What is Inventory management ? Objective of inventory management

What is Inventory management?

inventory management accounting 

What is Inventory management ? Objective of inventory management

Concept of inventory management

A manufacturing company requires many types of material to produce any goods or service. If a company does not get the required material as needed than the production system gets disturbed and fails to produce and sale required quantity of products on time. The over stock of inventory is unsuitable due to the large amount of investment on it as well as other cost associated with it. On the other hand, the lower stock inventory might create the problem of shortage resulting inn the disturbance on production. Therefore, inventory management includes the requirement of different types of inventory, period of stock and cost associate on it.

Inventory is the stock that firm maintains to meet its future requirement for production and selling. The basis reason for holding inventory is to keep up the production activities unhampered. Inventories are a part of current assets, which are used within one year. In a normal courses of business operation manufacturing organizations maintains the inventory of raw materials, work-in-progress, finished goods, spare parts, suppliers etc. in case of manufacturing concern, inventories link the  production and sales. Tading organizations are unsold goods i.e. finished goods.

Hence, inventories may be defined as the combination of raw materials, work-in-progress, finished goods and other suppliers required for the smooth operation and sales of an sales of an organization. Managing the stock at lowest cost without compromising on the production and sales activities is called inventory management.

Types of inventory management
1. Raw materials; raw materials is Avery importance and inevitable factor of production. In includes physical commodities used to manufacture the final product.
2. Work-in-progress: work in progress inventory are semi-manufactured products, the products that needs more work before they are contented of finished products for sales, in other words, goods partially worked  on but not fully completed are called work in progress.
3. Finished goods: inventory of finished products are the stock of goods which are ready for sales. Stock of finished goods is required for smooth marketing operations of the products.
Inventory of inventory depends on certain risks and cost. Therefore, the inventory manager should try to maintain optimal size of inventory without disturbing the production and sales needs.
Objective of inventory management
The objectives of inventory management are mentioned below:
1. To supply the required materials continuously: there should be a continuous available of materials in the factory or finished goods for trade. The main objective of inventory management in to maintain required inventory so that production and sales process run smoothly.
2. To minimize the risk of under and over stocking of material: if a company keeps inventory without proper analysis, there will be a chance of overstocking, which will increase the cost of carrying the inventory or under stocking of inventory that create problem in smooth operation of a business. So one of the main objectives of the inventory management is to minimize the risk caused due to under and over stocking of inventory.
3. To maintain systematic record of inventory: management needs different information regarding inventory for planning and decision-making. A systematic recodes of inventory helps provides such information to the management. It also assists to evaluate the current inventory management policy.
4. To reduce losses, damages and misappropriation of materials: inventory management aims to reduce or remove the losses and misappropriate of materials. This is done by maintaining the proper stocks of materials with utmost care.
5. To minimize the cost associated with inventory: the proper maintenance of the information regarding inventory helps to make decisions like whether to take discounts or not, the size of order to be placed, when to order etc. the total cost associated with inventory may be minimized by analyzing the lot size to be acquired, the offer of discount on variable lot size and the timing of order. Such analysis helps to reduce the unnecessary inventory in inventories.
6. To make stability in price: an effective inventory management system minimizes the effects of regular price fluctuation. This is turn helps to gain the stability is selling price.
Reasons or motives of holding inventory
The main reason or motives of holding inventory is to supply the required of inventory to different department as needed so that production/ sales process does not get hampered. The motives or reason of holding inventory are:
1. Transaction motive: The manufacturing concerns need inventories of raw material and work in progress so as to maintain regular production activities. Similarly, the trading organization need the inventories of finish goods for supplying the goods and services to the customers regularly, in this way, holding of inventories helps to have regular transactions.
2. Precautionary motive: due to different reasons, like shortage of inventory with the suppliers, week relation with the supplier, disturbance in transaction, delay in inventory supply etc. might take place. It is also importance objective of holding the inventory to take precaution from take the above.
3. Speculative motive: generally the price of inventories rise, so the companies may keep additional amount of inventory to get benefit by selling the surplus inventory at higher price than purchase price. It crates risk when the price of inventory falls.
Techniques of inventory management
To achieve the objective of the inventory management, different techniques are used. Some of them are mentioned below:
a. Economic order quality
b. Stock level:
• Re-order level
• Maximum stock level
• Minimum stock level
• Danger stock level
• Average stock level
• Safety stock
c. Just in time purchase 
d. Perpetual inventory system
e. Back analysis
Economic order quality –EOQ
Meaning and assumptions of economic order quality
Economic order quality is defined as the quality of inventories to be ordered each tie that minimizes the total inventory cost. Inventory cost comprise the ordering or set-up cost and carrying or holding cost less discount if any. In this way, EOQ is an inventory management tool, which shows quantity to be ordered each time that involves the minimum cost. Normally, the ordering cost and carrying cost are equal at the point of EOQ. Thus, EOQ is the quantity that minimizes the total inventory cost. It is also known as 'standard order quality', economic lot size or economic ordering quality or optimum ordering quality.
There are some assumptions for economic order quality. They are:
a. Annual or total requirement is known and does not fluctuate.
b. Ordering cost per order is fixed and known.
c. Carrying pieces of the inventory is known.
d. Purchase price of the inventory is known.
e. Purchase price of the inventory is known.
f. Demand of the inventory is uniform thought the year.
Types of inventory cost
They are two types of inventory cost. They are:
a. Carrying cost
It is the of holding a unit of inventory. Carrying cost is calculated on the basis of average inventory. When the number of orders increase, then total amounts of carrying cost decrease and vice-versa. Average carrying cost per unit remains constant and is denoted by "c".
Carrying costs are also called materials holding cost or possession costs and includes the following items:

