Term Paper on Inventory Control Techniques

Nikhil Ratnakaran 1PT11MBA35 Section B

Abstract
Inventory control is essential not only to the manufacturing firms but also to the marketing and servicing firms. Firms apply different forms of inventory control techniques to ensure that the required materials are available in the firm to forestall production or sales stoppages. Despite this immeasurable role of inventory control in the performance and survival of firms. Inventory control has been associated with certain costs which is not controlled increase the losses of the firm. Therefore the firms must ensure the effective inventory management system in the firm and selection of an appropriate inventory control technique. This study is about the various inventory control techniques that a firm can use for its effective inventory management. Inventory control technique ensures that production is not constructed due to the unavailability of recurring items. To achieve that involves determining correct minimum and maximum stock levels, timely recoupment and submission of shortage reports to purchasing unit.

Introduction
You are in trouble if you have to keep telling customers, I am sorry, we are out of that size. May we order it for you? This will lead to lose your customers if you do not have the item in stock. When the customer spends, you have got to be ready with the goods. Inventories are stocks of the product a company is manufacturing for sale and components that make up the product. The various forms which constitute the inventory of a firm are raw materials, work in progress, finished goods. It is important that a company maintains adequate stock of materials for a continues supply to the factory for an uninterrupted production in doing so such a company is exposed to two undesirable points namely excessive and inadequate inventories. Each of them has their own disadvantages. For instance, inventories can lead to unnecessary tying up of the firms funds and loss of profit, excessive carry costs, etc. The reorder point can also be known as the minimum stock level since it is the level which stocks should not be normally allowed to fall. If stocks go below this level, there is the danger of stock out which can result to production stoppage. The next stock level that is necessary to be computed by a firm is the maximum stock level maximum stock level is the level above which stock should not normally be allowed to rise. It is desirable that the level should be as low as possible, but it must allow fairest usage of materials and time delays in delivery. Therefore the firms have to control its inventories in a most effective manner. Firms use various techniques to control its inventories in a most appropriate quantity, without any excess or shortage. Effective inventory control requires a careful planning that will end up striking a balance between over investment and under investment in inventories. Inventory control is associated with different types of costs. Hence the needs for effective inventory control mechanism to minimize the costs. These costs can be classified into carrying costs, and ordering costs, stock out cost and excessive inventory cost. Majority of the firms attempted to achieve effective inventory control through the use scientific approach than depending on guesswork. Thus simple mathematics formulas of varying degree have been developed to calculate the various stock levels so as to cover such emergencies as abnormal usage of materials or unexpected delays in delivery of fresh supplies.

Literature Review
1. Inventory Management
Inventory management can be briefly described as: - Acquiring an adequate supply and assortment of merchandise from which customers can buy. - Providing safety stocks to meet unexpected demand or delays in inventory replenishment. - Maintaining clear, correct and current records. - Purchasing the proper assortment of goods in quantities that will maintain inventory levels consistent with business requirement, while providing adequate safety stocks.

2. Inventory Investment Control

Inventory control is accomplished in two ways: - Prompt elimination of overstocked items. - Reordering inventory in anticipation of customer demand. Whenever a particular item is overstocked, it should be reduced as promptly as possible. The most effective and profitable way is to sell it to the customer, even at a discount.

Types of Inventories
Inventories may be classified as under: 1. Raw Materials and Production Inventories These are raw - materials, parts and components which enter into the product direct, during the production process and generally form part of the product. 2. In-Process Inventories Semi-finished parts, work-in-process and partly finished products formed at various stages of production. 3. M.R.O. Inventories Maintenance, repairs and operating supplies which are consumed during the production process and generally do not form part of the product itself. 4. Finished Goods Inventories The products which are completed all the production processes and ready for sales to the customers. 5. Lot-size Inventories In order to keep costs of buying, receipt, inspection and transport and handing charge slow, larger quantities are bought than are necessary for immediate use. It is common practice to buy some raw materials in large quantities in order to avail of quantity discounts. 6. Movement and Transit Inventories This arises because of the time necessary to move stocks from one place to another. 7. Fluctuation Inventories In order to adjust against unpredictable demands these are maintained, but they are not absolutely essential in the sense that such stocks are always uneconomical. Rather than taking what they can get, general practice of serving the customer better is the reason for holding such type of inventories. 8. Anticipation Inventories Such inventories are carried out to meet predictable changes in, demand. In case of seasonal variations in the availability of some raw materials, it is of inventory and also to some extent economical to build up stocks where consumption pattern may be reasonably uniform and predictable.

