Inventory management techniques

The inventory of an industrial organization consists of hundreds and even thousands of items having widely varying costs,usage and lead time together with procurement and/or technical problems. It is neither desirable nor possible to exercise the same degree of control over all these items. The management should pay more attention to items whose usage value is high and less attention to items having low usage value. The organization should,therefore , be selective in its approach towards inventory control and the techniques used are called selective inventory control techniques.

Inventory Control Methods

In order to control the consumption of materials, within a given production house, cost accountants resort to different inventory control methods. Some effective inventory control methods are explained in the following paragraphs. According to the second International Accounting Standard (IAS 2), inventories are a list of all items in stock and are valued at a price lower than the net realizable cost. Indeed producer's logic is very realistic because, a stock is always valued less than net realizable and in addition to that, over consumption of stock, uncontrolled wastage, delayed stock supply and unaccounted stock, add to the production expenditure. Thus the basic motive of implementing inventory control methods is:

To minimize wastage and over consumption To keep a good and even flow of the intake and issue of stock

The art of costing probably originated during the world wars, when war profiteers realized that controlling an expenditure even before it is incurred, is much more profitable and saves a lot of resources. This nature of cost accounting has proved to be advantageous as it overcomes the demerits of financial accounting, which aims at just recording transactions, after they have taken place. The various techniques applied for inventory management are as follows: 1. Selective inventory control 2. Setting of various stock levels 3. Systems of inventory control 4. Economic ordering quantity (EOQ) 5. Re-order point and safety stock 6. Application of computers to inventory management 7. Just-in-time inventory management 8. Materials requirement planning (MRP) 9. Inventory audit.

Selective inventory control

Effective inventory management requires the understanding and knowledge of the nature of inventories, and to gain this understanding the following analysis and classification techniques are available. 1. ABC analysis 2. HML analysis 3. XYZ analysis 4. VED analysis 5. FSN analysis 6. SDE analysis 7. GOLF analysis 8. SOS analysis The motive behind these analyses and their clasiifications is to tackle the important aspects more rigorously. Moreover, an equally critical analysis of all items will be very expensive and will have a diffused effect regardless of priorities.

Classification of inventories
Technique ABC ( Always Better Control) Basis Value of conception Main use To control raw material, components and work-inprogress inventories in the normal course of business Mainly to control purchases

Unit price of HML(High,Medium,Low) the material Value of the To review the inventories and XYZ items in their uses at scheduled storage intervals Criticality of the To determine the stocking VED(Vital,Essential,Desirable) component levels of spare parts Consumption To control obsolescence FSN(Fastmoving,slowmoving,non- pattern of the moving) components Problems faced Lead time analysis and SDE(Scarce, Difficult, Easy to in procurement purchasing strategies obtain) Source of the Procurement strategies GOLF( Government, Ordinary, material Local, Foreign sources) Nature of Procurement/holdingstrategies SOS(Seasonal,Off-Seasonal) supplies for seasonal items like agricultural products
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ABC Analysis
Any stock is segregated into different sections. These items are classified into 3 sections, A, B and C. The logic of segregating these items into sections is that section A consists of limited number of items that are very expensive. Section B has items that are not expensive and the number of units that is to be ordered is also not very large. The section C consists of numerous items, that have a low monetary value. The logic behind such segregation is that every section is viewed differently by the cost accountant, due the difference in order time, reorder time and delivery period. For example, though the unites in section A are less, their monetary value is also high and so is their delivery period. The ABC analysis is a simple and probably the most effective of all stock control methods. It contemplates to classify all the inventory items into three categories based on their usage values. Items of high usage value but small in number are classified as A items and would be under strict control of top level management. C items are large in number but require little capital and would be under simple control. Items of moderate value and size are classified as B items and would attract reasonable attention of the middle level management. ABC analysis ( Always Better Control analysis) is also known as control by importance and exception and proportional value analysis. It has been found that normal inventory items in most organizations show the following distribution patterns A : 5 to 10 % of the total number of items accounting for 70 to 80 % of the annual usage value. B : 10 to 20 % accounting for about 15 to 20 % of tha annual usage value, and C: 70 to 80 % of the number of items accounting for 5 to 15 % of the annual usage value.

HML analysis
In this analysis,items are classified on the basis of unit cotst rather than their usage value as in ABC analysis. Accordingly, they are classified as H-high , M-Medium ,Llow. This analysis helps in keeping control over materials consumption at departmental level.

XYZ analysis
This analysis is based on the closing inventory values of different items. X items have high inventory values while Z items have low tied-up capital. Y items lie in between. This analysis helps to reduce the capital investment in high value items. Class of items X A Efforts to be made for reducing stocks to the Z category B Efforts to be made for converting stocks to the Y category Efforts to be made for converting stocks Stock levels may be reviewed twice a year
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C Steps to be taken for disposing of the surplus stocks Control may be further tightened -

VED analysis
The VED analysis popularly known as Vital,Essential and Desirable analysis is used primarily for the control of spare parts. On the basis of the critical nature or relative importance, spare parts may be classified into 3 categories, namely vital(V), essential (E) and desirable (D). the vital items have extreme criticality, the desirable items are not critical and essential falls somewhere in between vital and desirable.

