreasing prices, it leads to increase in the tax

liability.

This method will lead to fluctuations in cost of different jobs.

3. Weighted Average Cost Method

Under this method, material issued is priced at the weighted average cost of material in

stock:

WAC = Value of material in stock/Quantity in stock.

4. Standard Price Method

Under this method a standard price is predetermined. The price of issues predetermined

for a stated period taken into account all the factors affecting price such as anticipated

market trends, transportation charges, and normal quantity of purchase. Standard prices

are determined for each material and material requisition are priced at standards

irrespective of the actual purchase price. Any difference between the standard and actual

price results in materials price variance.

5. Current price

According to this method, material issued is priced at their replacement or realizable

price at the time of issue. So the cost at which identical material could be purchased from

the market should be ascertained and used for valuing material issues

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Valuation of Stocks:

There are three important types of inventories carried by a manufacturing organization:

(i)Raw material inventory(ii)Work-in-process inventory, and(iii)Finished goods inventory.The valuation of work-in-process and finished goods inventory depend on:

(i)The method used for pricing materials, and(ii)The manner in which fixed manufacturing overhead costs are treated.Since the methods for pricing materials have been discussed earlier, let us look at how

fixed manufacturing overheads costs are treated for this purposes, two systems of costing

are used:

1.Direct costing and2.Absorption costingUnderdirect costing, fixed manufacturing overheads costs are treated as period costs and

not as product costs. Put differently, they are charged directly to the income statement

and hence not reflected in the valuation of inventories.

Under absorption costing, on the other hand, fixed manufacturing overheads cost are

treated as product costs and not period costs. Hence inventory valuation reflects an

allocated share of fixed manufacturing overhead costs.

Quite naturally, the valuation of work-in-process and finished goods inventory is lower,

ceteris paribus, under direct costing and higher under absorption costing. Further, when

the inventory level increases, the reported profit under direct costing is lower that the

reported profit under absorption costing. By the same token, when the inventory level

decreases, the reported profit under direct costing is higher than what it is under

absorption costing.

Control of Inventories

Inventories consist of raw materials, stores, spares, packing materials, consumables,

works-in-progress and finished products in stock either at the factory or deposits. The

maintenance of inventory means blocking of funds and so it involves the interest and

opportunity cost to the firm. In many countries great emphasis is placed on inventory

management. Efforts are made to minimize the stock of inputs and outputs by

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proper planning and forecasting of demand of various inputs and producing only that

much quantity which can be sold in the market.

In general, a good inventory management implies their formation at a level that will

ensure both the requirements of the production process and the demand on the market,

but will also allow the achievement of the companys performance indicators. Control of

inventory, which typically represents 45% to 90% of all expenses for business, is needed

to ensure that the business has the right goods on hand to avoid stock-outs, to prevent

shrinkage (spoilage/theft), and to provide proper accounting. Many businesses have too

much of their limited resource, capital, tied up in their major asset, inventory. Worse,

they may have their capital tied up in the wrong kind of inventory. Inventory may be old,

worn out, shopworn, obsolete, or the wrong sizes or colors, or there may be an imbalance

among different product lines that reduces the customer appeal of the total operation.

THE ANALYSIS OF INVENTORY CONTROL SYSTEM

The financial management of firms pursues broad coverage regarding inventory, but in

terms of financial analysis, we consider relevant the inventory structure and its rotation.

The inventory structure allows the financial analyst to highlight the following aspects:

the oversize or sub dimensioning of inventory elements;

highlighting inactive inventory or slow-moving inventory, which generatesexpenditures;

the evolution over time of inventory structure. The relevant inventory for anenterprise is: raw materials, work-in-process and finished goods. The increase of the

share of raw materials within total inventory reflects the following aspects:

the oversize of stock supply;

the existence of inactive or slowly moving raw materials;

reducing other categories of inventory due to the shortening of the production cycleand the speeding of distribution.

Objectives of Inventory Control

The primary objectives of inventory control are:

(i) To minimize the possibility of disruption in the production schedule of a firm forwant of raw material, stock and spares.

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(ii) To keep down capital investment in inventories.

So it is essential to have necessary inventories. Excessive inventory is an idle resource of

a concern. The concern should always avoid this situation. The investment in inventories

should be just sufficient in the optimum level.

The major dangers of excessive inventories are:

(i)the unnecessary tie up of the firms funds and loss of profit.(ii)excessive carrying cost, and(iii)the risk of liquidity

The effective inventory control system should

(i)maintain sufficient stock of raw material in the period of short supplyand anticipate price changes.

(ii)ensure a continuous supply of material to production departmentfacilitating uninterrupted production.

