Advance Management Accounting

Inventory Management
By:
Salma Sadiq
Layout

• Inventory Control

• Objective of inventory control

• Techniques of inventory control

Inventory Control
• Inventory control is the systematic control and regulation of purchase, storage and
usage of materials in such a way as to maintain an even flow of production and at
the same time avoiding excessive investment in materials.

• Efficient material control reduces loses and wastages of materials that otherwise
pass unnoticed.
Objective Of Inventory Control
• To provide continuous flow of required materials, parts and components for
efficient and uninterrupted flow of production.

• To minimize investment in inventories keeping in view operating requirements.

• To provide for efficient store of materials so that inventories are protected from
loss by fire and theft and handling time and cost are kept at a minimum.

• To keep surplus and obsolete items to minimum.

Techniques of Inventory Control
• Min-max Plan

• The Two-bin System

• Order Cycling System

• Fixation of various levels

• ABC Analysis

• Use of Perpetual Inventory System and Continuous Verifications

• Use of Control Ratios

• Review of Slow and Non-moving Items

Min-max Plan

• The analyst lays down a maximum and minimum for each stock item keeping in
view its usage, requirements and margin of safety required to minimize risks of
stock-outs.

• The minimum level establishes the reorder point and order is placed for that
quantity of material which will bring it to the maximum level.
 The Two-bin System
• Under this system for each item of stock, two piles, bundles, or bins are maintained.

• The first bin stocks that quantity of material which is sufficient to meet its usage during
the period that elapses between receipt of an order and the placing of the next order.

• The second bin contains the safety stock and also the normal amount used from order to
delivery date.

• The moment stock contained in the first bin is exhausted and the second bin is tapped, a
requisition for new supply is prepared and submitted to the purchasing department.
 Order Cycling System
• In this system, quantities in hand of each item or class of stock is reviewed periodically
say, 30, 60 or 90 days.

• In scheduled periodic review it is observed that the stock level of a given item will not be
sufficient till the next scheduled review keeping in view its probable rate of depletion, an
order is placed to replenish its supply.

• Review period will vary from firm to firm and also among different materials in the same
firm.

• Critical items of stock usually require a short review cycle.

 Fixation of various levels

• The top management usually sets monitory limits for investment in inventories.

• The materials department has to allocate this investment to the various items and
ensure the smooth operation of the concern.

• A number of factors enter into consideration in the determination of stock levels for
individual items for the purpose of control and economy.
Cont.
1. Lead time for deliveries.
2. The rate of consumption.
3. Requirements of funds.
4. Keeping qualities, deterioration, evaporation etc.
5. Storage cost.
6. Availability of space.
7. Price fluctuations.
8. Insurance cost.
9. Obsolescence price.
10. Seasonal consideration of price and availability.
11. EOQ (Economic Order Quantity), and
12. Government and other statuary restriction
 Cont.
To avoid the under-stock and over-stock the management use the different fixation level of
inventories .

(a) Maximum Level

(b) Minimum Level

(c) Danger Level

(d) Ordering Level

(e) Ordering Quantity: It is the quantity that is ordered.

Maximum level

• This represents the minimum quantity above which stocks should not be held at
any time.

Maximum stock level = Re-order level + Re-ordering quantity – (Minimum

consumption x Minimum re-order period)
Minimum Level

• This represents the minimum quantity of stock that should be held at

all times.

Minimum level = Re-order level - (Normal consumption x Normal re-

order period).
Danger/ Safety Level:

• A safety or reserve stock is kept to avoid stock-out. The desirable safety

stock level is that amount which minimizes stock-out costs and also the
carrying costs.

Safety stock level = Ordering level – (Average rate of consumption × Re-

order period)
OR
(Maximum rate of consumption - Average rate of consumption)
× Lead time
Ordering Level

• It is the level at which indents should be placed for replenishing stocks.

• The annual consumption of an item and the time lag between ordering
and receiving can be collected from past records.

Ordering level = Minimum level + Consumption during time lag period

OR
Maximum consumption × Maximum re-order period.
OR
Maximum consumption × Lead time + Safety Stock
Cont.

The ordering level is calculated from the following factors:

(a) The expected usage

(b) The minimum level

(c) The lead time.

 Example:
Materials X and Y are used as follows:

Minimum usage − 50 units each per week

Maximum usage − 150 units each per week

Normal usage − 100 units each per week

Ordering quantities X = 600 units

Y = 1,000 units

Delivery period X = 4 − 6 weeks

Y = 2 − 4 weeks

Calculate for each material (i) Maximum level (ii) Minimum level and (iii) Ordering level.
Solution
Material X
Ordering level = Maximum usage x Maximum delivery period
= 150 x 6
= 900 units.
Minimum level = Ordering level - (Normal usage x Normal delivery period)
= 900 − (100 x 5)
= 400 units
Maximum level = (Ordering level + Ordering quantity) −(Minimum usage x Minimum
delivery period)
= 900 + 600 − (50 x 4)
= 1,500 − 200
= 1,300 units
Cont.
Material Y

Ordering Level = Maximum usage x Maximum delivery period

= 150 x 4 = 600 units

Minimum Level = Ordering level − (Normal usage x Normal delivery period)

= 600 − (100 x 3) = 300 units

Maximum Level = (Ordinary level + Ordering quantity) - (Minimum usage x Minimum

delivery period)

= 600 + 1,000 − (50 x 2)

= 1,600 − 100 = 1,500 units.

 Ordering Quantity/ Economic Order Quantity
• Economic ordering quantity defined as placing the ideal order size.

• In decision of ideal order size, factors such as material carrying charges and the
ordering cost associated with the placement of purchase orders are to be considered;
the total of both has to be minimized.

• The optimum ordering quantity, i.e., the quantity for which the cost of holding plus
the cost of purchasing is the minimum is known as Economic ordering Quantity.
Formula
Thanks