a. Interest of investment in inventory or opportunity cost.
b. Rent, insurance and tax of warehouse.
c. Safety and supervision cost
d. Loss or depreciation
e. Maintenance and inspection cost.
f. Since, the carrying cost is a per unit cost, the higher stocking of inventories results in higher carrying cost and vice versa.
The carting cost is calculated as follows:

b. Ordering cost
The cost of placing and receiving an order is called ordering cost. It is also called procurement cost or processing costs of materials or set up cost. The ordering cost depend on number of orders, when the number of order increases, the total amount of ordering cost also increase and vice-versa, but ordering costs per order remains constant and is denoted by 'O'.
a. Cost of staff associated with the purchasing department.
b. Cost of inspection for materials control
c. Cleric and administrative costs of purchasing department.
d. Transportation and shipping costs.
e. Tooling and set-up costs.
Total ordering cost is calculated as follows:
Ordering cost = no. of orders x ordering cost per unit
Determination of economic order quantity
Economic order quantity can be computed by using different methods. Among them some important methods are as follows.
a. Formula method
b. Trial and error method or tabular method
c. Graphic method
The way of calculating the economic order quantity under each method has been presented below:
a. Formula  method
The formula has been developed considering that the total carrying cost is always equal with the total carrying cost.
Total ordering costs = total carrying costs
b. Tabular or trial and error method
Under this approach, the total costs are calculated under different order size. The economic order quantity is that inventory level that minimizes the total of ordering and carrying cost. Under trial and error approach, we prepare a table and try to find out the total cost at different order sizes.
c. Graphic method
Under this method, the carrying cost, ordering cost and total cost are shown in graph. Cost data are plotted on Y-axis and quantity on X axis. It based on the principle that the total carrying cost increase as the order size increase. However, the ordering cost decrease as the order size increase. The ordering cost curve slopes down from the left to the right but the carrying cost curve slopes upwards from the left to right as the carrying cost increase with the number of orders. The point where ordering and carrying cost curve interest each other, total cost is minimum and the point is called the economic order point.

