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INVENTORY MANAGEMENT TECHNIQUES INTRODUCTION Inventory is stores of goods and stocks. In manufacturing, items in inventory are called stock – keeping items, held at a stock point. Stock – keeping usually are raw materials, work – in – progress, finished products and supplies. Maintaining inventories means extra expenditure or carrying cost. On the other hand, a shortage of inventory or stockouts means production stoppage or losing a customer, which may prove more expensive. Thus, maintaining adequate inventory is essential:- a) To avoid interruption in production due to stock – outs. b) To take advantage of price discounts on bulk purchases. c) To achieve economy in transportation cost. d) To ensure adequate customer service. Excess inventory is, however, not desirable because:- a) Extra inventory means locking up capital, which could have been put to alternate use. b) Maintenance of inventory cost money, in terms of warehousing, personnel, breakage, obsolescence etc. Thus, the problem of excess or inadequate inventories needs to be balanced through inventory control. Inventory control means determination of quantities that should be ordered at a time and the method of ordering it., so that both inventory carrying cost and losses arising put of stocks – out are minimized. BENEFITS OF INVENTORY MANAGEMENT Reduced stocking costs resulting from efficient matching of requirements to stock. Re-order recommendations highlight urgent needs. Help prevent stock-outs. Instant access to 24 month usage pattern aids decision-making, reveals trends. Old data easily purged. Automatic capture on audit trail of all stock movement details helps resolve queries. Instant month-end valuation of receipts, issues, adjustments etc. Rapid stock and work-in-progress evaluation. True multi-location without constraints. Easy monitoring of slow moving stocks. Automation of inventory checking cycles ensures that items are not forgotten, improves control. Automatic tracking of scrap rates and recalculation of safety levels reduces effort, improves control. ABC analysis system focuses attention on high value stock holdings. CHARACTERISTICS The holding of inventory is risky because of the capital investment and the potential for obsolescence. Investments for inventory cannot be used to obtain other goods or assets that could improve enterprise performance. Funds supporting inventory must be borrowed, increasing the firm‟s interest expense. A second form of risk is the possibility that the product will be pilfered or become obsolete. These factors and the relative magnitude of assets that are inventory- related contribute substantially to the riskiness of most enterprises. It is important to understand that the nature and extent of risk vary depending on an enterprise‟s position in the distribution channel. INVENTORY TECHNIQUES ABC analysis underline a very important principle “Vital few: trivial many”. Statistics reveal that only a handful of items account for bulk of the annual expenditure on materials. These few items called „A‟ items therefore hold the key to business. The other items known as „B‟ and „C‟ items are numerous in number but their contribution is less significant. ABC analysis thus tends to segregate all items into three categories: A, B, and Con the basis of their annual usage. The categorization so made enables one to pay the right amount of attention as merited by the items. ABC CLASSIFICATION SYSTEM A-Items: It is hardly found that 5-15% of items account for 70-80% of the total money spent on materials. These items require detailed and rigid control and need to be stocked in smaller quantities. These items should be procured regularly, the quantity per occasion being small. A healthy approach would be to enter into contract with the manufacturers of these items and have their supply in staggered lots according to the demand is steady. Alternatively, the inventory can be kept at minimum by frequent ordering. B-Items: These items are generally 30% of all items and represent 15% of the total expenditure on the materials. These are intermediate items. The control on these items need not be as detailed and as rigid as applied to Citems. C-Items: There are numerous (represent hardly 5-10% of the total expenditure on materials) and hence insignificant (d not require close control) items. The procurement policy for these items is exactly the reverse of „A‟ items. Citems should be procured infrequently and in sufficient quantities. This enables buyer to avail price discounts and reduce workload of the concerned departments. Percentage of Annual Consumpti on Value(ACV) Percentage of items CONDUCTING ABC ANALYSIS: 1) Prepare the list of items and estimate their annual consumption (units). 