Introduction

The term ‘inventory’ originates from the French word

‘Inventaire’ and Latin word ‘Inventariom”, which implies a
list of things found.

The term ‘inventory’ can be defined as,

“The term inventory includes materials like – raw, in

process, finished packaging, spares and others; stocked

in order to meet an unexpected demand or distribution

in the future.”

Inventory includes the following categories of items:

a. Production Inventories: Raw materials, parts and

componen8ts which enter the firm’s product in the
production process. These may consist of two types –
special items manufactured to company specifications
and standard industrial items purchased ‘off the shell’.

b. MRO Inventories: Maintenance, Repair, and Operating

supplies which are consumed in the production process
 but which do not become the partof the product. (e.g.
lubricating oil, soap, machine repair parts)

In-process Inventories: Semi-finished products found at

various stages in the production operation.

Finished goods Inventories: Completed products ready for

shipment.

"Inventory Control" focuses on the process of movement and accountability of inventory.

This consists of strict polices and processes in regards to:

The physical and systemic movement of materials

Physical Inventory and cycle counting

Measurement of accuracy and tolerances

 Good Accounting Practices

Need for inventory control

Inventories constitute the most significant part of the current assets, representing as
much as 50%-70% of the capital investment. Therefore it is absolutely imperative to
manage inventories effectively and efficiently in order to avoid unnecessary investment
in them.

If a company's inventory level is too low, it risks delays in fulfilling it's customers
orders.

If the inventory level is too high, it is using up money that can be better used in

other areas. It also risks obsolescence and spoilage.

Inventory Control Techniques

Inventory control techniques are employed by the inventory control

organization within the framework of one of the basic inventory
models, viz., fixed order quantity system or fixed order period
system. Inventory control techniques represent the operational
aspect of inventory management and help realize the objectives of
inventory management and control.

Several techniques of inventory control are in use and it depends on

the convenience of the firm to adopt any of the techniques. What
should be stressed, however, is the need to cover all items of
inventory and all stages, i.e. from the stage of receipt from
suppliers to the stage of their use. The techniques most commonly
used are the following:
ABC analysis

HML Classification

VED Classification

SDE Classification

FSN Classification

XYZ Analysis

SOS Analysis

GOLF Analysis

Economic order quantity

Reordering Level

JIT System
.2 Process of Inventory Management and Control
Inventory management and control refers to the planning for
optimum quantities of materials at all stages in the
production cycle and evolving techniques which would
ensure the availability of planned inventories. Following four
steps are involved in the process:

a. Determination of optimum inventory levels and

procedures of their review and adjustment: It is a significant step
but a difficult one. Too much inventory results in locking up of
working capital accompanied by increased carrying costs (but
reduced ordering costs). Excess inventories, however, guarantee
uninterrupted supply of materials and components, to meet
production schedules and finished goods to meet customers
demand. Too less of inventory releases working capital for
alternative uses and reduces carrying costs and increases ordering
costs. But there is the risk of stock out costs.

b. Determination of the degree of control that is

for the best results: The second aspect of inventory management
is to decide just how much control is needed to realize the
objectives of inventory management. The difficulty is best overcome
by categorization of inventory on the basis of value. Popularly
called the ABC categorization, this approach is useful in deciding
the degree of control. ‘A’ class items are ‘high’ in value but ‘low’ in
quantity, ‘C’ class inventories are the opposite of ‘A’ group i.e.
‘high’ in quantity and ‘low’ in value. In between are the ‘B’ group
stocks which are more or less equal in quantity and value
proportion to the total inventory. Tight control is exercised on ‘A’
category items through accurate records of receipts and issues and
by co-ordination of incoming shipments with production
managements.

c. Planning and design of the Inventory control system: An inventory

system provides the organizational structure and the operating policies
for maintaining and controlling goods to be inventoried. The system is
responsible for ordering and receipt of goods, timing the order
placement,and keeping track of what has been ordered, how much, and
from whom.
d. Planning of the Inventory control organization: It is yet
another important aspect of inventory management because
choosing the panel to control is very difficult.
 ABC Analysis: ABC analysis is a business term used to
define an inventory categorization technique often used in
materials management. It is also known as ‘Selective
Inventory Control.’ ABC analysis provides a mechanism for
identifying items which will have a significant impact on
overall inventory cost whilst also providing a mechanism
for identifying different categories of stock that will require
different management and controls. When carrying out an
ABC analysis, inventory items are valued (item cost
multiplied by quantity issued/consumed in period) with
the results then ranked.

