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Inventories constitute the most significant part of current assets of the business concern. It is also essential for smooth running of the business activities.
A proper planning of purchasing of raw material, handling, storing and recording is to be considered as a part of inventory management. Inventory management means, management of raw materials and related items. Inventory management considers what to purchase, how to purchase, how much to purchase, from where to purchase, where to store and when to use for production etc.
The dictionary meaning of the inventory is stock of goods or a list of goods. In accounting language, inventor y means stock of finished goods. In a manufacturing point of view, inventory includes, raw material, work in process, stores, etc.
1 Kinds of Inventories
Inventories can be classified into five major categories.
It is basic and important part of inventories. These are goods which have not yet been committed to production in a manufacturing business concern.
Work in Progress
These include those materials which have been committed to production process but have not yet been completed.
These are the materials which are needed to smooth running of the manufacturing process.
These are the final output of the production process of the business concern. It is ready for consumers.
It is also a part of inventories, which includes small spares and parts.
2 Objectives of Inventory Management
The major objectives of the inventory manage me nt are as follows:
To efficient and smooth production process.
To maintain optimum inventory to maximize the profitability.
To meet the seasonal demand of the products.
To avoid price increase in future.
To ensure the level and site of inventories required.
To plan when to purchase and where to purchase
To avoid both over stock and under stock of inventory.
3 Techniques of Inventory Management
Inventory management consists of effective control and ad ministration of inventories. Inventory control refers to a system which ensures supply of required quantity and quality of inventories at the required time and at the same time prevent unnecessary investment in inventories. It needs the following important techniques.
Inventory management techniques may be classified into various types:
A. Techniques based on the order quantity of Inventories
Order quantity of inventories can be deter mined with the help of the following techniques :
Stock level is the level of stock which is maintained by the business concern at all times. Therefore, the business concern must maintain optimum level of stock to smooth running of the business process. Different level of stock can be determined based on the volume of the stock.
The business concern must maintain minimum level of stock at all times. If the stocks are less than the minimum level, then the work will stop due to shortage of material.
Re-ordering level is fixed between minimum level and maximum level. Re-order level is the level when the business concern makes fresh order at this level.
Re-order level= maximum consumption × maximum Re-order period.
It is the maximum limit of the quantity of inventories, the business concern must maintain. If the quantity exceeds maximum level limit then it will be overstocking. Maximum level = Re-order level + Re-order quantity – (Minimum consumption × Minimum delivery period)
It is the level below the minimum level. It leads to stoppage of the production process.
Lead time is the time normally taken in receiving delivery after placing orders with suppliers. The time taken in processing the order and then executing it is kno wn as lead time.
Safety stock implies extra inventories that can be drawn down when actual lead time and/ or usage rates are greater than expected. Safety stocks are deter mined by opportunity cost and carrying cost of inventories. If the business concerns maintain low level of safety stock, it will lead to larger opportunity cost and the larger quantity of safety stock involves higher carrying costs.
Economic Order Quantity (EOQ)
EOQ refers to the level of inventory at which the total cost of inventory comprising ordering cost and carrying cost. Determining an optimum level involves two types of cost such as ordering cost and carrying cost. The EOQ is that inventor y level that minimizes the total of ordering of carrying cost.
EOQ can be calculated with the help of the mathematical formula:
a = Annual usage of inventories (units)
b = Buying cost per order
c = Carrying cost per unit
4 Techniques Based On The Classification Of Inventories
It is the inventory management techniques that divide inventory into three categories based on the value and volume of the inventories; 10% of the inventory‘s item contributs to 70% of value of consumption and this category is known as A category. About 20% of the inventor y item contributes about 20% of value of consumption and this category is called category B and 70% of inventor y item contributes only 10% of value of consumption and this category is called C category.
Inventory Breakdown Between Value and Volume
ABC analysis can be explained with the help of the following Graphical presentation.
Inventor ies are classified according to the period of their holding and also this method helps to identify the movement of the inventories. Hence, it is also called as, FNSD analys is—
F = Fast moving inventories
N = Normal moving inventories
S = Slow moving inventories
D = Dead moving inventories
This technique is ideally suited for spare parts in the inventory management like ABC analysis. Inventories are classified into three categories on the basis of
usage of the inventories.
V = Vital item of inventories
E = Essential item of inventories
D = Desirable item of inventories
Under this analysis, inventories are classified into three categories on the basis of the value of the inventories.
H = High value of inventories
M = Medium value of inventories
L = Low value of inventories
Techniques On The Basis Of Records
A. Inventory budget
It is a kind of functional budget which facilitates the estimated inventory required
for the business concern during a particular period. This budget is prepared based
on the past experience.
B. Inventory reports
Preparation of periodical inventory reports provides information regarding the order level, quantity to be procured and all other information related to inventories. On the basis of these reports, Management takes necessary decision regarding
inventory control and Management in the business concern.
Valuation of Inventories
Inventories are valued at different methods depending upon the situation and
nature of manufacturing process. Some of the major methods of inventory
valuation are mentioned as follows:
First in First Out Method (FIFO)
v Last in First Out Method (LIFO)
v Highest in First Out Method (HIFO
v Nearest in First Out Method (NIFO)
v Average Price Method
v Base Stock Method
v Standard Price Method
v Market Price Method
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