INVENTORY MANAGEMENT

CONTENTS:

1) 2) 3) 4)

Executive summary Introduction to the concept Industry profile Company profile a) Back ground and inception of the company b) Nature of the business carried c) Vision , mission and quality policy d) Product/services profile e) Area of operation global/national/regional ownership pattern f) Competitors information g) Infrastructural facilities h) Achievement award i) Workflow model (end to end) 5) Mckinseys seven S Model a) Structure b) Skill c) Style d) Strategy e) System f) Staff g) Shared value 6) Research methodology a) Title of the project

b) Statement of the problem c) Objectives d) Operational definitions e) Data collection f) Statistical tools used for research g) Sampling techniques sampling unit, sample size and sampling method. h) Plan of analysis i) Limitations 7) Data analysis and interpretation 8) Summary of the findings 9) Suggestions 10) Conclusions future growth 11) Learning experience 12) Annexure a) Financial statements b) Questionnaires c) Bibliography.

EXECUTIVE SUMMARY

EXECUTIVE SUMMARY
Title of the project

A STUDY ON INVENTORY MANAGEMENT

STATEMENT OF PROBLEM
A study of inventory management at ABB LTD is undertaken in order to know the inventory performance and position of the company and to know the strength and weakness and to assess the profitability of the company. Inventories constitute most significant part of assets of large majority of the companies in India. Inventory a double edged sword is usually an asset of an organization, if not used properly it will become liability. It is therefore absolutely very important to manage inventories efficiently and effectively in order ltd. to overcome unnecessary investment. And To identify the

problems/challenges involved in the Inventory Management process at ABB

OBJECTIVES OF THE STUDY

The main objectives of the study are:-

OBJECTIVES: 1. To study the tools and techniques of inventory management adopted at ABB Ltd. 2. To study the inventory control measures in inventory management. 3. To study the demand forecast of inventory management at ABB Ltd.

4. To study how ABC analysis and aging schedule is implemented in inventory management. 5. To determine the stock level in inventory management at ABB Ltd. 6. To identify problems related to inventory management and to find out suitable measures to overcome them. 7. To study the methods of valuation of inventory on ABB Ltd. 8. To study the inventory management procedure. 9. To make a comparative study of inventory management in last 5 years using ratio analysis technique. Methodology of data collection
a) Primary data The primary data is collected by personal interviews with officials. b) Secondary data Files, annual reports, periodicals, manuals and text book. Which have already been passed through the statistical process are the secondary data used. c) Field work This was under taken individually to collect various information regarding the study by visiting following sections. Stores department Information regarding stocking of materials receipts and issues to workshops. Inventory control procedures in various wards inside the department were obtained. Accounts department Remaining all the information was obtained from accounts department through personal interviews with section officials.

Plan of analysis The analysis and interpretation was collected from finance department thus processed and tabulated is in the form of tables and graphs. The table thus obtained by calculating average, percentage, turnover ratio, graphs and diagram in respect of the stock of raw materials sales & inventory control procedures and thus to draw conclusion from the analysis done.

Scope of the study

This study is to find the facts and opinions of inventory management and control at ABB plant. In accordance with the present trends it aims mainly at finding out the inventory control procedures at ABB. This study gives the brief information about the inventory management of the indo ABB ltd The study was done by using annual reports, inventory manualetc.

Limitation of the study

Time restriction was only 30 days of project work in the organization. The information, which was needed, could not be made public by the organization. The study are related to ABB ltd Bangalore only The finding and suggestion cannot be generalized. The study covered a wide concept hence wide collection and coverage of information was not easily possible.

INTRODUCTION TO THE CONCEPT

INTRODUCTION:

Every enterprise needs inventory for smooth running of its activities. It server as a link between the production and distribution process. The greater a

time lag, the higher the requirement of inventory the unforeseen fluctuation of inventory demand and supply of goods, fluctuating inventory prices, necessitate the need for inventory management.

The investment inventory constitutes the most significant part of the current assets inventory of the under taking. Thus it is very essential to have a proper control and management of inventory.