(iii)minimize the carrying cost and time.(iv)maintain sufficient stock of finished goods for smooth sales operations.(v)ensure that materials are available for use in production and production services

as and when required.

(vi)ensure that finished goods are available for delivery to customers to fulfil orders,smooth sales operation and efficient customer service.

(vii)minimize investment in inventories and minimize the carrying cost and time.(viii)protect the inventory against deterioration, obsolescence and unauthorized use.(ix)maintain sufficient stock of raw material in period of short supply and

anticipate price changes.

(x)control investment in inventories and keep it at an optimum level.Inventory Control Features and Benefits

Following are some of the major features and benefits of the Inventory Control system

Scope we can obtain necessary information for supporting buying and selling

operations.

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Stock and non stock items We can use the Inventory Tracking flag in the ItemLocation file to set up items as stock in an inventory location and non stock in a

supply location.

Bin control We can control the bins you use for receipts, issues, incominginspection,lots, and serial numbered items.

We can also control storage space limitations by bin and store items in multiple bins.

Lot, sub lot, and serial number tracking The system walks us through requireddetailforms to process transactions for lot and serial number tracked items.

Multiple levels of stock-on-hand balance controlWe can inquire on stock-on-hand detail for bins, lots, serial numbers, units of measure,

allocated totals, location totals, and so on

Multiple transaction types The system processes, by location, inventory receipts, issues,

transfers, in transit transfers, bin transfers, physical inventory, and adjustments.

Multiple units of measure The system can track and order an item in differentunits ofmeasure.

Availability control You can select the item availability calculation to includeon-orderand in-transit quantities.

Catch weights The system can control and track the quantity of an item byweight plusone other unit of measure.

Comment types The system lets we group item comments into user-definedtypes. Forexample, you might define comment type S as shipping instructions.

Multiple costing methods (standard, average, LIFO, and FIFO)The system can manage negative stock-on-hand quantities using the average or standard

costing method.

Inventory auditing The system ensures that all the inventory transactions created in the

system are defined correctly.

Fixation of Norms of Inventory Holdings

Either by the top management or by the materials department could set the norms for

inventories. The top management usually sets monitory limits for investment in

inventories. The materials department has to allocate this investment to the various items

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and ensure the smooth operation of the concern. It would be worthwhile if norms of

inventories were set by the management by objectives, concept. This concept expects the

top management to set the inventory norms (limit) after consultation with the materials

department. A number of factors enter into consideration in the determination of stock

levels for individual items for the purpose of control and economy. Some of them are:

1.Lead time for deliveries.2.The rate of consumption.3.Requirements of funds.4.Keeping qualities, deterioration, evaporation etc.5.Storage cost.6.Availability of space.7.Price fluctuations.8.Insurance cost.9.Obsolescence price.10.Seasonal consideration of price and availability.11.EOQ (Economic Order Quantity), and12.Government and other statuary restrictionThe fixation of inventory levels is also known as the demand and supply method of

inventory control. Carrying too much or too little of the inventories is detrimental to thecompany. If too little inventories are maintained, company will have to encounter

frequent stock outs and incur heavy ordering costs. Very large inventories subjects the

company to heavy inventory carrying cost in addition to unnecessary ties up of capital.

Minimum Level

The minimum level of inventories of their reorder point may be determined on the

following bases:

1Consumption during lead-time.2Consumption during lead-time plus safety stock.3Stock out costs.4Customers irritation and loss of goodwill and production hold costs.

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To continue production during Lead Time it is essential to maintain some inventories.

Lead Time has been defined as the interval between the placing of an order (with a

supplier) and the time at which the goods are available to meet the consumer needs.

Maximum Level

The upper limit beyond which the quantity of any item is not normally allowed to rise is

known as the Maximum Level. It is the sum total of the minimum quantity, and ECQ.

The fixation of the maximum level depends upon a number of factors, such as, the

storage space available, the nature of the material i.e. chances of deterioration and

obsolescence, capital outlay, the time necessary to obtain fresh supplies, the ECQ, the

cost of storage and government restriction.

Re-Order Level

Also known as the ordering level the reorder level is that level of stock at which a

purchase requisition is initiated by the storekeeper for replenishing the stock. This level is

set between the maximum and the minimum level in such a way that before the material

ordered for are received into the stores, there is sufficient quantity on hand to cover both

normal and abnormal circumstances. The fixation of ordering level depends upon two

important factors viz, the maximum delivery period and the maximum rate of

consumption.

Re-Order Quantity

The quantity, which is ordered when the stock of an item falls to the reorder level, is

know as the reorder quantity or the EOQ or the economic lot size.

