Chapter 5 Inventory Management 03/22/2023NESREDIN y CHAPTER 5 INVENTORY MANAGEMENT Meaning and Nature of inventory In accounting language it may mean stock of finished goods only In a manufacturing co[.]
NESREDIN y 03/22/2023 CHAPTER 5-INVENTORY MANAGEMENT Meaning and Nature of inventory In accounting language it may mean stock of finished goods only In a manufacturing concern, it may include raw materials, work in process and stores, etc Inventory includes the following things: (a) Raw Material: (b) Work in Progress: (c) Consumables: (d) Finished goods: (e) Spares: NESREDIN y 03/22/2023 BENEFITS OF HOLDING INVENTORY There are three main purposes or motives of holding inventories: The Transaction Motive which facilitates continuous production and timely execution of sales orders The Precautionary Motive which necessitates the holding of inventories for meeting the unpredictable changes in demand and supplies of materials The Speculative Motive which induces to keep inventories for taking advantage of price fluctuations, saving in re-ordering costs and quantity discounts, etc NESREDIN y RISK AND COSTS OF HOLDING 03/22/2023 INVENTORY The various costs and risks involved in holding inventories are: Cost of Ordering Cost of Stock-outs Storage and Handling Costs Risk of Price Decline Risk of Obsolescence Risk Deterioration in Quality Capital costs NESREDIN y 03/22/2023 OBJECTIVE OF INVENTORY MANAGEMENT The main objectives of inventory management are operational and financial The operational objectives mean that the materials and spares should be available in sufficient quantity so that work is not disrupted for want of inventory The financial objective means that investments in inventories should not remain idle and minimum working capital should be locked in it NESREDIN y 03/22/2023 OBJECTIVES OF INVENTORY MANAGEMENT The following are the objectives of inventory management: To ensure continuous supply of materials spares and finished goods so that production should not suffer at any time and the customers demand should also be met To avoid both over-stocking and under-stocking of inventory To keep material cost under control so that they contribute in reducing cost of production and overall costs To minimize losses through deterioration, pilferage, wastages and damages To ensure perpetual inventory control so that materials shown in stock ledgers should be actually lying in the stores CONT’D NESREDIN y 03/22/2023 To ensure right quality goods at reasonable prices To maintain investments in inventories at the optimum level as required by the operational and sales activities To eliminate duplication in ordering or replenishing stocks This is possible with help of centralizing purchases To facilitate furnishing of data for short term and long term planning and control of inventory To design proper organization of inventory A clear cut accountability should be fixed at various levels of management NESREDIN y 03/22/2023 TOOLS AND TECHNIQUES OF INVENTORY MANAGEMENT 1.Determination of Stock Levels 2.Determination of Safety Stocks 3.Determination of Economic Order Quantity 4.A.B.C Analysis 5.VED Analysis 6.Inventory Turnover Ratios 7.Aging Schedule of Inventories Just in Time Inventory NESREDIN y 03/22/2023 DETERMINATION OF STOCK LEVELS Carrying of too much and too little of inventories is detrimental to the firm If the inventory level is too little, the firm will face frequent stock-outs involving heavy ordering cost and if the inventory level is too high it will be unnecessary tie-up of capital Therefore, an efficient inventory management requires that a firm should maintain an optimum level of inventory where inventory costs are the minimum and at the same time there is not stock-out which may result in loss of sale or stoppage of production NESREDIN y 03/22/2023 VARIOUS STOCK LEVELS (a) Minimum Level: This represents the quantity which must be maintained in hand at all times If stocks are less than the minimum level then the work will stop due to shortage of materials Minimum stock level = Re-ordering level-(Normal consumption x Normal Re-order period) CONT‘D NESREDIN y 03/22/2023 Following factors are taken into account while fixing minimum stock level: Lead Time: A purchasing firm requires some time to process the order and time is also required by supplying firm to execute the order The time taken in processing the order and then executing it is known as lead time Rate of Consumption: It is the average consumption of materials in the factory The rate of consumption will be decided on the basis past experiences and production plans Nature of Material: The nature of material also affects the minimum level If material is required only against special orders of customer then minimum stock will not be required for such materials NESREDIN y 03/22/2023 DETERMINATION OF SAFETY STOCKS Safety stock is a buffer to meet some unanticipated increase in usage It fluctuates over a period of time The demand for materials may fluctuate and delivery of inventory may also be delayed and in such a situation the firm can face a problem of stock-out The stock-out can prove costly by affecting the smooth working of the concern In order to protect against the stock out arising out of usage fluctuations, firms usually maintain some margin of safety or safety stocks NESREDIN y 03/22/2023 ECONOMIC ORDER QUANTITY (EOQ) A decision about how much to order has great significance in inventory management The quantity to be purchased should neither be small nor big because costs of buying and carrying materials are very high Economic order quantity is the size of the lot to be purchased which is economically viable This is the quantity of materials which can be purchased at minimum costs Generally, economic order quantity is the point at which inventory carrying costs are equal to order costs CONT’D NESREDIN y 03/22/2023 In determining economic order quantity it is assumed that cost of a managing inventory is made of solely of two parts i.e ordering costs and carrying costs (A) Ordering Costs: These are costs that are associated with the purchasing or ordering of materials These costs include: Inspection costs of incoming materials Cost of stationery, typing, postage, telephone charge Expenses incurred on transportation of goods (B) Carrying Costs: These are costs for holding the inventories These costs will not be incurred if inventories are not carried EXAMPLE NESREDIN y 03/22/2023 MOENCO, sole distributor of TOYOTA cars has sales of 2000 units of pickup cars a year Inventory carrying cost is birr $50 per unit per year And ordering cost is $500 per year Currently the company has ordered 500 units of pick ups at a time Required; How much is the total cost of inventory per year How much is the EOQ for pickups If EOQ is have been ordered what would be the cost saving of the firm What is the optimum number of orders and what is the optimum time interval between each order assuming 360 days in a year NESREDIN y 03/22/2023 EXERCISE-1 Moenco, sole distributor Toyota cars has sales of 4000 units of pick up cars a year Inventory carrying cost is birr 60 per unit per year and ordering cost is birr 300 per year Currently the company has ordered 400 units of pickups at a time Required; How much is the total cost of inventory per year How much is the EOQ for pickups If EOQ is have been ordered what would be the cost saving of the firm What is the optimum number of orders and what is the optimum time interval between each order assuming 360 days in a year NESREDIN y 03/22/2023 EXERCISE -2 Nifas silk Paint Company uses 30,000 gallons of pigment per year The pigment is purchased by Br per gallon The cost of ordering pigment is Br 300 per order, and the cost of carrying the pigment in inventory is Br per gallon per year The firm uses pigment at a constant rate every day throughout the year The supplier of the pigment offered that if the company could order 5000 gallon of pigment at once % discount is given (Assume the 360 – day year) ... Maximum Re- order period = 150 ×7=1 050 units (2) Maximum Level = Re-order level + Re-order quantity –( Minimum consumption × Minimum delivery period) = 1 050 + 50 0 – (50 × 5) = 1300 units (3) Minimum... (Normal consumption × Normal delivery period) = 1 050 – (100 × ) = 450 units (4) Average Level = Maximum level + Minimum level = 1300 + 450 = 8 75 units NESREDIN y 03/22/2023 DETERMINATION OF SAFETY... of 2000 units of pickup cars a year Inventory carrying cost is birr $50 per unit per year And ordering cost is $50 0 per year Currently the company has ordered 50 0 units of pick ups at a time Required;