Meaning and nature of inventory

The general meaning of inventory is stock of goods

or list of goods

inventory. In accounting language it means stock of finished goods. For inventory manufacturing concern it includes raw materials, work in progress, consumables finished goods and spares etc.

1) Raw materials: If forms a major input inventory in organization. The quantity of raw materials required will be determined by the rate of consumption.

2) Work in Progress : The work in progress is that stage of stocks, which are in between raw materials and finished goods.

3)

Consumables : These are the material, which are needed to smoothen, the process of production. catalyst. These do not directly go into production, but act as

4) Finished Goods : These are the goods, which are ready to sale for the consumers. The stock of finished goods provides as buffer between production and market.

5) Spares: Spares also from a part of inventory. The stocking policies differ from industry to industry.

Inventories cost account for nearly 55 percent of the cost of production, as it is clear from an analysis of financial statements of large number of private and public sector organizations. So, It essential to establish suitable procedures for proper control of materials from the time of purchase order placed with supplier until they have been consumed properly and accounted for.

Definition:

The term inventory refers to assets, which will be sold in future in the normal course of business operations. The assets, which the firm stores as inventory in anticipation of need, are raw materials, work -inprogress/process, and finished goods.

Inventory often constitute a major element of a total working capital and hence ft has been correctly observed, 'Good inventory management is good financial management.

Inventory control is a system, which ensures the provision of the required quantity at the required time with the minimum amount of capital.

Inventories are the second largest asset category for the manufacturing firms next to plant and equipment.

Inventory control includes scheduling, the requirements, purchasing, receiving and inspecting, maintaining stock records and stock control. Inventory control is a matter of coordination. A proper material control helps in improving the input-output ratio.

Objective of inventory management The main objective of inventory management are operational and financial. The operational object means availability of materials and spares in sufficient quantities for undisturbed flow of production. The financial objective means investments in inventories should not remain idle and minimum working capital should be locked in it. THE OTHER OBJECTIVES ARE:

1)

To ensure continues supply of inventories to the production.

2)

To avoid over stocking and under stocking.

3)

To maintain optimum level of investment in inventories.

4)

To keep material cost under control, to keep low cost of production.

5) To eliminate duplication in ordering or replacing stocks.

6) To minimize losses through, deterioration, pilferage, wastage and damages.

7) Designing structures for good inventory management.

8) Perpetual inventory control of materials.

9) To ensure right quality of goods at reasonable prices. Analysis of prices cost and value.

10) To facilitate data for short and long term planning and control of inventory. NEED FOR INVENTORY CONTROL:

If a cost accounting system is to be effective there must be a proper control of inventory and supplies form the time orders are placed with suppliers until they have been effectively utilized in production.

Materials are equivalent to cash and they make up an important part of the total cost. It is essential that materials should be properly safeguarded and correctly accounted. Proper control of material can

make a substantial contribution to the efficiency of a business. The success of a business concern largely depends upon efficient

purchasing, storage, consumption and accounting.

In a large firm the planning and routing department is responsible for arranging how and where the work is to be done and issue instructions. It sets definite time schedules so that necessary ma terials are delivered to the proper department in proper time not too long before hand neither lest it should interfere with other work nor after they are required as this result in idle time.

Business firm keep inventories for different purposes. Every f irm big or small trading or manufacturing has to maintain some minimum level of inventories. Based on some motives the inventories are maintained. a. Transaction motives:

Every firm has to maintain some level of inventory to meet the day -today requirements of sales, production process, customer demand etc. In this finished goods as well as raw material are kept as inventories for smooth production process of the firm.

b.

Precautionary motive:

A firm should keep some inventory for unforeseen circums tances also like loss due to natural calamities in a particular area, strikes, lay outs etc so the firm must have some finished goods as well as raw-materials tc meet circumstances.

c.

Speculative motive:

The firm may be made to keep some inventory in order to capitalize an opportunity to make profit due to price fluctuations.

REASONS AND BENEFITS OF INVENTORY:

The optimal level of maintaining inventory is a subjective matter and depends upon the features of a particular firm,

(i)

Trading firm:

In case of a trading firm there may be several reasons for holding inventories because of sales activities that should not be interrupted. More over it is not always possible to procure the goods whenever there is a sales opportunity as there is always a time gap required between

purchase and sale of goods. Thus trading concern should have some stock of finished goods in order to under take sales activities independent of the procurement schedule.