2) Determine unit price (or cost) of each item. 3) Multiply each annual consumption by its price (or cost) to obtain its annual consumption in rupees (annual usage). 4) Arrange items in the descending order of their annual usage starting with the highest annual usage down to the smallest usage. 5) Calculate cumulative annul usage and express the same as cumulative usage percentages. Also express the number of items into cumulative item percentages. 6) Graph cumulative usage percentages against cumulative item percentages and segregate the items into A, B and Categories. 7) To separate items into A, B and Categories, first few items which contribute between 70-75% of cumulative usage can be considered as A category, next few items which together with A category items segregated earlier contribute between 80-90% of cumulative usage can be considered B category, and left over items can be considered B category, and left over items can be taken as C-category. EXAMPLE A firm has 7 different items in its inventory. The average number of each of these items held, along with their costs, is listed below. The firm wishes to introduce an ABC inventory system. Suggests a breakdown of the items of the items into A, B and C classification. Item number Average number of Average cost per unit units in inventory 1 20000 Rs. 60.80 2 10000 102.40 3 32000 11.00 4 28000 10.28 5 60000 3.40 6 30000 3.00 7 20000 1.3 Solution Item Units Percent Unit Total cost Percent cost of total (1) (2) (3) (5) (6) (4) 1 20000 10 Rs. Rs.1216000 38 60.80 2 10000 5 102.4 1024000 32 3 32000 16 11.00 352000 11 4 28000 14 10.28 288000 9 5 60000 30 3.40 204000 6.38 6 30000 15 3.00 90000 2.80 7 20000 10 1.30 26000 0.82 TOTAL 200000 100 3200000 100 The A B C system of classification should, however, be used with caution. For example, an item of inventory may be very inexpensive. Under the A B C system it should be classified as Category. But it may be very critical to the production process and may not be easily available. It deserves the special attention of management. But in terms of the A B C framework, it would be included in the category, which requires the least attention. This is a limitation of the A B C analysis. HML ANALYSIS H-M-L analysis is similar to ABC analysis except for the difference that instead of “usage value”, “price” criterion is used. The items under this analysis are classified into three groups, which are called “High”, “Medium” and “Low”. To classify, the items are listed in the descending order of their unit price. The cut-off-lines are then fixed by the management for deciding three categories. For example, the management may decide that all items of unit price above Rs. 1000 will be of „H‟ category, those with unit price between Rs. 100 and Rs. 1000 will be of „M‟ category and those having unit price below Rs. 100 will be of „L‟ category. HML analysis helps to: Assess storage and security requirements (e.g. high priced items like bearings, worm shafts, worm wheels, etc. require to be kept in the cupboards). To keep control over consumption at the departmental head level (e.g. indents of high and medium priced items are authorized by the departmental head after careful scrutiny of the consumption figures. Determine the frequency of stock verification (e.g. high priced items are checked more frequently than low priced items). To evolve buying policies to control purchase (e.g. excess supply than the order quantity may not be accepted for “H” and “M” groups while it may be accepted for “L” group. To delegate authorities to different buyers to make petty cash purchase (“H” and “M” category of items may be purchased by senior buyers and “L” category of items by junior buyers). VED ANALYSIS VED analysis represents classification of items based on their criticality. The analysis classifies the items into three groups called Vital, Essential and Desirable. “Vital” category encompasses those items whose stock-outs cost is very high. And “Desirable” group comprises of items which do not cause any immediate loss of production or their stock-outs entail nominal expenditure and cause minor description for a short duration. VED (Vital-Essential-Desirable) analysis is carried out to identify critical items. An item, which usage-wise belongs to C-category, may be critical from production point of view if its stock-out cause heavy production loss. An item may be vital for a number of reasons, namely 1. If the non-availability of the item can cause serious production losses. 2. Lead-time for the procurement is very large. 3. It is non-standard item and is procured to buyer‟s design. 