In the above graph, the ordering cost and carrying cost are equal at point M, so the ordering quantity under that is regarded as economic order quantity.
Discount and economic order quantity
Sometimes, the suppliers offer certain discount if the purchase are made in large quantity. Such discount reduces the total cost. The offer of discounts is profitable when the discount exceeds the increased carrying cost due to bulk purchase. To accept or reject the offer of discount, the total costs under eoq and offer are calculated. The cost under offer is calculated by subtracting the discount from the sum of carrying and ordering cost. If the total cost under offer is less than the of eoq, the offer should be accepted; otherwise not.
Price discount and economic order quantity
When the suppliers offer discount to the buyer for the purchase, the purchase price decrease. When carrying cost is not given on the basis of purchase price, the quantity discount and price discount are equal however, if the carrying cost is calculated from the purchase price and the price discount has been offer, the carrying cost also decrease. The new purchase price and carrying cost are calculated on the following manager if the price discount has been given.
New purchase price = old purchase price – discount received
Economic order quantity and re-Oder quantity
Economic order quantity and re-Oder quantity both convey the same meaning i.e. the quantity of material order each time. Economic order quantity is the order quantity in which the total cost is the least. But, re-order quantity is the quantity of material that is actual order. The total cost at re-order quantity may not be the least. In this way, it can be concluded that an economic order quantity is s re-order quantities but a re-order may not be an economic order quantity.
Stock level
Stock level means the different levels of stock that an organization has to maintain to run its activities without any obstruction. Under it, different types are calculated as per the requirement and purpose. The stock level can be calculated under two situations as given in the following table.

Re-order level

It is the level of stock at which to storekeeper initiates the purchase requisition for fresh supplies of material. The fresh order must be made before the actual touches the minimum level. This level should be fixed by taking into account as abnormal usages of material; unexpected delay in procuring the material etc. the following factors should be taken into consideration while fixing re-ordering level.

a. Minimum quantity of the item to be maintained.

b. Rate of consumption

c. Lead time

The re-order point, order quantity and procurement time may be show by diagram as given above. Re ordering level can be computed by using one of the following formula's based on information available.

Re-order level = maximum consumption x maximum Re-ordering period

Re-order level = safety stock + daily consumption x lead time

Re-order level = safety stock + normal consumption x normal re-ordering period

If no information has been given, the minimum stock level should be assumed to be the safety stock lead time. Delivery period and re-order period refer to the total time taken to receive the material after the order has been placed. Consumption, usage and need refer to the need of material for a certain period of time, say per day, week month etc.

Minimum stock level

It is also known as 'buffer stock', ' safety stock', minimum limit' or ' minimum stock', this represents the minimum quantity of the material which must be kept in hand at all the times. Such level of material is fixed so that production may not be held up due to shortage of material. The following points should be considered to determine the minimum stock level:

a. Lead time: it is a time lag between the points of placing an order and receiving the material.

b. Consumption rate: the consumption rate of material during the lead time should also be considered.

c. Re-order level: the level at which initiation to purchase requisition for new purchase of materials is taken by the store in-charge is the re-order level. It should also be considered.

d. Disruption of supply: the possibility of any disruptions in supply of material in near future should be taken into mind.

