Inventory management considers what to purchase, how to purchase, how much to purchase, from where to purchase, where to store and when to use for production etc. Inventory management means, management for raw materials and related items.
Inventories constitute the most significant part of the current assets of the business concern. It is also essential for smooth running of the business activities.
Meaning of Inventory management
The dictionary meaning of the inventory is stock of goods or a list of goods. In accounting language, inventory means stock of finished goods. In a manufactured point of view, inventory includes, raw material, work in process, stores, etc.
Kinds of Inventories
Inventories can be classified into five major categories.
- Raw material
- Work in progress
- Finished goods
1. Raw material
It is basic and important part of inventories. These are goods which have not yet been committed to production in a manufacturing business concern.
2. Work in Progress
These include those materials which have been committed to production process but have not yet been completed.
These are the materials which are needed to smooth running of the manufacturing process.
4. Finished goods
These are the final output of the process of the business concern. It is ready to consumers.
It is also a part of inventories, which includes small spares and parts.
Objectives of Inventory management
Inventories occupy 30-80% of the total current assets of the business concern. It is also very essential part not only in the field of financial management but also it is closely associated with production management.
Efficient management of inventories is an essential part of any kind of manufacturing process concern. The major objectives of the inventory management are as follow:
- To efficient and smooth production process.
- To maintain optimum inventory to maximize the profitability.
- To meet the seasonal demand of the products.
- To avoid price increase in future.
- To ensure the level and site of inventories required.
- To plan when to purchase and where to purchase.
- To avoid both over stock and under stock of inventory.
Techniques of Inventory management
Inventory management consists of effective control and administration of inventories. Inventory control refers to a system which ensures supply of required quantity and quality of inventories at the required time and at the same time prevents unnecessary investment in inventories.
Inventory management techniques may be classified into two various types:
- Techniques based on the order quantity of Inventories
- Techniques based on the classification of Inventories.
Techniques based on the order quantity of Inventories
Order quantity of inventories can be determined with the help of the following techniques.
- Stock level
- Safety Stock
- Economic Order Quantity
1. Stock level
Stock level is the level of stock which is maintained by the business concern at all times. Therefore, the business concern must maintain optimum level of stock to smooth running of the business process.
Different level of stock can be determined based on the volume of the stock.
The business concern must maintain minimum level of stock at all times. If the stocks are less than the minimum level, then the work will stop due to shortage of material.
Re-order level is fixed between minimum level and maximum level. Re-order level is the level when the business concern makes fresh order at this level.
Re-order level = maximum consumption x maximum re-order period.
It is the maximum limit of the quantity of inventories, but the business concern must maintain. If the quantity exceeds maximum level limit then it will be overstocking.
Maximum level = Re-order level + Re-order quantity –
(Minimum Consumption x Minimum delivery period)
It is the level below the minimum level. It leads to stoppage of the production process.
Danger level = Average consumption x Maximum re-order period for emergency purchase
Average Stock level
It is calculated such as,
Average stock level = Minimum stock level + ½ of re-order quantity maximum level
Lead time is the time normally taken in receiving delivery after placing orders with suppliers. The time taken in processing the order and then executing it is known as lead time.
2. Safety Stock
Safety stock implies extra inventories that can be drawn down when actual lead time and/or usage rates are greater than expected. Safety stocks are determined by opportunity cost and carrying cost of inventories.
If the business concerns maintain low level of safety stock, it will lead to larger opportunity cost and the larger quantity of safety stock involves higher carrying costs.
3. Economic Order Quantity
EOQ refers to the level of inventory at which the total costs of inventory comprising ordering cost and carrying cost. The EOQ is that inventory level that minimizes the total of ordering of carrying cost.
EOQ can be calculated with the help of the mathematical formula:
EOQ = 2ab/c
- A = Annual usage of inventories
- B = Buying cost per order
- C= Carrying cost per unit
Techniques based on the classification of Inventories
Classification of inventories can be determined with the help of the following techniques.
- A-B-C analysis
- VED analysis
- HML analysis
- Aging schedule of Inventories
1. A-B-C Analysis
It is the inventory management techniques that divide inventory into three categories based on the value and volume of the inventories. Where
- A = 10% of the inventory item contributes to 70% of value of consumption
- B = 20% of the inventory item contributes about 20% of value of consumption
- C = 70% of the inventory item contributes only 10 % of value of consumption.
2. VED Analysis
This technique is ideally suited for spare parts in the inventory management like ABC analysis. Inventories are classified into three categories on the basis of usage of the inventories.
- V = Vital of inventories
- E = Essential of Inventories
- D = Desirable item of Inventories
3. HML Analysis
Under this analysis, inventories are classified into three categories on the basis of the value of the inventories.
- H = High value of inventories
- M = Medium value of inventories
- L = Low value of inventories
4. Aging Schedule of inventories
Inventories are classified according to the period of their holding and also this method helps to identify the movement of the inventories. Hence, it is also called as FNSD analysis – Where
- F = Fast moving inventories
- N = Normal moving inventories
- S = Slow moving inventories
- D = Dead moving inventories
At last words, our point of view for this article we can say that A proper planning of purchasing of raw material, handling storing, recording, effective control and administration of inventories are called inventory management.