Economy Order Quantity

The EOQ refers to the order size that will result in the lowest total of order and carrying

costs for an item of inventory. If a firm place unnecessary orders it will incur unneeded

order costs. If a firm places too few order, it must maintain large stocks of goods and will

have excessive carrying cost. By calculating an economic order quantity, the firm

identifies the number of units to order that result in the lowest total of these two costs.

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Reorder Point

The reorder point is the level of inventory at which the firm places an order in the amount

of EOQ. If the firm places the order when the inventory reaches the reorder point, the

new goods will arrive before the firm runs out of goods to sell.

In designing reorder point subsystem, three items of information are needed as inputs to

the subsystem.

1. Usage rate- This is the rate per day at which the item is consumed in productionor sold to customers. It is expressed in units. It may be calculated by dividing

annual sales by 365 days

2. Lead time-- This is the amount of time between placing an order and receivinggoods. This information is usually provided by the purchasing department. The

time to allow for

an order to arrive may be estimated from a check of the companys record and the time

taken in the past for different suppliers to fill orders.

3. Safety stock-- The minimum level of inventory may be expressed in terms of several

days sales. The level can be calculated by multiplying the usage rate and time in the

number of days that the firm wants to hold as a protection against shortages.

Re-order point = (Usage rate)(Lead time + Days of safety) = (Lead Time x Consumption

rate) + Safety stock. The probabilistic approach is found to be cumbersome and

unfeasible for a multi period problem. It is proposed an order point whereby an order is

placed. When inventory reaches so many units

Re-order point S (L) +FSR (L)

L = Lead Time

R = Average number of units per

order F = Stock out acceptance factor.

The foregoing analysis is based on certain simplifying assumption. In the real worked

some additional consideration ought to be taken into account:

(i)Anticipated scarcity of raw material(ii)Expected price charge(iii)Obsolescence risk

(iv)Government restriction on inventory(v)Competitive market.


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Inventories Control Techniques

Store / Inventory control technique is the important tool in the hands of the modern

management. It is indispensable for each and every manufacturing concern. The

following are the important techniques of store control.

ABC Analysis of Inventories

ABC analysis is always a better control system. Under this method inventory items are

classified in to three categories such as ABC basing upon its value and cost significance.

The number of items and the value of each class are expressed as percentage of the total

and categorize as under

(i) Items of high value and small in numbers termed as 'A'(ii)Items of moderate value and moderate in number is termed as 'B'(iii)Items of small in value and large in number is termed as 'C'

The ABC inventory control technique is based on the principle that a small portion of the

items may typically represent the bulk of money value of the total inventory used in the

production process, while a relatively large number of items may from a small part of the

money value of stores. The money value is ascertained by multiplying the quantity ofmaterial of each item by its unit price. According to this approach to inventory control

high value items are more closely controlled than low value items. Each item of

inventory is given A, B or C denomination depending upon the amount spent for that

particular item.

A or the highest value items should be under the tight control and under responsibility

of the most experienced personnel, while C or the lowest value may be under simple

physical control.

The relative position of these items show that items of category A should be under the

maximum control, items of category B may not be given that much attention and item C

may be under a loose control.

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Table No 2.1

Particulars A item B item C item

Control Tight Moderate Loose

Requirement Exact Exact Estimated

Check Close Some Little

Expenditure Regular Some No

Posting Industrial Individual Group/none

Safety Stock Low Medium High

After classification, the items are ranked by their value and then the cumulative

percentages of total value against the percentage of item are noted. A detailed analysis of

inventory may indicate above figure that only 10 per cent of item may account for 75 per

cent of the value, another 10 per cent of item may account for 15 per cent of the value

and remaining percentage items may account for 10 per cent of the value. The importance

of this tool lies in the fact that it directs attention to the key items.

Advantages of ABC Analysis

1. It ensures a closer and a more strict control over such items, which are having asizable investment in there.

2. It releases working capital, which would otherwise have been locked up for amore profitable channel of investment.

3.It reduces inventory-carrying cost.4.It enables the relaxation of control for the C items and thus makes it possible for asufficient buffer stock to be created.

5. It enables the maintenance of high inventory turnover rate.

Fixation of various stock levels: Under this method various stock levels are fixed

scientifically to avoid over stocking and under stocking of materials. Over stocking of

materials leads to unnecessary blockage of materials and investment and under stocking

of material leads to disputation in production. These are the following stock levels which

help for planning of materials.

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Economic ordering quantity: Economic ordering quantity is that quantity of material

which are to be ordered in one time in order to minimize ordering cost, carrying cost as

well as cost of holding stock.

