INVENTORY MANAGEMENT

Origin : 1375–1425; Late Middle English ‘inventorie’ and ‘inventorium’ in Latin.

AIM

• Aim of this presentation is to introduce the topic of Inventory Management to an already stressed, hard-pressed and unsuspecting class of students.

(presented by Sneha, Atul & Ajay K Raina)

SCOPE

• Part 1 – Basic Concepts.

• Part 2 – Systems and Methods.

• Part 3 – Miscellaneous Aspects.

• Interactive Session and Conclusion.

PART 1 – BASIC CONCEPTS

INVENTORY : FIN ACCTG

• The assets that are:-– Held for sale in the ordinary course of business; or– In the process of production for such a sale; or– In the form of materials or supplies to be

consumed in the production process; or– In the rendering of services.

• Relevance : Trading concern & Manufacturing unit.

• Loose tools v/s spares.

TYPES OF INVENTORY…

Work inprocess

Work inprocess

Work inprocess

Finishedgoods

RawMaterials

Vendors Customers

…….TYPES OF INVENTORY• Raw Materials – Basic inputs that are converted

into finished product through the manufacturing process.

• Work-in-progress – Semi-manufactured products that need some more work before they become finished goods for sale.

• Finished Goods – Completely manufactured products ready for sale.

• Supplies – Office and plant cleaning materials that do not directly enter production but are necessary for production process and do not involve significant investments.

RELEVANCE : INVENTORY • Constitute significant part of current assets.

• Realised or consumed in the operating cycle.

• Held primarily for trading.

• Cash or cash-equivalent.

(An asset which is not a current asset is classified as a non current asset)

CURRENT ASSETS

RELEVANCE: INVENTORY• Constitute significant part of current assets.• On an average, inventory forms approx 60% of

current assets in Public Limited Companies in India.• Huge financial implications.• Effective and efficient management is imperative to

avoid unnecessary investment.• Improper inventory management affects long term

profitability and may cause failure ultimately.• 10 to 20% of inventory can be reduced without any

adverse effect on production and sales by using simple inventory planning and control techniques.

INVENTORY MGT

NEED :-• Demand related:-– Meet unexpected demands.– Smooth seasonal or cyclical demands.

• Pricing related:-– Hedge against price increases.– Take advantage of quantity discounts.

• Process and supply surprises related:-– Internal – upsets in parts of or our own processes.– External – delays in incoming goods.

The act or manner of managing, handling, directing or controlling the flow of inventory.

OBJECTIVES: INVENTORY MGT

• To maintain an optimum size of inventory for efficient and smooth production and sales operations.

• To maintain a minimum investment in inventories to maximize the profitability.

• Effort should be made to place an order at the right time with right source to acquire the right quantity at the right price and right quality.

SUCCESS MANTRA

• 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.

• Minimize the carrying cost and time.• Control investment in inventories and keep it at an

optimum level.

WHAT IF WE OVER REACT?

• Unnecessary tying down of firm’s funds and loss of profit.

• Excessive carrying costs.• Risk of liquidity- difficult to convert into cash.• Physical deterioration of inventories while in

storage due to mishandling and improper storage facilities.

WHAT IF ONE IS TOO COOL!

• Production hold-ups – loss of labour hours.• Failure to meet delivery commitments.• Customers may shift to competitors which will

amount to a permanent loss to the firm.• May affect the goodwill and image of the firm.

• Track inventory.

• How much to order?

• When to order?

IN A NUTSHELL

• IF we know the value, all these functions will get addressed!!

BTW,…it is tough to do inventories in Afghanistan because of the tally ban.

PART 2 – SYSTEMS & METHODS

INVENTORY SYSTEMSFactor Periodic Inventory System Perpetual Inventory System

Basis of ascertaining inventory By actual physical count On the basis of records

Calculation of inventory Directly by applying the method of valuation of inventories

Closing Inventory = opening inventory+ purchases – cost of goods sold

Calculation of cost of goods sold

Cost of goods sold = opening inventory + purchases – closing inventory

Directly calculated by applying the method of valuation of inventories

Lost Goods Cost of goods sold includes cost of lost goods (if any)

Cost of closing inventory includes cost of lost goods (if any)

METHODS OF VALUATION

• First In First Out (FIFO) Method.

• Last In First Out (LIFO) Method.

• Weighted Average Cost/price Method.

An inventory valuation allows a company to provide a monetary value for items that make up its inventory.

Methods:-

FIFO METHOD

• Based on the assumption that the goods that are received first are issued first.

• For purpose of assigning costs and not exactly for purpose of physical flow of goods.

• Goods sold, thus, consist of earliest lots and are valued at the price paid for such lots.

• The ending inventory consists of latest lots and is valued at the price paid for such lots.

• Balance sheet shows ending inventory costed as per approx market price.

(QUESTION) – ABC Ltd. Provides you with the following information : - 1.1.20 11 Opening Stock 100 units @ Re 1.- 2.1.20 1 1 Purchased 400 units @ Rs 1.50.- 3.1.20 1 1 Issued 450 units. -4.1.20 11 Purchase 500 units @ Re 2.06.- 5.1.2011 issued 300 units.

REQUIRED : Compute the value of inventory and cost of goods sold as on 5.1.2011 assuming:-(a) Perpetual system; and (b) periodic system under FIFO method.