4. The sources of supply are only one and are located far off from the buyer‟s plant. Steps involved in making VED analysis are as under: Identify the factors to be considered for VED analysis: These commonly considered factors affected on production (e.g. stock out cost in the event of its non availability), lead-time, and nature of the item and sources of supply. Assign points/weight ages to the factors according to their importance to the company. Typical examples of the weight ages to the above four factors may be 30, 30, 20, and 20points. Divide each factor into three degrees and allocate points to each degree. Usually, the first degree is assigned points equal to the weightage of its factor; second degree is allocated points equal to twice the weightage of the factor and third degree is assigned points equal to thrice the weightage of the factor. Prepare categorization plan (shown below), which provides the basis of classification of items into vital, essential and desirable categories. Evacuate items one by one against each factor and assign points to the item depending upon the extent of presence of the factor in the item Place the item into V, E and D categories depending upon the points scored by the (table below) and basis of classification set under step (iv)- FACTOR FIRST SECOND THIRD DEGREE DEGREE DEGREE Stock out cost in Above Rs. X Between Rs. Above Rs. Y the event of non – (30) X to Y (60) (90) availability (30) Lead time for 1 – 4 weeks 4-8 weeks Over 8 weeks procurement (30) (30) (60) (90) Nature of an item Produced to Produced to Produced to (20) commercial suppliers‟ buyer‟s design standard, or design (40) or proprietary off the shelf items (60) availability (20) Sources of supply Local (20) Outstation Imported quota (20) (40) items i.e. controlled supply (60) Typical Categorization Plan POINTS CLASSIFICATION 100-160 DESIRABLE 161-230 ESSENTIAL 231-300 VITAL VED analysis is best suited for spares inventory. In fact, it is advantageous to use more than one method. E.g. ABC and VED analysis together would be helpful for inventory control of spares. S – D – E ANALYSIS S – D – E analysis is based on the problem of procurement namely: Non – availability Scarcity Longer lead – time Geographical location of suppliers Reliability of suppliers, etc. S – D – E analysis classifies the items into three groups called “Scarce”, “Difficult” and “Easy”. The information so developed is then used to decide purchasing strategies. “Scarce” classification comprises of items, which are in short supply, imported or canalized through government agencies. Such items are best to procure limited number of times a year in lieu of effort and expenditure involved in the procedure of import. “Difficult” classification includes those items, which are available indigenously but are not easy to procure. Also items which come from long distance and for which reliable sources do not exist fall into this category. Even the items, which are difficult to manufacture and only one or two manufacturers are available belong to this group. Suppliers of such items require several weeks of advance notice. “Easy” classification covers those items, which are readily available. Items produced to commercial standards, items where supply exceeds demand and others, which are locally available, fall into this group. S – D – E analysis is employed by the purchase department: 1. To decide on the method of buying. E.g. Forward buying method may be followed for some of the items in the “Scarce” group; “scheduled buying” and “contract buying” for “Easy” group 2. To fix responsibility of buyers. E.g. Seniors buyers may be given the responsibility of “S” and “D” groups while terms in “E” group may be handled by junior buyers or even directly by the storekeeper. G – NG – LF ANALYSIS / GOLF ANALYSIS G – NG – LF analysis (or GOLF analysis) like S – D – E analysis based on the nature of the suppliers which determine quality, lead time, terms of payment, continuity or otherwise of supply and administrative work involved. The analysis classifies the items into four groups namely G – NG – L and F. “G” group covers items procured from “Government” suppliers such as the STC, the MMTC and the public sector undertakings. Transactions with this category of suppliers involve long lead time and payments in advance or against delivery. “NG” (O in GOLF analysis) group comprises of items procured from “Non- government” (or Ordinary) suppliers. Transactions with this category of suppliers involve moderate delivery time and availability of credit, usually in the range of 30 to 60 days. “L” group contains items bought from “Local” suppliers. The items bought from local suppliers are those which are cash purchased from blanket orders. “F” group contains those items, which purchased from “foreign” suppliers. The transactions with such suppliers: 1. Involve a lot of administrative and procedural work. 2. Necessitate search of foreign suppliers. 