Material, Purchase and Store Management
Inventory
Control
Inventory control is the
technique of maintaining stock-keeping items at the desired level, whether they
be raw-materials, goods in process or finished products.
Inventory control is the
process of keeping the right number of parts and products in stock to avoid
shortages, overstocks, and other costly problems.
The simplest definition
of inventory control, also known as stock control, refers to the process of
managing a company’s warehouse inventory levels. The inventory control process
involves managing items from the moment they are ordered; throughout their
storage, movement and usage; to their final destination or disposal. Many
systems, processes, and technologies have been developed over the years to help
companies streamline the supply chain processes involved in inventory control
systems.
Inventory
control is the processes employed to maximize a company's use of inventory. The
goal of inventory control is to generate the maximum profit from the least
amount of inventory investment without intruding upon customer satisfaction
levels. Given the impact on customers and profits, inventory control is one of
the chief concerns of businesses that have large inventory investments, such as
retailers and distributors.
Inventory management process: 5 key
stages
The inventory management process involves tracking
and controlling stock as it moves from your suppliers to your warehouse to your
customers. There are five main stages to follow:
1. Purchasing: This can mean buying raw materials to
turn into products, or buying products to sell on with no assembly required
2. Production: Making your finished product from its
constituent parts. Not every company will get involved in manufacturing —
wholesalers, for instance, might skip this step entirely
3. Holding stock: Storing your raw materials before
they’re manufactured (if required), and your finished goods before they’re sold
4. Sales: Getting your stock into customers’
hands, and taking payment
5. Reporting: Businesses need to know how much it is
selling, and how much money it makes on each sale
Important Inventory
Control System Processes and Formulas
Over
time, different inventory control processes and formulas were created in order
to help companies with the complexity that is inventory control. Let’s take a
look at what some of these essential inventory control processes are and why
they are important for companies today.
Quality
Control
Quality
Control is an essential part of inventory control and the processes
you use have a dramatic impact. When you work with a supplier that has the same
quality standards as you do, over time, you develop a long-term relationship.
Organizational
control
An
organized inventory system begins by labelling your stock
with SKUs that are easily understandable and simple to read. Start
with an initial stocktake and then use the right inventory tracking
system to keep track of movements and levels.
Reorder
Point Formula
The
Reorder Point is a way of controlling inventory that determines the right
time to order more stock. Calculating this means adding together your lead
time demand in days and safety stock in days.
Basically,
reorder point = lead time demand + safety stock.
Economic
order quantity (EOQ)
Economic
order quantity (EOQ), refers to the optimum amount of an item that should be ordered
at any given point in time, such that the total annual cost of carrying and
ordering that item is minimized. EOQ is also sometimes known as the optimum lot
size. Simply put – how much product should you purchase to maintain a
cost-efficient supply chain?
EOQ
is the optimum inventory we should purchase to minimize the costs of ordering
and holding. We’ll need to know our annual fixed costs (D), demand in units
(K), and carrying costs per unit (H).
EOQ
= √(2DK / H), or the square root of (2 x D x K / H)
EOQ formula
·
Determine
the demand in
units
·
Determine
the order cost (incremental
cost to process and order)
·
Determine
the holding
cost (incremental cost to hold one unit in inventory)
·
Multiply
the demand by
2, then multiply the result by the order
cost.
·
Divide the
result by the holding cost.
·
Calculate
the square root of the result to obtain EOQ.
In short: EOQ = square root of (2 x D x S/H) or
√ (2DS / H)
Where:
·
D represents
demand, or how many units of product you need to buy.
·
S represents
setup cost.
·
H represents
the holding fee or storage cost per unit of product.
In this method, the
company will get to know how much quantity of inventory should the company
order at any point of time and when should they place the order considering the
minimum level of inventory.
How is economic order quantity understood?
Economic order quantity will be higher if
the company’s setup costs or product demand increases. On the other hand, it
will be lower if the company’s holding costs increase.
Example of How to Use EOQ
EOQ takes into account the timing of
reordering, the cost incurred to place an order, and the cost to store
merchandise. If a company is constantly placing small orders to maintain a
specific inventory level, the ordering costs are higher, and there is a need
for additional storage space.
Example
1: a retail clothing shop carries a line of men’s
jeans, and the shop sells 1,000 pairs of jeans each year. It costs the company Rs.5
per year to hold a pair of jeans in inventory, and the fixed cost to place an
order is Rs. 2.
The EOQ formula is the square root of (2
x 1,000 pairs x Rs.2 order cost) / (Rs.5 holding cost) or 28.3 with rounding.
The ideal order size to minimize costs and meet customer demand is slightly
more than 28 pairs of jeans. A more complex portion of the EOQ formula provides
the reorder point.
Example 2: Matt
runs a men’s clothing line. Matt needs to buy 12,000 shirts per year to fulfil
demand (D). He incurs a setup cost of Rs.100 (S) and a holding fee (H) of Rs.16
per shirt. He needs to know his EOQ.