Perpetual inventory system: Perpetual inventory system is defined as "a system of

records maintained by the controlling department which reflects the physical movement

of stocks and their current balances."Bin card and store ledger constitute the bedrock of

perpetual inventory system. It is a method of recording store after every receipt & every

issue and their current balances to avoid closing down the firm for stock taking. To

ensure accuracy the physical verification may be made which must have to agree with the

balance of Bin Card & store ledger. If there is any discrepancy between the two, it may

be adjusted by preparing debit note and credit note.

Perpetual Inventory System of inventory control is the maintenance of inventory control

on a continuous basis. After the material are received into the stores, the storekeeper will

arrange for the storing of each item in the allotted rack, bin, shelf or other receptacles and

attach a card to each bin for the purpose of making entries there-in, relating to the

receipts, issues and balance. The bin card or the locker card, this becomes a perpetual

inventory record for each item of stores. If the stores balance is recorded on continuous

basis after every receipt and issue, the record is said to be one of perpetual inventory and

the method of recording is called the perpetual inventory system. Thus the perpetual

inventory is a method of recording store balance after every receipt and issue to facilitate

regular checking and to obviate closing down for stock locking .As a perpetual inventory

record, the bin card records the receipt, issues and the balance of every item of stores

only in physical quantities, and not in value. The advantages of a continuous stocktaking

where perpetual inventory records are maintained may thus be summarized as follows:

(i)The elaborate and costly work involved in periodic stock taking can be avoided.(ii)The stock verification can be done without the necessity of closing down the

factory.

(iii)The preparation of interim financial statement becomes possible.

(iv)Discrepancies are easily located and corrected immediately.(v)It ensure a reliable check on the stores.

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(vi)It exercises a moral influence on the stores staff.(vii)Fast and slow moving items can be distinguished and the fixation of proper

stock levels prevents not only over-stocking, but under-stocking also.

(viii) A perpetual inventory record of the nature of the bin cards enables thestorekeeper to keep an eye on the stock levels, and replenish the stock of

every item whenever the limit falls to the reorder level.

(ix)It provides reliable information to the management of the number of units, and thevalue of every item of stores.

(x)It ensures secrecy of the items that are verified.

Controlling Inventory

The reasons for inventory control are:

Helps balance the stock as to value, size, color, style, and price line in proportionto demand or sales trends.

Help plan the winners as well as move slow sellersHelps secure the best rate of stock turnover for each item.Helps reduce expenses and markdowns.Helps maintain a business reputation for always having new, fresh merchandise inwanted sizes and colours.

Controlling inventory does not have to be an onerous or complex proposition. It is a

process and thoughtful inventory management. There are no hard and fast rules to abide

by, but some extremely useful guidelines to help your thinking about the subject. A five

step process has been designed that will help any business bring this potential problem

under control to think systematically thorough the process and allow the business to make

the most efficient use possible of the resources represented. The final decisions, of

course, must be the result of good judgment, and not the product of a mechanical set of

formulas.

STEP 1: Inventory Planning

Inventory control requires inventory planning. Inventory refers to more than the goods on

hand in the retail operation, service business, or manufacturing facility. It also represents

goods that must be in transit for arrival after the goods in the store or plant are sold or

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used. An ideal inventory control system would arrange for the arrival of new goods at the

same moment the last item has been sold or used. The economic order quantity, or base

orders, depends upon the amount of cash (or credit) available to invest in inventories, the

number of units that qualify for a quantity discount from the manufacturer, and the

amount of time goods spend in shipment.

STEP 2: Establish order cycles

If demand can be predicted for the product or if demand can be measured on a regular

basis, regular ordering quantities can be setup that takes into consideration the most

economic relationships among the costs of preparing an order, the aggregate shipping

costs, and the economic order cost. When demand is regular, it is possible to program

regular ordering levels so that stock-outs will be avoided and costs will be minimized.

STEP 3: Balance Inventory Levels

Efficient or inefficient management of merchandise inventory by a firm is a major factor

between healthy profits and operating at a loss. There are both market-related and budget-

related issues that must be dealt with in terms of coming up with an ideal inventory

balance:

Is the inventory correct for the market being served?Does the inventory have the proper turnover?What is the ideal inventory for a typical retailer or wholesaler in this business?

To answer the last question first, the ideal inventory is the inventory that does not lose

profitable sales and can still justify the investment in each part of its whole.

Customer will be especially irritated if the item out of stock is one they would normally

expect to find from such a supplier. Repeated experiences of this type will motivate

customers to become regular customers of competitors.