Similarly, a firm may have several incentives being offered in terms of quantity discounts or lower price etc by the supplier of goods. There is trading concern inventory helps in a de-inking between sales activity and also to capitalize a profit of opportunity due to purchase made at a discount will result in lowering the total cost resulting in higher profits for the firm.

(ii)

Manufacturing firm:

A manufacturing firm should have inventory of not only the finished goods, but also of raw materials and work-in-progress for following reasons.

(a)

Uninterrupted production schedule:

Every manufacturing firm must have sufficient stock of raw materials in order to have the regular and uninterrupted production schedule. If there is stock out of raw materials in order to have the regular and uninterrupted production schedule. If there is stock out of raw material at any stage of production process then the whole production may come to a half. This may result in custom dissatisfaction as the goods cannot

be delivered in time more over the fixed cost will continue to be incurred even ff there is no production.

Further work-in-progress would let the production process run smooth. In most of manufacturing concerns the work in progress is a natural outcome of the production schedule and it also helps in fulfilling when some sales orders, even if the supply of raw-materials have stopped.

(b)

Independent sales activity:

Inventory of finished goods is required not only in trading concern but manufacturing firms should also have sufficient stock of finished goods. The production schedule is a time consuming process and in most of the cases goods cannot be produced just after receiving orders. Therefore, every firm has to maintain minimum level of finished goods in order to deliver the goods as soon as the order is received. Costs involved in inventory: Every firms maintains inventory depending upon requirement and other features of firm for holding such inventory some cost will be incurred there are as follows:

(a)

Carrying Cost;

This is the cost incurred in Keeping or maintaining an inventory of one unit of raw materials, work-in -process or finished goods. Here there are two basic cost involved.

(i)

Cost of storage:

It includes cost of storing one unit of raw materials by the firm. This cost may be for the storage of materials. Like rent of spaces occupied by stock, stock for security, cost of infrastructure, cost of insurance, and cost of pilferage, warehousing costs, handling cost etc.

(ii)

Cost of financing:

This cost includes the cost of funds invested in the inventories .It includes the required rate of return on the investments in inventory in addition to storage cost etc. The Carrying cost include there fore both real cost and opportunity cost associated with the funds invested in the inventories. The total carrying cost is entirely variable and rise in directly proportion to the level of inventories carried.

Total carrying cost = (carrying Cost per unit) x (Average inventory)

(b)

Cost of ordering:

The cost of ordering includes the cost of acquisitions of inventories. It is the cost of preparation and execution of an order including cost of paper work and Communicating with the supplier. The total ordering cost is inversely proportion to annual inventory of firm. The ordering cost may have a fixed componen t, which is not affected by the order size: and a variable component, which changes with the order size.

Total Ordering Cost = (No.Of orders) x (cost per order).

(c)

Cost of stock out:

It is also called as Hidden cost. The stock out is the situation when the firm is not having units of an item in stores but there is a demand for that Item either for the customers or the production department .The stock out refers to zero level inventory .So there is a cost of stock out in the sense that the firm face a situation of lost sales or back orders .The

stock outs are quite often expensive. Even the good will of firm also be effected due to customers dissatisfaction and may lose business in case of finished goods, where as in raw materials or work in process can cause the production process to stop and it is expensive because employees will be paid for the time not spend in producing goods.

The carrying cost and the ordering cost are opposite forces and collectively. They determine the level of inventors in a firm.

Total cost =(cost of items purchased) +(Total Carrying and ordering cost)

Valuation of Inventory:

The methods of valuing inventory are combination of the actual cost and replacement cost plans. The chief advantage of the cost or net realizable value rule is that it is conservative. Hence the methods of Valuation of inventory are quite independent of system of mincing.

In balance sheet closing stock is shown under current assets and is also credited to manufacturing or trading accounts. The inventories are valued on the basis as follows.