3. Require opening of letter of credit. Requiring making of arrangement for shipping and port clearance. S – OS ANALYSIS S – OS analysis is based on seasonality of the items and it classifies the items into two groups S (seasonal) and OS (Off season). The analysis identifies items, which are: Seasonal and are available only for a limited period. Example: agriculture produce like raw mangoes, raw materials for cigarette and paper industries, etc. are available for a limited time and therefore such items are procured to last the full year. Seasonal but are available throughout the year. Their prices, however, are lower during the harvest time. The quantity of such items requires to be fixed after comparing the cost savings due to lower prices if purchased during season against higher cost of carrying inventories if purchased throughout the year. Non – seasonal items whose quantity is decided on different considerations. M – N – G ANALYSIS M – N – G analysis based on stock turnover rate and it classifies the items into M(Moving items), N(Non – moving items) and G(Ghost items). M(Moving items) are those items which are consumed from time to time. N(Non – moving) are those, which are not consumed in the last one year. G(Ghost items) are those items, which had nil balance, both in the beginning and at the end of the financial year, and there were no transactions(receipt or issues) during the year. Analysis mainly helps to identify non – existing items for which the store keeps bin – cards or waste computer stationary while preparing store ledger. Stores department even might have even ear – marked space for these non – existing items. All pending / open purchase orders (if any) of such items should be cancelled. F – S – N ANALYSIS F – S – N analysis is based on the consumption figures of the items. The items under this analysis are classified into three groups: F(fast moving) S(slow moving) N(Non – moving) To conduct the analysis, the last date of receipt or the last date of issue whichever is later is taken into account and the period, usually in terms of number of months that has elapsed since the last movement is recorded. Such an analysis helps to identify: 1. Active items, which required to be reviewed regularly. 2. Surplus items whose stocks are not being consumed. The last two categories are reviewed further to decide on disposable action to deplete their stocks and thereby release company‟s productive capital. 3. Non – moving items which are not being consumed. The last two categories are reviewed further to decide on disposable action to deplete their stocks and thereby release company‟s productive capital. Further detailed analysis is made of the third category in regards to their year – wise stocks and items can be sub – classified as non – moving for two years, non – moving for 3 years, non – moving for 5 years and so on. X – Y – Z ANALYSIS X – Y – Z analysis is based of value of stocks on hand(i.e. inventory investment). Items whose inventory values are high are called X items while those inventory values are low are called Z items. And Y items are those, which have moderate inventory stocks. Usually X – Y – Z analysis is used in conjunction with either ABC analysis or HTML analysis. XYZ analysis when combined with ABC analysis is as used as under: Class of items A B C X Efforts to be made Efforts to be made Steps to be taken to reduce stocks to to convert them to to dispose off Z category. Y category. surplus stocks. Y Efforts to be made * Control may be to convert these to further tightened. Z category. Z * Stock levels may be * reviewed twice a year. * Items are within control. No further action is necessary. X – Y – Z analysis when combined with F – S – N analysis helps to formulate more specific strategies as under: Class of items F S N X Tighten control. Deplete stocks to Dispose off very low level. immediately at optimum level. Y * Deplete the stocks Dispose off as early further at a good as possible. price. Z Liberalize control * Dispose off as early (to reduce clerical as possible even at cost). a lower price. * Items are within control. No further action is necessary. XYZ, therefore, helps to identify a few items which account for large amount of money locked up in stock and take steps for their liquidation / reduction. XYZ when combined with FSN analysis helps to classify non – moving items into XN, YN and ZN group and thereby identify a handful of non – moving items, which account for bulk of non – moving stock. These can be studied individually in details to take decision on their disposal or retention.
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