Unit 3 Inventory Control and supply chain Management Notes ( By Neha Chhabra)

Men

Machine

Materials The 5 M’s : the basic fundamentals of an organisation

Money

Management

Inventory Control is dealing with Material Management.

Material management is a scientific technique, concerned with Planning, Organizing &

Control of flow of materials, from their initial purchase to destination.

Inventory:

Inventory is a stock or store of goods, commodities, or other resources that are stored in an

organisation at any given period of time, for future production. It also means "the aggregate

of those items of tangible personal property which: -

1. Are held for sale in ordinary course of business.

2. Are in the process of production for such sale or

3. Are to be currently consumed in the production of goods or services to be available for

sales

Thus, it includes:

a) Raw materials and purchased parts

b) Partially completed goods

c) Finished-goods inventories or merchandise

d) Replacement parts, tools, and suppliers

e) Goods-in-transit to warehouses or Goods –in- progress

Need of Inventory

1) Transaction Motive : The Company may be required to hold the inventory in order to

facilitate the smooth and uninterrupted production and sale operations. It may not be possible

for the company to procure the raw material whenever necessary. There may be a time lag

between the demand for the material and its supply. Hence it is needed to hold the raw

material inventory. Similarly it may not be possible to produce the goods immediately after

they are demanded by the customers. Hence it is needed to hold the finished goods inventory.

They need to hold work in progress may arise due to production cycle.

Reasons for Transaction Motive thus include:

a) Economies of scale ( discounts on bulk purchase and transport economies)

b) Specialisation

2) Precaution Motive: In addition to the requirement to hold the inventory for routine

transactions, the company may like hold them to guard against risk of unpredictable changes

in demand and supply forces. Eg. The supply of raw material may get delayed due to factors

like strike, transport, disruption, short supply, lengthy processes involved in import of raw

material etc. hence the company should maintain sufficient level of inventory to take care of

such situations. Similarly, the demand for finished goods may suddenly increase (especially

in case of seasonal type of products) and if the company is unable to supply them, it may

mean gain of competition. Hence, company will like to maintain sufficient supply of finished

goods.

Precautionary Motive thus includes:

a) Inventory as buffer

b) Hedge against price change

c) Protection against demand and lead time uncertainty

3) Speculative Motive: The Company may like to purchase and stock the inventory in the

quantity which is more than needed for production and sales purpose. This may be with the

intention to get advantage in term of quantity discounts connected with bulk purchasing or

anticipating price rise. ( opportunity to capitalize on an opportunity to make profit)

4) To maintain company’s goodwill and improve customer service.

Types of Inventories:

On basis of Nature of Material On Basis of use

Direct Inventories and Indirect inventories Speculative, transaction,

precautionary etc

Direct:

Raw material is a type of inventory which acts as the basic constituent of a product. For

example cotton is raw material for cloth production and plastic is raw material for production

of toys. Raw material is usually held by manufacturing companies because they have to

manufacture goods from raw material.

Work-In-Process

Work in process is a type of inventory that is in the process of production. This means that

work-in-process inventory is in the middle of production stage and it is partly complete.

Work-in-process account is used by manufacturing companies.

Finished Goods

Finished goods inventory is a type of inventory which comes into existence after the

production process in complete. Finished goods are ready for sale inventory.

Indirect :

Consumables: Light bulbs, hand towels, computer and photocopying paper, brochures, tape,

envelopes, cleaning materials, lubricants, fertilizer, paint, dunnage (packing materials), and

so on are used in many operations. These are often treated like raw materials.

MRO, Maintenance, Repair and Operating inventories or Service, repair, replacement, and

spare items (S&R items): These are after-market items used to “keep things going.” As long

as a machine or device of some type is being used (in the market) and will need service and

repair.

On basis of use:

1) Buffer/safety inventory: This type of inventory can serve various purposes, such as:

a) Compensating for demand and supply uncertainties.

b) “Decoupling” and separating different parts of your operation so that they can

function independently from one another.

2) Anticipation Stock: This is inventory produced in anticipation of an upcoming season,

such as fancy chocolates for Mother’s Day or Valentine’s Day. Failure to sell in the

anticipated period could be disastrous, because you may be left with considerable amounts of

stock past its perceived shelf life

3) Transaction Inventory

4) Speculative Inventory

INVENTORY COSTS

There are four main types of cost in inventory :

Purchase Cost : The actual cost of materials

Ordering costs:

Ordering costs have to do with placing orders, receiving and storage. Transportation and

invoice processing are also included. Lowering these costs would be accomplished by placing

small number of orders, each for a large quantity. Unlike carrying costs, ordering expenses

are generally expressed as a monetary value per order. If the business is in manufacturing,

then to production set up costs are considered instead.

