THE INVENTORY CONCEPT

The Inventory Concept:

The dictionary meaning of the word inventory is “Stock of goods”. The term ‘Inventory’ refers to the commodities supplied to an undertaking for the purpose of consumption in the process of manufacture or for transformation into products.

To the finance executive, ‘Inventory’ can be taken as the value of raw materials, consumables, spares, work in progress and finished goods in which the company’s working capital funds have been invested.

Inventories constitute the most significant part of current assets of a larger majority of companies in India. On an average inventories are approximately 60% of current assets in public ltd companies in India. Because of the large size of inventories maintained by firms, a considerable amount funds is required to the committed to them. It is, therefore absolutely imperative to manage inventories efficiently and effectively in order to avoid unnecessary investment.

A firm neglecting the management of inventories will be jeopardizing its long run profitability and may fail ultimately. It is possible for a company to reduce its levels of inventories to a considerable degree, e.g.: 10 to 20 %, without any adverse effect on production and sales, by using simple inventory planning and control techniques.

The reduction in ‘excessive’ inventories carries a favorable impact on a company’s profitability

Classification of inventories

Classification of Inventories:-

The Inventories in an Industrial concern is generally classified as following:

·         Raw material Inventory - This is used in manufacturing. When the demand arises, they are drawn from stores and processed or use value is added during the process and finally finished product comes out.

·         Semi finished goods - When the material being processed, it may have to wait between two processes, such materials are known as semi finished goods or semi finished material or Work in process inventory.

·         Components - The parts used in assembly of product, are known as components. When these components are purchased from outside, it is known as bought out components or bought out material.

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·         Spare parts Inventory - When manufacturing or servicing facility breakdown, it is to be repaired. In such case, the defective or worn-out parts of the machine are to be replaced by new one. These new parts of the machine are known as spares or spare parts.

·         Obsolete Inventory - When any facility becomes unserviceable, and it is to be replaced by a new one, after replacing, the old machine/facility is to disposed. Such machines, which have become useless, are termed as obsolete inventory.

·         Waste, Scrap and Rejects - This type of inventory occurs in manufacturing firms or in service organizations. While processing material, chips are produced and it is of no use for the organization and it is to be disposed. Similarly, defective components, which cannot be reprocessed (rejects) and materials which cannot be used in any way in the organization (waste), all these are to be disposed. They may not be having any use value for the organization, but they may be reprocessed by some other organizations to produce a useful product.

NEED FOR HOLDING OPTIMUM INVENTORY

Need for Holding Optimum Inventory

Though inventory of materials is an idle resource (as they are not used immediately and stocked for future use), almost every business must maintain it for efficient and smooth running of its operations. If an enterprise has no inventory of material at all, on receiving a manufacturing order, it will have to place order for purchase of raw material, wait for arrival and receive of material and then start production.

            The customer will have to wait for a long period for the delivery of his product and may frustrated and turn to another manufacturer. Maintaining of inventory becomes necessary for the following reasons:.

·         It helps in smooth and efficient running of the production system and the enterprise. It decouples the production from the customers and vendors.

·         It provides services to the customers at a short notice. Timely deliveries may increase the goodwill of the company.

·         In the absence of inventory, the enterprise may have to pay very high prices because of piecemeal purchasing. Maintaining inventory may earn price discounts on bulk purchases. It also takes advantage of favorable market.

·         It reduces the product cost, since there is an added advantage of batch production and mass production runs.

·         It acts as a buffer stock when raw materials are received late and shop rejects are too many.

·         Bulk purchases reduce the number of orders and hence less clerical work.

·         It helps in maintaining economy by absorbing some of the fluctuations when the demand for an item fluctuates or is seasonal

MOTIVES FOR HOLDINGS INVENTORIES

Motives for Holdings Inventories

Economists have established three motives for holding inventories.

1. Transaction motive.
2. Precautionary motive.
3. Speculative motive.

1. Transaction motive – Firms may require holding certain amount of finished products perpetually in stock for display or demonstration purpose. They may also hold inventories to meet a sudden demand, thus reducing the delivery tags.

 

2. Precautionary motive – Firms may hold inventories for fear of stock outs and losing its goodwill. Some of the precautionary motives give rise to ‘safety stock’ to deal with uncertainty in supply and demand.

3. Speculative motive – A firm may also hold both raw materials and finished products when it expects a price in future, thereby realizing a stock profit. Inventories held for speculative motive are termed as profit-making inventory.

Of the three motives, Precautionary motive requires much attention. Besides accumulation of inventory due to the three motives mentioned above, inventories also get accumulated because of inefficient management of working capital. This type of inventory is called, Flabby inventory.

OPERATING OBJECTIVE

OBJECTIVES OF INVENTORY MANAGEMENT

The objectives of the inventory management are discussed under two heads:

Ø  Operating objectives.

Ø  Financial objectives.

OPERATING OBJECTIVES: -   The operating objectives of inventory management is further divided as follows:

• Availability of materials: - The first and the foremost of inventory management is make all types of materials available at all times they needed by the production departments. So that the production may not be held up for want of materials. It is therefore advisable to maintain the minimum quantity of all types of materials to move on production schedule.

• Minimizing the wastage: - Inventory management has to minimize the wastage at all levels that is during its storage in the go downs or at work in the factory. Normal wastage, in other words uncontrollable wastage, should only be permitted.

• Promotion of manufacturing efficiency: - The manufacturing efficiency of the enterprise increases if right types of raw material are made available to production department at the right time. It reduces wastage & cost of production & improves the moral of workers.

• Better service to customers: - In order to meet to the demand of the customers, it is the responsibility of inventory management to produce sufficient stock of finished goods to execute the orders received from customers.

• Optimum level of inventories: - Proper control of inventories helps management to procure materials in right time in order to run the plant efficiently. Maintaining the optimum level of inventories keeping in view the operational requirements avoids the out of stock danger.
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FINANCIAL OBJECTIVES: - The Financial objectives of Inventory management is further divided as follows –

·         Economy in purchasing: - Proper inventory management system brings certain advantages and economies in purchasing the raw materials. Management makes every attempt to purchase raw materials in bulk quantity and to take advantage of favorable market conditions.

• Optimum investment and efficient use of capital: - The primary objective of inventory management, from financial point of view, is to have an optimum level of investment in inventories. Inventory management has to setup minimum and maximum levels of inventories to avoid deficiency or surplus stocks.

• Reasonable prices:- Inventory management has to ensure the supply of raw materials at a reasonable low price, but without sacrificing the quality it helps to reduction of cost of production and improvement in the quality of finished goods in order to maximize the profits of the organization

• Minimizing the costs: - Minimizing inventory costs such as handling, ordering and carrying costs etc is one of the main objectives of inventory management. It helps in reduction of inventory costs in a way that it reduces the costs per unit of inventory and there by reduction of total cost of production.