Module 5. Inventory control

Lesson 10

INTRODUCTION AND GENERAL NOTATIONS

10.1 Introduction

Inventory, in broad sense, is a stock of physical assets having some economic value, which can be either in the form of material, money or men and is defined as any idle resource of an enterprise. It is a physical stock of goods kept for the future purposes. The term is generally used to indicate raw material, work-in-progress (intermediate good), finished goods, packaging material and other stock in order to meet an expected demand or distribution in future as well as day to day functioning of any organization. Though inventory of materials is an idle resource, it is not meant for immediate use, it is always essential to maintain inventory of goods for smooth functioning of an enterprise. For example, suppose a milk plant does not have Inventory of materials at all. If this plant receives a sales order, then

i)        It will have to order out raw material required to complete the order.

ii)      It has to wait till the material arrives and then start production.

iii)    Customers have to wait too long for the delivery of finished goods.

iv)    The plant may have to purchase raw materials at very high prices which will increase the cost of production and decrease the margin of profit.

Centuries ago, inventories were viewed as measures of the wealth and power of a country or of an individual. Now-a-days, inventories are viewed as a large potential risk rather than as a measure of wealth due to the fast developments and changes in product life, therefore, it has necessitated the use of scientific techniques in the management of inventories known as inventory control. It is the technique of maintaining stock-items at desired levels. Different departments within the same organization adopt different attitudes towards inventory. This is mainly because the particular functions performed by a department influence the department’s motivation. For example, the sales department might desire large stock in reserve to meet virtually every demand that comes. The production department similarly would ask for large stocks of materials so that the production system runs uninterrupted. On the other hand, the finance department would always argue for a minimum investment in stocks so that the funds could be used elsewhere for other better purpose.

10.2 Inventory (Production Management)

The study or function of directing the movements of goods through the entire manufacturing cycle from the raw material to the inventory of finished goods orderly mannered to meet the objective of maximum customers service with minimum investment and efficient plant operation. This process is known as inventory control. Inventory may be defined as stock of goods, commodities or other economic resources that are stored or reserved in order to ensure smooth and efficient running of business. Inventory, for example may include raw material which are kept in stock for in the production of goods (raw material inventory), Semi finished goods or goods in process which are stored during the production process (Work in progress inventory), finished goods awaiting shipment from plant, wholesaler etc. (finished goods inventory). Inventory also includes furniture, machinery fixtures etc. The term inventory is generally classified into two categories:

10.2.1 Direct inventory

Direct inventories play a direct role in the manufacturing and become a bigger part of finished goods. They are further classified into three groups:

i)     Raw material inventories are provided

a)      for economical bulk purchasing.

b)     to enable production rate changes.

c)      to provide production buffer against transportation.

d)     seasonal fluctuations.

ii)   Work in progress inventories are provided

a)      to enable economical lot production.

b)     to consider the variety of production for replacement of base.

c)      to maintain uniform production even if  amount of sales may vary.

iii) Finished goods inventories are provided

a)      for maintaining of self delivery.

b)     to allow stabilization of production level.

c)      for sales promotion.

10.2.2 Indirect inventory

They include those items which are necessary for manufacturing but do not become component of finished production, such as oil, grease, petrol, lubricant, office material, maintenance material etc.

10.3 Types of Inventory

10.3.1 Fluctuation inventory

These have to be carried because sales and production time can’t be predicted accurately. There is fluctuation in the demand and lead times that affect the production of items such type of results stock or safety stock are called fluctuation inventory.

10.3.2 Anticipation inventory

These are built in advance for the season of large sale a promotional programme or a plant shut down period. In this inventory are store for future requirement.

10.3.3 Cycle or lot size inventory

In practical situations it seldom happens that the rate of consumption is same as rate of production so the items are purchased in large quantity than they are required. This results in cycle or lot size inventory.

