Significance/Advantages of Inventory control
1. Protects from fluctuations in demand: There are always chances of fluctuations in the demand of a material. These fluctuations can be adjusted if there are sufficient items in the stock of inventory. Therefore, proper inventory control protects the company from fluctuations in demand.
2. Better services to customers: If the company maintains a proper inventory of raw-materials, then it can complete its production in time. So, it can deliver the finished goods to the customers in time. Similarly, if the company has a proper inventory of finished goods, then it can satisfy the additional demand of the customers.
3. Continuity of production operations: Proper inventory control helps to maintain continuity of production operations. This is because it maintains a smooth flow of raw materials. So, there are no shortages of raw-materials required for production process.
4. Reduces the risk of loss: Proper inventory control helps to reduce the risk of loss due to obsolescence (outdated) or deterioration of items. This is because it checks all the items regularly.
5. Minimizes the administrative workload: Proper inventory control helps to minimize the administrative work load of purchasing, inspection, warehousing, etc. This will reduce the manpower requirement and will minimize the labour cost too.
6. Protects fluctuation in output: Inventory control tries to reduce the gap between planned production and actual production. There are cases where the production schedule cannot be followed because of Sudden breakdown of machines, Problems in supply of materials, Sudden labour strikes, Loss due to failure of power supply, etc. In such cases, the difference between planned production and actual production can be bridged by inventories held in stock.
7. Effective use of working capital: Proper inventory control helps to make effective use of working capital. Inventory control helps in maintaining the right amount of stocks of materials, components, etc. Over stocking is avoided. Therefore, the working capital will not be blocked in excess inventory.
8. Check on loss of materials: Inventory control helps to maintain a check on the loss of materials due to carelessness or pilferage. If there is no proper inventory control, then there are more chances of carelessness and pilferage by the employees, especially in the store-keeping department.
9. Facilitates cost accounting activities: Inventory control facilitates cost accounting activities. This is because, inventory control provides a means of allocating materials cost of products, departments or other operating accounts.
10. Avoids duplication in ordering: Inventory control avoids duplication in ordering of stock. This is done by maintaining a separate purchase department.
Inventory Control Techniques
The techniques or the tools generally used to effect control over the inventory are the following:
a) Budgetary techniques for inventory planning;
b) A-B-C. System of inventory control; (SHORT NOTE)
c) Economic Order Quantity (E.O.Q.) i.e., how much to purchase at one time economically; (SHORT NOTE)
d) VED Analysis;
e) Perpetual inventory system and the system of store verification; (SHORT AND BROAD QUESTION)
f) Fixation of Stock Level;
g) Control Ratios.
a) Budgetary Techniques: For the purchase of raw materials and stocks, what we required is a purchase Budged to be prepared in terms of quantities and values involved. The sales stipulated as per sales Budget of the corresponding period generally works out to be the key factor to decide the production quantum during the budget period, which ultimately decides the purchases to be made and the inventories to be planned.
b) ABC Analysis: ABC System: In this technique, the items of inventory are classified according to the value of usage. Materials are classified as A, B and C according to their value.
Items in class ‘A’ constitute the most important class of inventories so far as the proportion in the total value of inventory is concerned. The ‘A’ items constitute roughly about 5-10% of the total items while its value may be about 80% of the total value of the inventory.
Items in class ‘B’ constitute intermediate position. These items may be about 20-25% of the total items while the usage value may be about 15% of the total value.
Items in class ‘C’ are the most negligible in value, about 65-75% of the total quantity but the value may be about 5% of the total usage value of the inventory.
The numbers given above are just indicative, actual numbers may vary from situation to situation. The principle to be followed is that the high value items should be controlled more carefully while items having small value though large in numbers can be controlled periodically.
