Inventories can be classified into raw-materials, work-in-progress, finished goods, consumable parts and spare parts, maintenance materials and tools, packing materials etc. Inventories have to be kept at optimum level as any excess of inventory would cause huge working capital to be blocked along with possible losses due to deterioration, spoilage etc. Any shortage of inventory would result in loss of sales, ultimately resulting in loss of customers as well as profit. Therefore, proper inventory control measures and techniques are essential for sound and efficient management.
Inventory control Techniques
1) Perpetual Inventory system
It is defined as “a system of records maintained by the controlling department which reflects the physical movements of stocks and their current balances”.
2) ABC Control Method
Under this method, inventories are grouped under three categories: A, B and C. ‘A’ denotes high value items; ‘B’ denotes medium-value items and ‘C’ for low-value items. Values of the items are converted into percentages, each item being stated as a percent of the total value of all items.
3) Input-Output Ratio analysis
This ratio is the ratio of the raw materials put into manufacturing and the standard raw material content of the actual output. A standard ratio of input of material and output of material should be determined and the actual ratio would be compared with the standard ratio.
4) Inventory Turnover Ratio
With the help of inventory turnover ratio, the firm knows which items are slow-moving and fast-moving, so that capital blockage can be made accordingly. A low ratio indicates slow-moving stock and a high ratio indicates fast-moving stock.
5) Determination of Stock Levels
The demand and supply method of stock control technique determines different stock levels: Maximum level, Minimum level, Re-order level, Danger level and Average level.
6) Economic Order Quantity
EOQ is the optimum order quantity or the most correct quantity to be ordered that creates a trade-off between the ordering costs and carrying costs.
Where: A = Annual consumption in units
O = Ordering cost per unit
C = Carrying cost per unit
Example: Cost of a unit is $50 and the annual consumption is 200,000 units. The ordering cost is $200 per unit and the carrying cost is 10% of the inventory value. Find the EOQ.
Carrying cost = 10% of (200,000 units x $50 per unit)
Carrying cost per unit = $1,000,000/200,000 units
è $5 per unit.
Therefore, EOQ =
( (2 x 200,000 x $200)/$5 ) 1/2
è 4,000 units.
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