inventory-a key to control

DEFINITION:
 The perpetual inventory system is intended as an aid to material control. It is a system of stock control followed by stores department. The system follows a method of recording stores by which information about each receipt, issue and current balance of stock is always available.
The Institute of Cost and Management Accountants of England and Wales, defines perpetual inventory as "A system of records maintained by the controlling department, which reflects the physical movement of stocks and their current balances."
According to Weldon, "Perpetual inventory system is a method of recordings stores balances after every receipt and issue, to facilitate regular checking and obviate closing down of work for stock-taking."
Thus, it is a system of ascertaining current balance after recording every receipt and issue of materials through stock records. An important point which should be kept in mind is that the perpetual inventory is usually checked by a programme of continuous stock-taking. Perpetual inventory means the system of it cords whereas continuous stock-taking means the physical checking of those records with actual stocks. '

OBJECTIVES OF INVENTORY

1) Meet Demand

Effective inventory control ensures that products demanded by customers are available for sale when the customer is ready to purchase. This function requires careful coordination with the marketing efforts of the business to make sure that adequate stock is on hand during sales promotions and for gathering sales data over time to anticipate seasonal demand. The process is a delicate balancing act that takes into account likely demand, storage costs, transportation lag times and quantity discounts to identify appropriate stock levels

2) Control Costs

Inventory is a cost that must be carefully managed. Storage costs and available warehouse space are very real constraints. Even if the purchasing department can buy a large amount of stock at a low price, it may not make sense because the cost of storing the additional inventory may outweigh the savings.
Product turnover is another important consideration. Inventory items that sell quickly will require more warehouse space and a larger inventory to ensure availability. Those products that sell infrequently or make up a small part of the company's profit should be stocked at a lower lever.
Product availability and transit time from the vendor play an important role in determining inventory levels. If a fast-selling product is readily available and can be delivered from the vendor quickly and reliably, then it makes sense to maintain a lower level of inventory. On the other hand, if the product is only sporadically available or can't be delivered quickly or reliably it may make sense to increase inventory levels. Ideally, inventory levels should be maintained at the minimum level possible while still being able to meet every order.

3) Identify Opportunities

Effective inventory management gives business managers a window into the operation of the business. The data collection component of inventory management provides valuable information that can be used to find opportunities for savings on purchases, periods of peak demand, eliminating unprofitable product lines, and focusing on product lines that sell well. Over time, inventory data can be used by the marketing department to identify those products that are the most profitable so they can focus their promotion efforts more accurately.

OTHER OBJECTIVES

1. To keep inventory at sufficiently high level to perform production and sales activities smoothly.
2. To minimize investment in inventory at minimum level to maximize profitability.
3. To ensure that the supply of raw material & finished goods will remain continuous so that production process is not halted and demands of customers are duly met.
4. To minimize carrying cost of inventory.
5. To keep investment in inventory at optimum level.
6. To reduce the losses of theft, obsolescence & wastage etc.
7. To make arrangement for sale of slow moving items.
8. To minimize inventory ordering costs.

TYPES OF INVENTORIES

Basically there are two types of inventories
1. Periodic or physical inventory
2. Perpetual inventory

