bhavani wil inv. mgt

8/3/2019 Bhavani WIL Inv. Mgt

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INVENTORY MANAGEMENT:

Inventory management, or inventory control, is an attempt to balance inventory needs andrequirements with the need to minimize costs resulting from obtaining and holdinginventory. There are several schools of thought that view inventory and its functiondifferently. These will be addressed later, but first we present a foundation to facilitatethe reader's understanding of inventory and its function.

Inventory management is primarily about specifying the size and placement of stockedgoods. Inventory management is required at different locations within a facility or withinmultiple locations of a supply network to protect the regular and planned course ofproduction against the random disturbance of running out of materials or goods. The

scope of inventory management also concerns the fine lines between replenishment leadtime, carrying costs of inventory, asset management, inventory forecasting, inventoryvaluation, inventory visibility, future inventory price forecasting, physical inventory,available physical space for inventory, quality management, replenishment, returns anddefective goods and demand forecasting.

Other definitions of inventory management from across the web:

Involves a retailer seeking to acquire and maintain a proper merchandise assortmentwhile ordering, shipping, handling, and related costs are kept in check.

Systems and processes that identify inventory requirements, set targets, providereplenishment techniques and report actual and projected inventory status.

Handles all functions related to the tracking and management of material. This wouldinclude the monitoring of material moved into and out of stockroom locations and thereconciling of the inventory balances. Also may include ABC analysis, lot tracking, cyclecounting support etc.

Management of the inventories, with the primary objective of determining.controllingstock levels within the physical distribution function to balance the need for productavailability against the need for minimizing stock holding and handling costs.

Effective inventory management is a crucial aspect of a successful business

practice.

Inventory management is an integral part of a successful business. Inventories typicallyconsist of goods, raw materials and finished products. Each of these elements translatesinto money for the business owner. The key to profitability is a carefully balancedinventory.


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Balanced inventories are important because many businesses rely on its stock of items tomake a profit. Stockpiles that never move from the shelves do little good for thecompany. A proper balance is of the utmost importance.

Mismanaged Inventories

Inventory mismanagement can be detrimental to a business, especially considering theweight these items carry. Inventories that run out of control can lead to significant lossesthat the company may not be able to recoup. Considerable investment is required todevelop adequate stock. Poorly managed supplies lead to profit loss.

Booming Inventory Management

Properly managing supplies requires the ability to create a balance. Part of the balancingapproach should include aspects of inventories that many business owners fail torecognize. Issues that may be underestimated include:

Storage cost Insurance Taxes Ordering dilemmas Pricing

Storage costs, insurance and taxes are important aspects of stocking shelves and keepingnecessary supplies at hand. These costs should be figured into the purchasing budget forthe stock. The upfront purchasing costs are complicated with ordering dilemmas andpricing considerations.

Ordering and Pricing

Managing inventories can be complicated, but some considerations can make the processmuch easier. Management may be concerned primarily with having a balanced stockwhile keeping supplies readily available without overstocking the shelves. Otherconsiderations are important as well.

Balanced assortment of items Quick, efficient turnover Maintaining service quality

Stocking up-to-date items High volume purchases Cost control

Successful inventory management may seem as if it requires psychic abilities, and whilea peek into the future can help, managers can fare pretty well by addressing managerialperformance. Creating realistic goals backed by evaluations can be beneficial. The data


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If a supplier (an external firm or an internal department or plant) cannot supply therequired goods on demand, then the client firm must keep an inventory of the neededgoods. The longer the lead time, the larger the quantity of goods the firm must carry ininventory.

A just-in-time (JIT) manufacturing firm, such as Nissan in Smyrna, Tennessee, canmaintain extremely low levels of inventory. Nissan takes delivery on truck seats as manyas 18 times per day. However, steel mills may have a lead time of up to three months.That means that a firm that uses steel produced at the mill must place orders at least threemonths in advance of their need. In order to keep their operations running in themeantime, an on-hand inventory of three months' steel requirements would be necessary.

HEDGE.

Inventory can also be used as a hedge against price increases and inflation. Salesmenroutinely call purchasing agents shortly before a price increase goes into effect. This

gives the buyer a chance to purchase material, in excess of current need, at a price that islower than it would be if the buyer waited until after the price increase occurs.

QUANTITY DISCOUNT.

Often firms are given a price discount when purchasing large quantities of a good. Thisalso frequently results in inventory in excess of what is currently needed to meet demand.However, if the discount is sufficient to offset the extra holding cost incurred as a resultof the excess inventory, the decision to buy the large quantity is justified.

SMOOTHING REQUIREMENTS.

Sometimes inventory is used to smooth demand requirements in a market where demandis somewhat erratic. Consider the demand forecast and production schedule outlined inTable 1.

Notice how the use of inventory has allowed the firm to maintain a steady rate of output(thus avoiding the cost of hiring and training new personnel), while building up inventoryin anticipation of an increase in demand. In fact, this is often called anticipationinventory. In essence, the use of inventory has allowed the firm to move demandrequirements to earlier periods, thus smoothing the demand.

CONTROLLING INVENTORY

Firms that carry hundreds or even thousands of different part numbers can be faced withthe impossible task of monitoring the inventory levels of each part number. In order tofacilitate this, many firm's use an ABC approach.


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ABC analysis is based on Pareto Analysis, also known as the "80/20" rule. The 80/20comes from Pareto's finding that 20 percent of the populace possessed 80 percent of thewealth. From an inventory perspective it can restated thusly: approximately 20 percent ofall inventory items represent 80 percent of inventory costs. Therefore, a firm can control80 percent of its inventory costs by monitoring and controlling 20 percent of its

inventory. But, it has to be the correct 20 percent.

