What is inventory control management and how implement it in an organization?
The most important objective or inventory control is to determine and maintain an optimum level of investment in the inventory. Most companies have now successfully installed one or the other system of inventory planning and control. The inventory control models range from very simple methods to highly sophisticated mathematical inventory models.
In the simplest method, the purchase man periodically reviews the stock, perhaps visually; to see what inventory items are in short supplies and places order when he thinks a minimum level has been reached or when the inventory of a particular item is exhausted. No inventory levels are kept on records.
Obviously, such a method is likely to incur excessive purchasing and carrying costs on the one hand and stock out costs on the other. While excess purchase would lead to excessive investment in obsolete or slow moving goods, shortage or inventory may disrupt production or sales may be permanently lost.
To improve upon the visual method a re-order line may be drawn in the bin or storage area so that when stock reaches this line, order will be placed. The re-order line in the bin would be high enough to cover normal usage until the new order arrives. A variation of this method is to use the two bins systems: an order is placed when the working stock bin is empty.
Another inventory control approach is through the perpetual inventory system. Managers are already familiar with the principles and procedures of this system. Another method used to assist in the control of inventory is the ABC classification.
Here the inventory items are classified into groups, usually three, according to the annual cost of the item used and ranked according to the rupee value of the usage. It may, however , be pointed out here that ABC analysis is not actually a control system in itself: it shows the way to decide which items are most in need of strict control system. It is ultimately the management who decides how best to control each class of items.
Techniques of inventory control:
1. Economic purchase
order quantity (How much to order)
2. Reorder level (when to order)
3. Minimum inventory or safety stock.
Economic Purchase Order Quantities: In order to control inventory a decision model has been developed to determine the optimum quantity of materials to be purchased on each purchase order. The model determines the optimum working stock level to be maintained.
Each time a purchase order is placed, the company incurs certain costs. In order to minimize the costs of placing purchase orders, the company could increase the order quantity to meet the company’s entire needs for the year at one time, incurring only the cost of one purchase order. However, such a practice will lead to having a large average inventory of working stock, resulting in increased carrying costs. The costs of ordering and costs of carrying inventory may be summarized as followsl:
Cost of Ordering :
- Preparing purchase
or production orders, receiving and preparing and processing related
- Incremental costs of purchasing or transportation for frequent orders (Purchase in small lots is often costlier and transportation costs also increase)
- Out of pocket costs of postage, telephones, telegrams, cost of stationery, traveling etc.
- Extra costs of numerous small production runs, overtime, setups, training etc. In addition- fixed costs in form of salaries, wages of employees connected with this work in purchasing, receiving, inspection and Material handling Departments.
Costs of Carrying:
- Interest on Investment.
- Losses from absolescence and deterioration, spoilage.
- Storage-space costs, including Rent, Rates, Taxes, Electricity, etcs.
- Insurance, in addition- fixed costs in form of salaries, wages etc of employees connected with this work in stores and Material handling Departments.
It should be noted that in the consideration of the optimum inventory decision, the costs of buying the inventory would usually be irrelevant, because it is assumed that the quantity required for the year would be the same for various alternative. The important relevant costs to be considered are the costs of ordering and the costs of carrying.
Lead time is the time interval between placing an order and receiving delivery. If the lead time and the quantity of demand during lead time are known with certaininty the recorder point may be determined. If in the above example, lead time is 2 weeks and the average usage is 18 per week, the recorder point will be 18*2=36units. The day the level of stock falls to 36 units, an order for 173 units will be placed. By the time these are delivered, the stock would be nil and on the day of delivery it will shoot up again to 173 units and so on.
or Safety Stock:
In our previous paragraph, we had assumed with certainity that 18 units would be used per week. In practice, we seldom come across such a situation and demand cannot be forecast accurately. Actually the demand may fluctuate from period to period. If, therefore the usage per week at anytime goes beyond 18 units per week, the company will be out of stock for sometime. Hence arise the need for providing for some safety stock, i.e. some minimum or buffer as inventory as a cushion against such stock outs.
The recorder point is inter-related with the safety stocks because as the recorder point is moved upwards, the amount of the cushion is increased. Thus the recorder point is the resultant of the demand during lead-time plus safety stock. By increasing the safety allowance the recorder point is increased by the same amount. It should be noted that the economic order quantity does not come into the picture and is independent of safety stock analysis.
There are several methods determining safety stock levels. A rough and ready method followed by many companies is to provide a constant safety stock of say, one or two month’s usage requirements regardless of the item. Another method mainly based on intuition is to have large safety stock when quantity usage is high, lead time is long or the ordering schedule is frequent. Small safety stocks can be maintained when there is low usage, short lead time or infrequent ordering.
Another method makes a statistical analysis of the probability of a stock out by predicting the dispersion of usage around average usage and the dispersion of lead times around the average lead time. The above discussions of inventory control are based on the two bins or constant order quantity system.