Inventory Management Techniques

What is Inventory Management?
Inventory management is the process of overseeing the procurement, use, and maintenance of inventory (purchases and stock) for the benefit of the business. It is not merely an observance but includes efficient control and streamlining of purchases, issues, and storage of goods, with prudence and sound decision-making skills.

Inventory management involves efficient tools and techniques for better control of stocks and purchases.

Let us take a look at some of the most important tools and techniques employed in inventory management.

Employing Economic Order Quantity Technique

I have already discussed this method in my previous article: Definition and Method of applying this technique through the calculation of Economic Order Quantity as an equation of EOQ= square root of [{2DS}/H] 
You can refer to that article for a detailed understanding of this technique.

Application of ABC Analysis of Inventory Technique

This is another popular method of inventory management. It is a kind of Pareto analysis. Economist Vilfred Pareto introduced an 80:20 rule which presumes that almost 80% of results come from 20% of inputs or causes.

This ABC technique is applied in any type of business (or studies conducted) to categorise suppliers, customers, staff, places or activities into different groups of importance for dealing with them accordingly. ABC analysis of inventory implies the following steps and features.

• In this technique, all items of inventory are categorized into 3 major groups of A, B and C based on their importance and significance for the business.
• "A" group items are the most important as they constitute mostly costly and critical items for the running of the business. 
• C group of items is the least important and consists of very low-cost items. 
• B group consists of medium-importance items for running the business.
• Once all items are categorized into these three groups, the top management can concentrate more on the A group of inventory, and the other groups of inventory can be overseen by lower-level supervisors.
• This will enable more efficient control of inventory and thus minimise the costs and losses.
• Generally, "A" group items may constitute 10% to 20% of the total number of items in quantity, but in value they may be about 60% to 70% of the total value of inventory.
• "C" group items can be 70% of the total quantity of items and may have a value less than 10% of the total inventory value.

Fixed Order Quantity Technique

This fixed-order-quantity model technique is most suitable for high-cost items, such as critical spares for plant and machinery, without which your plant will stop running. So, you need to keep some stock of these items for emergencies. You may study the past consumption trend for such items and estimate your requirement for a particular period, say one year. Then you will place an order for these items irrespective of immediate requirement and keep them in stock.

Fixed Time Order Technique 

When a fixed-time-period inventory model is applied, you will place orders at fixed intervals without waiting for requirement indents from departments. You will set these intervals based on the weekly or monthly consumption of these items, which mostly consist of general, regularly used items of small value. These items will mostly be tear-and-wear or use-and-throw items.

Cycle Counting Technique

This is another popular technique used by businesses for better management of inventory. 

Popularly known as cycle counting in inventory management, this method employs physical counting of inventory items in small groups at various places of a warehouse or storerooms of the business establishment instead of counting all inventory on a single day so as to facilitate normal running of the business activities.

In this process, goods are stored in small groups at different places with proper records maintained of receipts and issues. Periodic checkings are done by counting the items and tallying with records. This will ensure efficient management of inventory without hindering the production cycle or business functions.

When to Place Purchase Orders?

Placing purchase orders to replenish goods is one of the key factors in inventory management and must be applied prudently. Inventory managers should be highly efficient at determining the correct timing for placing purchase orders.

• A thorough analysis of your business's consumption and purchase statistics over the past 2 or 3 years can give you a clear picture of the requirements for a particular month or period to run the business. You can estimate how much is consumed during a specific interval of time.
• So, you can determine the quantity required for each item for a week, a fortnight, or a month, as the case may be.
• Now, you may enquire about the delivery period for these items and the time taken by the consignments to reach your place. These details can be easily obtained from your suppliers and transporters or from your previous experiences.
• Further, you must be able to calculate an extra grace period required in case of failures in transportation systems or due to weather conditions and other factors that may occur. 
• You may have to provide for a sudden spurt in demand for your products, thereby increasing your consumption of inventory.
• You may have to provide for shortages in supplies or any other problems with suppliers that can affect your purchases being delayed.
• So, when you will have to place an order depends on all these circumstances. You should add all these points to calculate your ordering times.