The top 20 percent of the firm's most costly items are termed "A" items (this shouldapproximately represent 80 percent of total inventory costs). Items that are extremelyinexpensive or have low demand are termed "C" items, with "B" items falling in betweenA and C items. The percentages may vary with each firm, but B items usually representabout 30 percent of the total inventory items and 15 percent of the costs. C itemsgenerally constitute 50 percent of all inventory items but only around 5 percent of thecosts.

By classifying each inventory item as an A, B or C the firm can determine the resources

(time, effort and money) to dedicate to each item. Usually this means that the firmmonitors A items very closely but can check on B and C items on a periodic basis (forexample, monthly for B items and quarterly for C items).

Another control method related to the ABC concept is cycle counting. Cycle counting isused instead of the traditional "once-a-year" inventory count where firms shut down for ashort period of time and physically count all inventory assets in an attempt to reconcileany possible discrepancies in their inventory records. When cycle counting is used thefirm is continually taking a physical count but not of total inventory.

A firm may physically count a certain section of the plant or warehouse, moving on to

other sections upon completion, until the entire facility is counted. Then the process startsall over again.

The firm may also choose to count all the A items, then the B items, and finally the Citems. Certainly, the counting frequency will vary with the classification of each item. Inother words, A item may be counted monthly, B items quarterly, and C items yearly. Inaddition the required accuracy of inventory records may vary according to classification,with A items requiring the most accurate record keeping.

BALANCING INVENTORY AND COSTS

As stated earlier, inventory management is an attempt to maintain an adequate supply ofgoods while minimizing inventory costs. We saw a variety of reasons companies holdinventory and these reasons dictate what is deemed to be an adequate supply ofinventory. Now, how do we balance this supply with its costs? First let's look at whatkind of costs we are talking about.

There are three types of costs that together constitute total inventory costs:


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holding costs,

set-up costs, and

purchasing costs.

HOLDING COSTS.

Holding costs, also called carrying costs, are the costs that result from maintaining theinventory. Inventory in excess of current demand frequently means that its holder mustprovide a place for its storage when not in use. This could range from a small storage areanear the production line to a huge warehouse or distribution center. A storage facilityrequires personnel to move the inventory when needed and to keep track of what is storedand where it is stored. If the inventory is heavy or bulky, forklifts may be necessary tomove it around.

Storage facilities also require heating, cooling, lighting, and water. The firm must paytaxes on the inventory, and opportunity costs occur from the lost use of the funds thatwere spent on the inventory. Also, obsolescence, pilferage (theft), and shrinkage areproblems. All of these things add cost to holding or carrying inventory.

If the firm can determine the cost of holding one unit of inventory for one year (H) itcan determine its annual holding cost by multiplying the cost of holding one unit by theaverage inventory held for a one-year period. Average inventory can be computed bydividing the amount of goods that are ordered every time an order is placed ( Q ) by two.Thus, average inventory is expressed as Q /2. Annual holding cost, then, can be expressedasH( Q /2).

SET-UP COSTS.

Set-up costs are the costs incurred from getting a machine ready to produce the desiredgood. In a manufacturing setting this would require the use of a skilled technician (a cost)who disassembles the tooling that is currently in use on the machine. The disassembledtooling is then taken to a tool room or tool shop for maintenance or possible repair(another cost). The technician then takes the currently needed tooling from the tool room(where it has been maintained; another cost) and brings it to the machine in question.

There the technician has to assemble the tooling on the machine in the manner required

for the good to be produced (this is known as a "set-up"). Then the technician has tocalibrate the machine and probably will run a number of parts, that will have to bescrapped (a cost), in order to get the machine correctly calibrated and running. All thewhile the machine has been idle and not producing any parts (opportunity cost). As onecan see, there is considerable cost involved in set-up.

If the firm purchases the part or raw material, then an order cost, rather than a set-up cost,is incurred. Ordering costs include the purchasing agent's salary and travel/entertainment


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budget, administrative and secretarial support, office space, copiers and office supplies,forms and documents, long-distance telephone bills, and computer systems and support.Also, some firms include the cost of shipping the purchased goods in the order cost.

If the firm can determine the cost of one set-up ( S) or one order, it can determine its

annual setup/order cost by multiplying the cost of one set-up by the number of set-upsmade or orders placed annually. Suppose a firm has an annual demand (D ) of 1,000units. If the firm orders 100 units ( Q ) every time it places and order, the firm willobviously place 10 orders per year (D / Q ). Hence, annual set-up/order cost can beexpressed as S(D / Q ).

PURCHASING COST.

Purchasing cost is simply the cost of the purchased item itself. If the firm purchases a partthat goes into its finished product, the firm can determine its annual purchasing cost bymultiplying the cost of one purchased unit (P) by the number of finished products

demanded in a year (D ). Hence, purchasing cost is expressed asPD.

Now total inventory cost can be expressed as:Total = Holding cost + Set-up/Order cost + Purchasing costorTotal =H( Q /2) + S(D / Q ) +PD

If holding costs and set-up costs were plotted as lines on a graph, the point at which theyintersect (that is, the point at which they are equal) would indicate the lowest totalinventory cost. Therefore, if we want to minimize total inventory cost, every time weplace an order, we should order the quantity ( Q ) that corresponds to the point where the

two values are equal. If we set the two costs equal and solve forQ we get:H( Q /2) = S(D / Q )Q = 2DS/H

The quantity Q is known as the economic order quantity (EOQ). In order to minimizetotal inventory cost, the firm will orderQ every time it places an order. For example, afirm with an annual demand of 12,000 units (at a purchase price of $25 each), annualholding cost of $10 per unit and an order cost of $150 per order (with orders placed oncea month) could save $800 annually by utilizing the EOQ. First, we determine the totalcosts without using the EOQ method:Q = $10(1000/2) + $150(12,000/1000) + $25(12,000) = $306,800

Then we calculate EOQ:EOQ = 2(12,000)($150)/$10= 600And we calculate total costs at the EOQ of 600:Q = $10(600/2) + $150(12,000/600) + $25(12,000) = $306,000Finally, we subtract the total cost ofQ from Q to determine the savings:$306,800 306,000 = $800


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Notice that if you remove purchasing cost from the equation, the savings is still $800. Wemight assume this means that purchasing cost is not relevant to our order decision andcan be eliminated from the equation. It must be noted that this is true only as long as noquantity discount exists. If a quantity discount is available, the firm must determinewhether the savings of the quantity discount are sufficient to offset the loss of the savings

resulting from the use of the EOQ.

