Friday, 20 February 2015

Inventory Management Techniques

What is Inventory Management?
Inventory management is a process of managing and supervising the procurement, usage and maintenance of inventory (purchases and stocks) for benefit of the business. It is not a simple observance but includes efficient control and streamlining of the purchases, issues and storage of the goods with prudence and smart decision making skills.

Inventory management involves application of some efficient tools and techniques for a better control of the inventory.

So let us have a look at some of the most important tools and techniques employed in inventory management.

Employing Economic Order Quantity technique
I have already discussed about this method- what is the definition and method of applying this technique through the calculation of Economic order quantity as an equation of EOQ= square root of [{2DS} / H ] 
So, you can refer to that article for detailed understanding of this technique.

Applying ABC Analysis of Inventory technique
This is another popular method of inventory management. It is a kind of Pareto analysis applied in any type of business or studies conducted to categorise suppliers, customers, staff, places or activities into different groups of importance for dealing with them accordingly. ABC analysis of inventory implies the following steps and features.

  • In this technique, all items of inventory are categorized into 3 major groups of A, B and C according to their importance and significance for the business.
  • "A" group items are of most important significance as they constitute mostly costly and critical items for the running of business. 
  • C group of items are of least important and of very low cost items. 
  • B group consists of medium importance of items for running the business.
  • Once all items are categorized into these three groups, the top management can concentrate more on the A group of inventory and other groups of inventory can be managed at lower levels of supervisors.
  • This will enable more efficient control of inventory and thus minimise the costs and losses.
  • Generally "A" group items may constitute 10% to 20% of total number of items in quantity or to identify in value they may be about 60% to 70% of the total value of inventory.
  • "C" group items can be of 70% in number to the total quantity of items and may value less than 10% of the total inventory value.
Fixed Order Quantity technique
This fixed order quantity model technique can be applied mostly for high costly items like most important spares for plant and machinery without which your plant will stop running. So, you need to keep some stock of these items for emergency purpose. You may study the past trend of consumption for such items and estimate your requirement for a particular period, say one year. Then you will place order for these items irrespective of immediate requirement and keep them in stock.

Fixed Time Order technique 
When fixed time period inventory model is applied, you will be periodically placing orders at given intervals of time without waiting for requirement indents placed from departments. You will be fixing the intervals according to the consumption levels per week or month of these items, which mostly constitute general regular usage items of small values. These items will constitute mostly of tear and wear or use and throw items.

Cycle Counting technique
This is one more popular technique applied for better management of inventory. Popularly known as cycle counting in inventory management, this method employs physical counting of inventory items in small groups at various places of a ware house or stores of the business establishment instead of counting all inventory on a single day so as to facilitate normal running of the business activities.

In this process, goods are stored in small groups at different places with proper records maintained of receipts and issues. Periodical checking are done by counting the items and tallying with records. This will ensure efficient management of inventory without hindering production or business functions.

When to place purchase orders?
Placing purchase orders for replenishment of goods is one of the key factors of inventory management which needs to be prudently applied by inventory management. The inventory managers should be mostly efficient in calculating the correct time of when to place purchase orders.

  • A deep analysis of the consumption and purchase statistics of your business during a period of last 2 or 3 years can give you a correct picture of what are the requirements during a certain month or period for running the business. You can estimate how much is consumed during a certain interval of time.
  • So, you can frame up the quantity required of each item for a certain week or fortnight or a month as the case may be.
  • Now, you may enquire about the delivery period of these items and the time taken by the consignments in reaching your place. These details can be easily obtained from your suppliers and transporters or from your previous experiences.
  • Further, you must be able to calculate some extra grace period required in case of failures in systems of transportation or due to weather conditions and other factors that may occur. 
  • You may have to provide for sudden spurt in demand for your products thereby increasing your consumption of inventory.
  • You may have to think of shortages in stocks with suppliers or any other problems of suppliers that can affect your purchases being delayed.
  • So, when you will have to place an order depends on all these circumstances. You should add all these points to calculate your ordering times.