STEP 4: Review Stocks

Items sitting on the shelf as obsolete inventory are simply dead capital. Keeping

inventory up to date and devoid of obsolete merchandise is another critical aspect of good

inventory control. This is particularly important with style merchandise, but it is

important with any merchandise that is turning at a lower rate than the average stock

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turns for that particular business. One of the important principles newer sellers frequently

find difficult is the need to mark down merchandise that is not moving well.

STEP 5: Follow-up and Control

Periodic reviews of the inventory to detect slow-moving or obsolete stock and to identify

fast sellers are essential for proper inventory management. Taking regular and periodic

inventories must be more than just totaling the costs. Any clerk can do the work of

recording an inventory. However, it is the responsibility of key management to study the

figures and review the items themselves in order to make correct decisions about the

disposal, replacement, or discontinuance of different segments of the inventory base.

Caution and periodic review of reorder points and quantities are a must. Individual

market size of some products can change suddenly and corrections should be made.

COMMON CHARACTERISTICS OF INVENTORIES

Inventories share the following characteristics:

Inventory represent a financial investment for the company

Inventories become part of the cost of goods sold and are therefore a business expenses.

The availability of the right item at the right time is necessary for operating any

production process or satisfies a demand by a customer for a finished product.

Economic Order Quantity

One of the major inventory management problem to be resolved is how much inventory

should be added when inventory is replenished .If the firm is buying raw materials, it has

to decide lots in which it has to be purchased on each replenishment. If the firm is

planning a production run, the issue is how much production to schedule. These problems

are called order quantity problems. The task of the firm is to determine economic order

quantity. The economic order quantity is that inventory level which

minimizes the costs.

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Determine economic inventory level involves two types of costs.

a) Ordering costs

The term ordering costs includes the entire costs of acquiring raw materials. They include

cost incurred in the following activities : requisitioning purchase ordering, transporting,

receiving, inspecting and ordering cost increases in proportion to the number of orders

placed except clerical and staff costs on a prodata basis. Ordering costs increases with

the number of orders : thus the more frequently inventory is acquired ,the higher the firms

ordering costs. On the other hand if the firm maintains the inventory levels, there will be

few orders placed and ordering costs will be relatively small. Thus ordering costs

decreases with increasing size of inventory.

b) Carrying costs :

Costs incurred for maintaining a given level of inventory called carrying costs.They

include storage, insurance, taxes, deterioration and obsolescence. The storage costs

comprise cost of storing space, stores handling costs of clerical and staff service costs

incurred in recording and providing facilities. Carrying costs vary with inventory size. It

is contrary to that of ordering costs which decline with increase in inventory size .The

economic size of inventory would thus depend on trade off between carrying costs and

ordering costs.

Assumptions of the EOQ Model:

The basic EOQ model is based on the following assumptions:

1.The forecast usage / demand for a given period; usually one year, is known.2.The usage / demand is even throughout the period.

3. Inventory orders can be replenished immediately (there is no delay in placing andreceiving orders).

4. There are two distinguishable cost associated with inventories: costs of orderingand costs of carrying.

5.The cost per order is constant regardless of the size of order.6.The cost of carrying is a fixed percentage of the average value of inventory.EOQ Formula:

For determining the EOQ formula we shall use the following symbols:

U = annual usage / demand

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Q = quantity ordered

F = Cost per order

C = per cent carrying

cost P = price per unit

TC = total costs of ordering and carrying.

Given the above assumptions and symbols, the total cost of ordering and carrying

inventories are equal to

TC = U * F + Q * P * C

Q 2

Benefits of Holding Inventory

Holding of inventories results in a following benefits.

Quick Services:

A customer desires a prompt fulfillment of orders. A firm will have to make the goods

available for sale. In the event of its not being able to offer quick service to customers,

the latter are likely to get their orders executed by competitors.

Reduction in Order Costs

Each order increases certain costs. If the number of orders is reduced, it is possible toeconomize on these costs or the procedure involving each other need not be repeated each

time.

Discounts:

A firm is in position to take advantage of trade discounts by placing bulk order with

suppliers. A proper proportion will have to be maintained between the costs of

maintaining inventories and the discount that is likely to be gained.

Effects of holding high stock

Increased storage costs.

Increased risk of obsolescence.

Increased capital investment, which reduces the capital available for other activities and

projects.

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Cost of holding inventories

Inventories tie up funds. They also expose a firm to a number of risks and costs. The

different costs are material cost, cost of ordering, holding or carrying the inventory, under

stocking costs and over-stocking costs.

Material Cost:

This is the cost of purchasing goods plus the transportation and handling charges.

Order Cost:

This is a variable cost of placing an order for goods. The cost of ordering also includes

the following costs:

Stationery, typing and dispatch of orders and reminders.