Inventory Control Techniques

The following are some important inventory control techniques largely used by the firms: 1. 2. 3. 4. 5. 6. ABC Analysis or Selective Inventory Control The Two Bin System Max Mini System Economic Order Quantity Safety or Buffer Stock FSN/VED Analysis

All these techniques mentioned above are explained below in detail.

1. ABC Analysis or Selective Inventory Control(SIC)

80 per cent of the income and wealth were concentrated in the hands of about 20% of the population. This 80-20 relationship also holds good in most cases of inventories where it may be found that about 20 per cent of the total number of items are responsible for about 80 per cent of the value. The idea of studying such, inventory value is to find out 'where the money lies'. AS this '20per cent of items, 80 per cent of value' rule holds good in many inventory situations, high value items need more stringent control, which may be termed 'A' class items, and the remaining ones can be classified as 'B' and 'c' class items according to descending order of value. Controlling these inventories tightly means reviewing frequently and frequency in turn tends to determine the order quantity of inventories, an item would be reviewed frequently, and because of their high value they will be ordered in small quantities in order to keep the inventory investment minimum. B items will be renewed less frequently and C items still less. The following table illustrates the ABC analysis technique for inventory control:

Class A B C Total

No. of items in use(%) 20 30 50 100

Value (%) 80 15 5 100

2. The Two-Bin System

One of the earliest systems of stock control is two-bin system, which is a simple method of control exercised by two simple rules. One is when the order should be placed, and the other is what quantity should be covered.

Bin No. 1

Bin No. 2

(use till Bin 1 is empty)

(use when Bin 1 is empty)

The bins contain, say fibre cables. The fibre cables are issued from the first bin as and when required, and as soon as the first bin is empty, more fibre cables are ordered. The replenishment arrives just when the second bin is empty. While delivery is awaited, the fibre cables from the second bin are issued. When the delivery arrives, then both the bins are again filled in. Such a method is appropriate only when consumption rate is constant, that is to say, it is a deterministic system.

3. Max Mini System

Under this method, maximum level and minimum level are fixed. Re-ordering is done after a period of review and order or re-order is placed when the quantity touches a certain level. Following are the major disadvantages of this technique: - Stock levels are actually fixed at lower levels since managers have no time to study inventory levels of individual items. - Re-order points and safety levels once fixed are not frequently changed after study. - Delay in postings makes the records useless for control as often even a critical item can be held up for want of posting which otherwise would have been shown that the re-order point has been touched. There are four important terms in max mini system. They are: Minimum level Maximum level Order level or Reorder level Order quantity

The two basic control systems under Max Mini system are: Periodic Review System: This is a time-bound system which requires periodic reviews of the stock-levels of all items. Here, period of review is fixed either at three months, six months or once in a year. Fixed Order Quantity System: Under this system, order quantity is fixed but the time varies. This system recognizes the fact that each item in inventory possesses its own characteristics and optimum order quantity requirements. Designing of this system requires consideration of many factors, such as, price, usage rate and other pertinent factors. Maximum and minimum levels are determined for each inventory item and an order or re-order point is established in between the two levels.

4. Economic Order Quantity or EOQ Formulae

Under EOQ method, the inventory costs may be broadly divided into the following components: PROCUREMENT COST (this includes administrative and provisioning costs.) STORAGE COST (this includes carrying, handling, etc.) STOCK-OUT COST (this may be laid down by management according to its policy.) A point of minimum cost is reached at which the ordering cost will be just equal to the carrying cost so that the total cost is minimum at that point. In other words, neither excess quantity of material is ordered, nor too frequently assumes, however, that no stock- out or idle- time cost has to be accounted for. Also, where quantity discounts are allowed on lot-purchases or where there are price-breaks, this will not hold true. In such cases, linear relationship of the unit price with purchase quantity breaks down and distorts, the following formulae can be used to find out the Economic Order Quantity.

