Inventory Management

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Topic- Inventory Management
Subject- Working Capital Management

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Inventory Management

  1. 1. INVENTORYMANAGEMENT Dr. NEERAJ CHITKARADr. Neeraj ChitkaraAssistant ProfessorSamalkha Group of InstitutionsEmail- neer.chitkara@gmail.com
  2. 2. INTRODUCTIONInventories are assets of firm and as such they represent an investment. Because such investment Dr. NEERAJ CHITKARA requires the precious funds, managers must ensure that the firm maintains inventories at the correct level. If they become too large, the firm loses the opportunity to employ those funds more effectively. Similarly, if they are too small, the firm may lose sales. Managing the level of inventories is like maintaining the level of water in a bath tub with an open drain. The water is flowing out continuously. If the water is let in too slowly, the tub is soon empty. If the water is let in too fast, the tub overflows.
  3. 3. TYPES OF INVENTORIES The common types of inventories for most of the business firms may be classifies as finished goods, w-i-p and raw materials. Dr. NEERAJ CHITKARAFinished Goods These are the goods which are either being purchased or being produced or being processed by the firm. These are just ready for sale to customers. Inventories of finished goods arise because of the time involved in production process and the need to meet customer’s demand promptly. If the firms do not maintain a sufficient finished goods inventory, the customer who are unwilling to wait may turn to competitors. The purpose of finished goods inventory is to bring smoothness in the production and sales function.
  4. 4. Work-in Progress It refers to the raw materials engaged in various phases of production schedule. The degree of completion may be varying for different units. Some Dr. NEERAJ CHITKARA units might have been just introduced, while some others may be 40% complete or others may be 90% complete. The work-in-progress refers to partially produced goods. The value of work-in-progress includes the raw materials costs, the direct wages and expenses already incurred and the overheads, if any. The qty. and the value of work-in-progress depends upon the length and complexity of production cycle.R
  5. 5. Raw Materials The raw materials include the materials which are used in the production process and every manufacturing firms has to carry certain stock of raw Dr. NEERAJ CHITKARA materials in stores. These units of raw materials are regularly issued/transferred to production department. Inventories of raw materials are held to ensure that the production process is not interrupted by a shortage of these materials. The requirement of stock of raw material is based upon many factors including speed with which raw materials can ordered and procured, uncertainty in the supply of raw materials etc. Its purpose is just to make the production and purchasing functions independent.
  6. 6. OBJECTIVES OF HOLDING INVENTORY Transaction Motive Dr. NEERAJ CHITKARA Precautionary Motive Strikes, labour problems, natural calamities etc. Speculative Motive to earn extra profit due to shortage Contractual Agreements
  7. 7. BENEFITS OF HOLDING INVENTORYFor Trading Concerns Dr. NEERAJ CHITKARA Uninterrupted selling process Quality discountsFor manufacturing concerns Uninterrupted production schedule Independent sales activity
  8. 8. COST OF INVENTORY The cost of holding inventories may include the following: Carrying Costs: This is the cost incurred in keeping or Dr. NEERAJ CHITKARA maintaining n inventory of one unit of raw material or work-in-progress or finished goods. There are two components of it: Cost of Storage e.g. rent of space, salary of storekeeper, cost of infrastructure, cost of insurance, cost of warehousing, handling costs etc. Cost of Financing e.g. opportunity costs, interest on borrowings ( carrying cost is always variable cost and directly varies in the same direction in which the stock varies)
  9. 9.  Ordering Costs : The costs of ordering include the cost of acquisition of inventories i.e. cost of preparation and execution of an order, cost of paper work and cost of communication with supplier, cost of inspection, checking & handling, salaries & wages of the purchase department. Dr. NEERAJ CHITKARA1. Total annual ordering cost= Cost per order × No. of orders placed in the year The ordering cost may have fixed components as well as variable components; fixed component is not affected by the order size whereas variable component is affected by the order size e.g. transactioncharges may be payable per unit subject to a minimum charges per trip. The carrying cost and the ordering costs are the opposite forces and collectively they determine the level of inventory. A financial manager has to achieve a trade- off between carrying costs and the ordering costs.
  10. 10. Cost of stock-outs (a hidden cost) A stock out is a situation when the firm is not having units of an item in store but there is a demand for that either from customers or the production department. The stock out refers to Dr. NEERAJ CHITKARA demand for an item whose inventory level has already reduced to zero or insufficient level. Stock out does not appear if the item is not demanded even if the inventory level has fallen to zero. Costs of stock outs of finished goods i.e. lost sales, cancellation of orders, adverse affect to the goodwill etc. Costs of stock outs of raw material is the hurdle in the production process.
  11. 11. INVENTORY High Levels Low LevelsBenefits Benefits Dr. NEERAJ CHITKARA •Low Storage costs•Happy Customers •Less risk of Obsolescence•Few productions delays(always have need parts onhand)Costs Costs•Expensive •Shortage•High Storage Costs •Dissatisfied customers•Risk of Obsolescence
  12. 12. TECHNIQUES OF INVENTORY MANAGEMENT Explosion process Past-usage Methods Dr. NEERAJ CHITKARA Value-volume Analysis ABC Approach VED Classification HML Classification XYZ Classification FSN Classification SDE and Golf Classification SOS Classification
  13. 13. INVENTORY CONTROL MODELS Economic Order Quantity Model Probabilistic Inventory control Dr. NEERAJ CHITKARA Just-In-Time Inventory Management SystemOther Control Devices Control Account Physical Counting Visual View Two-bin-System Minimum-maximum System Periodic Order System
  14. 14. INVENTORY MANAGEMENT & VALUATION Dr. NEERAJ CHITKARA Average Cost Method First-In , First-out (FIFO) Inventory Method Last-In, First-out (LIFO) Method`
  15. 15. DETERMINATION OF STOCK LEVELS Both the excess and shortage of materials are harmful for the firms. Hence various stock levels Dr. NEERAJ CHITKARA must be determined: Minimum Level: This represents the quality which must be maintained in hand at all times. The following things must be considered regarding it Lead Time, Rate of Consumption, Nature of materials etc.Minimum Level=Re-ordering level - (Normal consumption × Normal re-order period)
  16. 16. RE-ORDERING LEVEL When the quality of materials reaches at a certain figure then fresh order is send to get materials again. Re-ordering level is fixed between minimum level and maximum level. Dr. NEERAJ CHITKARA The following points are considered while determining re-ordering level: rate of consumption, no. of days required to replace the stock etc.Re-ordering level= Maximum consumption × Maximum re-order period.
  17. 17. MAXIMUM LEVEL It is the quality beyond which a firm should not exceed its stock otherwise there will be overstocking. Maximum stock level depends upon the following factors: The availability of capital for the purchase of materials. Dr. NEERAJ CHITKARA The maximum requirement at any point of time. The availability of space for storing the materials. The rate of consumption of materials during lead time. The cost of maintaining the stores. The possibility of fluctuations in prices. The nature of materials. Restrictions imposed by govt.Maximum stock level= Re-ordering level + Re-ordering quantity-(Minimum consumption × Minimum re-ordering period).
  18. 18. DANGER LEVEL It is the level beyond which materials should not fall in any case. If danger level arise then Dr. NEERAJ CHITKARA immediate steps should be taken to replenish the stock even if more cost is incurred in arranging the materials. If materials are not arranged immediately there is a possibility of stoppage of work.Danger level= Average consumption × maximum re- order period for emergency purchase
  19. 19. AVERAGE STOCK LEVEL; Dr. NEERAJ CHITKARAAverage stock level = Minimum stock level +1/2 of Re-order quantity

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