There are a number of assumptions that must be made with the use of the EOQ. Theseinclude:

Only one product is involved. Deterministic demand (demand is known with certainty). Constant demand (demand is stable through-out the year). No quantity discounts. Constant costs (no price increases or inflation).

While these assumptions would seem to make EOQ irrelevant for use in a realisticsituation, it is relevant for items that have independent demand. This means that thedemand for the item is not derived from the demand for something else (usually a parentitem for which the unit in question is a component). For example, the demand for steeringwheels would be derived from the demand for automobiles (dependent demand) but thedemand for purses is not derived from anything else; purses have independent demand.

OTHER LOT-SIZING TECHNIQUES

There are a number of other lot-sizing techniques available in addition to EOQ. Theseinclude the fixed-order quantity, fixed-order-interval model, the single-period model, and

part-period balancing.

FIXED-ORDER-QUANTITY MODEL.

EOQ is an example of the fixed-order-quantity model since the same quantity is orderedevery time an order is placed. A firm might also use a fixed-order quantity when it iscaptive to packaging situations. If you were to walk into an office supply store and ask tobuy 22 paper clips, chances are you would walk out with 100 paper clips. You werecaptive to the packaging requirements of paper clips, i.e., they come 100 to a box and youcannot purchase a partial box. It works the same way for other purchasing situations. Asupplier may package their goods in certain quantities so that their customers must buy

that quantity or a multiple of that quantity.

FIXED-ORDER-INTERVAL MODEL.

The fixed-order-interval model is used when orders have to be placed at fixed timeintervals such as weekly, biweekly, or monthly. The lot size is dependent upon how muchinventory is needed from the time of order until the next order must be placed (order


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cycle). This system requires periodic checks of inventory levels and is used by manyretail firms such as drug stores and small grocery stores.

SINGLE-PERIOD MODEL.

The single-period model is used in ordering perishables, such as food and flowers, anditems with a limited life, such as newspapers. Unsold or unused goods are not typicallycarried over from one period to another and there may even be some disposal costsinvolved. This model tries to balance the cost of lost customer goodwill and opportunitycost that is incurred from not having enough inventory, with the cost of having excessinventory left at the end of a period.

PART-PERIOD BALANCING.

Part-period balancing attempts to select the number of periods covered by the inventoryorder that will make total carrying costs as close as possible to the set-up/order cost.

When a proper lot size has been determined, utilizing one of the above techniques, thereorder point, or point at which an order should be placed, can be determined by the rateof demand and the lead time. If safety stock is necessary it would be added to the reorderpoint quantity.Reorder point =Expected demand during lead time + Safety stock

Thus, an inventory item with a demand of 100 per month, a two-month lead time and adesired safety stock of two weeks would have reorder point of 250. In other words, anorder would be placed whenever the inventory level for that good reached 250 units.

Reorder point =100/month 2 months + 2 weeks' safety stock = 250

NEED FOR INVENTORY MANAGEMENT:

Inventory management is a very simple concept - don't have too much stock and don'thave too little. Since there can be substantial costs involved in straying above and belowthe optimal range, careful inventory management can make a huge difference in theprofitability of a business. Although the concept is simple, the process of getting the rightbalance can be quite a complex and time consuming task without the right technology.

There are two fundamental questions that must be answered, in order to manage theinventory of any physical item - when to order and how much to order.

Inventory Management & your customers

One of the main reasons many businesses carry excess stock is because they don'tunderstand the needs of their customers. In fact, does every customer require the entireorder immediately? A more thorough understanding of each major customers detailed


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delivery time-frame, can frequently identify issues that can result in benefits for bothsupplier and customer. Possibly supplying 50% of the order this week, with theremaining 50% delivered next week could be adequate or even preferred by yourcustomer.

While many companies offer volume discounts to their customers for placing largeorders, this can freqently have a negative impact on cashflow unless effective supplychain management strategies are in place. Build-to-order manufacturers may receive abenefit from large orders by reducing setup costs, many stocking manufacturers, dealersor wholesalers often require less stock when shipping smaller orders more frequently.Understanding your customer's needs is fundamental to your inventory managementsuccess, and a critical component of Core Logistics Consulting's approach to creating aneffective Inventory Management Strategy for your company.

Business inventory

[edit] The reasons for keeping stock

There are three basic reasons for keeping an inventory:

1. Time - The time lags present in the supply chain, from supplier to user at everystage, requires that you maintain certain amount of inventory to use in this "leadtime"

2. Uncertainty - Inventories are maintained as buffers to meet uncertainties indemand, supply and movements of goods.

3. Economies of scale - Ideal condition of "one unit at a time at a place where userneeds it, when he needs it" principle tends to incur lots of costs in terms of

logistics. So bulk buying, movement and storing brings in economies of scale,thus inventory.

All these stock reasons can apply to any owner or product stage.

Buffer stockis held in individual workstations against the possibility that theupstream workstation may be a little delayed in long setup or change-over time.This stock is then used while that change-over is happening. This stock can beeliminated by tools like SMED.

SMED:

Single Minute Exchange of Die (SMED) is one of the many lean productionmethodsfor reducing waste in a manufacturing process. It provides a rapid and efficient way ofconverting a manufacturing process from running the current product to running the nextproduct. This rapid changeover is key to reducing production lot sizes and therebyimproving flow (Mura).

