Inventory Management Of Nepalese Public Enterprises

CHAPTER-2

Review of Literature

There are many researches made in inventory Management of Nepalese Public enterprises and Private enterprises. Most of them has made on the manufacturing enterprises. In this chapter attempts has been made to present the review of literature regarding inventory management.

2.1 Conceptual Framework

Inventory Management

The writer (Saxena, 2009, p. 2) defines inventory as any kind of idol resource that has potential economic value considered as locked up capital. Inventory is a list of goods and materials which is available in stock by business (Saxena, 2009). Other write (Li, 2007, p. 175) defines inventory as the stock of any items or resources used in an organization. Stock consists of all goods and materials that are stored by an organization which is kept for future use (Waters, 2003). According to (Roy, 2005, p. 100) inventory is list of goods or items.

Inventory management is the active control program which allows the management of sales, purchases and payments (Inventorymanagement). The author (Saxena, 2009, p. 2) refers inventory management as a process of managing raw materials, semi-finished products and finished-products by a firm. The inventory management is a set of the process and policies that determines what inventory level should be maintained, what stock should be replenished and how large order should be (Li, 2007, p. 175). According to (Toomey, 2003, p. 1) inventory management is a branch of business management which concerned in planning and controlling inventories.

Effective stock management means providing the desired stock service level or maximizing your profit while at the same time keeping your total stock costs as low as possible by;

Selecting products that initially sell, well and discontinuing those that stop selling.

Purchasing the right quantity (how much to buy)

Purchasing at the right time (when to buy)

Keeping your total inventory investment in balance with the expected levels of sales

To control costs and improve profit, it is necessary to actively manage every asset we own. And it is particularly true of the management of goods and material we buy and keep on land either far our own use or for resale. The goal of inventory management is to increase profit on inventory while increasing customer services (Frazelle, 2002, p. 91)

The dictionary meaning of inventory is stock of goods or a list of goods. Various authors define the word inventory in their ways. In accounting language may mean stock of finished goods. In a manufacturing concern, it may include raw materials, work in process and stores. To understand the exact meaning of inventory the word inventory we may study it form the usage side and from the point of entry in the operation

Among the different aspects of management, inventory management is also one of the major factors to play significant role in management of material , part supplies, expenses tools , working process, finished products and then record on the books and maintenance of store rooms, warehouses by an organization is known as inventory management .

2.2 Nature of Inventory

The company holds different kinds of inventories to obtain their goals (Waters, 2003). Basically we can divide inventory into three parts which are following,

Raw material

Work in progress

Finished goods

(Toomey, 2003, pp. 20-21)

Raw Material

The stocks or inventories and purchase parts which is not part of manufacturing process is called raw material (Toomey, 2003). Raw materials are those basic inputs that have to be gone through the different process to convert into finished goods.

Raw materials inventories are such kind of inventories which have been purchased and stored for future manufacturing process. Raw materials are hold in store by manufacturing company to smooth running of production process. The author defines raw material as those kinds of stocks which is imported from suppliers and are store until needed for manufacture (Waters, 2003, p. 9).

Work in progress

Work in progress refers to inventory units that are currently being worked on (Waters, 2003, p. 9). Work in progress inventories are neither a finished product nor raw materials. It is middle of raw materials and finished product. The author (Toomey, 2003, pp. 20-21) defines work in progress (WIP) inventories are those kinds of inventories which are in different phase of completion throughout the manufacturing process. It is very difficult to separate which materials are WIP and which are not. Because the same materials may be a raw material in one industry and same material may be a WIP as well as finished goods in other industry. It depends upon nature of production.

Finished goods

The finished goods inventory represents products that are ready for sale. According to (Toomey, 2003, pp. 20-21) finished goods are those items which are awaiting shipment to customers. Finished goods inventories includes all the completed products which going to be sold (Muller, 2003, pp. 19-20).These are goods fully manufactured inspected and ready for dispatch to a customer. In manufacturing firm, these are the final output of the production process. Stocks of finished goods are held by manufacturing and non-manufacturing company for market operation.

2.3 Purpose of inventory

Inventory is the most important to all manufacturing organization in today’s industrial world and it plays vital role to exist the company. So it is necessary to manage it properly because both situations of inventories either excessive or inadequate are not acceptable to the firm. There are two larger points within which the firm should operate. The objective of inventory management should be to determine and maintain optimum level of inventory investment. The optimum level of inventory will lie between two danger points of excessive and inadequate inventories.