Cost of raw materials in stock may include freight charges and carrying cost. But such cost should not exceed market price,

Work -in -process is generally valued at cost, which includes cost of materials, labor. And the proportionate factory overhead, as it is reasonable according to degree of completion,

Cost of finished goods wound normally to be total or full cost it includes prime cost plus appropriate amount of the overhead. Selling and distribution cost is deducted on the other hand work in progress may be valued at work in progress may be Valued at work cost, marginal cost, prime cost or, even at direct materials.

ISSUE PRICING METHODS:

There are two categories: (i) Cost prices:

(a) (b) (c) (d) (e)

FIFO (First in First out) LIFO (last in first out) Specific price Base stock price HIFO (highest in first out)

(ii) (a) (b) (c) (d) (e) (f)

Derived from cost prices: Simple average price Weighted average price Periodic simple average price Periodic weighted average price Moving simple average price Moving weighted average price

(iii) Notional prices: (a) (b) (c) (d) Standard price Inflated price Re-use price Replacement price

First in First out (FIFO)

This is the price paid for the material first taken into stock from which the material to be priced could have been drawn.

Under this method stocks of materials may not be used up in chronological order but for pricing purpose it is assumed that items longest in stock are used up first. The method is most suitable for use where in material is slow-moving and comparatively high unit cost.

Advantages:

i.

Price

is

based

on

actual

cost

and

not

on

basis

of

approximations such as no profits or losses arises by reasons of adopting this method. ii. The resulting stock balance generally represents fair

commercial valuation of stock. iii. It is based on traditional principles.

Disadvantages:

i.

The number of calculations in the stores ledger involved tends to be complicated with increase in clerical error.

ii.

The cost of consecutive similar jobs will differ if the price changes suddenly,

iii.

In times of rising prices, the charge to production is unduly

low as the cost of replacing the material will be higher.

Last in first out (LIFO)

This is the price paid for the material last taken into stock from which the materials to be priced could have been drawn. This method also ensure material being issued at the actual cost. Its use is based on the principle that costs should be as closely as possible related to curren t price level. Under this method production cost is calculated on basis on replacement cost.

Advantages:

i.

Production is charged at the most recent prices so that it is based on the principle that cost should be related to current price levels.

ii.

It

obviates

the

necessity

for

continuously

ascertaining

the

replacement price. iii. iv. Neither profit nor loss is usually made by using this method. In the times of rising prices there is no wind fall profit as would have been obtained under FIFO method.

Disadvantages:

i. ii. iii.

Needs more clerical work. Compassion among similar jobs is very difficult. Stock valves relating to prices of the oldest cost on hand may be entirely out of the current replacement prices.

Weighted average price:

This is the price which is calculated by dividing the total cost of material in the stock from which the material to be priced have been drawn, by the total quantity of material in the stock. This method differs from all other methods because here issue prices are calculated on receipts of materials and not on issue of materials. Thus as soon as new lot is received a new price is calculated and issues are then taken. Advantages:

i.

This method is advantageous where the price varies widely as its use even out the effect of these wide variations.

ii.

The basis of price calculations is a simple one involving only the division of total amount of material in stock by quantity in stock.

iii.

Calculation of new prices arises only when receipt of stocks are received.

iv.

Stock records under this method give a fair indication of the stock values, which can be used in financial analysis.

Disadvantages:

This method is completed than simple average because it takes into consideration the total quantities and total costs in stock. i. ii. iii. Profit or loss may be incurred as in simple average price, As LIFO or FIFO this method calls for many calculations, In order to calculate the accurate value of issues the average price must normally be calculated to four to five decimal places. Standard price:

It is the predetermination of fixed price on basis of a specification of all factors affecting price like the quantity of materials in hand and to be normally purchased and rate of discount compared with existing price including or excluding freight and ware housing expense.

A standard price for each material is set and the actual price paid is compared with standard. It is paid exceeds the standard a loss will be realized if not profit will be obtained.

Advantages: i. ii. This method is easy to operate. Comparing the actual prices with the standard price will determine the efficiency of purchase department.

iii. iv. v.

The effect of price variations is eliminated from job costs. It reduces classical costs by eliminating detailed cost records. In times of inflation or price fluctuations is very difficult to fix a standard price.

vi.