To sum up, 

Efficient inventory management requires inventory managers to anticipate all factors that can affect procurement and stock levels and to make prudent, well-informed decisions. Therefore, an efficient inventory manager will consider combining the strengths of all the above-mentioned inventory management techniques to achieve maximum benefits.

Economic Order Quantity: How to Calculate EOQ and Apply it in Inventory Management

Economic Order Quantity (EOQ) is the quantity of any purchase order placed at each indent to add the optimum number of units to the inventory at minimum overall costs. It is the ordering quantity that reduces the overall costs of inventory, such as ordering costs, holding costs, and shortages or losses. 

Before studying how to calculate EOQ, let us know about the components of Inventory cost. 

Inventory cost is made up of the following components:

• Unit cost: This is the purchase price per unit of the item purchased.
• Order Cost: This is the cost incurred each time while placing an order. It includes transportation/shipping costs, handling charges, and any other expenses such as octroi and toll tax.
• Holding Cost: This is the storage cost incurred, like building or godown rent, insurance, interest paid or lost due to capital invested, salaries paid to store staff, and any other costs like refrigeration, maintenance, etc., incurred in storing the inventory.
• Losses: This element of cost is due to shortages, damages to items during handling, or loss due to tear and wear of stocks. 
• All these losses are to be borne by the business. So, they are included in the cost of stocks by increasing their unit cost.

How to Calculate Economic Order Quantity

EOQ is calculated using a formula EOQ = square root of {(2*D*S)/H}

Q is the Economic Order Quantity

D is the annual Demand quantity

S is the cost for Setting/placing an order, known as order cost (some put it as K also)

H is the Holding cost per unit, and storage losses can be added to this holding cost

This formula assumes that two opposite forces are affecting your order quantity. The forces of ordering cost and holding cost. So, the median of these two opposing forces is the EOQ.

Now, let us apply this formula in an example:

Suppose your business enjoys an annual demand of 10,00,000 bags of cement
Placing one order, say, costs $10, and let the holding cost be $2 per 1000 bags or .002 per bag

Now, according to above formula, EOQ = the square root of {2*1000000*10 / .002}

Let us first solve the result of the figures within the brackets:

So, (2*1000000*10)=20000000

Now divide by .002

The net figure=200,00,000/.002 = 1,00,000

Now, we have to calculate the square root of 1,00,000, which comes to 3162.28

So EOQ is 3,162 bags. So you have to place each order for 3,162 bags. 

The above is a sample for calculating Economic Order Quantity in a more or less reasonable sense. 

But some factors may affect the accurate calculations in actual circumstances.

Factors affecting EOQ calculation

• Employing the EOQ formula assumes that prices are constant over a given period.
• It is assumed that stockouts (running out of stock) do not happen.
• It is assumed that order-placing costs are constant.
• It also assumes that interest rates and storage rentals do not change during the period.
• It further assumes that demand is constant for those goods.

How to Apply EOQ Method Prudently

We cannot guarantee or predict changes in tastes, prices, or any other factors governing EOQ calculations. 

• A good finance manager should review the calculations at frequent intervals to ensure their efficient application in managing inventories.
• He should be in constant touch with the production, purchases, and marketing teams regarding any changes in production targets, purchase prices, or market demands to ensure that EOQ calculations are constant. 
• If the initial calculations prove to be incorrect or no longer feasible, you should revise the calculations to reflect current circumstances and modify your orders to minimize negative impacts from variations in the factors controlling your Economic Order Quantity calculations.

Inventory Control and its Importance

Inventory Control is the management of stores &stock to the utmost benefit of the business. 

Before discussing Inventory Control, let us know what constitutes an Inventory.

What is Inventory?

Inventory is the stock of goods or resources available to you at any given time.

It can be any raw materials, finished goods, or products under process and at an incomplete stage, and spare parts, stores, and accessories that are at your disposal as at the time of your counting or valuation.

So, virtually anything you hold in stock for your consumption, for reuse in production, or for any other purpose constitutes the overall stock. 