Systems of inventory control

The main systems of inventory control are: 1. Perpetual inventory ( automatic inventory) system 2. Double bin system

Perpetual inventory system

The control of inventories while in storage is effected through what is known as the perpetual inventory. Thus the two main functions of the perpetual inventory are: 1. Recording store receipts and issues so as to determine at any time the stock in hand, in terms of quantity or value, or both, without the need for a physical count of the stock 2. Continuous verification of the physical stock with reference to the balance recorded in the stores records, at any frequency, as convenient to the management. The perpetual inventory system consists of: 1. Bin cards 2. Stores ledger 3. Continuous stock taking

Double Bin System

The double bin system is used to establish a connection between the order and reorder procedures. As mentioned above, from the point of view of a producer, uneven supply of stock and odd consumption is not very healthy. Such unevenness is sorted by two-bin system. In such a system, the stock is sorted into two bins, or piles. The first stock (bin 1), is the larger of the two and is used up between the time period that lasts from purchase of stock till the reorder. The second stock (bin 2), can be used from the time when the reorder is placed till the order is actually received. The second stock, has a considerable amount of stand by that can be used for emergencies
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Order Cycling System

This system is based upon a review timetable. According to this system, a review of the entire inventory is done at regular intervals, such as 30 days, 60 days or 90 days. After the review is done, the cost accountant views stock items with low quantities that will not last up to the next review interval. The purchase order for such a stock item is placed immediately. The order cycling system is not exactly foolproof and one requires a rather experienced cost accountant to efficiently conduct it. There are many other methods such as FIFO and LIFO (issuance inventory valuation methods) that are considered to be very effective inventory control methods. In addition to that, you might also refer to some established mathematical formulas such as economic ordering quantity. These are the basic inventory control methods, that can be implemented by you for any kind of stock or item.

Inventory management techniques followed in industry

ABC analysis: Levis used ABC analysis method of inventory management. A: jeans fall under this category which contributes to 70 to 80 % in value B: t-shirts and shirts fall under this category which contributes to 20 to 25 % in value C:caps,belts,shoes etc., fall under this category which contributes to 10 to 15 % in value VED : Shahi exports follows VED V: Fabric is the vital inventory E: Trims are essential inventory D: Spare and lubricants are desirable inventory FSN: Cannimara Public library,Chennai follows FSN F: Newspapers are fast moving S: issue books are slow moving N: reference books are non moving

Perpetual inventory system: Multiplex departmental stores use perpetual inventory system. On day to day basis stocks are replenished. Periodic inventory system: More supermarket uses periodic inventory system. How much ever is consumed, checked and placed the order. Time period is fixed and quantity keeps on changing. Double bin system: Kirana stores uses double bin system. Larger quantities of goods are stored in a larger bin. Required quantity is transferred in a smaller bin for sale. When it gets over, the goods are refilled from larger bin.

Inventory management technique used in book store(Landmark)

Book sales are highly seasonal. Most of the sales occur between the months of January and April. During a month, sales peak in the first week.Sales are usually higher on Sunday, Monday and Tuesday, and peak hours are between 5 and 10 p.m. Transactions range from 100 to 150 a day. Wholesale orders, mostly received over the phone, account for about 15% of total sales. During school vacations sales are minimal. Occasionally, sales promotion events are held, but only to attract more customers rather than to compensate for weak sales. Customers are given receipts for purchases made. One copy of the receipt is left in the cash memo. From this copy, transactions are fed daily into the computerized cash register. Two types of reports, X and Z are generated (AZed report, indicates the total sales on any day of the year, and the type and number of items sold). ZED reports are generated daily from these entries of the cash register; at the end of the year these reports are used for accounting purposes. Information like number of items sold, department wise sales, number of customers, return entries, any advance payments, and credits given is available on these forms. In the beginning of the year the stock of the store is checked, the sales are found from the ZED reports, at the end of the year the stock is rechecked and the whole exercise gives the annual revenue generated and level of pilferage. Inventory Reordering & Recording: As much as 70 percent of purchases are made on credit. Items have to be picked by the store purchaser from the suppliers outlet. The whole process of inventory management starts with reordering. Whenever a stockout occurs for an item, demand is registered in a demand book.
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Purchase orders are checked by the owner before allowing the purchaser to make purchases. A new item is added to the list of purchases if salesmen receive repeated demands (2-3 times) from customers. The purchaser calls twice a day to find if there is some new entry on the demand register, and if so, checks for the new item in the market. Items are purchased from two or three main vendors.Vendor selection depends mostly upon the price; the one who offers the lowest price becomes the supplier as long as his price remains the lowest. When purchases arrive,the purchase invoice goes to the purchase book, while the purchased item goes to the stock room where they are repriced and are issued for shelf display. The size of the purchase order is decided in the light of past experience. Sometimes text books are stocked just before the start of the new educational year, to avoid disappointed customers. Inventory Process: When any item is issued from the stock, three copies are made to record the issuance and delivery of these items. One remains with the stock room record,while two are sent to the shopping hall, from where one of these copies is signed (as a proof of receiving the items) and returned back to the stock room, while the other is retained at the store. The ZED report is checked daily and if there is any doubt, the audit roll at the till is used to remove it. The items which are not to be selected by the customer are picked up by the salesman while the rest are picked by the customer right off the shelf. Some of the products are repriced in the back room. Return claims are honoured if they are backed by a sales receipt. The returned product goes back to the shelf. Inventory Checking: Inventory is checked twice a year and on each occasion two days are spent for the purpose. There is no permanent staff for inventory checking. At the time of the biannual check, all employees are involved in this work. There is an average inventory shortage of 2% per month in spite of a guard who is employed to keep a watchful eye on customers. According to the owners, kids are generally responsible for shoplifting. Once, one of the employees was caught. He was later removed from his job. Managerial & Inventory Control: The owner had decided to develop the existing system over a period of 2 to 3 years, so that regular business procedures were not disrupted. The existing system focuses on cash and sales flow. The owner expects that a formal organized system will yield positive results not only for sales and revenues but also for store image. Development of an effective inventory control system is being seriously considered these days.