This method also incurs a profit or loss on issues and closing stock.

Inflated price: This is the price, which includes a charge designed to cover the cost of contingencies or related costs This price includes not only the cost involved in bringing the

material to the purchases premises but also the loss due to evaporation and Breakage etc. as well as carrying costs.

MATERIAL PURCHASING AND PURCHASING PROCEDURE

Purchase of material is one of the important function of material management. At times more than 50% of the total product cost is material.

Functions of Purchase Department

1.

Deciding the items to be purchased based on demand. 2. Selection of sources of supply.

3. Collection the price information. 4. Placing the ordered. 5. Follow-up the ordered. 6. Checking the invoices. 7. Maintenance of purchase records. 8. Maintenance of vendors relations.

PURCHASE PROCEDURE Purchasing procedure start with the initiation of purchase requisitions and ends with the receipt of materials in the stores.

CENTERIZED PURCHASING It is most important and relevant to large organizations operating deferent plants may or may not be located at different places. For a single place organization decentralization might be feasible on a very limited place. But where as M & M Ltd., is a multiple plants operating organization.

In Mahindra and Mahindra Centralized purchasing procedure is following to purchase of materials.

Centralized purchasing avoids duplications of efforts and working at cross purpose from one plant to another.

Centralized purchasing permits consolidation of order of materials commonly used for two or more plants. The ultimately results in greater buying power, favorable contracts and trade agreements.

Easier to maintain the quality of purchased parts / items through centralized testing and inspection. testing and inspection facilities. It is also possible to conduct

Centralized purchasing permits to avail facilities like quantity discounts and cash discounts thus its helps to reduce cost.

 It is beneficial to vendor also in case the size of order constituted major proportion of his total production capacity

INVENTORY MANAGEMENT TECHNIQUES

Based on order quantity

Based on the classification

Based on the records

ABC analysis

VED analysis

HML analysis

Aging schedule

Determination of stock level

Determination of stock

Economic order quantity

Inventory report

Inventory budget

ABC ANALYSIS:

ABC analysis classifies various inventory into three sets or groups of priority and allocates managerial efforts in proportion of the priority the most important item are classified into class -A, those of

intermediate importance are classified as "class-B" and remaining items are classified into class-C'. The financial manager has to monitor the items belonging to monitor the items belonging to different groups in that order of priority and depending upon the consumptions.

The items with the highest value is given top priority and soon and are more controlled then low value item. The re-rational limits are as follows.

Category

% of Items

% of total materials

A B C

5-10 10-20 70-85

70-85 10-20 5-10

Procedure:

(i) (ii)

Items with the highest value is given top priority and soon. There after cumulative totals of annual value of consumption are expressed as percentage of total value of consumptions,

(iii)

Then these percentage values are divided into three categories.

ABC analysis helps in allocating managerial efforts in proportion to importance of various items of inventory.

ECONOMIC ORDER QUANTITY:

After various inventory items are classified on the basis of the ABC analysis the management becomes aware of the type of control that would be appropriate for each of the three categories of the inventory items.

The determination of the appropriate quantity to be purchased in each lot to replenish stock as a solution to the order quantity problems necessitates resolution of conflicting goals. Buying in a higher average inventory level will assure.

(i) (ii)

Smooth production / sale operation and Lower ordering or setup costs. But it will involve higher

carrying costs. On the other hand small orders would reduc e the carrying cost of inventory by reducing the average inventory level but the ordering costs would increase, as there is a likelihood of interruption in operations due to stock-outs. A firm should not place either too high or small orders on the basis of a trade off between benefits derived from the availability of inventory and the cost of carrying that level of inventory, appropriate or optimum level of order to be placed should be determined. The optimum level of inventory is popularly referred to as the economic order quantity or economic lot size. It may be defined as that level of inventory order that minimizes the total lost associated with inventory management. It is based on some assumptions, which are restrictive.

a.

The firm knows with certainty the annual usage of a particular item of inventory.

b. c.

Rate at which the firm uses inventory is steady over time. The orders placed to replenish inventory stocks are received at exactly that point in time when inventories reach zero.

d.