Holding\ carrying cost\Safety stock:

This cost is measured as a percentage of the unit cost of the item. This measure, gives a basis

for estimating what it actually costs a firm to carry stock. This cost includes:

1) Interest on capital.

2) Insurance and tax charges.

3) Storage costs – any labour, the costs of provisions of storage area and facilities like

bins, racks, etc.

4) Allowance for deterioration or spoilage.

5) Salaries of stores staff.

6) Obsolescence.

These charges increase as inventory levels rise. To minimize carrying costs, management

makes frequent orders of small quantities. Holding costs are commonly assessed as a

percentage of unit value, rather than attempting to derive monetary value for each of these

costs individually. This practice is a reflection of the difficulty inherent in deriving a specific

per unit cost, for example, obsolescence or theft.

Stock-out costs:

Stock out or shortfall costs(Ks) represent lost sales due to lack of supply for consumers. How

these costs are calculated can be a matter of contention between sales and logistics managers.

Sales departments prefer these numbers be kept low so that an ample stock will always be

kept. Logistics managers prefer to err on the side of caution to reduce warehousing costs.

They include sales that are lost, both short and long term, when a desired item is not

available; the costs associated with back ordering the missing item; or expenses related to

stopping the production line because a component part has not arrived. These charges are

probably the most difficult to compute, but arguably the most important because they

represent the costs incurred by customers when an inventory policy falters.

Inventory control

Inventory control is a means for maintaining the right level of supply and reducing loss to

goods or materials before they become a finished product or are sold to the consumer.

The simplest language, inventory control may be said to be a planned method whereby

investment in inventories held in stock is maintained in such a manner that it ensures

proper and smooth flow of materials needed for production operations as 'well sales, while

at the same time, the total costs of investment in inventories is kept at a minimum.

Inventory control is one of the greatest factors in a company’s success or failure. Proper

inventory control will balance the customer’s need to secure products quickly with the

business need to control warehousing costs. To manage inventory effectively, a business must

have a firm understanding of demand, and cost of inventory

USES OF INVENTORY CONTROL

a) To ensure adequate supply of products to customer and avoid shortages as far as

possible.

b) To make sure that the financial investment in inventories is minimum (i.e., to see that

the working capital is blocked to the minimum possible extent).

c) Efficient purchasing, storing, consumption and accounting for materials is an

important objective.

d) To maintain timely record of inventories of all the items and to maintain the stock

within the desired limits.

e) To ensure timely action for replenishment.

f) To provide a reserve stock for variations in lead times of delivery of materials.

g) To provide a scientific base for both short-term and long-term planning of materials

h) To determine size of inventory

i) To assign responsibility for carrying out inventory control functions, and help in

decision making

Objectives

(Source : J S Sangal)

INVENTORY CONTROL TECHNIQUES

Some important analysis carried out are :

a) ABC Analysis - based on annual consumption.

b) VED Analysis - criticality for production.

c) SDE Analysis - availability.

d) GOLF analysis-based on suppliers

e) HML Analysis - weight / cost permit.

f) FSN Analysis - consumption rate.

g) SOS Analysis-based on seasonality

h) XYZ Analysis-Left out stock value

a) ABC ANALYSIS :

ABC is said to connote “Always Better Control”. ABC analysis is the analysis of the store

items cost criteria. Of the various techniques, ABC classification is the most important

technique. The cost of each item is multiplied by the number used in a given period and then

these items are tabulated in descending numerical value order. It will be seen that first 10% of

items approximately account for 70%, the next 20% for 20% of value and the last 70%

account for 10% of value.

It has been seen that a large number of items consume only a small percentage of resources

and vice- versa. A – Items represent the high cost centre, B items represent the immediate

cost centres, and C- items represent low cost centres. A very close control is exercised over A

items while less stringent control is adequate for those in the category B, and less attention

for category C.

By concentrating on controlling A- items, and to a lesser degree on B items, it will be

possible to control the inventory quiet effectively both in the way of cost control and

lessening the risk of ‘stock out’. Since A items are of the highest value and are required in

large numbers they could be purchased more frequently and the others, B & C items less

frequently. In so far as inventory control is concerned the following guidelines will help in

keeping the system optimum (i.e. Healthy balance between financial constraints and purchase

of required quantity of materials)

A- Items: on

1. Tight controls

2. Rigid estimates of requirements

3. Strict and close watch ( monitoring)

4. Safety stocks should be low

5. Management of items should be done at top management level.

B- Items

1. Moderate control

2. Purchase based on rigid requirements

3. Reasonably strict watch and control

4. Safety stocks moderate

5. Management be done at middle level

C- Items

1. Ordinary control measure

2. Purchase based on usage estimates

3. Controls exercises by store keeper.

4. Safety stocks high

5. Management be done at lower levels.

b) VED ANALYSIS :

ABC analysis does not tell anything about the criticality of the items. VED analysis is done to

control a critical inventory situation. Through this analysis, we identify the criticality of

production situation and accordingly plan for the inventory. Materials are classified into the

three types as under:

V-Vital: items without which production will completely stop. i.e. non- availability cannot

be tolerated. Eg. Due to the absence of bearing, rolling machine cannot operate. Airlines

industry is bound to keep stand-by engines as its absence; at times, the industry may require

flight cancellation, which costs to the industry an enormous revenue loss.

