The techniques or the tools generally used to effect control over the inventory are the following:
1. Budgetary techniques for inventory planning
2. A-B-C. System of inventory control
3. Economic Order Quantity (E.O.Q.) i.e., how much to purchase at one time economically
4. VED Analysis
5. Perpetual inventory system and the system of store verification
6. Fixation of Stock Level
7. Control Ratios
1. 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.
2. A-B-C Analysis: 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.
3. 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:
4. 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.
5. 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:
i) It requires more efforts to maintain inventory under this method.
ii) Quantity balances shown by the store ledger and bin cards are reconciled.
iii) A number of items are physically checked systematically and by rotation.
iv) The method is comparatively costly as compared to periodical inventory system.
v) Store ledger and bin cards keeps inventory record up-to date and decent.
vi) 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.
vii) Causes for difference between physical balances and book balances can be explored.
viii) Making corrective entries in case of discrepancies.
Advantages of Perpetual Inventory System
A) Easy detection of errors: Errors and frauds can be easily detected at an early date. It helps in preventing their occurrence.
B) 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.
C) No interruption of production process: Production process is not interrupted as the physical verification of stock is made on a planned and regular basis.
D) 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.
E) 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.
F) Early detection of loss of stock: Loss of stock due to shrinkage, evaporation, accident, fire, theft, etc. can be easily detected.
G) 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.
H) Easy to prepare interim accounts: It is possible to prepare periodical profit and loss account and balance sheet without physical stock-taking being made.
i) Availability of correct stock data- Correct stock data is readily available for settlement of insurance claims.
6) 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.
7) Control Ratios: The control ratios are mainly two:
a) Inventory Turnover Ratio which we have studied and
b) 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.
ii. 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.