The phrase "single minute" does not mean that all changeovers and startups should takeonly one minute, but that they should take less than 10 minutes (in other words, "single
http://en.wikipedia.org/w/index.php?title=Inventory&action=edit&section=2http://en.wikipedia.org/wiki/SMEDhttp://en.wikipedia.org/wiki/SMEDhttp://en.wikipedia.org/wiki/Lean_productionhttp://en.wikipedia.org/wiki/Lean_productionhttp://en.wikipedia.org/wiki/Mura_(Japanese_term)http://en.wikipedia.org/w/index.php?title=Inventory&action=edit&section=2http://en.wikipedia.org/wiki/SMEDhttp://en.wikipedia.org/wiki/Lean_productionhttp://en.wikipedia.org/wiki/Mura_(Japanese_term)


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digit minute").[1] Closely associated is a yet more difficult concept, One-TouchExchange of Die, (OTED), which says changeovers can and should take less than 100seconds

Most manufacturing organizations usually divide their "goods for sale" inventory into:

Raw materials - materials and components scheduled for use in making a product. Work in process, WIP - materials and components that have begun their

transformation to finished goods. Finished goods - goods ready for sale to customers. Goods for resale - returned goods that are salable. Spare parts

For example:

[edit] Manufacturing

A canned food manufacturer's materials inventory includes the ingredients to form thefoods to be canned, empty cans and their lids (or coils of steel or aluminum forconstructing those components), labels, and anything else (solder, glue, ...) that will formpart of a finished can. The firm's work in process includes those materials from the timeof release to the work floor until they become complete and ready for sale to wholesale orretail customers. This may be vats of prepared food, filled cans not yet labelled or sub-assemblies of food components. It may also include finished cans that are not yetpackaged into cartons or pallets. Its finished good inventory consists of all the filled andlabelled cans of food in its warehouse that it has manufactured and wishes to sell to fooddistributors (wholesalers), to grocery stores (retailers), and even perhaps to consumers

through arrangements like factory stores and outlet centers.

TYPES OF INVENTORIES

Generally, inventory types can be grouped into four classifications: raw material,

work-in-process, finished goods, and MRO goods.

RAW MATERIALS

Raw materials are inventory items that are used in the manufacturer's conversion process

to produce components, subassemblies, or finished products. These inventory items maybe commodities or extracted materials that the firm or its subsidiary has produced orextracted. They also may be objects or elements that the firm has purchased from outsidethe organization. Even if the item is partially assembled or is considered a finished goodto the supplier, the purchaser may classify it as a raw material if his or her firm had noinput into its production. Typically, raw materials are commodities such as ore, grain,minerals, petroleum, chemicals, paper, wood, paint, steel, and food items. However,
http://en.wikipedia.org/wiki/SMED#cite_note-0%23cite_note-0http://en.wikipedia.org/wiki/Raw_materialshttp://en.wikipedia.org/wiki/Work_in_processhttp://en.wikipedia.org/wiki/Finished_goodshttp://en.wikipedia.org/w/index.php?title=Inventory&action=edit&section=6http://en.wikipedia.org/wiki/Factory_outlethttp://en.wikipedia.org/wiki/SMED#cite_note-0%23cite_note-0http://en.wikipedia.org/wiki/Raw_materialshttp://en.wikipedia.org/wiki/Work_in_processhttp://en.wikipedia.org/wiki/Finished_goodshttp://en.wikipedia.org/w/index.php?title=Inventory&action=edit&section=6http://en.wikipedia.org/wiki/Factory_outlet


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items such as nuts and bolts, ball bearings, key stock, casters, seats, wheels, and evenengines may be regarded as raw materials if they are purchased from outside the firm.

The bill-of-materials file in a material requirements planning system (MRP) or amanufacturing resource planning (MRP II) system utilizes a tool known as a product

structure tree to clarify the relationship among its inventory items and provide a basis forfilling out, or "exploding," the master production schedule. Consider an example of arolling cart. This cart consists of a top that is pressed from a sheet of steel, a frameformed from four steel bars, and a leg assembly consisting of four legs, rolled from sheetsteel, each with a caster attached. An example of this cart's product structure tree ispresented in Figure 1.

Generally, raw materials are used in the manufacture of components. These componentsare then incorporated into the final product or become part of a subassembly.Subassemblies are then used to manufacture or assemble the final product. A part thatgoes into making another part is known as a component, while the part it goes into is

known as its parent. Any item that does not have a component is regarded as a rawmaterial or purchased item. From the product structure tree it is apparent that the rollingcart's raw materials are steel, bars, wheels, ball bearings, axles, and caster frames.

WORK-IN-PROCESS

Work-in-process (WIP) is made up of all the materials, parts (components), assemblies,and subassemblies that are being processed or are waiting to be processed within thesystem. This generally includes all materialfrom raw material that has been releasedfor initial processing up to material that has been completely processed and is awaitingfinal inspection and acceptance before inclusion in finished goods.

Any item that has a parent but is not a raw material is considered to be work-in-process.A glance at the rolling cart product structure tree example reveals that work-in-process inthis situation consists of tops, leg assemblies, frames, legs, and casters. Actually, the legassembly and casters are labeled as subassemblies because the leg assembly consists oflegs and casters and the casters are assembled from wheels, ball bearings, axles, andcaster frames.

FINISHED GOODS

A finished good is a completed part that is ready for a customer order. Therefore, finishedgoods inventory is the stock of completed products. These goods have been inspected andhave passed final inspection requirements so that they can be transferred out of work-in-process and into finished goods inventory. From this point, finished goods can be solddirectly to their final user, sold to retailers, sold to wholesalers, sent to distributioncenters, or held in anticipation of a customer order.


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Any item that does not have a parent can be classified as a finished good. By looking atthe rolling cart product structure tree example one can determine that the finished good inthis case is a cart.