Inventory is this stock in terms of money value as at a particular date or time.

Now let us discuss Inventory Control.

What is Inventory Control

Inventory control is the process of supervising and managing the procurement or supply, storage, and consumption of goods to improve efficiency in their use. It involves tracking purchases, their maintenance, and optimal usage to reduce costs, waste, and overuse.
                                            

Importance of Inventory Control

Inventory Control, or efficient management of stocks and purchases, is necessary for the following reasons:

• To ascertain that quality is maintained and utmost utilisation is made of each stock. 
• To control unnecessary purchases, thereby avoiding locking up your working capital that could be used for better purposes.
• To work out when to purchase, where to purchase, and how much to purchase.
• To avoid wastage due to the wear and tear of stocks.
• To facilitate easy and accurate identification of stocks and avoid undue delays in production due to a lack of knowledge of items or due to incorrect entries and storage.
• To facilitate accurate stock valuation and disposal of obsolete items.

How to Control and Manage Inventories

A good inventory control system involves the following steps:

1. The first step in inventory control is the proper identification of stock items, item-wise, by assigning a number or nomenclature to each item. This should be done by the technical department, which has full knowledge of each item's usage. They will inform the inventory staff how to identify and group items into different categories according to their usage.
2. The second step is to classify and group the items so that items required for a particular process or machine are stored in one place, organized into categories and subcategories. This will facilitate the issue of these items when that particular process or department places requirements.
3. Each item is stored on a shelf or in a container labeled with its subcategory, and all subcategories of a particular main category are stored in a separate rack, cabinet, or room allotted to it, with nameplates bearing the main category. This facilitates location and identification at the time of storage and at the time of issuance of items.
4. Valuations can be easily done with this method. Simply count the number of objects and multiply by the unit rate.
5. Periodic checks should be done by both technical and inventory control staff to ensure that no errors are committed.
6. Any destroyed or obsolete items should be disposed of during these checks so that quality and standards are maintained and your books show correct values of usable items only. 

Management Information System: An Introduction to MIS

A Management Information System (MIS) is a periodic statement prepared by the accounting department. It involves an organized and systematic approach to the study of data required by an organisation's management for making strategic decisions and facilitating efficient control at all levels of the organisation.

The aim of MIS is to provide accurate and timely information in suitable and required formats to the management for better management and control of the business.

This process involves the collection and analysis of various data in the form of statements and surveys. These statements are known as managerial information statements. They are prepared through the mutual coordination of finance, accounts, and all other departments.

Normally, most of the MIS statements are derived from preset formats of the computer software programmes. But some reports may also be prepared manually in their fixed formats. These formats are designed by the management in consultation with all departmental heads.

These statements can be prepared either weekly, fortnightly, or monthly. It depends on the requirements of the organisation's nature and structure.

The following are some of the examples that are required by the management:

• Production Report (product-wise)
• Labour Report (plant-wise engagement & total strength & cost of labour)
• Stock Report (item-wise)
• Sales Report (product-wise)
• Debtors Report
• Creditors Report
• Process-wise Cost Report
• Cash Flow
• Fund Flow
• Budget & Actual expenditure comparison Report
• Break-even point statement

There can be many more reports and statements as per the management's requirements to control the business efficiently.

MIS for Financial Management

Financial management involves the efficient handling of the company's finances through constant vigilance and regular analysis of the inflow and outflow of funds.

The main aim of a Finance Manager should be to minimise cost and maximise profit for the company.

This is done through collection and comparison of various data related to the production processes, including sales, stock, and funds utilisation.

• Data for the current period is compared with previous years' figures, and deviations in results are to be explained with proper reasons.
• Each item of deviation in performance needs to be located within the process and reported to management and the related departments.
• In this process, product-wise cost sheets may also need to be prepared, and deviation charts are to be prepared.
• Budget planning is also a part of MIS. Budgets are prepared by comparing past achievements and fixing a reasonable target for the current year based on those results.
• Fund management is done through analysis of Cash Flow and Fund Flow statements and through efficient Inventory Control methods.