According to (Wild, 2002, p. 7) the propose of the inventory management function in supporting in the business activities is to optimize the three sectors customer services, inventory cost and operating cost. The author refers about purpose of inventory like this the inventory is created when supply excesses the demand. The main purpose of holding the inventory in the company is to prevent from shortage of raw materials, expected demand, to gain more profit (Li, 2007, p. 176).

Firm should always aware from over investment or under-investment in the inventories. Over investment and under investment in inventory is unhealthy for the company. Due to over investment into inventory, makes unnecessary tie-up and the amount which we can’t invest in other purpose, increasing carrying costs, risk of liquidity. Excessive carrying costs will directly effect in the company profit. Due to over inventories; it may not be possible to sell them in time and at full value. Similarity, WIP is far more difficult to sell because as we said before WIP is not finished goods. In the same way finished goods inventory should sold at low prices due to fall in the price in market and the seasonal factors. So, more investment in inventories is harmful to producer/company. It should be cut down.

Similarly, under investment in inventories also not good for company. It carries some problems such as production hold-ups, frequent production interruptions. If finished goods are not sufficient, we do not meet the customer’s demand and our goodwill also loss. Thus, the objectives of inventory management should be neither excessive nor inadequate level of inventories but maintaining sufficient inventory level for the smooth production and sales operations. An optimum level of inventory should be determined on the basis of the trade-off between costs and benefits. The various importance of inventory management can be summarized up as follows:

Predictability

Unreliability of supply

Price protection

Lower ordering cost

Anticipated demand

2.7 Procedure of Inventory Management

These are lot of function have to be done For the achievement of its objectives business performs a wide variety of function, namely production, marketing, personnel, office research and development of these production and marketing are basic operating functions in a typical business enterprise. Marketing is concerned with the demand side of goods and services, while production is concerned with the supply side. One cannot exist without other; however, decisions about the production activities constitute one of the most important functions of the top management. Production is concerned with the provision of goods and services for the satisfaction of the customer wants. Therefore the consumer depends upon the good economical and efficient production system good inventory management there should be used different activities in ought procedure or manner. General activities such as purchasing, receiving, store-keeping and issuing and pricing are the procedure of inventory management. They are described as follows:

2.7.1 Purchasing

Purchasing is the fulcrum when it comes to meeting customer demands (Johnson, 2010) . Purchasing is the most important function of inventory management to select the suppliers, because it brings significant saving for the organization (Elanchezhian, et al 2010). All organization need various kinds of input like goods and services form external suppliers. The writers ( Baily, Farmer, Jessop, & jones, 2005, pp. 3-4) define purchasing as to acquire right quantity of material, at the right time, in the right quantity, from the right source, at the right price. In simple words purchasing is relate to going the open market finding the require materials at the lowest price and selecting the supplier who offers it at that price having the quality of the materials in minds. In fact the process of inventory management begins with purchasing .The need for particular materials initiates purchasing in a firm. A good purchasing management has played important role in the manufacturing companies. We should pay more attention in the purchasing raw materials, supplies in the right quantity of the right quality from the right origin at the right time and cost. The production is hampered the scarcity of raw materials on time, purchasing department should take grater responsibilities and should analysis the existing procurement policy and should tune with the overall organizational objectives and policies. We can improve management of purchase by the help of standardization, value analysis, material substitution, transportation saving and cost reduction of packing modification.

There are the following functions of a purchase department.

How to purchase?

Where to purchase?

How much to purchase?

At what price to purchase?

To perform there function effectively, the purchase department follows the following procedures

Receiving purchase requisition

Exploring the sources of supply and choosing of suppliers

Preparation and execution of purchase order.

Receiving and inspecting materials.

Checking and issuing of bills for payment. [3] 

The objectives of purchase department is to arrange the supply of materials, spare parts and services or semi-finished goods required for desired production .Walters observes purchasing functions as ‘The Procurement and Purchase of the proper materials, machinery, equipment and supplies for stores used in the manufacturing of a product adopted to marketing in the proper quality at the proper time and at the lowest price constant with desired.?