ABC CODES
"A class" inventory will typically contain items that account for
80% of total value, or 20% of total items.

"B class" inventory will have around 15% of total value, or 30% of
total items.
 "
C

class" inventory will account for the remaining 5%, or 50% of total
items.
USAGE OF ABC ANALYSIS

In day to day warehouse operations, materials are some

time under issued, over issued, issued and not
accounted into the system, misplaced, stolen etc. This
results into inaccuracy in the inventory. Cycle counting
is the process to count and reconcile the materials.
Ideally, every material in the warehouse should be
counted during a fixed interval (every year) for
maintaining 100% accuracy, but counting & reconciling
every material is not cost effective and very expensive.
To count the accuracy of the inventory in a cost
effective manner, it is recommended to count the
materials based on inventory classification. If A class
materials are counted within a fixed interval (could be
six months or a year) then the firm needs to count only
5% to 10% of the total materials and it will cover 60%
to 80% of the inventory value. It means that firm only
 counts 5 % to 10% of the materials and remove the
inaccuracy from the inventory value from 60% to 80%.
Similarly B class materials can also be counted on a
less frequency ( from once in 18 months to 24 Months)
as the number of materials become higher and C class

materials at even lesser frequency (once in 27 months

to 36 months) as number of material becomes more
(60% to 85% of the total materials).

An inventory controller shall be concentrating more on the

A class items for reducing the inventory as he/she shall
be concentrating only 5% to 10% of the total items and
shall be getting the opportunity to reduce inventory on
60% to 80% of the value.

Any reduction in lead time of A class items shall result in reduction

in inventory, so procurement manager will work out with suppliers
to reduce the lead time.

On issue of materials, tight control on A class, Moderate control on

B class, Loose Control on C class. So ‘A’ class items may be issued

after getting the approvals from Senior Executives of the company.
B may be moderately controlled. Very little control can be exercised

while issuing C class item.

 Advantages of ABC analysis :

Helps to exercise selective control over such items, which are having a sizable.

Helps to point out obsolete stocks easily.

Provides sound basis for allocation of funds & human resources.

It enables the maintenance of high inventory turn over rate.

Disadvantages of ABC analysis :

Considers only money value of items & neglects the importance of items for the
production process or assembly or functioning.

It does not categorize the items based on their critical needs, hence sometimes the
purpose of ABC categorization may be defeated.

Economic Order Quantity

This model is known asEconomic order quantity (EOQ) model, because it established the
most economic size of order to place. It is one of the oldest classical production
scheduling models. In 1913, Ford W. Harris developed this formula whereas R. H. Wilson
is given credit for the application and in-depth analysis on this model.By using this
model, the companies can minimize the costs associated with the ordering and inventory
holding.It can be a valuable tool for small business owners who need to make decisions
about how much inventory to keep on hand, how many items to order each time, and how
often to reorder to incur the lowest possible costs.There are two most important
categories of inventory costs are ordering costs and carrying costs.

Ordering costs:

It is the costs that are incurred on obtaining additional inventories. They include costs
incurred on communicating the order, traveling allowance and daily allowance to
purchase officers, printing and stationary, salary of purchase department, cost of
inspection, cost of receiving the material, transportation cost etc. all above cost, other
than transport costs remain unchanged per order irrespective of the order size. Therefore,
it is assumed that ordering cost per order remain constant. The more frequently orders are
placed, and fewer the quantities purchased on each order, the grater will be ordering cost
and vice versa. This relation is shown in the figure 1.

Carrying cost:

It is the cost incurred for holding inventory in hand. They include interest on the money
locked up in stocks, storage costs, deterioration spoilage costs, insurance, evaporation,
godown rent, pilferage, shrinkage, obsolescence, other overhead of stores department etc.
 They are assumed to be constant per unit of inventory. The large the volume of inventory,
the higher will be the inventory carrying cost and vice versa. This relation is shown in the
figure 2.

From the above discussion it is clear that ordering costs and carrying costs are quite opposite
to each other. If we need to minimize carrying costs we have to place small order which
increases the ordering costs. If we want minimize our ordering costs we have to place few
orders in a year and this requires placing large orders which in turn increases the total
carrying costs for the period.We need to minimize the total inventory costs, Thus EOQ is
determine by the intersection of ordering cost curve and carrying cost line. At this point total
ordering cost is equal to total carrying cost, and the total of the two costs is the least this is
shown in the figure 3.