Plugging those numbers into the EOQ formula, you get:
EOQ = √ (2 x 12,000 x 100/16)
EOQ = √ 3,456,000 / 16
EOQ = √216,000
EOQ = 465 units (rounded up to the nearest whole
unit)
The EOQ is usually used to set the reorder point within
your inventory management workflows. Together, these metrics tell you when to
place an order (reorder point) and how much order to place (EOQ formula). This
prevents you from carrying too much deadstock or facing stock outs.
Why is economic order quantity important?
Economic order quantity is important
because it helps companies manage their inventory efficiently. Without
inventory management techniques such as this, companies will tend to hold too
much inventory during periods of low demand, while also holding too little
inventory in periods of high demand. Either problem creates missed
opportunities for companies: too much inventory generally means too little cash
on hand, while not holding enough inventory will lead to missed sales. For
investors, calculating the economic order quantity for a company can help to
assess how efficiently that company is managing its inventory.
The
EOQ helps companies minimize the cost of ordering and holding inventory. As
explained by the economic concept known as economies of scale, the cost per
unit of ordering a product falls, the larger the total quantity of the order.
However, the larger the total quantity of an order, the higher the cost to hold
and carry your inventory.
ABC
analysis
The
stock is divided into three sections namely A, B and C. A section consist of
inventories that are high in value with low sales frequency or consumption.
This category of stocks requires to be controlled closely. Category B consists
of stocks that are of moderate value and with decent sales frequency. In
category C, you have inventories with low value having high sales frequency
requiring minimum inventory control.
Every
single item we order does not have equal value. Some parts cost more. Some are
used more frequently. Some are both. ABC inventory analysis helps categorize
those items so we can understand which ones should receive our full attention.
As the name suggests, this inventory categorization
technique groups your inventory in three buckets: A, B, & C.
·
A’ items are the most important to an organization. This material
should receive your full focus due to its high usage rate or a high price (or
both).
·
‘B’
items have a lower dollar volume and are thus less important than ‘As’.
·
Finally, ‘C’
items are the low rung on the ladder. Out of the three groups, you’ll have the
highest number of ‘C’ items, but they will account for the lowest portion for
your inventory value.
The Pareto Principle states that 80% of your
inventory costs comes from just 20% of your inventory. This is known as the
80/20 rule and it helps shape the results of your ABC Analysis. Lean DNA
recommends the following breakdown as the optimal way to determine the three
categories:
·
‘A’ items
– 80% of the annual inventory value of your items (likely made up of just 20%
of your items)
·
‘B’ items
– 15% of the annual inventory value of your items (likely made up of 30% of
your items)
·
‘C’ items
– 5% of the annual inventory value of your items (likely made up of 50% of your
items)
In order to
determine which parts, fall into which categories, use the following steps:
1.
Determine
inventory value by multiplying the price of an item by the consumption volume
of that item in a year period. Simply put, item cost * annual
consumption = inventory value.
2.
Repeat step 1
for all items to calculate total inventory value.
3.
Sort your
parts from highest inventory value to lowest.
4.
Calculate each
item’s percentage of total inventory value. That item’s inventory value
/ sum of all inventory values = item % of total inventory value.
5.
Group the
parts that account for the highest 80% of your total inventory and allocate
them as ‘A’ items. Group the parts that account for the next 15% and allocate
them as ‘B’ items. Group all remaining items as ‘C’.
ABC analysis is widely used for unfinished good, manufactured
products, spare parts, components, finished items and assembly items. This method of management divides the items into three
categories A, B and C; where A is the most important item and C the least
valuable.
Advantages of implementing the ABC method
of inventory control
i)
This method helps businesses to maintain control over the costly items which
have large amounts of capital invested in them
ii) It provides a
method to the madness of keeping track of all the inventory. Not only does it
reduce unnecessary staff expenses but more importantly it ensures optimum
levels of stock is maintained at all times
iii) The ABC method
makes sure that the stock turnover ratio is maintained at a comparatively
higher level through a systematic control of inventories
iv) The storage
expenses are cut down considerably with this tool
v) There is provision
to have enough C category stocks to be maintained without compromising on the
more important items
Disadvantages of using the ABC analysis
i)
For this method to work and render successful results, there must be proper
standardization in place for materials in the store
ii) It requires a good
system of coding of materials already in operation for this analysis to work
iii) Since this
analysis takes into consideration the monetary value of the items, it ignores
other factors that may be more important for your business.
Need for Inventory:
A business firm maintains inventory for the
following purposes:
(i) To carry on the day-to-day operations
of business:
The inflow and outflow of inventory
cannot be synchronised completely. There is a time lag between production and
sales and inventories get built up during this time lag. This is the
transactional motive of inventory.
(ii) To ensure regular production:
In the absence of adequate stock of raw
materials production would be hampered. Both men and machines would become
idle. By holding stocks of raw material a firm can keep its output at a
constant level.
(iii) To maintain a safety margin:
It is not possible to predict demand
exactly. Therefore, business firms maintain stock of finished goods to
safeguard against fluctuations in demand. This is known as the precautionary
motive of inventory.
(iv) To take advantage of price:
When a business firm expects rise in
prices of inventory it may hold stock of goods when the price is low until the
price becomes high. This is called the speculative motive of holding inventories.
It is fruitful to hold inventory when expected price rise exceeds the cost of
holding inventory.
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