e. Nature of material: it is another factor, which should be considered while fixing minimum level. Minimum level is not need in the case of the material that is required against customer's specific order.
Maximum stock level
It is a peak level of the material in stock. It is also called as 'maximum limit' or maximum stock'. It represents the maximum quantity of an item of material, which may be held in stock. The stock should not exceed his quantity. The purpose of fixing this quantity is to avoid overstocking. Overstocking unnecessarily blocks working capital, which can be utilized in some profitable activities. Similarly, overstocking also increase the cost due to the requirement of more space in go down. There may be more chances of having obsolescent and deterioration of quality when the actual stock exceeds the maximum stock level.
The following points are to be considered while determining the maximum stock level.
a. Working capital: sufficient amount of working capital should be kept for maintaining the maximum level of stock.
b. Go down space: for putting the material safely, there is a need to have sufficient space in go down requirement may arise at any time.
c. Maximum requirement: there is a need to keep maximum stock of material since maximum requirement may arise at any time.
d. Time lag: the lead-time should be determined.
e. Rate of consumption: while fixing maximum level of material, the rate of consumption of material during the lead-time should be determined.
f. Cost of managing the store: it is another importance factor, which should be kept in mind while fixing maximum level of material.
g. Loss of managing the store: the maximum quantity of material will be fixed at a lower level in as of store, which deteriorates in quantity if they are stored over a lag period.
h. Seasonal nature of material: Some materials are available only during specific season in a year. Such materials should be stored beyond the maximum level during the season.
i. Change is fashion and habit: possibility of change in fashion and habit, which may necessitate changes in the requirement of materials, should also be considered.
j. Fluctuation in price: the fluctuation in the price of material may have effect on the fixation of maximum stock level. For instance, if it is anticipated that the price of the material will increase in future, a possible of decreasing the price of the material on the near future, maximum stock level may be fixed at a comparatively lower level.
k. Restrictions of government: it government has imposed some restriction on stock e.g. fire explosion this may have effect on the fixation of maximum stock level.

Re-order quantity
Re-order quantity is the quantity of material that is purchase each time. The is also termed as order size. The re-order quantity is also termed as economic order quantity if it can be acquired at the minimum cost. The re-order quantity can be calculated as under.
Re-order quantity = maximum stock level – re-order level + minimum consumption x minimum re-order period
Average stock level
Average stock level refers the normal or moderate stock level. It is calculated as under.
Average stock level= minimum stock level + v2 of recorder quantity (EOQ)
Danger level
This is the level of material at which issue of material is temporarily stopped. From this level material are issued for some abnormal situations only. The issue of material can be made against the special order from the level. Since it is a danger level, some serious actions should be taken to acquire materials.
Danger level = normal consumption x maximum re-order period for emergency purchase

Review of theatricals concept
1. What do you means by inventory management? Write any three objectives of inventory management?
A manufacturing company required many types of material to produce goods or services. If a company does not get the required materials as   needed than the production systems gets requirement materials as needs than the productions systems debts distributes and fails to produce and sales required quantify production on time. The over and under stock of inventory might create the requirements of different types of inventory, period of stock and cost associated on it.
a. To supply the required materials continuously:  the main objective of inventory management is to maintain required inventory so that production and sales process run smoothly.
b. To minimize the risk of under and over stocking of material: inventory management maims to minimize the risk caused due to under and   over stocking of inventory.
c. To reduce losses damages and misappropriation of materials: inventory management aims to reduce or remove the losses and misappropriation of materials which is done by maintaining the proper stock of materials with utmost care.
2. Write the reasons of holding inventory.
The motives or reasons of holding inventory are:
a. Transaction motive: the manufacture concerns need inventories of raw materials and work in progress so as to inventory of raw materials and work in progress so as to maintain regular production activities. Similarly, the trading organization needs the inventory of finished goods for supplying the good and services to the customers regularly.
b. Probationary motive: due to different reasons delay in inventory supply might take place. It is also an important objective of holding the inventory to take precaution from the above.
c. Speculative motive: generally the price of inventory rise, so the companies may keep additional amount of inventory to get benefit by selling the surplus inventory at higher price than purchase price. It creates risk when the price of inventory fails.
3. What do you mean by economic order quantity? Write its assumptions.
EOQ is an inventory management tool, which shows quantity to be ordered each time that inventory cost. Normally, the ordering cost and carrying cost are equal at the point of EOQ. Thus, EOQ is the quantity that minimizes the total inventory cost. There the some assumptions for economic order quantity. They are:
a. Annual or total requirement is known and does not fluctuate.
b. Ordering cost per order is fixed and known.
c. Carrying cost of inventory per unit is fixed and known.
d. Purchase cost of inventory is known.

e. Demand of the inventory is uniform thought the year.