Inventories can be further classified according to the purpose they serve. These types

include transit inventory, buffer inventory, anticipation inventory, decoupling inventory,cycle inventory, and MRO goods inventory. Some of these also are know by other names,such as speculative inventory, safety inventory, and seasonal inventory. We already havebriefly discussed some of the implications of a few of these inventory types, but will nowdiscuss each in more detail.

TRANSIT INVENTORY

Transit inventories result from the need to transport items or material from one locationto another, and from the fact that there is some transportation time involved in gettingfrom one location to another. Sometimes this is referred to as pipeline inventory.

Merchandise shipped by truck or rail can sometimes take days or even weeks to go froma regional warehouse to a retail facility. Some large firms, such as automobilemanufacturers, employ freight consolidators to pool their transit inventories coming fromvarious locations into one shipping source in order to take advantage of economies ofscale. Of course, this can greatly increase the transit time for these inventories, hence anincrease in the size of the inventory in transit.

BUFFER INVENTORY

As previously stated, inventory is sometimes used to protect against the uncertainties of

supply and demand, as well as unpredictable events such as poor delivery reliability orpoor quality of a supplier's products. These inventory cushions are often referred to assafety stock. Safety stock or buffer inventory is any amount held on hand that is over andabove that currently needed to meet demand. Generally, the higher the level of bufferinventory, the better the firm's customer service. This occurs because the firm suffersfewer "stock-outs" (when a customer's order cannot be immediately filled from existinginventory) and has less need to backorder the item, make the customer wait until the nextorder cycle, or even worse, cause the customer to leave empty-handed to find anothersupplier. Obviously, the better the customer service the greater the likelihood of customersatisfaction.

ANTICIPATION INVENTORYOftentimes, firms will purchase and hold inventory that is in excess of their current needin anticipation of a possible future event. Such events may include a price increase, aseasonal increase in demand, or even an impending labor strike. This tactic is commonlyused by retailers, who routinely build up inventory months before the demand for theirproducts will be unusually high (i.e., at Halloween, Christmas, or the back-to-schoolseason). For manufacturers, anticipation inventory allows them to build up inventory


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when demand is low (also keeping workers busy during slack times) so that whendemand picks up the increased inventory will be slowly depleted and the firm does nothave to react by increasing production time (along with the subsequent increase in hiring,training, and other associated labor costs). Therefore, the firm has avoided both excessiveovertime due to increased demand and hiring costs due to increased demand. It also has

avoided layoff costs associated with production cut-backs, or worse, the idling or shuttingdown of facilities. This process is sometimes called "smoothing" because it smoothes thepeaks and valleys in demand, allowing the firm to maintain a constant level of output anda stable workforce.

DECOUPLING INVENTORY

Very rarely, if ever, will one see a production facility where every machine in the processproduces at exactly the same rate. In fact, one machine may process parts several timesfaster than the machines in front of or behind it. Yet, if one walks through the plant itmay seem that all machines are running smoothly at the same time. It also could be

possible that while passing through the plant, one notices several machines are underrepair or are undergoing some form of preventive maintenance. Even so, this does notseem to interrupt the flow of work-in-process through the system. The reason for this isthe existence of an inventory of parts between machines, a decoupling inventory thatserves as a shock absorber, cushioning the system against production irregularities. Assuch it "decouples" or disengages the plant's dependence upon the sequentialrequirements of the system (i.e., one machine feeds parts to the next machine).

The more inventory a firm carries as a decoupling inventory between the various stagesin its manufacturing system (or even distribution system), the less coordination is neededto keep the system running smoothly. Naturally, logic would dictate that an infinite

amount of decoupling inventory would not keep the system running in peak form. Abalance can be reached that will allow the plant to run relatively smoothly withoutmaintaining an absurd level of inventory. The cost of efficiency must be weighed againstthe cost of carrying excess inventory so that there is an optimum balance betweeninventory level and coordination within the system.

CYCLE INVENTORY

Those who are familiar with the concept of economic order quantity (EOQ) know that theEOQ is an attempt to balance inventory holding or carrying costs with the costs incurredfrom ordering or setting up machinery. When large quantities are ordered or produced,inventory holding costs are increased, but ordering/setup costs decrease. Conversely,when lot sizes decrease, inventory holding/carrying costs decrease, but the cost ofordering/setup increases since more orders/setups are required to meet demand. When thetwo costs are equal (holding/carrying costs and ordering/setup costs) the total cost (thesum of the two costs) is minimized. Cycle inventories, sometimes called lot-sizeinventories, result from this process. Usually, excess material is ordered and,consequently, held in inventory in an effort to reach this minimization point. Hence, cycle


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inventory results from ordering in batches or lot sizes rather than ordering materialstrictly as needed.

MRO GOODS INVENTORY

Maintenance, repair, and operating supplies, or MRO goods, are items that are used tosupport and maintain the production process and its infrastructure. These goods areusually consumed as a result of the production process but are not directly a part of thefinished product. Examples of MRO goods include oils, lubricants, coolants, janitorialsupplies, uniforms, gloves, packing material, tools, nuts, bolts, screws, shim stock, andkey stock. Even office supplies such as staples, pens and pencils, copier paper, and tonerare considered part of MRO goods inventory.

THEORETICAL INVENTORY

In their bookManaging Business Process Flows: Principles of Operations Management,Anupindi, Chopra, Deshmukh, Van Mieghem, and Zemel discuss a final type ofinventory known as theoretical inventory. They describe theoretical inventory as theaverage inventory for a given throughput assuming that no WIP item had to wait in abuffer. This would obviously be an ideal situation where inflow, processing, and outflowrates were all equal at any point in time. Unless one has a single process system, therealways will be some inventory within the system. Theoretical inventory is a measure ofthis inventory (i.e., it represents the minimum inventory needed for goods to flow throughthe system without waiting). The authors formally define it as the minimum amount ofinventory necessary to maintain a process throughput ofR, expressed as:Theoretical Inventory = Throughput Theoretical Flow Time

Ith = R TthIn this equation, theoretical flow time equals the sum of all activity times (not wait time)required to process one unit. Therefore, WIP will equal theoretical inventory wheneveractual process flow time equals theoretical flow time.