Purchasing now become a specialized function in many organization wasting expenses that “Purchasing is a managerial activity that goes beyond the simple act of buying and includes the planning and policy, objectives covering wide range of related and complimentary included in such activities are the research and development required for the proper selection of materials and sources from which these materials may be brought. [4] 

In the words of matter industrial purchasing is “ The procurement by purchase of Alfred and Beauty .Principles of industrial the proper adopted to marketing in the proper quantity and quality at the proper time and at the lowest price consistently with the quality desired “

A Purchasing means a policy well planned, Procedures free from much formalities and development of up to date methods and techniques of higher standard to reveal efficiency and economy. [5] 

2.7.2 Receipt and Store Keeping

After sometimes of placing the order, flow-up process starts to get quick delivery of the items. The items are received by the purchasing department at the time of delivery and received items are compared with purchase order and actual materials received should be entered in goods received note. Then all items received by the purchasing department should be passed into store for protection against deterioration and pilferage. They are stored in such a way that their location is easily identified at the time of issue “The store function involves both keeping the store of materials and keeping the store records, the former being physical task and the later being accounting task depending upon the nature and requirements of the organizations the stores are classified as centralized and decentralized store. [6] 

In the words of Maynard, the duties of store keeping are “to receive materials to protect than while in storage from damage and unauthorized removal to issue the materials in the right quantity at the right time , to the right place and to provide these services promptly and at least costs.?

Good store keeping should help achieve location identification, receipt and issue without delay. Storage space should be economically utilized and materials should be protected against deterioration, fine theft, details of quantities should be available on request. General code numbers are assigned to materials for easy identification. Materials may be stored in bin, rack, drawer, tray, boxes or floor area. [7] 

Store keeping in the activity of receiving or distributing stores or supplies, stores included direct raw materials, indirect materials (supplies) and finished goods [8] 

Generally the physical stock available in the store after counting, weighting , measuring , listing as the case may be is properly recorded by only of the following methods.

2.7.3 Issued and Pricing

Materials are kept in stores so that the storekeeper may issue them whenever these are required by the production departments. Materials should be issued on receipt of materials requisition of Bill of materials under proper authority to avoid the misappropriation of materials. [9] 

Materials issued from the stores are debited to the jobs or work orders which received them and credited to the materials account. These jobs are debited with the value of material issued to them. [10] 

Each item inside the inventory has some value associated with it. This value depends on the price duration of the item inside the inventory, procurement cost, storage cost etc. Generally the time of purchase and time of issue of any items are different and the market prices of the items also vary with time. Thus, for costing purposes, the problems of pricing at the time of issue are great signification. [11] 

2.7.4 Cost Basis for Inventory Valuation

The primary basis of accounting for inventory is cost which has been defined generally as the price paid to considerate given to acquire an asset. As applied to inventories, cost means in principal the sum of the applicable expenditure and changes directly or indirectly incurred in bringing an article to its existing condition and location. [12] 

Conceptually the process of valuation the inventory is simple. We can calculate inventory value that multiplying physical quantity of goods by cost per unit. But in practice, many organizations purchase different types of raw materials at different price and different

time. Price of materials changes time to time. There are many types of raw materials remain in the stock. It is not always possible to identify the individual particular purchase group. At the solution firms have faced difficulties in valuation the inventories. In this situation there are many methods which are based on historical cost used in determining the value of inventory are:

a. First In First Out Method

Under the First In First Out method the units are assumed to have been disposed of in the order in which they were acquired and the units remaining are assumed to be those which were acquired last. This assumption is realistic in that good merchandising requires that older stock be moved to the front and new purchases placed in back of the bin. Consequently the oldest merchandise in sold first, because sales orders are filled from the front of the bins. The last merchandise purchased remains in the inventory. [13] 

b. Last In First Out Method

Under this method, the cost of goods sold consists of the cost of the most recently acquired goods, and the ending inventory consists of the cost of the oldest goods which were available for sale during the period. [14] 

This method does not conform to the physical flow of the units of goods but is nevertheless widely used. In periods of steadily rising prices, the inventory value will be at the lower cost of the earliest units acquired. The value of the inventory on the statement of financial position is a conservative one. In the statement of income the cost of goods sold is higher, and when costs increase net income is lower resulting in lower income taxes of course, in periods of falling prices, the results will be opposite, the cost of good sold will be lower and net income will be higher. Under LIFO method, whether costs are rising or falling, the net income over a series of years shows less variation. [15] .

c. Specific Price or Identification Method

Under this method, materials issued to production are priced at their purchase prices. The basic assumption in following this method is that materials in the stores are capable of being identified as belonging to specific lots. Identification can be made by placing some distinguishing mark usually price tag on every lot. When materials are issued, price tags are removed and forwarded to the costing department for ascertaining the material cost of production.