E-Essential: items whose cost of non availability can be tolerated for 2-3 days, because

similar or alternative items are available. For example, some paper mills, bamboo is an

important raw material. Availability of bamboo from the forests, at times, becomes uncertain

because of number of reasons due to climate, natural calamities etc.,

Desirable: items whose non availability can be tolerated for a long period. Although the

proportion of vital, essential and desirable items varies from organisation to organisation.

Although not included in scientific VED analysis, in some public organizations which are

static or inefficiently managed, there is a peculiar category of ‘U’ items which can be

grouped as unnecessary. These unnecessary items get purchased due to the following reasons.

a) Thoughtless continuation of previous purchase.

b) Indifferent attitude towards hospital formulary

c) Fear of change

d) Poor supervision and control

e) Unfair practice due to vested interest.

The vital items are stocked in abundance; essential items are stocked in medium amounts,

and desirable items we stocked in small amounts. By stocking the items in order of priority,

vital and essential items are always in stock which means a minimum disruption in the

services offered to the people. It should be realized that vital- V items and A items are not the

same. All the vital items are not expensive and all the expensive items are not vital. Domestic

examples of salt and matchbox proves that though these items are vital, they are not

expensive, similarly microwave oven and air conditioning unit are expensive, but they are not

essential.

It is possible to conduct a two dimensional analysis taking into consideration cost on one

hand , i.e. A,B,C categories, and critically VED on the other.

c) SDE ANALYSIS :

This analysis is based spares availability of an item –

S-Scarce Items

D-Difficult Items

E-Easy Items

S - refers to Scarce Items, especially imported and those which are very much in short

supply. Due to their nature, these items are procured on yearly interval.

D - are Difficult items which are procurable in market but not easily available. For example,

items which have to come from far off cities or where there is not much competition in

market or where good quality supplies are difficult to get or to be procured.

E - refers to Easy items – Items are those which are easily available; mostly local items. Due

to their easy availability, organizations may not require to hold these items in large volume in

their stock. It is normally advantageous to consider A, V & S items for selective controls.

d) GOLF ANALYSIS:

It is similar to SDE analysis, and it is based on the nature of market and suppliers. Suppliers

or Vendors are classified as under:

G-Government

O-Ordinary or Non-government

L-Local

F-Foreign

All these suppliers have their own payment terms, own administrative procedure and soon.

For a materials Manager, therefore, it is important to keep in mind all these issues to function

efficiently and smoothly.

e) HML ANALYSIS :

The cost per item (per piece) is considered for this analysis

High cost items (H),

Medium Cost items (M) and

Low Cost item (L) help in bringing controls over consumption at the departmental level.

f) FSN ANALYSIS :

This analysis is to help control obsolescence and is based on the consumption pattern of the

items. The items are analyzed to be classified as

Fast-moving (F),

Slow-moving (S) and

Non-moving (N) items.

The Non-moving items (usually not consumed over a period of two years) are of great

importance. Scrutiny of non-moving items is to be made to determine whether they could be

used or be disposed off. The fast and slow moving classifications help in arrangement of

stock in stores and their distribution and handling methods.

g) SOS ANALYSIS:

SOS Analysis is done, keeping in view the seasonality or non-seasonality of the item.

S- Seasonal Items

OS – non-seasonal Items

Depends on seasonality and non-seasonality of the items, procurement actions vary.

Example: in case of sugar mills whose procurement is seasonal, these companies need to

procure their requirement for a longer duration so as to adjust their production plans. Green

tea leaves are available for a longer duration from February to October. Non-seasonal items

are available throughout the year without any major price variation. Since seasonal items,

which are available for a limited period, are procured in bulk to manage the production

process throughout the year.

h) XYZ ANALYSIS

This analysis is made based on the value of left out stock in the stores. ‘X’ items are those

whose value of left out stock is very high. ‘Y’ items are those whose left-out stock value is

moderate. ‘Z’ items are the residual items, whose left-out stock value is neither high nor

moderate. Materials managers, based on such analysis, can plan not only for procurement but

also for secured storage of items.