Mathematical Formulation of EOQ

EOQ = √(2×A×O)/C
Where,
EOQ = Economic order quantity
A = Annual demand in units
O = Cost incurred to place a single
order
 C = Carrying cost per unit per year

Limitations of the EOQ Model:

The assumptions made in the EOQ formula restrict the use of the formula. In practice cost
per unit of purchase of an item change time to time and lead time are also uncertain. It is
necessary for the application of EOQ order that the demands remain constant throughout the
year which is not possible. Ordering cost per order can’t be constant because it’s including
transport cost.

High, Medium and Low Classification: The High, medium

and Low (HML) classification follows the same procedure
as is adopted in ABC classification. Only difference is that
in HML, the classification unit value is the criterion and
not the annual consumption value. The items of inventory
should be listed in the descending order of unit value and
it is up to the management to fix limits for three categories

The HML analysis is useful for keeping control over

consumption at departmental levels, for deciding the
frequency of physical verification, and for controlling
purchases.

Procurement department is more concerned with

prices of materials so this analysis helps them to take
them the decisions such as, who will procure what based
on the hierarchy and price of material.
 Some of the other objective can be as under

Helps in taking the decision such as whether to

procure in exact requirement or opt for EOQ or
purchase only when needed

When it is desired to evolve purchasing policies

then also HML analysis is carried out i.e. whether
to purchase in exact quantities as required or to
purchase in EOQ or purchase only when
absolutely necessary

When the objective is to keep control over

consumption at the department level then

authorization to draw materials from the stores
will be given to senior staff for H item, next lower
level in seniority for M class item and junior level
staff for L class items.

Cycle counting can also be planned based on HML analysis. H

class items shall be counted very frequently, M class shall be
counted at lesser frequency and L class shall be counted at least
frequency as compared to H & M class.

c. VED Classification: While in ABC, classification

inventories are classified on the basis of their
consumption value and in HML analysis the unit value is
 the basis, criticality of inventories is the basis for vital,
essential and desirable categorization.

The VED analysis is done to determine the criticality of

an item and its effect on production and other services. It
is specially used for classification of spare parts.

d. SDE Classification: The SDE analysis is based upon the

availability of items and is very useful in the context of
scarcity of supply. In this analysis, items, generally
imported, and those which are in short supply. It refers to
difficult items which are available indigenously but are
difficult items to procure. Items which have to come from
distant places or for which reliable suppliers are difficult
to come by fall into category. It also refers to items which
are easy to acquire and which are available in the local
markets.

The SDE classification, based on problems faced in

procurement, is vital to the lead time analysis and in
deciding on purchasing strategies.
 SDE analysis is done based on purchasing problems
associated with items on day-to-day basis. Some of the
purchasing problems are as under: -

Long Lead Times

Scarcity and hardly available
Sourcing the same material from many geographically
scattered sources

Uncertain and unreliable sources of supply

Purchasing department classifies these materials and formulates the

strategy and policy of procurement of these items accordingly. So
classification of materials is done based on level of difficulty in
sourcing

e. FSN Classification: FSN stands for fast moving, slow

moving and non-moving. Here, classification is based on
the pattern of issues from stores and is useful in
controlling obsolescence.

To carry out an FSN analysis, the date of receipt or

the last date of issue, whichever is later, is taken to
determine the number of months, which have lapsed since
the last transaction. The items are usually grouped in
periods of 12 months.
 FSN analysis is helpful in identifying active items which
need to be reviewed regularly and surplus items which
have to be examined further. Non-moving items may be
examined further and their disposal can be considered.

f. SOS Analysis: ‘S’ stands for Seasonal items and ‘OS’

stands for off-seasonal items. It may be advantageous to
buy seasonal items at low prices and keep inventory or
buy at high price during off seasons. Based on the
fluctuation in prices and availability, suitable decision has
to be taken regarding how much to purchase and at what
prices.

g. XYZ Analysis: XYZ analysis is calculated by dividing an

item's current stock value by the total stock value of the
stores. The items are first sorted on descending order of
their current stock value. The values are then
accumulated till values reach say 60% of the total stock
value. These items are grouped as 'X'. Similarly, other
items are grouped as 'Y' and 'Z' items based on their
accumulated value reaching another 30% & 10%
respectively. The XYZ analysis gives an immediate view of
which items are expensive to hold. Through this analysis,
firm can reduce its money locked up by keeping as little as
possible of these expensive items.
 h. GOLF Analysis: This stands for Government, Open
market, Local or Foreign source of supply. For many

items imports are canalized through government agencies such as

State Trading Corporations, Mineral and Metals Trading
Corporations, Indian Drugs and Pharmaceuticals etc.

