Topic- Inventory Management Subject- Working Capital Management

1. INVENTORY
MANAGEMENT
Dr. NEERAJ CHITKARA
Dr. Neeraj Chitkara
Assistant Professor
Samalkha Group of Institutions
Email- neer.chitkara@gmail.com

2. INTRODUCTION
Inventories are assets of firm and as such they
represent an investment. Because such investment
Dr. NEERAJ CHITKARA
requires the precious funds, managers must ensure
that the firm maintains inventories at the correct
level. If they become too large, the firm loses the
opportunity to employ those funds more effectively.
Similarly, if they are too small, the firm may lose
sales. Managing the level of inventories is like
maintaining the level of water in a bath tub with an
open drain. The water is flowing out continuously. If
the water is let in too slowly, the tub is soon empty. If
the water is let in too fast, the tub overflows.

3. TYPES OF INVENTORIES
The common types of inventories for most of the business
firms may be classifies as finished goods, w-i-p and raw
materials.
Dr. NEERAJ CHITKARA
Finished Goods
These are the goods which are either being
purchased or being produced or being processed by
the firm. These are just ready for sale to customers.
Inventories of finished goods arise because of the time
involved in production process and the need to meet
customer’s demand promptly. If the firms do not
maintain a sufficient finished goods inventory, the
customer who are unwilling to wait may turn to
competitors. The purpose of finished goods inventory
is to bring smoothness in the production and sales
function.

4. Work-in Progress
It refers to the raw materials engaged in various
phases of production schedule. The degree of
completion may be varying for different units. Some
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units might have been just introduced, while some
others may be 40% complete or others may be 90%
complete. The work-in-progress refers to partially
produced goods. The value of work-in-progress
includes the raw materials costs, the direct wages and
expenses already incurred and the overheads, if any.
The qty. and the value of work-in-progress depends
upon the length and complexity of production cycle.
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5. Raw Materials
The raw materials include the materials which
are used in the production process and every
manufacturing firms has to carry certain stock of raw
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materials in stores. These units of raw materials are
regularly issued/transferred to production department.
Inventories of raw materials are held to ensure that the
production process is not interrupted by a shortage of
these materials. The requirement of stock of raw material
is based upon many factors including speed with which
raw materials can ordered and procured, uncertainty in
the supply of raw materials etc. Its purpose is just to make
the production and purchasing functions independent.

6. OBJECTIVES OF HOLDING INVENTORY
 Transaction Motive
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 Precautionary Motive
Strikes, labour problems, natural
calamities etc.
 Speculative Motive
to earn extra profit due to shortage
 Contractual Agreements

7. BENEFITS OF HOLDING INVENTORY
For Trading Concerns
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 Uninterrupted selling process
 Quality discounts
For manufacturing concerns
 Uninterrupted production schedule
 Independent sales activity

8. COST OF INVENTORY
The cost of holding inventories may include the
following:
 Carrying Costs:
This is the cost incurred in keeping or
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maintaining n inventory of one unit of raw material or
work-in-progress or finished goods. There are two
components of it:
Cost of Storage
e.g. rent of space, salary of storekeeper, cost of
infrastructure, cost of insurance, cost of warehousing,
handling costs etc.
Cost of Financing
e.g. opportunity costs, interest on borrowings (
carrying cost is always variable cost and directly varies in
the same direction in which the stock varies)

9.  Ordering Costs :
The costs of ordering include the cost of
acquisition of inventories i.e. cost of preparation and execution
of an order, cost of paper work and cost of communication with
supplier, cost of inspection, checking & handling, salaries &
wages of the purchase department.
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1. Total annual ordering cost= Cost per order × No. of
orders placed in the year
The ordering cost may have fixed
components as well as variable components; fixed
component is not affected by the order size whereas
variable component is affected by the order size e.g.
transactioncharges may be payable per unit subject to a
minimum charges per trip.
The carrying cost and the ordering costs
are the opposite forces and collectively they determine the
level of inventory. A financial manager has to achieve a trade-
off between carrying costs and the ordering costs.

10. Cost of stock-outs (a hidden cost)
A stock out is a situation when the firm
is not having units of an item in store but there is a
demand for that either from customers or the
production department. The stock out refers to
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demand for an item whose inventory level has
already reduced to zero or insufficient level. Stock
out does not appear if the item is not demanded
even if the inventory level has fallen to zero.
Costs of stock outs of finished goods i.e.
lost sales, cancellation of orders, adverse affect
to the goodwill etc. Costs of stock outs of raw
material is the hurdle in the production process.

11. INVENTORY
High Levels Low Levels
Benefits Benefits
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•Low Storage costs
•Happy Customers •Less risk of Obsolescence
•Few productions delays(
always have need parts on
hand)
Costs Costs
•Expensive •Shortage
•High Storage Costs •Dissatisfied customers
•Risk of Obsolescence

12. TECHNIQUES OF INVENTORY MANAGEMENT
 Explosion process
 Past-usage Methods
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 Value-volume Analysis
 ABC Approach
 VED Classification
 HML Classification
 XYZ Classification
 FSN Classification
 SDE and Golf Classification
 SOS Classification

13. INVENTORY CONTROL MODELS
 Economic Order Quantity Model
 Probabilistic Inventory control
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 Just-In-Time Inventory Management System
Other Control Devices
 Control Account
 Physical Counting
 Visual View
 Two-bin-System
 Minimum-maximum System
 Periodic Order System

14. INVENTORY MANAGEMENT & VALUATION
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 Average Cost Method
 First-In , First-out (FIFO) Inventory Method
 Last-In, First-out (LIFO) Method`

15. DETERMINATION OF STOCK LEVELS
Both the excess and shortage of materials are
harmful for the firms. Hence various stock levels
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must be determined:
 Minimum Level:
This represents the quality which must
be maintained in hand at all times. The following
things must be considered regarding it Lead Time,
Rate of Consumption, Nature of materials etc.
Minimum Level=Re-ordering level - (Normal
consumption × Normal re-order period)

16. RE-ORDERING LEVEL
When the quality of materials reaches at a
certain figure then fresh order is send to get materials
again. Re-ordering level is fixed between minimum
level and maximum level.
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The following points are considered while
determining re-ordering level: rate of consumption,
no. of days required to replace the stock etc.
Re-ordering level= Maximum consumption ×
Maximum re-order period.

17. MAXIMUM LEVEL
It is the quality beyond which a firm should not
exceed its stock otherwise there will be overstocking.
Maximum stock level depends upon the following
factors:
 The availability of capital for the purchase of materials.
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 The maximum requirement at any point of time.
 The availability of space for storing the materials.
 The rate of consumption of materials during lead time.
 The cost of maintaining the stores.
 The possibility of fluctuations in prices.
 The nature of materials.
 Restrictions imposed by govt.
Maximum stock level= Re-ordering level + Re-ordering
quantity-(Minimum consumption × Minimum re-ordering
period).

18. DANGER LEVEL
It is the level beyond which materials should
not fall in any case. If danger level arise then
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immediate steps should be taken to replenish the
stock even if more cost is incurred in arranging the
materials. If materials are not arranged immediately
there is a possibility of stoppage of work.
Danger level= Average consumption × maximum re-
order period for emergency purchase

19. AVERAGE STOCK LEVEL;
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Average stock level = Minimum stock level +1/2 of
Re-order quantity