Accounting - Inventory contro l, Study notes of Accounting

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What is Inventory

 Inventory :

It is a list for goods and materials, or

those goods and materials themselves, held

available in stock by a business.

Reasons for Keeping Inventory

 (^) Time - The time lags present in the supply chain, from supplier to user at every stage, requires that you maintain certain amount of inventory to use in this "lead time“

 (^) Uncertainty - Inventories are maintained as buffers to meet uncertainties in demand, supply and movements of goods.

 (^) Economies of scale - Ideal condition of "one unit at a time at a place where user needs it, when he needs it" principle tends to incur lots of costs in terms of logistics. So bulk buying, movement and storing brings in economies of scale, thus inventory.

What is Inventory Control

It is concerned with minimizing total cost of inventory. The most important objective of inventory control is to determine & maintain an optimum level of investment in an inventory.

Techniques of Inventory Control

1. Economic order quantity (EOQ)
2. Recorder Level
3. Minimum Inventory Level.

EOQ

 (^) An inventory-related equation that determines the optimum

order quantity that a company should hold in its inventory given a set cost of production, demand rate and other variables. This is done to minimize variable inventory costs

Recorder Level

Recorder Level:A level of stock at which a replenishment order should be placed. Traditional "optimizing" systems use a variation on the computation of maximum usage multiplied by maximum lead, which builds in a measure of safety stock and minimizes the likelihood of a stock out.

Minimum Inventory Level

Minimum Inventory Level:In order to meet the need of inventory when it is required hence arises the need for providing for some safety stock i.e., some minimum or buffer as inventory as a cushion against stock outs.

 (^) That means making the connections and understanding the relationships between given inputs – the resources brought to bear – and the outputs and outcomes that they achieve. It is also about understanding and actively managing risks within the organization and its activities.

 (^) This goes beyond the traditional preoccupation with budgets – how much have we spent so far, how much have we left to spend? It is about helping the organization to better understand its own performance

Safety Stock

 (^) Safety stock is defined as extra units of inventory carried as

protection against possible stockouts .(shortfall in raw material or packaging)

 (^) By having an adequate amount of safety stock on hand, a

company can meet a sales demand which exceeds the demand they forecasted without altering their production plan. It is held when an organization cannot accurately predict demand and/or lead time for the product. It serves as an

insurance against stockouts.

 (^) Service level: the desired probability that a chosen level of safety stock will not lead to stock-out. Naturally, when the desired service level is increased, the required safety stock increases as well.

 (^) Forecast error: an estimate of how far actual demand may be from forecasted demand. Expressed as the standard deviation of demand.

Formula for safety stock

 (^) Safety Stock =

*{Z * SQRT(Avg. Lead Time * Standard Deviation of Demand ^2 + Avg. Demand^2 Standard Deviation of Lead Time^2)}

Z: NORMSINV (Service level) , for example Z=1.96 for a 97.5% service level