Rent and depreciation on the space and equipment utilized by the concernedpurchasing personnel.

Insurance expenditure incurred to protect goods against fire and other risks etc. Cost of Carrying Inventories

The components of these costs are:

The cost of capital that is the cost of the money invested in the

inventory. The salaries and statutory payment of stores personnel.

Cost of tying of funds:

When funds are invested in the inventory, it is obvious that they are not available for anyother use.

Cost of under stocking:

Excess inventories represent additional and unnecessary cost. Under stocking or out-of-

stock cost is due to the non-stocking of an inventory.

Cost of overstocking:

It is basically opportunity cost arising out of the investment in inventory for a longer

period than necessary.

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3 RESEARCH DESIGN

Inventory

Inventory in general means stock of goods. It covers the stock of raw materials,

components, spare parts; work in process or semi-finished goods and finished goods.

Inventories constitute the most significant part of current asset of a large majority in

India. On the average, inventories are approximately 60% of the current asset in public

companies in India. Because of the large size of inventories maintained by firms, a

considerable amount of fund is required to be committed in them. Inventory can be

reviewed as idle resources of any kind having an economic value. They are those goods

which are procured, stored and used for the day to day functioning of an organization.

The term inventory includes materials-raw, in process, finished packaging, spares and

others stocked in order to meet an unexpected demand or distribution in the future.

Inventory can be used to refer to the stock on hand at a particular time of raw materials,

goods-in-process of manufacture, finished products, merchandise purchased for resale,

and the like, tangible assets which can be seen, measured and counted. In connection with

financial statements and accounting records, the reference may be the amount assigned to

the stock of goods owned by an enterprise at a particular time.

COMMON CHARACTERISTICS OF INVENTORIES

Inventories share the following characteristics:

Inventory represent a financial investment for the company

Inventories become part of the cost of goods sold and are therefore a business expenses.

The availability of the right item at the right time is necessary for operating any

production process or satisfies a demand by a customer for a finished product.

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OBJECTIVE OF INVENTORY CONTROL SYSTEM:

In the context of inventory, the firm is faced with the problem of meeting two conflicting

needs:

To maintain a large size of inventory for efficient and smooth production andoperations.

To maintain a minimum investment in inventories to maximize profitability. Both excessive and inadequate inventories are not desirable. These are two danger points

within which the firm should operate. The objective of inventory management should be

to determine and maintain optimum level of inventory investment. The optimum level of

inventory will lie between two danger points of excessive and inadequate inventories.

The firm should always avoid a situation of over investment or under-investment in

inventories. The major dangers of over investment are:

a)Unnecessary tie-up of the firms funds and loss of profitb)Excessive carrying costs, andc)Risk of liquidity.The excessive level of inventories consumes funds of the firm, which cannot be used for

any other purpose, and thus, it involves an opportunity cost. The carrying costs, such as

the cost of storage, handling, insurance, recording and inspection, also increase in

proportion to the volume of inventory. These costs will impair the firms profitabilityfurther. Excessive inventories carried for long-period increase chances of loss of

liquidity. It may not be possible to sell inventories in time and at full value. Raw

materials are generally difficult to sell as the holding period increases. There are

exceptional circumstances where it may pay to the company to hold stocks of raw

materials. This is possible under conditions of inflation and scarcity. Work in process is

far more difficult to sell. Similarly, difficulties may be faced to dispose of finished goods

inventories as time lengthens. The downward shifts in market and the seasonal factors

may cause finished goods to be sold at low prices. Another danger of carrying excessive

inventory is the physical deterioration of inventories while in storage. In case of certain

goods or raw materials deterioration occurs with the passage of time, or it may be due to

mishandling and improper storage facilities. These factors are within the control of

management, unnecessary investment in inventories can thus, be cut down.

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Maintaining an inadequate level of inventories is also dangerous. The consequences of

underinvestment in inventories are:

a)Production hold-ups andb)Failure to meet delivery commitmentsInadequate raw materials and work in process inventories will result in frequent

production interruptions. Similarly, if finished goods inventories are not sufficient to

meet the demands of customer regularly, customers may shift to competitors, which will

amount to a permanent loss to the firm.

The aim of inventory management, thus, should be to avoid excessive and inadequate

levels of inventories and to maintain sufficient inventory for the smooth production and

sales operations. Efforts should be made to place an order at the right time with the right

source of acquire the right quantity at the right price and quality. An effective inventory

management should:

Ensure a continuous supply of raw materials to facilitate uninterrupted production.

Maintain sufficient stocks of raw materials in periods of short supply and anticipate

price changes.

Maintain sufficient finished goods inventory for smooth sales operation and efficient

customer service.