Periodic Order Method

The periodic order method requires that order dates be fixed so that there are equal operating periods between order dates. Ordering may be done weekly, biweekly, or on any other regular schedule, depending on the decisions of management with respect to such considerations as frequency of ordering, storage space to be devoted to beverages, and funds available for inventory purchases, as well as on purveyors’ delivery schedules and the anticipated consumption of beverages.
Determination of anticipated consumption is a key element:
The person who sets order quantities must have some reasonable knowledge of the quantity of each beverage that is likely to be consumed in the interval between fixed order dates. There are two ways to determine this. The first, and by far the best, is to have records of the quantity of each beverage consumed during one such period. If bar requisitions of the type discussed in the following chapter are used, it is comparatively easy to determine quantities consumed. Without bar requisitions, some appropriate record-keeping system must be set up for one period. The second method is simply to estimate consumption, based on one’s experience in the particular operation, experience in other similar operations, or both of these.
Having established for each beverage the anticipated consumption for a particular period, one increases that number by an amount that will allow for such unanticipated occurrences as increases in business volume, time required to receive delivery, and possible delay in receiving delivery. Some multiply the usage figure by 150 percent; others use some other percentage. Many round the results to whole case lots for pouring brands and any other beverages accounting for high volume. In the periodic system, the number so determined for each beverage item is defined as the par stock for that item—the maximum quantity of the item that should be on hand at any given time.
There are thus two figures established for each beverage: anticipated usage and par stock. For each item in the inventory, both of these figures should be recorded on a label affixed to the shelf where the item is kept in the beverage storeroom. An example of such a shelf label is given. On the established date for placing orders, the individual responsible for determining purchase quantities reviews the entire beverage inventory in an orderly manner to determine the correct purchase quantity for each item in the inventory. This is done by means of the following standard procedure:

shelf label 

1. Count the inventory (the number of units on the shelf).
2. Subtract the inventory from the par stock figure on the shelf label.
3. Obtain the purchase quantity, which is the result of the previous subtraction.
Referring to the information provided on the shelf label, if there were 24 units of Relska vodka on the shelf, that number would be subtracted from the par stock figure, 72, to determine the proper order quantity: 48 units, or four cases.
                                Par stock         72
                 - Current inventory 24
                               =Purchase quantity 48
If the actual usage is the same as the usage figure on the label, the purchase quantity determined in this manner will be the same as the usage figure. If the subtraction results in a purchase quantity that is substantially different from the usage figure on the label, that is the signal that actual usage is not as anticipated and that the figures on the shelf label must be reviewed for possible change.
For example, if one finds 42 units of vodka on the shelf, the order quantity would appear to be 30. However, the fact that there are 42 units on the shelf means that usage has been considerably less than anticipated; thus, one should assess the need for a par stock of 72. Unless the decrease in the number of units consumed is a temporary phenomenon, par stock and usage figures on the label should be changed for future periods. In general, if the number of units in inventory on a given order date differs markedly from the difference between par stock and usage, the adequacy of these two figures for purchasing purposes must be reviewed.

Perpetual Order Method

The perpetual order method requires fixed purchase quantities and variable order dates. Its use depends on the establishment of a perpetual inventory system for beverages, with paper perpetual inventory cards on which all purchases and issues are recorded carefully and in a timely manner. Today, perpetual inventory records are more likely to be in a computer database. The perpetual inventory is normally maintained in a location other than the beverage storeroom. However, as an alternative, some managers attach perpetual inventory cards to the shelves on which the beverages are stored. To use the perpetual order method, several key figures must be established and recorded on the cards: par stock, reorder point and reorder quantity. As previously indicated, par stock is the maximum quantity that may be on hand at any given time. It takes into account the storage space to be allocated to the item, the desired frequency of ordering, anticipated usage, and a safety factor to cover such considerations as unanticipated increases in quantities consumed. Reorder point is the number of units to which inventory should decrease before an order is placed. It must take into account the time required to obtain delivery of the order. Reorder quantity is the amount that should be ordered each time an order is placed. It is calculated by subtracting the reorder point from par stock and adding the number of units consumed between order date and delivery date.
Figure below illustrates perpetual inventory card for a pouring gin in a restaurant open seven days a week. The card indicates that this gin is consumed at the rate of approximately five bottles per day. Management has determined that orders are to be placed at approximately two-week intervals, and experience has shown that it takes five days to obtain delivery. Therefore, par stock is calculated as follows.
5 bottles per day x 14 days x 150%
(to include a safety factor) = 105 units
This is rounded to 108 bottles—an even nine cases. Reorder point is determined by multiplying the number of units used in the five days required for delivery—25—by 150 percent to include a safety factor and rounding to the nearest whole case. Reorder quantity is determined by subtracting the reorder point from par stock and then adding the number of units used in the five-day period before receiving delivery. The standard procedures suggested here for determining order quantities assume that supplies of the needed items are readily available. Although this is normally true for all mixers, most spirits and beers, and many wines, it is not universally true for all beverages. There are a number of complicating factors. For example, some wines (especially vintage wines, both imported and domestic) may be unavailable at any given time, and this unavailability may be either temporary or permanent. In some control states, supplies of various items may not always be adequate to fill an order completely, making adjustments necessary. The beverage buyer must be prepared to meet contingencies as they arise and must be able to deviate from established purchasing procedures when required. Sometimes one can anticipate problems, as with particular wines that one knows will be available at an appropriate price for only a short time. This is sometimes the case with fine wines. In such instances, one must be prepared to place one order for the total amount required over a very long period, possibly several years.