Inventory exists in various categories as a result of its position in the production process(raw material, work-in-process, and finished goods) and according to the function itserves within the system (transit inventory, buffer inventory, anticipation inventory,decoupling inventory, cycle inventory, and MRO goods inventory). As such, the purposeof each seems to be that of maintaining a high level of customer service or part of anattempt to minimize overall costs.

HOW INVENTORY AFFECTS THE CASH FLOW OF A COMPANY?

Excess inventory reduces cash flow, while too little inventory can decrease sales.Inventory turnover and days inventory held are two measures of inventory management.


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Proper inventory management is essential to ensure that a company has sufficientinventory on hand to meet the needs of both its customers and its operations. However,an excessive amount of inventory on hand ties up cash and increases expenses such asinsurance costs, property taxes, and additional storage costs. In addition, excess inventoryheld too long can become obsolete and lose value which could significantly reduce

inventory value. Two measures that are helpful in evaluating the efficiency of inventorymanagement are inventory turnover and the number of day's inventory is held.

Inventory Turnover

The inventory turnover ratio measures how many times, on average, inventory is soldduring the year. It is calculated by dividing the cost of goods sold by the averageinventory. In order to determine average inventory, it may be necessary to use theinventory balance at the beginning of the year plus the inventory balance at the end of theyear and divide by two for an average inventory figure.

For example, if a company had an inventory balance of $283,000 at the beginning of theyear and a $261,200 inventory balance at the end of the year, the average inventory is$272,100 ($283,000 + $261,200/2). If the cost of goods sold at the end of the year is$953,200, the inventory turnover ratio is 3.5 ($953,200/$272,100).

Generally, the higher the inventory turnover, the better. However, differences acrosscompanies and industries are too great to make a general statement on what is a goodinventory turnover. A fast-food restaurant would have a much higher inventory turnoverthan a company that sells jewelry because food is perishable, and obviously jewelry isnot. However, industry standards can be found for comparison purposes for almost everybusiness.

Days Inventory Held

The number of day's inventory is held measures the average numbers of days it takes tosell the average inventory held. It is calculated by dividing the average inventory by theaverage daily cost of goods sold. For this analysis, the average inventory can becalculated the same way that it was calculated for inventory turnover-adding thebeginning inventory balance to the ending inventory balance and dividing by two.

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In order to arrive at an average cost of goods sold, it is a simple matter of taking thecost of goods sold figure and dividing by 365. For example, cost of goods sold at the endof the year is $953,200; therefore average daily cost of goods sold is $2,611($953,200/365). If the average inventory is $272,100 and the average daily cost of goodssold is $2,611 the number of days inventory is held is 104 days ($272,100/$2,611).
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Generally, a low number of days inventory is held are a sign of efficient management.The faster that inventory sells the less cash that is tied up in inventory. However, it isimportant that inventory is not too low because this could indicate under stocking ofinventory, which could lead to loss of sales and revenue. Again, it is difficult to make ageneral statement about what is a good measure of efficiency for every industry, but a

comparison to previous years and similar firms would be useful in assessing overallinventory management.

Physical Verification of Inventory

Inventory is physically verified by organizations to

ascertain its existence and accuracy. Depending on the

size and nature of the organization it is verified either

frequently or once annually. Give below are steps which

can be used to design the physical verification of

inventory process. These need to be fine tuned

according to the nature of industry.

Perpetual Inventory

Medium to large organizations having high quantity of stocks must design a perpetualinventory count system. Physical verification of inventory on a perpetual basis helps tomonitor and control the stocks effectively. A perpetual inventory system can be eitherweekly or monthly. An annual verification of stocks during year end audits can revealdifferences between physical and book quantities which would be difficult to identify anda rectification at that stage may not be possible leading to an excessive write off.

A weekly stock take procedure needs to be carried out on the day of the week when theoperations are expected to be at a minimum i.e. there is minimum movement ofinventory. Monthly physical verification needs to be carried out on the last day of themonth after all the invoices have been recorded and the inventory is dispatched.

help in completing the stock count quickly and without any errors.

A monthly stock count procedure would involve a complete stock count i.e. counting theentire inventory. A weekly perpetual inventory system on the other hand would involve


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counting some of the quantity on a weekly basis such that the entire stocks are countedatleast twice a year or once every quarter.

Inventory Schedule

The inventory schedule must be prepared prior to the stock count. It must specify the dateand time of the count and the staff who will be participating in the stock count. Theschedule must be communicated to the staff involved in the stock take.

Staff involved in stock count

Atleast 2 employees need to be involved in the stock count for each area. One employeemust be involved in handling the inventory on day to day basis (example Store Keeper)whereas other employee should not be involved in handling the daily stock movements(example Accountant, member of sales team etc.). One employee must count the stocks,whereas the other employee must verify and record the count.

Organizing Count Area Stores Department

The warehouse / count area where the inventory is stored must be well organized.Inventory needs to be stored in such a manner that it can be easily identified. Thus theracks where the inventory is kept must have labels specifying the item stored. Certainitems could have various stock keeping units i.e. could be available in varied pack sizeand weight i.e. 100 grams pack, 200 grams pack etc. These need to be separated andlabeled accordingly.

If inventory is stacked on pallets, certain standards need to be followed for the totalnumber of cartons on a pallet. For example 5 cartons kept horizontally and 6 verticallyi.e. total 30 cartons on a pallet. All the pallets in a storage area must be stacked in thesame manner. This would help in completing the stock count quickly and without anyerrors.
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Inventory Count Sheets

Area wise inventory count sheets must be available for the stock take. The inventory

count sheets need to be numbered and should have a complete list of all items in stock asper the stock records on the computer system. The unit of measurement specified on thecount sheet should match the unit of measurement in which stock is required to berecorded in the books. This will enable to compare the book stock with the physicalstocks counted and would reduce errors of conversion. For example if the book stock is inCartons and Pieces, the physical stock needs to be counted and recorded as Cartons andPieces. If the book stock is in kilograms, then the physical stock needs to be weighed andrecorded in kilograms.