Minimise the carrying cost and time.

Control investment in inventories and keep it at an optimum level.

To maintain adequate accountability of inventory assets.

To facilitate purchasing economies. To

contribute to profitability.

OBJECTIVES OF THE STUDY:

1. To known the procedure /methods used in maintaining inventory levels andprovide accurate information about inventory management.

2.To known the inventory control techniques.3. To achieve the use of ratio analysis as a tool for measuring the effectiveness of

inventory control system.

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OPERATIONAL DEFINATION OF THE CONCEPTS

Inventory:

Inventory is used to designate the aggregate of those items of tangible property which are

held for sale in the ordinary course of business and goods which are in process of

production for such sale and also goods currently consumed in the production of goods or

services. Thus inventory means stock of items kept in reserve for certain period of time.

It includes raw materials, work in progress, semi finished goods, finished goods and spare

parts for the maintenance of equipment.

Current Assets:

Current assets are all those assets which change their form and substance and which are

ultimately converted into cash during the normal operating cycle of business i.e. 12

months. In short all those assets which are changed into cash within a year are called

current assets.

Current liabilities:

Current liabilities refer to all short term obligations or liabilities which are required to be

repaid within a period of one year out of short term or current assets. They include bills

payable, sundry creditors bank overdraft etc.

Sales:

Cost of Goods Sold: Refers to opening stock of finished goods+ Purchase of finished goods + direct expenses- closing stock of finished goods.

PURPOSE OF THE STUDY

The inventory control helps in providing information to efficiently managing the flow of

materials, effectively utilize people and equipment, coordinate internal activities, and

communicate with customers. Thus this study provides the information which helps in

making more accurate and timely decisions to manage operations in the organization.

SCOPE OF THE STUDY:

The scope of the study is-

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LIMITATION OF THE STUDY

The project has some of the limitation are as follows:-

1)Some data which are given may not be up to date.2)More emphasis is given to the secondary data.3) There were some people who did not respond and much information was

not obtained. So it was not possible to go in depth.

4)The finance information is not given in depth, may be because of security.5) As market is fast changing and hence accurate calculation of value of stock

is practically not possible

TOOLS AND TECHNIQUES FOR COLLECTION OF DATA

The research design for the study was assessed and collected by the particular

information provided by the company regarding all types of stocks or inventories. The

following tools and techniques were used for collecting the data:

A. For collecting primary data

Information provided by company executives and managers.

B. For collecting secondary data

Company websites

Company handbook

Previous records

METHODOLOGY

Research methodology represents the strategies involves in collecting and analyzing

data collected, in order to have meaningful interpretations of the research findings. This

section attempts to give an insight into the way and manner in which this research was

carried out. This includes the mode of data collection, how these data were analyzed and

the research design.

Methods of Data Collection

Essential information for this research work were collected through primary

and secondary sources the combinations include:

(i) Interview with some key personnel in the stores, purchasing, production and inventory

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departments of the company.

(ii)Observation of the production process was done to see the flow of goods in theconversion process. Materials handling and storage were also observed and so was

the patrol /inspection procedures.

(iii)Record analysis of relevant data was obtained from the companys annual report andjournals.

(iv)Theoretical background information was gathered through review of related

literature on inventory management.

Financial analysts have sounded enough warning on the danger expose to the long run

profitability as well as continuity of business concern when its inventories are left

unmanaged. First, a company, which neglects it management of inventory, runs the risk

of production bottlenecks and subsequently unable to maintain the minimum investment

it requires to maximized profit. Second, inventories that are inefficiently managed may

apart from affecting sales create an irreparable loss in market for companies operating in

highly competitive industry. Invariably, a company must neither keep excess inventories

to avoid an unnecessary tying down of funds as well as loss in fund due to pilferage,

spoilage and obsolescence nor maintain too low inventories so as to meet production and

sales demand as at when needed. Therefore, the mere fact that ineffective inventory

management affects virtually the organizational objectives necessitates this type of

research work.

The analysis of the inventory was made using ratios; ABC analysis and inference were

drawn. Graphs are shown to pictorial depict the data.

Findings are summarized and suggestions were made based on data.

Type of research was-descriptive research aimed at identifying some of the key

problem areas in the field of inventory management.

Data source wasprimary as well as secondary data source (last 4 years data oninventory).

Data collection tool used was-website and companys internal data.