This method is simple in its mechanism and operation. This method does not create accounting complications as are associated with the working of FIFO, LIFO and average methods. But this method is useful where job costing is in operation and the actual material issued can be identified. It is also suited to the needs of a small business enterprise when a small number of items of materials are purchased and stored which can be easily identified. [16] 

d. Base Stock Method

Each concern always maintains a minimum quantity of material in stock. This minimum quantity is known as safety or base stock and this should be used only when an emergency arises. The base stock is created out of the first lot the material purchased and, therefore, it is always valued at the cost price of the first lot and is carried forward as a fixed asset.

This method works with some other method and is generally used with FIFO or LIFO method. Any quantity over and above the base stock is issued in accordance with the other method which is used in conjunction with this method. The objective of this method is to issue the material according to the current prices. This objective will be achieved only when the LIFO method is used together with the Base Stock method. [17] 

2.8 Cost Associated with Inventory

There are many cost associated with the size of inventory directly either advocating to decrease the inventory size or suggesting an increase in the inventory size, for an effective inventory analysis and control of the system one should have clear picture about the behavior of cost associated with different factors. Different kinds of costs associated with inventory management are explained below.

a. Carrying cost

Carrying cost per period, c, represent the cost of inventory storage, handling and insurance, together with the required rate of return on the investment in inventory. These costs are assumed to be constant per unit of inventory per unit of time. [18] Cost incurred for maintaining a given level of inventory are called carrying cost.

Carrying cost means storing cost. It starts when raw-materials are placed in warehouse and it continuous until finished goods have not produced except production cost. When we carry raw- materials to production spot and there make final product and that final product we carry into stock. In course of carrying to production spot and returned back to warehouse may labor, handling cost, this cost is also included in carrying costs. However the size of inventory increases, the carrying cost also increases. The carrying costs and the inventory size are positively related and move in the same direction.

Carrying cost is the first category of inventory management cost which is generally associated proportionally with the average value of inventory. [19] 

Total carrying cost vary in proportion to the value of inventory usually they are computed from the following formula.

Total carrying cost = Average inventory * carrying cost per unit

Symbolically TCC = Q/2 *C

Where,

Q = Quantity order size

b. Ordering cost

Ordering cost represent all of the cost of placing and receiving an order. When a firm is ordering from an external source, these include the costs of preparing the purchase requisition, expediting the order (long-distance calls and follow-up letters), receiving and inspecting the shipment and handling charge.

In practice, the cost per order generally contains both fixed and variable components, since a portion of the cost- such as that of receiving and inspecting the order- normally varies with the quantity ordered. Ordering cost may different in the sense of inventories nature. Such as for Raw-materials- ordering cost involves the clerical cost in placing an order as well as certain costs of receiving and checking the goods once they arrive. For finished goods- ordering cost involves scheduling a production run. And for work-in-progress- ordering costs are likely to involve nothing more than record keeping.

Ordering cost : the fixed expense in the preparation and execution of an order for goods. [20] 

Ordering cost increase in proportion to the number of orders placed. Thus more frequently the inventor is acquired, higher the firms ordering costs. On the other hand ordering costs decrease with increasing size of inventory.

Generally ordering costs involves:

Cost of placing an order

Requisitioning cost

Transportation/shipping cost

Receiving, inspecting and storing costs

Sales tax, Customs, etc

Clearing and forwarding costs

Insurance of raw-materials

Stationary cost

Bank commission/ L.C. charges

Telephone/Fax/Postage expense to follow up

Cost incurred when raw-materials in transit

Firms usually offer discount for purchase materials in large quantity. Such discount helps reduction in the unit price of the items purchases, such facilities encourage buyers to place a fewer orders rather than placing small once

Ordering cost is calculated by following formula

Ordering cost = Annual Requirement/Quantity order size *Ordering cost per unit

Symbolically,

TOC = A/Q x O

2.9 Inventory Systems

The inventory accounting system can be “Periodic System? or continuous system.