To sum up, an efficient inventory management involves great abilities of the inventory managers in foreseeing all factors that can affect your procurements and stocks and needs prudent and smart decision makings. So, efficient inventory manager will employ and consider combining all good points of all of the above mentioned techniques of inventory management to obtain maximum benefits.

Saturday, 14 February 2015

What is Economic Order Quantity and its application in Finance management

What is Economic Order Quantity?
Economic Order Quantity or EOQ is that quantity of any purchase order that is placed at each indent so as to add optimum units to the inventory at minimum overall costs. It is that ordering quantity which reduces the over all costs of inventory like ordering costs, holding costs and shortages or losses. 

What are the Inventory Costs?
Before studying How to calculate EOQ, let us know about the Inventory cost components. Inventory cost is made up of these following components.

  • Unit cost: This is the purchase price per unit of the item purchased.
  • Order Cost: This is the cost incurred in placing an order. It includes the transportation or shipment cost, handling charges and any other payments like octroi and toll tax, etc. incurred per each order.
  • Holding Cost: This is the storage cost incurred in keeping the stock like rent of the building or godown, insurance, interest paid or lost due to capital invested, salaries paid to stores staff and any other costs like refrigeration, maintenance, etc. incurred in storing the inventory.
  • Losses: This element of cost is due to shortages, damages to items during handling, or loss due to tear and wear of stocks. All these losses are to be borne by the business. So, they are included to the cost of stocks by increasing their unit cost.

How to calculate Economic Order Quantity?
EOQ is calculated using a formula EOQ = square root of {(2*D*S)/H}
Q is the Economic Order Quantity
D is the annual demand for quantity
S is the cost for placing an order known as order cost (some put is as K also)
H is the holding cost per unit and losses can be added to this holding cost

Let us consider an example.
Suppose, your business enjoys an annual demand of 1,000,000 bags of cement
Placing one order, say, costs $10 and let holding cost be $2 per 1000 bags or .002 per bag

Now, according to above formula, EOQ = the square root of {2*1000000*10 / .002}= square root of 
20,000,000/0.002 = square root of 20,000,000*1000/2 = square root of 10000, 000,000 = 100,000 bags
So EOQ is 100, 000 bags. You need to place orders for 100, 000 bags each time to maintain your inventory costs at lowest levels. So you will place total 10 orders in a year each being of 100,000 bags. 

The above is a sample for calculating Economic Order Quantity in a more or less reasonable sense. But there are some factors that may affect the accurate calculations in actual circumstances.

Factors affecting EOQ calculation
  • Employing EOQ formula assumes that prices are constant at a given period during the gap between calculation and its application.
  • It is assumed that orders are placed at exhaust of present inventory and it gets replenished immediately through immediate deliveries from suppliers.
  • It also assumes that interest rates and rentals do not change during the period.
  • It further assumes that demands are constant and there is no variation in the demanded quantity for that goods during that period.
A more prudent way of applying this EOQ method for better management
As we can not guarantee or get assured of changes in tastes and prices or any of the factors governing EOQ calculation, it will be more advisable for a good finance manager to check the calculations at frequent intervals to ensure its efficient application to manage inventories. If the initial calculations prove to be wrong or of no more feasible, you can change the calculations according to present circumstances and modify your orders to achieve minimal negative impacts due to the variations in factors controlling your Economic Order Quantity calculations.

Saturday, 7 February 2015

Inventory Control and its Importance

To know about inventory control, first let us know what is or what constitutes inventory.

What is Inventory?
Inventory is the stock of goods or resources at your disposal as on any time.It can be any raw materials, finished goods or products under process and at an incomplete stage and all the spares and accessories and store items that are at your disposal as at the time of your counting or valuation.

So, virtually whatever you held in stock for your consumption or reuse for production or for any purpose constitutes the stock. Inventory is this stock in terms of money value as at a particular date or time.

Now let us discuss about Inventory Control.