perpetual inventory card

IMPORTANCE OF INVENTORY

a) As there is an element of surprise check in this system of stock-taking, effective control over the items of stores can be exercised. The system does not necessitate the closing down of the stores to facilitate stock-taking. There is also less possibility of fraud and discrepancy, but the method is expensive and is adopted by big concerns only.
b) Easy detection of errors - Errors and frauds can be easily detected at an early date. It helps in preventing their occurrence.
c) 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.
d) No interruption of production process- Production process is not interrupted as the physical verification of stock is made on a planned and regular basis.
e) 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.
f) 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.
g) Early detection of loss of stock- Loss of stock due to shrinkage, evaporation, accident, fire, theft, etc. can be easily detected.
h) 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.

i) Easy to prepare interim accounts- It is possible to prepare periodical profit and loss account and balance sheet without physical stock-taking being made.
j) Availability of correct stock data- Correct stock data is readily available for settlement of insurance claims.

Disadvantages of excessive Stock are avoided - 

The following disadvantages of excessive stock are avoided:
(a) Loss of interest on capital locked up in stock.
(b) Loss through deterioration.
(c) Risk of obsolescence.
(xi) Employment of specialised staff - Since the work is spread throughout year, whole time specialised staff can be engaged for the purpose.
(xii) Moral check on employees - The system acts as a moral check on the employees working in the stores which increases their efficiency.
Such losses increase the cost of production. These losses may be in the form of wastage scrap, defective and spoilage. The problems of waste, scrap, spoilage or defectives materials must arise in almost all manufacturing industries. There is no uniformity the meaning and accounting treatment of waste, scrap, spoilage and defective However, steps should be taken to minimise the discrepancy so that efficiency can increased and proper material control is ensured.

INVENTORY CONTROL MODEL 

inventory control model

• In a stabilized production operation inventory of an item is controlled in such a way that:
• There is a minimum stock at any time.
• That material should never cross the maximum level.
• These levels are fixed with the help of operations staff in the plant based on historical data and the expected requirements of materials keeping in view the condition of the plant and machinery
• Crossing the maximum level means over stocking.
• When the inventory level goes below the minimum level, it could result in stock out.
• A reorder point is set in between these two set points i.e. the maximum and the minimum level of inventory.
• Order for material is placed at the reorder point is reached.
• The reorder point is set in such a manner that ordered material is received before the stock level reach the minimum stock level.
• An order is placed for the working quantity of the material.
• The working quantity is received at the end of the lead time, and when the inventory has reached to the minimum level.
• On receipt of material, the stock level of inventory jumps to the maximum level.

INVENTORY CONTROL CONCEPT

• Materials kept in the warehouse are known as inventory.
• These may include raw materials and spare parts and consumables.
• Materials are issued for use when needed.
• There should not be any shortage of materials when needed.
• Excess of materials in the stores is also not desirable.
• Control on the quantity of each item in the inventory is known as inventory control .
• Inventory control is to maintain inventory items in such a quantity that the items in the inventory do not remain in stock for long and has high turnover.
• Inventory should not block the useable financial resources.
• Inventory items should be in sufficient in quantity:
• so that they are available when needed and do not results in loss of production
• Do not delay in repair and maintenance of the machines.
• Cost of inventory is another aspect and is to be kept low by purchasing right quantity at right price and at right time.
• Inventory control is used as a tool for cost reduction

ASSUMPTION IN INVENTORY CONTROL

• The consumption of inventory is at a uniform rate through out the cycle,
• The order is placed when the inventory level reaches the reorder point.
• The ordered quantity is received by the time inventory level reaches to the minimum level.
• The lead time does not change between reorder point and the point when inventory reaches the minimum level when fresh quantity is received.
• However, in real life situations there are variations in each condition due to both internal and external factors and inventory controller has to review the situation regularly.