A blind count is always beneficial i.e. the system stock should not be mentioned on theinventory count sheet.

The staff involved in the stock count must initial / sign each and every page of theinventory count sheet.

Cut Off Procedures

Adequate cut off procedures need to be followed. For instance, GRN (goods receipt note)for all raw materials received need to be accounted prior to counting and included in thestock count during physical stock take. Similarly finished goods for which invoices areentered need to be segregated and transferred to dispatch section and should not becounted during physical stock take. All pending sales invoices and GRNs need to be

entered before generating the stock count sheets from the system.

Summarizing the above all goods just received for which GRN is not prepared and allsales invoices entered which are not yet dispatched should be segregated and not countedduring the physical stock take.

Completeness

To ensure completeness the stock needs to be counted in a systematic order. Thus stockcount should be pallet wise or stack by stack either from left to right or right to left.Similarly stocks kept on racks should be counted from top to bottom or vice versa.

Quantities present in more than one open carton must be combined before counting it as acarton or as pieces.

Each count area must be checked before moving to the next to make sure that nothingwas missed.

Obsolete Items


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Obsolete and slow moving stocks need to be counted and separately identified. Similarlyany items which are damaged need to be marked on the inventory count sheets, sincethese items would need to be valued at the lower of cost or net realizable value.

Third Party Stocks

During stock counts, inventory belonging to third parties in our stores need to beidentified. Similarly on a monthly or quarterly basis it is important to obtain aconfirmation from third parties with whom our stocks are kept. For example obtaining aconfirmation for stocks kept on consignment basis.

Comparison with System Stock

The physical stock must be entered in the system to compare with the book stock. Thestocks must be entered in the same unit of measurement as present on the system. Ifpossible the staff entering the stock needs to be different from the staff involved in the

stock count to ensure segregation of duties. This would depend on the size of theorganization and the staff available. Entry should be done from the count sheets page bypage to ensure all items are entered. Any items which were not present in the count sheetsand written manually during physical stock should be entered with care and checked withsimilar items in the system.

Subsequentdata entry of sales invoices and GRN can be done only after comparing thesystem stocks with the physical stock.

Variance Analysis

After entering the physical stocks, the variances, if any, must be analyzed. Hugevariances must be investigated by performing a recount of those items, verifying whetherthe entry of physical stock was correctly done, whether any errors are present in dataentry of invoices, stock receipts and stock issue.

The variances need to be accounted for such that the system stock reflects the result ofthe physical stock count.

Authorization of Inventory Stock Counts

The stock count sheets and the variances arrived at need to be verified by a Senior

Management Staff. The variances and the final result of the stock count must beauthorized.

The reviewer needs to verify whether the counting instructions were followed and thereasonableness of the variances before sending the adjustment entry to the accounting

department for recording.
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INVENTORY VALUATION

Specific Identification

Specific Identification is a method of finding out ending inventorycost. It requires a

very detailed physical count, so that the company knows exactly how many of eachgoods brought on specific dates remained at year end inventory. When this information isfound, the amount of goods are multiplied by their purchase cost at their purchase date, toget a number for the ending inventory cost.

On theory, this method is the best method, since it relates the ending inventory goodsdirectly to the specific price they were bought for. However, this method allowsmanagement to easily manipulate ending inventory cost, since they can choose to reportthat the cheaper goods were sold first, hence increasing ending inventory cost andlowering Cost of Goods Sold. This will increase the income. Alternatively, managementcan choose to report lower income, to reduce thetaxesthey needed to pay.

This method is also very hard to use on interchangeable goods. For example, it is hard torelate shipping andstorage costs to a specific inventory item. These number will need tobe estimated, and hence reducing the specific identification 's benefit of being extremelyspecific.

Weighted Average Cost

Weighted Average Cost is a method of calculating Ending Inventory cost. It takes Costof Goods Available for Sale and divides it by the total amount of goods from Beginning

Inventory and Purchases. This gives a Weighted Average Cost per Unit. A physicalcount is then performed on the ending inventory to determine the amount of goods left.Finally, this amount is multiplied by Weighted Average Cost per Unit to give an estimateof ending inventory cost.

Moving-Average Cost

Moving-Average Unit Cost is a method of calculating Ending Inventorycost. Assumethat both Beginning Inventory and beginning inventory cost are known. From them theCost per Unit of Beginning Inventory can be calculated. During the year, multiple

purchaseswere made. Each time, purchase costs are added to beginning inventory cost toget Cost of Current Inventory. Similarly, the number of units bought is added tobeginning inventory to get Current Goods Available for Sale. After each purchase, Costof Current Inventory is divided by Current Goods Available for Sale to get Current Costper Unit on Goods. Also during the year, multiple saleshappened. The Current GoodsAvailable for Sale is deducted by the amount of goods sold, and the Cost of CurrentInventory is deducted by the amount of goods sold times the latest (before this sale)Current Cost per Unit on Goods. This deducted amount is added to Cost of Goods Sold.
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At the end of the year, the last Cost per Unit on Goods, along with a physical count, isused to determine ending inventory cost.