FOR EASE OF ASSIMILATION

1…STOCK LEDGER UNDER FIFO METHOD

Quality Rate (Rs)

Amt. (Rs)

Quality Rate (Rs)

Amt. (Rs)

Quality Rate (Rs)

Amt. (Rs)

1-1-2011

_ _ _ _ _ 100 1.00 100

2-1-2011

400 1.50 600 _ _ _ 100400

1.001.50

100600

3-1-2011

_ _ _ 100 350

1.001.50

100 525

50 1.50 75

4-1-2011

500 2.06 1030 _ _ _ 50500

1.502.06

751,030

5-1-2011

_ _ _ 50250

1.502.06

75515

250 2.06

515

DATE RECEIPTS ISSUES BALANCE

2a… PERPETUAL SYSTEM Closing inventory calculated as residual figures:- - Opening inventory 100- Add: Purchases (₹ 600+Rs.1,030) 1,630- Less: Cost of good sold (₹515+75+525+100) 1,215 - Ending inventory (A+B-C) ₹ 515

Cost of goods sold is calculated as residual figures:- - Opening inventory 100- Add: Purchase(₹600+1030) 1,630- Less: Ending inventory (250 x ₹2.06) 515- Cost of goods sold (A+B-C) ₹ 1,215

2b… PERIODIC SYSTEM

LIFO METHOD• Based on assumption that goods that are received

last are issued first.• Assumption made for purposes of assigning costs

and not for actual physical flow of goods.• Flows of goods and costs may not coincide.• Goods sold, thus, consist of the latest lots and are

valued at the price paid for such lots.• The ending inventory consists of the earliest lots

and is valued as such.• Balance sheet has an inventory costed at old prices.

(QUESTION) – ABC Ltd. Provides you with the following information : - 1.1.20 11 Opening Stock 100 units @ Re 1.- 2.1.20 1 1 Purchased 400 units @ Rs 1.50.- 3.1.20 1 1 Issued 450 units. -4.1.20 11 Purchase 500 units @ Re 2.06.- 5.1.2011 Issued 300 units.

REQUIRED : Compute the value of inventory and cost of goods sold as on 5.1.2011 assuming:-(a) Perpetual system; and (b) periodic system under LIFO method.

RETRACING OUR STEPS A BIT

1…STOCK LEDGER UNDER LIFO METHOD

Quality Rate (Rs)

Amt. (Rs)

Quality Rate (Rs)

Amt. (Rs)

Quality Rate (Rs)

Amt. (Rs)

1-1-2011

_ _ _ _ _ 100 1.00 100

2-1-2011

400 1.50 600 _ _ _ 100400

1.001.50

100600

3-1-2011

_ _ _ 400 50

1.501.00

600 50 50 1.00 50

4-1-2011

500 2.06 1030 _ _ _ 50500

1.002.06

501,030

5-1-2011

_ _ _ 300 2.06 618 50200

1.002.06

50412

DATE RECEIPTS ISSUES BALANCE

2a… PERPETUAL SYSTEM Closing inventory calculated as residual figures:- - Opening inventory 100- Add: Purchases (₹600+Rs.1,030) 1,630- Less: Cost of good sold (₹600+50+618) 1,215 - Ending inventory (A+B-C) ₹ 462

Cost of goods sold is calculated as residual figures:- - Opening inventory 100- Add: Purchase(₹600+1030) 1,630- Less: Ending inventory (150 x ₹2.06) 462- Cost of goods sold (A+B-C) ₹ 1,268

2b… PERIODIC SYSTEM

WEIGHTED AVERAGE PRICE METHOD• Based on the assumption that each issue of goods

consists of a due proportion of the earlier lots and is valued at weighted average price.

• Weighted average price is calculated by dividing the total cost of goods in stock by the total quantity of goods in stock.

• This weighted price is used for pricing the issues until a new lot is received when a new weighted average price would be calculated.

• This method evens out the effect of widely varying prices of different lots that make up stocks.

FOR BETTER UNDERSTANDING

Units available Units sold Per unit cost

TOTAL COST in ₹

Opening inventory 100 -- 2.10 210

Sale -- 75 -- --

Purchase 150 -- 2.80 420

Sale -- 100 -- --

Purchase 50 -- 3.00 150

Total 300 175 780

1. The weighted-average cost per unit is ₹780/300 = ₹2.60.2. Ending inventory is 125 units (300 – 175) at ₹2.60 = ₹325;3. Cost of goods sold (ie 175 units at ₹2.60) = ₹455.

PART 3 – MISCELLANEOUS ASPECTS

CLASSIFICATION OF INVENTORY• ABC Classification(consumption) (25/80+15/15+70/05)• XYZ Classification(value stored) (Hi,Med,Low)• HML Classification(unit-value stored) (Hi,Med,Low)• VED Classification(spare parts mainly) (Vital,Ess,Des)• FSN Classification(consumption) (Fast, Slow, Non)• SOS Classification(agriculture) (Seasonal, Non)• SDF Classification(availability) (Scarce, Difficult, Easy)• GOLF Classification (source of supply) Govt, Ordinarily

available, Local and Foreign)

EMERGING TRENDS IN INVENTORY MANAGEMENT

• Entering into long term contracts at a fixed price to reduce uncertainties.

• Just-in-time.• Kanbans – Japanese technique (Only produce

when demand comes).• Internet based ordering systems.• Supply chain management.• Vendor development.• Investment in plant and machinery.

INVENTORY CONTROL RESPONSIBILITY• Purchasing naturally has vest interest in

inventories, even to the extend that in some companies the purchasing and stores functions are combined.

• Production looks after the work in progress.• Logistics plays a major role in inventory control• Inventories are economic importance to finance

department.• The fact that materials must be moved from one

place to another is of importance to materials department.

In effect, the responsibility cannot be kept on one head since inventory management

is an integrated effort

ANY QUESTIONS?

THANK YOU