10.3.4 Transportation inventory

Such inventory exists because the material is required to move from one place to another place when the transportation time is long and the items under transport can’t be served to customer. Therefore these inventories exist solely because of time.

10.3.5 Decoupling inventory

Such inventory is needed for meeting of demand for decoupling the different parts of the production system.

10.4 Inventory Decisions

The following are the decisions made for every item of inventory.

i)        How much amount of an item should be ordered when the inventory of that item is to be replenished.

ii)      When to replenish the inventory of that item

 10.5 How to Develop Inventory Control Model?

i)        First take physical stock of all inventory items in an inventory organization.

ii)      Second, classify all items in various categories.

iii)    Each of above classification may be further divided into different groups.

iv)    After classification of inventories, each item should be assigned a suitable code.

v)      Since the number of items is very large, separate inventory management model should be developed for each category of items A-B-C or V-E-D classification.

vi)    Estimates annual demand of each inventory item and their prevailing prices.

vii)  Estimate lead time, safety stock and reorder level, if supply is not instantaneous.

viii)   Develop the inventory mode.

ix)       Finally, review the position and make suitable alterations, if required due to current situations or constraints.

10.6 Costs Involved in Inventory Control Models

10.6.1 Holding cost

Costs associated with carrying or holding goods in stock is known as carrying or holding cost which is denoted by C1 or Ch per unit of goods for a unit of time, respectively. However cost is assumed to be varying directly the size of inventory as well as the time for which the item is in stock. The following components constitute the holding cost.

i)          Invested capital costs (Interest charged on capital investment):- This is the most important component so its rate of interest should be investigated carefully.

ii)         Record keeping and administrative costs: - This signifies the need of keeping funds for maintaining of records and necessary administration.

iii)       Handling cost:- It includes all costs associated with movement of stock such as cost of labour, overhead and other machinery required for this purpose.

iv)       Storage cost: - This involves the rent of storage space or depreciation in interest even if own space is used.

v)         Depreciation, deterioration or obsolescence cost: - Such cost is due to the item in stock being out of fashion or the item undergoes chemical changes during storage (e.g. rusting of iron), breakage and spoilage.

vi)       Insurance cost – The amount of money paid in the form of insurance premium is known as insurance cost. This cost is also a component of stock holding cost.

vii)   Purchase Cost or Production Cost: - Purchase price per unit item is affected by the purchase due to discount or price break. Production cost per unit item depends upon length of production time.

viii) Selling price or Salvage Cost: - When the demand for an item is affected by its quantities in stock, the decision model of the problem depends upon profit maximum and in revenue (sales tax etc) from the sale of the items. Generally     salvage cost is combined with storage cost and not considered independently.

Carrying cost can be determined as

Carrying cost= (Cost of carrying one unit of item for a given length of time) x (Average number of units carried for a given length of time)

10.6.2 Shortage cost or stock out cost

These are penalty costs that are incurred as a result of either delay in meeting the demand or inability to meet it at all due to running out of stock are known as shortage or stock out cost. It is denoted as C2 or Cs per unit of goods for specified period. This cost arises due to shortage of goods, sales may be lost, good will may be lost either by delay in meeting the demands or being quite unable to meet the demand.

10.6.3 Setup cost

These include the fixed cost associated with obtaining goods through placing of an order or purchasing or manufacturing or setting up of a machine before start of production. So they include cost of purchase, requisition, quality control etc. These are also known as order cost or replenishment cost. It is denoted by C3.

10.7 Objective of  Inventory Control

i)        It helps in smooth and efficient running of business.

ii)      It provides service to the customers immediately at a short notice.

iii)    Due to absence of stock the company has to pay high price because of piecewise purchasing.

iv)    It also acts as a buffer stock when raw material is received late or when orders are likely to be rejected.

v)      It reduces product cost.

vi)    It helps to maintain the economy by absorbing some of the fluctuations and the demand for an item fluctuates or is seasonal.