INVENTORY MANAGEMENT TECHNIQUES by amyncharaniya

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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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