In fact, in the inventory control of spare parts and components it is advisable for the organization to use a combination of ABC and VED Analysis. Stocks of fast moving items must be taken care of constantly and replenishment orders must be forwarded in time to prevent stock-outs. VED Analysis 8. At what level should the order be placed? In order to ensure that enough inventory or stock is held by an organization to meet both its internal and external demand commitments economically, the finance manager needs to decide –. A spare part is considered to be desirable if the production loss is not very significant due to its non-availability. The VED analysis is done to determine the criticality of an item and its effect on production and other services. ABC analysis is a technique of categorizing items and determining how much attention each item should receive. Therefore, M/s Raghav & Co. should reorder auto parts when there are 2500 units on hand. Despite the equation’s relative simplicity, it is still a core algorithm in the software packages that are sold to the largest firms in the world. Advantages and Disadvantages of JIT Approach: JIT method, when applied, offers the following advantages: Storing excess inventory may cost a lot of money, and reducing the amount of inventory you keep on hand may reduce your carrying costs as well. The EOQ equation in particular helps in identifying the level of inventory which allows for uninterrupted operations while minimizing reordering costs and hence enhances cash flow. Poor quality of raw materials or parts cannot be accepted. (b) The model assumes that there is no lead time between placing an order and getting its supply. The economic order quantity (EOQ) is a model that is used to calculate the optimal quantity that can be purchased or produced to minimize the cost of both the carrying inventory and the processing of purchase orders or production set-ups. But if the firm purchases in large quantities by each order, the number of orders will decrease and therefore, the total ordering costs will be smaller. Economic order quantity. The high value and low volume items are included in category A, items with intermediate value are included in category B and the remaining items are included in category C. The categorisation of items has been explained below: Items having high value and low volume are placed in this category. and purchase establishment expenses. The total inventory cost for the annual level of demand (including holding costs, ordering costs and purchase costs) should be compared with two order sizes: one for the order size determined by EOQ model and the other for the order size that enables the discount. Re-order point is calculated by the following formula: Re-order Level/Point = Lead Time × Average Usage. What should be the size of each order or each replacement? endobj If this method is applied with care, it ensures a considerable reduction in the storage expenses and it is also helpful in preserving costly items. There are three basis approaches to valuing inventory they are as follows: (i) First in First out Method (FIFO) — sold in the order in which they are purchased or produced. ABC concept is applied to inventory management as a rule-of-thumb. Slow moving stocks must be evaluated very cautiously before any replenishment orders are placed. Even if all the assumptions don’t hold exactly, the EOQ gives us a good indication of whether or not current order quantities are reasonable. The graphic presentation of the same is as follows: In Fig. Generally, EOQ is the point at which inventory carrying costs are equal to order costs. The formula to calculate reordering level is as follows: Reordering level = Maximum consumption x Maximum reorder point. The investment incurred in items of group B is moderate, thus, it deserves less attention than A but more attention than C. The ABC analysis divides the total inventory into three classes using their percentage value. Where, EOQ = Economic Order Quantity. Optimum level of inventory can be managed by answering two basic questions. Aging Schedule of Inventory 6. The economic order quantity (EOQ) is the order quantity that minimizes total holding and ordering costs for the year. Such control system would be found to be more effective and meaningful. All inventory models no matter how complex, address themselves to the problems of timing and magnitude of replenishment. (ii) The firm consumes the input at a uniform rate. 2 0 obj In order to achieve this proper inventory valuation mechanism is required, an inventory valuation facilitates a company to determine a monetary value for items that make up their inventory. The VED analysis can be very valuable to capital-intensive industries. A low turnover rate, on the other hand, indicates over-investment and locking up of working capital in undesirable items. Dead stock of inventory signifies money spent that cannot be realized. The techniques and methods of inventory management may be grouped under:- 1. Group C consists of about 60—75% of the total items that cost about 5% of the total value. Various techniques of inventory management are adopted to find the answers of these problems. The FSN method is considered to be important because of its ability to identify the following types of items: (i) Active items which require reviewing regularly. Refers to the rate of inventory at which the organization places the reorder of raw material. The EOQ can be mathematically calculated by using the following formula: Inventory management and control refers to a system, which ensures the supply of required quantity and quality of inventory at the required time. Another benefit of EOQ is that it is a key to better inventory management and when the company can manage its inventory in an effective way than it can reduce substantial operational costs which in turn will lead to more profits for the company. The turnover ratio may also be used to find out the holding period of inventory. They should be immediately discarded. The ABC analysis is explained with the help of the following Fig. Under ABC analysis all the items of inventory are classified into three categories – A, B and C on the basis of cost involved. In order to calculate the number of orders, the total purchase requirement during the year is divided by the quantity per order. Generally, FIFO leads to higher profits. The total cost for the order size of 600 units (EOQ) is Rs.1,800. The ordering cost per order is fixed and is constant over the year. In the context of the EOQ model, the idea with JIT is to reduce setup costs. Total Relevant* Cost (TRC) Economic Order Quantity (EOQ) EOQ Formula Same Problem FSD Analysis 12. The finance manager may be required to answer the following questions to ensure competent management of inventories: 1. (iii) Obsolete Items – These items have become out-dated. The category B deserves less attention than A but more attention than C. Items falling in category ‘C’ should be paid minimum attention. stream The downward sloping curve which commences high on the Y-axis and decreases as it approaches the X-axis and moves to the right is the ordering cost curve. In JIT inventory control, the inventories are obtained and introduced in production process at the right time. However, it is necessary to have some control on category ‘C’ items also because some items though very inexpensive may be very critical to whole manufacturing process and non-availability of those items on time may halt the production. 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