For such items, the buying firms cannot apply any inventory
control techniques and have to accept the quota allotted by the
Government. ‘Open market’ categories are those who form bulk of
suppliers and procurement is rather easy. ‘L’ category includes
those local suppliers from whom items can be purchased off-the –
shell on cash purchase basis. ‘F’ category indicates foreign
suppliers. Since an elaborate import procedure is involved, it is
better to buy imported items in bigger lots usually covering the
annual requirements.

j. Minimum-Maximum Technique: The minimum-maximum

system is often used in connection with manual inventory
control systems. The minimum quantity plus the optimum
lot size. In practice, a requisition is initiated when a
withdrawal reduces the inventory below the minimum
level; the order quantity is the maximum minus the
inventory status after the withdrawal. If the final
withdrawal reduces the stock level substantially below the
minimum level, the order quantity will be longer than the
calculated EOQ.
 The effectiveness of a minimum-maximum system is
determined by the method and precision with which the
minimum and maximum parameters are established. If
these parameters are based upon arbitrary judgments
with a limited basis, the system will be limited in its
effectiveness. If the minimum are based on an objective
rational basis, the system can be very effective.

k. Two-bin Technique: One of the oldest systems of

inventory control is the two bin system which is adopted
to control ‘C’ group inventories. In the two – bin system,
stock of each item is separated into two bins. One bin
contains stock, just enough to last from the date a new
order is placed until it is received in inventory. The other
bin contains a quantity of stock enough to satisfy
probable demand during the period of replenishment.

Developments in Inventory Management

In recent years, two approaches have had a major impact on
inventory management: Material Requirements Planning (MRP) and
Just-In-Time (JIT). Their application is primarily within
manufacturing but suppliers might find new requirements placed
on them and sometimes buyers of manufactured items will
experience a difference in delivery.

Material requirements planning are basically an information system

in which sales are converted directly into loads on the facility by
sub-unit and time period. Materials are scheduled more closely,
thereby reducing inventories, and delivery times become shorter
and more predictable. Its primary use is with products composed
of many components. MRP systems are practical for smaller firms.
The computer system is only one part of the total project which is
usually long-term, taking one to three years to develop.

Just-in-time inventory management is an approach which works to

eliminate inventories rather than optimize them. The inventory of
raw materials and work-in-process falls to that needed in a single
day. This is accomplished by reducing set-up times and lead times
so that small lots may be ordered. Suppliers may have to make
several deliveries a day or move close to the user plants to support
this plan.
Application of Inventory Management Techniques

Small businesses, both manufacturers and retailers, now have

the opportunity to reduce inventory-related costs
significantly through the use of various inventory techniques
implemented on a micro- or mini-computer. Inventory
techniques are divided into two categories--those for
independent demand items (finished goods) and those for
dependent demand items (manufacturing-in-process items
and raw material). The use of micro-computers is growing
rapidly, with material requirements planning (MRP) systems
currently available for use on micro-and mini-computers.
These MRP systems assist the small manufacturer in
planning and controlling inventory levels of dependent
 25
demand items and in scheduling work centers. Several
techniques offer potential for savings with independent
demand items. Independent demand item techniques are
subdivided into continuous review models, periodic review
models, and mixed models.

The model most frequently presented is the continuous

review model (reorder point/economic order quantity model).
However, an assumption implicit in continuous review
models is that a perpetual is maintained so that it is
practical to release a replenishment order on the day the
reorder point is reached. Thus, continuous review models
assume that point-of-sale information is being collected.

The continuous review technique, while very practical

for a computerized inventory system collecting point-of-sale
data, is not practical for manual systems handling numerous
different items.

CONCLUSIONS

"Inventory" to many small business owners is one of the more

visible and tangible aspects of doing business. Raw materials,
goods in process and finished goods all represent various forms of
inventory. Each type represents money tied up until the inventory
leaves the company as purchased products. Likewise, merchandise
stocks in a retail store contribute to profits only when their sale
puts money into the cash register.
In a literal sense, inventory refers to stocks of anything necessary
to do business. These stocks represent a large portion of the
business investment and must be well managed in order to
maximize profits. In fact, many small businesses cannot absorb
the types of losses arising from poor inventory management.
Unless inventories are controlled, they are unreliable, inefficient
and costly.

References

Chadda, R.S (1964), “Inventory Management in India”, Allied Publishers, Bombay, 1964.