2.10 Inventory Management Models

Push and Pull Models:

Inventory management models can be classified either push or pull models:

a. Push Inventory Models

Push models schedule orders for production or order good in advance or customer demand. Manufactures push the finished products through the distribution channel to intermediaries and the final consumer. Economic Order Quantity (EOQ), Material Requirement Planning (MRPI), Manufacturing Resource Planning (MRIP II) and distribution requirement planning (DRP) are all push models.

i. Economic order quantity (EOQ)

In an ideal environment, forecasting demand would be easy and straight forward. Simply look at past demand patterns to predict future consumption. Under these conditions, EOQ model can be used to calculate when to order the item and how much to order. The basic EOQ equation is as follows

EOQ = √2PD/CV

Where,

P=Cost of placing one order in rupees

D = Annual demand for the product

C = Annual inventory carrying cost expresses as a percentage of product’s cost of value.

V = Average cost or value of one unit of inventory

ii. Material Requirement Planning (MRPI)

MRPI is a computer- based management information system designed to manage dependent demand inventory items in the transformation process of operations management. “This computerized inventory system was developed in the 1960s to deal primarily with the timing the tedious record keeping of dependent demand inventory transactions.?

Many researchers believe that MRP systems historically have made a fundamental software development contribution that has helped cause computer-based system to integrate and therefore aid in the development of computer- integrated manufacturing (CIM) systems. [21] 

One of the most common dependent demand inventory system used in the United States is the managerial requirement planning (MRP) system. [22] It supports the planning and control of dependent demand inventory and is most popular in U.S organizations that have substantial dependent demand inventory to manage. It includes any products that are made from dependent demand inventory items such has components or raw materials. MRP processes information for production scheduling and capacity planning as well.

As an inventory management system, MRP can be used to plan inventory needs over a fixed planning horizon. Although MRP can plan inventory requirement for a period of from a single day to several years, the information the program generator is usually based on weekly intervals. In MRP terminology, the weekly (or other time period chosen) are referred to as time buckets. One of the primary objectives of an MRP system is provide an adequate supply of dependent demand inventory when required fro production. MRP also seeks to provide useful inventory, production scheduling, and capacity planning information for inventory control proposes.

There are two types of MRP systems:

Regenerative System:

This is a periodic data input system. Under this system, changes in input data are saved until a specific time, such as the end of a week or end of a month. Changes are then run on a group of batch basis.

Net-change System

This is a continuous data input system. Under this system, changes are immediately entered into the computer. New MRP planning information is then recomputed for all of the elements in the inventory system that are affected by the changes.

iii. Manufacturing Resources Planning (MRP II) System

The basis MRP system simply handles the materials aspects of production/ operations control. No real account is taken of capacity implications Therefore one more sophisticated system developed in Manufacturing resources planning (MRPII) system [24] In addition to producing the detailed material plan, the system can produce detailed capacity plans provided it has the necessary job-routing data and so on. The implementation of these plans allows shop-floor and purchase control to be carried out. MRP II is essentially a computer system. It has been suggested by Oliver Wight that MRP/ MRP II implementations can be classified on a four- point scale, from A to D. Table no . Briefly describes these states.

Class

Characteristics

D

MRP working in data-processing department only

Poor inventory records

Master schedule mismanaged

Reliance on shortage lists for progressing

C

Used for inventory ordering, not scheduling

Scheduling by shortage lists

Overloaded master schedule

B

System includes capacity planning, shop-floor control

Used to plan production, not manage the business

Helps still needed from shortage lists

Inventory higher than necessary

A

Uses closed-loop MRP

Integrates capacity planning, shop-floor control, vendor scheduling

Used to plan sales, engineering, purchasing

No shortage lists to over-ride schedules

Most organization implementing MRP/ MRP II are on the path from class D status to class A status. A difficult faced is knowing, in a quantitative sense, where on the path the organization is, and what steps to take to effect improvements.

iv. Distribution Requirement Planning (DRP)

DRP applies MRP II principles to the flow of finished goods to field warehouses and customers. Although MRP II improved MRP by taking into account both material management and production scheduling. It failed to account for this out bound movement. DRP adjusts ordering patterns of inventory needs vary, responds more readily to system wide inventory needs and better deals with product availability and receipt timing.