What is Inventory Control?
Inventory control is the process of supervising and controlling the procurement or supply,  storage and consumption of goods to bring efficiency in its utilization. It is a process of tracking the purchases, their maintenance and optimum usage so as to reduce costs, wastage and excess utilization.
Why the need for Inventory Control?
Inventory Control and inventory management is necessary for following reasons:

  • To ascertain that quality is maintained and utmost utilisation is done of each stock. 
  • To control unnecessary purchases thereby locking up your working capital unnecessarily.
  • To workout when to purchase, where to purchase and how much to purchase.
  • To avoid wastage due to wear and tear of stocks.
  • To facilitate proper and easy identification of stocks so as to avoid undue delays in production due to lack of knowledge of items or prevent wrong inputs and issues done.
  • To facilitate accurate stock valuation and disposal of obsolete items.
How Inventory Control is done?
A good inventory control system involves the following steps.
  1. First step in inventory control is proper identification of stocks item wise by allotting some number or nomenclature to each item. This is to be done by the technical department who have full knowledge of the usage of each item. They will inform the inventory staff how to identify and group items under different categories according to their usages. 
  2. Second step is to classify and group the items under different groups so that items required for a particular process or machine are stored at one place in various categories and sub categories. This will facilitate the issue of these items when that particular process or department places requirements.
  3. So each item is stored in a shelf or container labelled with its sub-category and all the subcategories of a particular main category are stored in a separate rack, cabin or room allotted for it with their name plates bearing the main category. This facilitates each location and identification at the time of storage and also at the time of issuance of items.
  4. Valuations can be easily done with this method. As you have to simply count the number of objects and multiply with its unit rate.
  5. Periodical checkings should be done by both technical and inventory control staff to ascertain that no errors are committed.
  6. Any destroyed or obsolete items should be disposed off during these checkings so that quality and standards are maintained and your books show correct values of usable items only. 

Wednesday, 4 February 2015

What is Management Information System and its need in Finance Management

Management Information System (shortly known as MIS) is a process which involves an organised and systematic approach to the study of data required by an organisation's management for making strategic decisions in order to facilitate an efficient control of the organisation at all levels.

The aim of MIS is to discover and implement smart processes and procedures for providing accurate and timely reports in suitable and required formats, periodically, to the management for a better management and control of the business.

This process involves in collection and analysis of various data in the form of statements and surveys. These statements are known as managerial information statements (or MIS in short). They are prepared through the mutual coordination of finance, accounts and all other departments.

Normally, most of the MIS statements are derived from preset formats of the computer software programmes. But some reports may also be prepared manually in their fixed formats. These formats are designed by the management with the consultation of all departmental heads.

Some of the kind of information provided to management can include the following reports which can be provided on Daily, Weekly and Monthly basis:-

  • Production Report (product-wise)
  • Labour Report (plant-wise engagement & total strength & cost of labour)
  • Stock Report (item-wise)
  • Sales Report (product-wise)
  • Debtors Report
  • Creditors Report
  • Process wise Cost Report
  • Cash Flow
  • Fund Flow
  • Budget & Actual expenditure comparison Report
  • Break Even Point statement
There can be many more reports and statements as per requirements of the management to control the business efficiently.

MIS for Financial Management

Finance Management involves efficient handling and management of finances of the company through constant vigilance and regular analysis of the inflow and outflow of funds.

The main aim of Finance Manager should be to minimise cost and maximise profit for the company. This is done through collection and comparison of various data related to the production processes of the company including sales, stock and funds utilisation.

  • Data relating to current period is compared with previous years' figures and deviations in results are to be explained with proper reasons.
  • Each item of deviation in performance needs to be located in the process and it is to be reported to the management and also to the related departments.
  • In this process, product wise cost sheets may also require to be prepared and deviation charts are to be performed.
  • Budget planning is also a part of MIS. Budgets are prepared by comparing past achievements and fixing a reasonable target for the current year on those results.
  • Fund management is done through analysis of Cash Flow and Fund Flow statements and through efficient Inventory Control methods.