Inventory management technique used in departmental store (.more- aditya birla group)
Sales are seasonal in nature. They are typically higher during winter months (October to December); on Thursdays and on Saturdays during a typical week and between 5 and 8 p.m.on a typical day. On average there are over a thousand business transactions a day. Only a few of these are on credit. All sales are documented in cash registers. There are four automated cash registers which maintain daily sales records. Inventory Reordering & Recording: The process of reordering a product initiates at the salesman level. On finding a shelf partially depleted, the salesman checks the inventory for that product in the stock room. If there is nothing stored, he writes a purchase order which is handed over to the department head. The department head accumulates all such orders from his department and gives them to the store purchaser. The store purchaser groups all purchase orders received from various departments into 'Store' and 'Market' purchases. Store purchases are conducted via telephone and are delivered at the store by the manufacturer, while market purchases are made by a market purchaser who is always accompanied by one of the directors. These two spend most of their time in the market. Intelligent purchases of this team result in high profit items being purchased. According to the owner, most of the store's profits are earned through intelligent purchases made by market purchase teams. Inventory Process: Purchase documentation is handled by the accounts staff. When a purchase consignment arrives at the store, it is checked against the invoice. Supplies received from local suppliers are returned if found damaged, but imported items or those received from Karachi have to be destroyed and the loss has to be borne. All products are labelled with prices in a back-room. Most of the inventory is stocked in godowns, with only a part placed on the display shelves. Customers pick items and bring it to the department's cash counter, where payment is made and a receipt in triplicate is made. A red coloured copy of the receipt is left in the department's cash memo which is a record of the sale of the product at that department's counter, while a white coloured original copy is issued to the customer. At the same time the purchased item is sent along with a blue coloured carbon copy to the main counter on the ground floor. The customer is handed over the item after matching his receipt with its copy at the ground floor counter before the exit. When a customer brings a claim of a damaged product it is first inspected and then the refund is made. For this purpose, suitable adjustment is made in the cash register and the product is replaced on the shelf or sent back to the manufacturer. Inventory Checking: Store wide inventory checking takes place once a year but inventory of high cost products is checked regularly. Three weeks are required for
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the annual inventory checking, and another three days to rearrange the products back on shelves. In addition to inventory checking, store pilferage is checked by three employees who keep a vigilant eye to catch shoplifters. Despite these measures a monthly inventory shortage of one percent on the average remains unaccounted for. Inventory Control: Items for promotion and mark-downs are selected on the basis of the approaching expiry dates, especially if there is a large quantity already in stock. Sometimes the store is stuck with a product as a result of changes in fashions and trends (especially in the dresses and cloth department). The placement and display of such slow moving items are improved in order to attract customers. There is, however, no regular procedure to monitor the volume of sales of a particular product. The owner believes that formal' organized inventory control management system would streamline the process and "cleanup the mess in inventory management". He expects that an improved system will speed up the sales transaction, improve store image and even increase revenue. As a matter of fact the owner is looking for some specialist who could develop a system to manage inventory and improve the control system. The owner considers checking purchases and performance of salesmen to be the key strategic control issues.

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References :
1. http://www.buzzle.com/articles/inventory-control-methods.html 2. http://cmer.lums.edu.pk/upload/Current_Practices_in_Retail_Inventory.pdf 3. http://www.purchasing-procurement-center.com/inventory-managementtechniques.html

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