b. Pull Inventory Model

Pull inventory models are based on making goods once customer demand is known . The product is pulled through the channel of distribution by the order. Recent trends suggest a movement to use pull inventory models to reduce inventory throughout the channels. JIT and KanBan are the must widely used pull inventory models.

i. KanBan Pull Model

The KanBan Mean “visual record? and is the production control system the uses JIT production system, allowing production with smaller inventories, KanBan is also referred to as card system, a single card KanBan and two card KanBan system.

ii. Single Card KanBan

The single card kanban system uses only a conveyance (move) kanban and no production kanban. The single card kanban is must common used in Japan. [25] 

iii. Two card KanBan

Inventroy is usually controlled at low levels by using a manual two card KanBan system. One card is conveyance KanBan, the requisition and authorization of transferenceof materials form supply center to work center. A second card the production KanBan, authorizes the production of materials.

2.11 Techniques of Inventory Management

In inventory management techniques we seek how to minimize the inventory cost. Adequate inventories facilitate smooth production activities. On the other hand, excessive inventory is idle resource of the firm and the large amount of money is blocked unnecessarily. According to Atton N. Smith, “Inventory is money on which a company pays interest rather than collects interest. It is money always in danger of devaluation.? Every firm should an optimum level of inventory or optimal balance level between too must inventory position.

To manage inventories effectively, a firm should use a system approach to inventory management. A system approach considers in a single model all the factors that affect the inventory. The model called a system, may have any number tied together to achieve a single goal. In the case of inventory system, the goal is to minimize to costs.

Inventory control or stores control, as commonly known, refers to the techniques used to ensure that stocks are kept at levels, which provides maximum services at minimum cost. The main objective of inventory control is to ensure that “Stock-Outs? do not occur and that surplus stocks are not accumulated and carried. Many mathematical or statistical models with various degrees of sophistication have been developed to avoid excess cost, physical loss, damage, theft, over-inventory and low-inventory. Here we are going to describe some important inventory management techniques to solve inventory management problem faced by the most of the manufacturing firms.

2.11.1 Economic Order Quantity

The economic order quantity may be defined as that level of inventory order that minimizes the total cost associated with inventory management [26] .

The determination of the appropriate quantity to be purchased in each lot to replenish stock as a solution to the order quantity problem necessitates resolution of conflicting goals. Buying in large quantities implies a higher average inventory level which will assure (1) smooth production/ sale operations, and (2) lower ordering or set-up costs. But, it will involve higher carrying costs. On the other hand, small orders would reduce the carrying costs of inventory by reducing the average inventory level but the ordering costs would increase as there is a likelihood of interruption in the operation due stock-outs. A firm should place neither too large nor too small orders. On the basis of a trade-off between benefits derived from the availability of inventory and the cost of carrying that level of inventory, the appropriate of optimum level of the order to be placed should be determined. The optimum level of inventory is popularly referred to as the Economic order quantity (EOQ). It is also known as the economic lot size.

The two principal types of costs involved in the inventory maintenance are the cost of ordering and the cost of carrying. These two types of costs are inversely related, minimization of total cost can be achieved only by maintaining the inventory at the optimal level which is a function of the interaction of the ordering cost and the carrying cost. This the fundamental ground on which the model of Economic Order Quantity is based [27] .

Economic Order Quantity Model

In this figure when carrying cost goes up whereas the ordering cost goes down with the increase in the inventory level making the total cost curve concaved. The optimal inventory level or the order size is determined at the minimum point in the total cost curve which is point m that corresponds to point Q* in the horizontal axis. The point Q* is the indication of optimal size of order quantity.

The EOQ model provides some basic information needed for the management of inventory. Management needs to know the time and size of order to be placed, frequency of orders, and average investment on inventories. The EOQ model prescribes the optimal quantity to be ordered each time and sets the reorder level. Besides, the use of the model provides other information such as average investment in inventories, maximum level of inventory at any point of time, etc.

Without getting into highly refined decision models we can illustrate the concept of EOQ with a basis mathematical model. We calculate EOQ by using the following formula.

EOQ = √2AO/C

Where,

A = Annual demand /Requirement/Sales

O = Ordering cost per order

C = Carrying or holding cost per unit per year

EOQ = Economic order quantity

2.12 Fixation Of Stock Level

Reorder Point

2.12.2 Minimum Stock Level

This represents the minimum quantity of the material which must be maintained in hand all times. The quantity id fixed so that production may not be held up due to shortage of the material. It is computed as :

Minimum Stock Level = Re-ordering Level (Normal Consumption *Normal re-order period )

In fixing this level the following factors are taken into consideration.