Advantages of ABC analysis
a) Reduction in investment:under ABC analysis, the materials from group 'A' are purchase in lower quantities as much as possible. With this, the effort to reduce the delivery period is also made. These in turn help to reduce the investment in material.
b) Optimization of Inventory management function: Each class of the inventory gets management attention as per its value and accordingly, manpower is allocated and expenses are incurred to manage it. It ensures that most important items are regularly monitored and closely observed whereas such efforts are expended with for the less important items.
c) Control on high value material:under ABC analysis, strict control can be exercised to the materials in group 'A' that have higher value.
d) Reduction in Storage cost:Since Class “A” material is of high value and are purchase in lower quantities as much as possible, it reduces the total storage cost.
e) Saving in time and cost: Since a signification effort is made for management of the material from group 'A', it helps to save time as well as cost.
f) Opportunity to convert Class B items into Class A: As Class B items hold potential for growth, the business may tap into this opportunity and convert it frequent yet low-value customers into regular, high-value customers to Class A.
Disadvantage of ABC analysis
a) No Proper classification of material: ABC analysis will not be effective if the material are not classified into the groups properly.
b) Not suitable if materials are of same value: It is not suitable for the organization where the costs of materials do not vary significantly.
c) No scientific base: There is no any scientific base for the classification of material under ABC analysis.
d) Not suitable for small organisation: The classification of the materials into different groups may lead to extra cost. Hence, it may not be suitable for small organization.
c) Economics order quantity: Economics order quantity represents the size of the order for which both order, ordering and carrying costs together are minimum. If purchases are made in large quantities, inventory carrying cost will be high. If the order size is small, ordering cost will be high. Hence, it is necessary to determine the order quantity for which ordering and carrying costs are minimum. The formula used for determining economics order quantity is a s follows:
d) VED Analysis: VED – Vital, Essential, Desirable – analysis is used primarily for control of spare parts. The spare, parts can be divided into three categories – vital, essential or desirable – keeping in view the critically to production.
e) Perpetual Inventory System: Perpetual Inventory system means continuous stock taking. CIMA defines perpetual inventory system as ‘the recording as they occur of receipts, issues and the resulting balances of individual items of stock in either quantity or quantity and value’. Under this system, a continuous record of receipt and issue of materials is maintained by the stores department and the information about the stock of materials is always available.
Entries in the Bin Card and the Stores Ledger are made after every receipt and issue and the balance is reconciled on regular basis with the physical stock. The main advantage of this system is that it avoids disruptions in the production caused by periodic stock taking. Similarly it helps in having a detailed and more reliable check on the stocks. The stock records are more reliable and stock discrepancies are investigated and appropriate action is taken immediately.
Salient features of perpetual inventory system
- It requires more efforts to maintain inventory under this method.
- Quantity balances shown by the store ledger and bin cards are reconciled.
- A number of items are physically checked systematically and by rotation.
- The method is comparatively costly as compared to periodical inventory system.
- Store ledger and bin cards keeps inventory record up-to date and decent.
- The method applies to those concerns usually that sell high-value items (Such as car, personal computer, equipments etc.) not at a large quantity as compared to items under periodic system.
- Causes for difference between physical balances and book balances can be explored.
- Making corrective entries in case of discrepancies.
- Removing the causes of discrepancies between physical quantities and book balances.
Advantages of Perpetual Inventory System
- Easy detection of errors - Errors and frauds can be easily detected at an early date. It helps in preventing their occurrence.
- Better control over stores- The system exercises better control over all receipts and issues in such a manner so as to give a complete picture of both quantities and values of stock in hand at all times.
- No interruption of production process- Production process is not interrupted as the physical verification of stock is made on a planned and regular basis.
- Acts as internal check- Under the system, records are made simultaneously in the bin cards and stores ledger accounts which acts as a system of internal check for detection of errors as and when they are committed.
- Investment in materials kept under control - The investment in materials is kept at a minimum level as the actual stock is continuously compared with the maximum level and minimum level.
- Early detection of loss of stock- Loss of stock due to shrinkage, evaporation, accident, fire, theft, etc. can be easily detected.
- Accurate and up-to-date accounting records- Due to continuous stocktaking, the store-keeper and stores accountant become more vigilant in their works and they maintain accurate and up-to-date records.
- Easy to prepare interim accounts- It is possible to prepare periodical profit and loss account and balance sheet without physical stock-taking being made.