ELEMENTS OF INVENTORY CONTROL

1. Minimum stock level.
2. Maximum stock level.
3. Safety stock level
4. Reorder level.
5. Lead time.

MINIMUM STOCK LEVEL

• It is the level below which the inventory level is not allowed to fall.
• If the level of inventory is below this level, there are chances that plant operations are adversely affected.
• As soon as the stock level reaches the minimum level for any reason:
• The matter is to be reported to the higher management immediately
• Extra efforts are made or additional resources are deployed to ensure that the material is received at the earliest.
• What is done?
o The item could be received by faster mode of transport say by air or by courier service in place of sea or rail or is purchased from any other source even at a higher cost.
• Minimum level is an indication of the danger and provides alert for stock out situation.

MAXIMUM STOCK LEVEL

• It is the inventory level, beyond which the stock level is not allowed to exceed.
• The maximum level is used as a control point to avoid any extra stocks.
• Order quantity for material is controlled in such a way that when the material is received the inventory level is below the maximum level.
• However, at times the maximum level is crossed:
• To avail benefits of  attractive discounts,
• Saving on the transportation/freight charges,
• Due to strategic buying decision.
• The maximum level if crossed with prior evaluation of overall benefits is a correct approach.
• If it  crossed due to lack of control, the matter should be viewed seriously.
• Failure to control the maximum level may result in non-moving or slow moving items and in some cases obsolete items.
• Inventory turnover would be adversely affected if maximum level is not controlled.
• Maximum level is fixed by taking into consideration the lead time for the item.

SAFETY STOCK

• Safety stock is the level of inventory which is to be maintained always to take care of unforeseen factors such as:
• Delay in ordering,
• Delay in supply by supplier,
• Delay in transportation
• Hindrances' in execution of orders by the supplier, which may be beyond his control like war, flood or strike.
• A very high degree of safety would need high level of inventory,
• A low degree of safety would require low inventory stock.
• Safety stock follows the path of ‘S’curve.
• Higher level of inventory is to be maintained for high level of safety and blocking of financial resources:
• The safety level is decided depending on:
o The criticality of the stoppage of operations,
o Reliability of source of supply,
o Location of supplier
o Number of sources of supply.
• The desired safety level of inventory level then determine the ‘Safety Stock’.
• Normally, most of the organizations maintain safety stock equal to minimum stock level.

safety curve

Reorder Point

• Reorder point is important tool for controlling inventory and to ensure that there is no stock out.
• Reorder point is dependant on lead time.
• It is set in such a manner that if order is placed at reorder point, the material is received by the time the inventory level reaches minimum stock level.
• Reorder point shifts with the change in rate of consumption and is set based on average yearly consumption.
• The lead time if changes, the reorder point should be adjusted.
• In practice, the reorder point is established quite correctly based on:
o Past experience,
o Rate of consumption
o Lead time.
o Reorder point is normally calculated by computer automatically.

factor influencing inventory control

• An operating plant faces new problems every time, which have an impact on inventory control activities.
• Rate of consumption of materials, order quantity, reorder point and lead time undergo changes for one or the other reasons and disturb the theoretical inventory control model.

INCREASE IN INVENTORY LEVEL DUE TO SHORTER LEAD TIME THAN THE SCHEDULED LEAD TIME

SHORTAGE OF INVENTORY DUE TO LONGER LEAD TIME THAN THE SCHEDULED LEAD TIME

calculation of minimum,mas,reorder point

effect of lower rate of consumption

effect of lower rate of consumption