EOQ=
a= Annual requirement b= Ordering cost c= Carrying cost

In determining the EOQ, this mathematical model has assumed that the cost of managing inventory item consist solely of two parts: Ordering Cost: This is the additional cost of placing an order or re-order. Its characteristic is that it is independent of the order size. It increases with the number of orders and is not influenced by the size of the order. Carrying Cost: The characteristic of the carrying cost is that it increases with the volume of inventory irrespective of the number of orders. It is linearly related with quantum of inventory. The cost of inventory carrying is generally expressed as an annual percentage of the unit purchase cost. Therefore, a firm holds optimum inventory level when the slope of the order cost curve meets the rising of the carrying cost. Limitations of the EOQ formulae The very restrictive nature of the assumptions made in the EOQ formulae restrains the use of the formulae in many cases of practical inventory situations. The following are some major limitations of the EOQ formulae: Price breaks or Quantity discounts: Quantity discounts are allowed by firms in order to boost their sales and it becomes preferable to purchase in some bulk quantities to avail of the discounts. In that case, it is more profitable than the EOQ. Again, if the unit cost of purchase fluctuates greatly when time to time, then the EOQ for that particular item will not hold good. Lead time variation: The formula was also developed on the basis of invariant lead time, that is, the time interval between placement of an order and actual replenishment will not vary for all practical purposes. Often this supposition is invalid, because schedule of deliveries varies for many reasons. Order or Re-order point: Thus, while EOQ tells us something about how much to order, it tells us almost nothing about when to order or re-order, for, this depends upon the level of inventory in question. The order or reorder point should be set at such a level that the stock on hand plus on orders should last till fresh supplies are received. This will require ascertaining the usage rate of that particular item.

5. Safety of Buffer Stock

Some additional stocks are always provided in order to meet contingencies of unanticipated, demand due to both (a) lead time variations usage pattern during lead time. This additional stock, safety or buffer stock as it is called will, however, depend upon the service level desired on the one hand, and, the risk of stock-out, on the other. If the rate of consumption remains fairly constant, the suppliers' delivery times do not vary, there are no rejections during inspection, it would have been a simple matter to place a new order whenever stock on hand reaches the quantity equal to the lead time usage. A hundred percent service level can be easily .attained in such circumstances when there will be no occasion for stock-outs as fresh supplies would always be arriving before the existing stock out. The EOQ was developed on the presumption that such an ideal situation holds true and the average inventory holding during the twelve-month period is 1/2during the year. So, the inventory level is equal to Q or EOQ intermediately upon receipt of the order quantity and is reduced at a constant rate of depletion until it reaches a zerolevel again. But such an ideal situation is hard to come across. In practice, demands vary greatly, supplies are uncertain, prices do not remain constant and a host of other variables and seen circumstances and difficulties are experienced, which may lead to occasional stock out conditions. On the other hand, unnecessary apprehension about stock shortages leads to holding of a building up of huge stock piles. So, an inventory control system should be provided that can absorb the shocks or bumps up and down, the system itself not being too costly at the same time. The problem of determining safety stock of buffer stock is a comparatively simple matter, where the rate of consumption fairly constant or can be accurately forecast. At this point mill be appreciated that variations in future consumption are not only cause of stock-outs. The variations in lead time use ages and related uncertainties of delivery time must also be taken into account, which make the calculation of safety stock a complicated affair. It involves numerous repeated trials or tests of the combined effect of variations in demand and in lead time use ages to arrive at an ideal safety stock level.

6. FSN/ VED Analysis

A-B-C Analysis was evolved on the principle of graduated control stringency. The degree of control was equated with the frequency of reviews of a given inventory record. Controlling tightly means reviewing frequently, this tends to determine order quantity. A-items would be reviewed frequently and order in small quantities to keep inventory investment low. B-items less, C-items still less. But this approach does not take into account the fact that sometimes a low-valued small item of critical nature needs as much attention as high-valued A-class item, so that inventories also need to be classified according to Vital, Essential and Desirable (V -E-D), which in essence means that stress is more on importance rather than on value. Again, inventories may also be classified according to Fast-moving, Slow-moving and Non-moving items (F-S-N) in order to see the rapidity of their use and to weed out the unnecessary ones. This is aimed at keeping the total inventory size down and reduces investment. Thus, selective control may be exerted under different types of classification according to necessity. A single-type approach may not prove fruitful under all circumstances.

Conclusion
The company by understanding the materials and production process done nearby the location can save ample time in production process and also save a lot in terms of transportation cost. And also the company can find out optimum position for the location of the company so that all the factors that are needed will be not a long distance from the company.