- Availability of correct stock data- Correct stock data is readily available for settlement of insurance claims.
f) Fixation of stock level: The object of fixing stock levels for each item of material is to maintain required quantity of materials in the store and thereby the expenses may be reduced. The different stock levels are:
(1) Minimum stock level
(2) Maximum stock level
(3) Reorder stock level
a) Minimum stock level: It represents the minimum quantity of an item of material to be kept in the store at any time. Material should not be allowed to fall below this level. If the stock goes below this level, production may be held up for want of materials. This stock is also known as safety stock level or buffer stock.
b) Maximum stock level: It is the stock level above which stock should not be allowed to rise. This is the maximum quantity of stock of raw materials which can be had in the stock. It is goes above, it will be overstocking.
c) Reorder stock level: It is the point at which the storekeeper should initiate purchase requisition for fresh supply. This level lies between the maximum level and the minimum level.
d) Control Ratios: The control ratios are mainly two:
- Inventory Turnover Ratio which we have studied and
- Input-output Ratio.
- Inventory Turnover: Inventory Turnover is a ratio of the value of the materials consumed during a period to the average value of inventory held during that period.
If the inventory turnover rate in terms of value of materials is high, or if the length of the inventory turnover period is short, the material is said to be fast moving. So if the rate of consumption is fast or if the inventory turnover rate is good, it is a healthy measure of efficiency of materials control, as the capital employed is properly utilized.
- Input-output Ratio: The Input-output Ratio is the ratio of the raw material put into manufacture and the standard raw materials content of the actual output. This ratio enables one to find out whether the usage of the materials is favourable or not. A standard ratio of input of materials and output of material should be determined and the actual ratio should be compared with the standard ratio.
Also Read: Important Questions for Upcoming Exam
Unit – 2: Material Control – Purchase and Issue (Part A)
(These Questions are subject to modification, if necesary. Download DTS Application for complete notes)
Q. What do you mean by Inventory Control (2017SN)? What are its objectives (Need)? Explain the essentials of Material Control. 2014, 2015SN
Q. What are various techniques of Inventory Control? Explain them in detail. 2015SN, 2018
Q. Explain various methods of pricing of material issue together with their respective merits and demerits. 2013, 2015SN
Q. What do you mean by Perpetual Inventory system (2013SN)? What are its essential features? Explain its importance in material control. 2016
Q. How Perpetual Inventory System differs from ABC analysis? State the advantages ofABC analysis. 2017
Q. Explain in brief the process of purchasing and receiving goods.
Q. “Store ledgers are essential to an efficient costing system”. Considering this statement highlight the uses and values of store ledgers. Distinguish between Store ledger and Bin Card (2015SN).
Q. Write Short notes on:
Ø EOQ and its calculation 2010, 2015
Ø ABC analysis differs from VED analysis 2013, 2014, 2016SN, 2019SN
Ø Perpetual (2018SN) and Periodical Inventory System
Ø Materials Losses, Scraps, Defectives and Spoilage
Q. Practical Questions:
a) Calculation of EOQ with offer comparison, 2012
b) Various levels of material – Reorder level, maximum level, minimum stock level. 2014
c) Pricing of material issue – LIFO, FIFO, Weighted average and Simple average (focus of return and loss of goods). 2019
Difference between ABC analysis, Perpetual Inventory system and VED analysis
| ABC analysis |
Perpetual Inventory System |
VED analysis |
| Its main objective is to reduce the investment in material. |
Its main objective is physical verification of all items. |
Its main objective is to prevent stoppage of production due to shortage of essential material. |
| In this system, stocks are classified on the basis of value. |
There is no classification of stock. |
The analysis classifies items on the basis of their criticality for the industry or company – vital, essential and desirable. |
| It will not pay equal attention to all types of inventory. |
Equal attention is given to all types of inventory. |
More attention is given to essential inventory. |
| ABC analysis is applicable when there is small variety of stock. |
This system is applicable whether or not stocks are of large varieties or small varieties. |
VED analysis is specially applied in the case when there is a large variety of stocks such as spare parts inventory, medical stores etc. |
| Store ledger and bin card is not prepared in this analysis. |
Store ledger and bin card is prepared in this system. |
Store ledger and bin card is not prepared in this analysis. |
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