Lead time, i.e. time lag between indenting and receiving of the material. It is the time required to replenish the supply.

Rate of consumption of material during the lead time.

Nature of the material: Minimum level is not required in case of a special material which is required against customer.

2.12.3 Maximum Stock Level

It represents the maximum quantity of an item of material which can be held in stock at any time. Stock should not exceed than this (quantity) at any time.

The quantity is fixed so that there may be no over stocking. It is computed as

Maximum Stock Level = Re-order Level – (Minimum usage * Minimum delivery time) +

Recorder quantity.

The maximum stock level is fixed by taking into account the following factors.

Amount of capital available for maintaining stores.

Go-down space available

Rate of consumption of the material during the lead time .

The time lag between indenting and receiving of the material.

Possibility of loss in stores by deterioration and evaporation

Cast of maintaining stores .

2.13 ABC Analysis

Usually, a firm has to maintain several types of inventories for different purpose. Equal control the effort for all items is not ordinarily justified. First the different value of inventory items suggest the we should concentrate our attention on higher valued items and be less concentrate on lower valued items. The firm should therefore, classify inventories to identify which items should receive the most priority in controlling. The firm should be selective in its approach to control investment in various types of inventories.

According to P.V. Kulkarni “Inventory control is a science based art of ensuring that enough inventory or stock is hold by an organization to meet both its internal and external demand commitment economically.

The firm should pay maximum attention to those items where value is the highest. The firm should be selective in it’s approach to control investment in various types of inventories. This analytical approach is called ABC analysis. The high value items are classified as ‘A’ items least value items are classified as ‘C’ items and ‘B’ items fall in between these two categories. The ABC analysis concentrates on importance and exception. As the items are classified in the importance of their relative value, this approach is also known as proportional value analysis.

The table and figure illustrate ABC analysis

Classification of Items

% of inventory items

% of value of cost

Nature and level of control

A

Low

High

High usage, low safety stock level frequent physical verification, minimum economic quantity ordered close schedule control and review daily if possible

B

Moderate

Moderate

Contract not as tight as for a items but tighter than for (items C)

C

High

Low

Low usage high inventory levels, purchasing larger quantity at low frequent intervals, minimize clerical efforts is control large safety our risk.

Colley, 1977

This table shows that ‘A’ items’ includes low volume and high cost of all items with tightest level of control. But ‘B’ items’ consist moderate volume items and low cost of all items with higher level of control at last ‘C’ items’ consist higher of volume items and low total cost with low level of control.

Controls for Class ‘A’ Items

Close control is requited for inventory items that have high stock out cost and those items that account for a large function of the total inventory value. The closes control might be reserved for raw materials that are used continuously in extremely high volume. Purchasing agents may arrange contracts with vendors for the continuous supply of these materials at rates. In such instances the purchase of raw materials is not guided by changing rate of flow are made periodically as demand and inventory position changes. Minimum supplies are maintained to guard against demand fluctuations and possible interruptions of supply.

For the balance of class ‘A’ items periodic ordering, perhaps on a weekly basis provides the necessary close surveillance over inventory levels variations in usage rate are absorbed quickly by the size of each weekly order according to the periodic system or optimum system. Also because of the close surveillance, the risk of a stock out is small. Nevertheless, buffer stocks that provide excellent service levels will be justified for items having large stock-out costs.

Controls for Class ‘B’ Items

These items should be monitored and controlled by a computer based system with periodic reviews by the management. Many of the models discussed in this chapter are relevant for these items. However, model parameters are reviewed less often then with class.

Control for Class ‘C’ Items

Class ‘C’ items account for the great bulk of inventory items, and carefully designed but routine controls should be adequate. A reorder point system that does not require a physical stock evaluation, such as the two bin system, will ordinarily sufficient. For each item action is triggered when inventories fall to the reorder point. If usage changes order will be triggered earlier or later than average, providing the needed compensation semiannual review of the system parameters should be performed to update usage rates, estimates of supply lead times and costs that might results in changes in EOQ, A periodic review at a long interval can also be used. [28]