FIFO vs. LIFO accounting

Main article: FIFO and LIFO accounting

When a merchant buys goods from inventory, the value of the inventory account isreduced by the cost of goods sold (CoG sold). This is simple where the CoG has notvaried across those held in stock; but where it has, then an agreed method must bederived to evaluate it. Forcommodityitems that one cannot track individually,accountants must choose a method that fits the nature of the sale. Two popular methodswhich normally exist are: FIFO and LIFO accounting (first in - first out, last in - firstout). FIFO regards the first unit that arrived in inventory as the first one sold. LIFOconsiders the last unit arriving in inventory as the first one sold. Which method anaccountant selects can have a significant effect on net income andbook value and, inturn, on taxation. Using LIFO accounting for inventory, a company generally reports

lower net income and lower book value, due to the effects of inflation. This generallyresults in lower taxation. Due to LIFO's potential to skew inventory value,UK GAAPandIAS have effectively banned LIFO inventory accounting.

Inventory ValuationAn inventory valuation allows a company to provide a monetary value for items thatmake up their inventory. Inventories are usually the largest current asset of a business,and proper measurement of them is necessary to assure accurate financial statements. Ifinventory is not properly measured, expenses and revenues cannot be properly matchedand a company could make poor business decisions.

Effectively measuring and managing inventory is essential in keeping a companiesfinancial statements up to date; inventories are a part of thebalance sheetand arerepresented as short-term assets. Inventory can be defined as assets that are held for thepurpose of sale or inventory can refer to assets that are being converted to a form whichcan be sold or even assets that assist in the production of goods which will be sold.

To determine how much inventory a company has on hand, the following formula can beused. It is pretty straight forward, take the inventory at hand at the start of the reportingperiod and add any new inventory purchases and then subtract the cost of any inventorythat has been sold.
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Inventory Valuation

Inventory valuation and management is a very important part of managing the currentassets account on the balance sheet. If this aspect is not done properly, the ramificationsare far reaching; total assets and shareholders equity wil be affected on the balance sheetwhile net income will be affected on the income statement.

In order to properly manage and match up revenues derived from the cost of inventory,companies use the following inventory valuation methodologies; First-In First-Out(FIFO),Last-In Last-Out (LIFO),Average Cost, andSpecific Identification.

FIrst-in First-out (FIFO)

FIFO matches up sales with inventories in a sequential manner by matching the revenuesfrom the first sale with the costs associated with the first product that was made. Forexample, assume that a textile company created 500 tablecloths at a cost of $1.00 per unitand then created another 1000 with a unit cost of $1.25. The revenue from the sale of thefirst 500 tableclothes will be matched up with the tablecloths which have a cost basis of$1.00.

Last-in First-Out (LIFO)
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LIFO takes the opposite approach to FIFO; it matches in the reverse order. The first saleis matched against the last product produced and therefore, the last good sold will bematched up with the first good produced. Basically, LIFO is assuming that a companysells off its last product produced, first. The diagram below takes the same example fromabove and depicts LIFO inventory management.

Average Cost

The average cost method of inventory management is pretty straight forward. Thismethod values inventory costs as the average unit cost between the assets in thebeginning inventory and the newly acquired assets. There is no inventory matchingrequired.

Specific Identification

Specific identification is more manually intensive method of managing inventory.Companies will literally identify each item in inventory and record thecapital gain(loss)when that specific item is sold. Each item will remain in the inventory until it is sold.

Conclusion

Choosing the appropriate methodology is a difficult task as there are many unknown

variables that go into the decision, such asinflationor shelf life. With high inflation,or in markets with prices increasing, companies will achieve a higher profits by matchingsales against inventory which was produced at lower prices; earnings per sharewillincrease but so will tax liability due to an increase in profits. Using LIFO on the otherhand will produce the opposite effect. In essence, you will be matching new sales againsthigher production costs, thereby lowering net income and EPS. Some companies mayactually prefer this to keep their tax liability down. Companies cannot use differentmethodologies when reporting to the government and their shareholders so choosing
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either one may be a gift or a curse. Also remember, when analyzing inventoryvaluations, it is important to compare one company against another company in the sameindustry.

Methods of valuations

There are three basis approaches to valuing inventory that are allowed by GAAP

(a) First-in, First-out (FIFO): Under FIFO, the cost of goods sold is based upon the costof material bought earliest in the period, while the cost of inventory is based upon thecost of material bought later in the year. This results in inventory being valued close tocurrent replacement cost. During periods of inflation, the use of FIFO will result in thelowest estimate of cost of goods sold among the three approaches, and the highest netincome.

(b) Last-in, First-out (LIFO): Under LIFO, the cost of goods sold is based upon the costof material bought towards the end of the period, resulting in costs that closelyapproximate current costs. The inventory, however, is valued on the basis of the cost ofmaterials bought earlier in the year. During periods of inflation, the use of LIFO willresult in the highest estimate of cost of goods sold among the three approaches, and thelowest net income.

(c) Weighted Average: Under the weighted average approach, both inventory and thecost of goods sold are based upon the average cost of all units bought during the period.

When inventory turns over rapidly this approach will more closely resemble FIFO thanLIFO.

Firms often adopt the LIFO approach for the tax benefits during periods of high inflation,and studies indicate that firms with the following characteristics are more likely to adoptLIFO - rising prices for raw materials and labor, more variable inventory growth, anabsence of other tax loss carry forwards, and large size. When firms switch from FIFO toLIFO in valuing inventory, there is likely to be a drop in net income and a concurrentincrease in cash flows (because of the tax savings). The reverse will apply when firmsswitch from LIFO to FIFO.

Given the income and cash flow effects of inventory valuation methods, it is oftendifficult to compare firms that use different methods. There is, however, one way ofadjusting for these differences. Firms that choose to use the LIFO approach to valueinventories have to specify in a footnote the difference in inventory valuation betweenFIFO and LIFO, and this difference is termed the LIFO reserve. This can be used toadjust the beginning and ending inventories, and consequently the cost of goods sold, andto restate income based upon FIFO valuation.


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NON MOVING OR SLOW MOVING INVENTORY:Explanation:

Basically stock that isn't sold and incurs time, effort and money to continue holding them.

Therefore, reducing them is a means of reducing costs.

bhavani wil inv. mgt

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