EOQ can be illustrated by

(i) (ii)

Trial and error approach, Mathematical approach.

Trial and Error approach:

In this approach the procedure of procuring the inventory is assumed the smaller the lot the lower is average inventory and vice versa and high average inventory would involve high carrying costs. This approach is used for determination of EOQ uses different permutations and combinations of lots of inventory purchases so as to find out the least ordering and carrying cost combinations. The carrying cost and acquisition cost for different sizes of order to purchase inventories are computed and the order size with lowest total cost of inventory is EOQ.

Mathematical Approach:

The EOQ quantity can use a short-cut method calculated by following EOQ= EOQ
2AB C

Where,

A = Annual usage of inventory B = Buying cost per order C = carrying cost per unit

Limitations:

While using EOQ it should be noted that it suffers from shortcomings, which are mainly due to the restrictive nature of the assumptions on which it is based.

The important limitation is assumption of a constant consumption usage and, the instant replenishment of inventory is of doubtful validity

There may be unusual and unexpected demand for stocks to meet such [contingencies the firm has to keen additional inventories like safety stocks. Another weakness is to assume known annual inventories is open to question and there is likelihood of a discrepancy between the actual and expected demand leading to wrong estimate of EOQ.

VED ANALYSIS:

Vital Essential and Desirable analysis is done mainly for control of spare parts keeping in view of the criticality to production.

Vital spares are spare the stock-out of which even for a short time will stop production for quite sometime. Essential spares are spares the absence of which cannot be tolerated for more than a few hours a day. Desirable spares are those, which are needed, but their absence for even a week or so will lead to stoppage of production.

THE RE-ORDER LEVEL:

The re-order level is the level of inventory at which the fresh order for that item must be placed to procure fresh supply. The re -order level depends upon

a)

Length of time between the placement of an order and receiving the supply.

b)

The usage rate of the item. The inventory is constan tly being used up. The rate at which the inventory is being used up. The rate at which the inventory is being used

up is called the usage rate.

The reorder level can be determined as follows:

R = M+tu R = Reorder level M = Minimum level of inventory T = Time gap / delivery time U = Usage rate

The reorder level and inventory patterns have be shown as follows:

The figure shows that if the usage rate is constant, the orders are made at even intervals for the same amounts each time and the inventory goes to zero just before an order is received.

Safety Stock:

The safety stock protects firm from Trade offs due to unanticipated demand for the items level of inventory investment is however increased by the amount of safety stock. Safety level is ascertained in inventory as a part because there is always an uncertainty involved in time lag usage rate or other factor.

Usually smaller the safety level greater the risk of stock -outs. If stocklevels are predictable then there is a chance of stock out occurring. However stock inflows and outflows are unpredictable or lesser

predictable it becomes to carry additional safety stock to prevent unexpected stock outs so usage rate is estimated if cost is low then no safety stock is needed.

JUST-IN-TIME INVENTORY:

The basic concept is that every firm should keep a minimum level of inventory on hand, relying suppliers to furnish stock just in time as and when required. JIT helps in emphasizing sufficient levels of stocks to ensure that production will not be interrupted. Although the large inventories may be bad idea due to heavy carrying JIT is a modern approach to inventory management and the goal is essentially to minimize such inventories and there by maximizing the turnover.

JIT system significantly reduces inventory-carrying cost by requiring that the raw materials be procured just in time to be placed into production. Additionally the work in process inventory is minimized b y eliminating inventory is minimized by eliminating inventory buffers between different production departments.

If JIT is to be implemented successfully there must be a high degree of coordination and co-operation between the supplier and manufacturer and among different production centers. JIT does not appear to have any relation with EOQ however it is in fact alters some of the assumptions of EOQ model. The average inventory level under the EOQ model is defined as

Average inventory= 1/2 EOQ + safety level JIT attacks this equation in two ways. (i) (ii) By reducing the ordering cost By reducing the safety stock.

The basic philosophy in JIT is that the benefits, associated with reducing inventory and delivery time to a bare minimum through adjustment in the EOQ model; will more than offset the costs associated with the increased possibility of stock-outs.