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METHODS OF ANALYSIS

Measure of Effectiveness of Inventory Control

1.Size of Inventory = Total inventory/Total Current assets2.Size of Raw material Inventory = Raw material inventory/Total inventory3.Size of Work in Process Inventory = Work in process Inventory/Total Inventory

4. Size of Stores and Spares parts Inventory = Stores and Spares partsinventory/Total Inventory

5.Size of Finished Goods Inventory = Finished goods inventory/Total inventory6.Overall inventory turnover ratio = Cost of goods sold/average total inventories at cost

7. Raw material inventory turnover ratio = Annual consumption of Raw material /Average Raw material inventory

8. Work-in-process inventory turnover ratio = Cost of manufacture/average work-in-process inventory at cost

9.Finished Goods inventory turnover ratio = Cost of goods sold / Average finished stock10.Stores and spare parts inventory turnover ratio = Stores and Spares

consumed/Average stock of stores and spares

11.Age of Finished Goods inventory = 365/Finished Goods inventory turnover ratio12.Average age of raw material inventory = 365/Raw material inventory turnover ratio

13.Average age of Work-in-Process inventory = 365/Work-in-Process inventoryturnover ratio

14.Age of Stores and spare parts inventory = 365/Stores and spare parts inventoryturnover ratio

15.Inventory holding period = 365/Inventory turnover ratio

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FINANCIAL RATIOS

Ratio analysis has a wider application as a measure of inventory control among most

manufacturing firms. Some of the important ratios are explained below:

(1) Inventory to Sales (Total Inventory/Sales for the Period)

The ratio explains variations in the level of investment. An increase in inventory levels,

substantially beyond that which might be expected from an increase in sales, may reflect

such phenomena as the result of a conscious policy shift to higher stock levels, of

unintended accumulation of unsold stocks, and of inventory speculation, or simply

stocking in anticipation of an almost certain surge of orders.

(2) Inventory Turnover (Cost of Goods Sold/Average Inventory)

The ratio tells us the rapidity with which the inventory is turned over into receivables

through sales. Generally, the higher the inventory turnover, the more efficient the

management of a firm is. However, a relatively high inventory turnover ratio may be the

result of too low a level of inventory and frequent stock outs. Therefore, the ratio must be

judged in relation to the past and expected future ratios of the firm and in relations of

similar firms or the industry average or both.

(3) Sales to Inventory (Annual Net Sales/Inventory at the End of Fiscal Period)

The ratio indicates the volume of sales in relation to the amount of capital invested in

inventories. When inventory for a firm is larger in relation to sales (the condition which

causes it to have a lower net sales to inventory ratio than other firms) the firms rate of

return is less since it has more working capital tied up in inventories than has the firm

with a higher ratio.

(4) Inventory to Current Assets (Total Inventory/Total Current Assets)

The ratio indicates the amount of investment in inventory per rupee of current assets

investment. Generally an increasing proportion of inventory is indicative of inefficient

inventory management. The ratio may also indicate the state of liquidity position of

concern. The lower the inventory to current assets lowers the liquidity as compared to

other current assets, viz., receivables, cash and marketable securities.

(5) Inventories Expressed in Terms of Number of Days Sales (Inventory/Sales x 365)

The ratio indicates the size of inventory in terms of number of days sales. For this

purpose first the sales per day are calculated and inventory is divided by the amount of

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salesper day. The increasing inventory in terms of number of days sales may indicate either

accumulation of inventory or decline in sales. Inventory for this purpose is assumed to

include finished goods only. While the former situation signifies poor inventory management,

the later indicates the poor performance of the marketing department.

(6) Sundry Creditors to Inventory (Sundry Creditors/Inventory)

The ratio reveals the extent to which inventories are procured through credit purchases.

Inventories for this purpose are assumed to include raw materials and stores and spares only.

If the ratio is less than unity, it reveals that the credit available is lower than the total

inventory required. It also explains the extent of inventory procured through cash purchases.

Indirectly it emphasizes the inventory financing policy of the firm. If the ratio is more than

one, it explains that the entire inventory is purchased on credit.

(7) Inventory to Net Working Capital (Inventory/Net Working Capital)

The ratio explains the amount of inventory per rupee of equity/long-term financed portion of

current assets. A higher ratio may mean greater amount of net working capital investment in

inventory. In order to control each category of inventory, the following ratios can be

calculated. The inventory represents an essential component for the assets of the enterprise

and the economic analysis gives them special importance because their accurate management

determines the achievement of the activity object and the financial results. The efficient

management of inventory requires ensuring an optimum level for them, which will guarantee

the normal functioning of the activity with minimum inventory expenses and funds which are

immobilized. The paper presents an analysis model for inventory management based on their

rotation speed and the correlation with the sales volume illustrated in an adequate study. The

highlighting of the influence factors on the efficient inventory management ensures the useful

information needed to justify managerial decisions, which will lead to a balanced financialposition and to increased company performance.

hangyo project

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