Inventory Control Techniques
Chapter Twelve
Syllabus topic 2, "Meaning, Need for and Importance of Materials, Procedures, Documentations and Inventory Control techniques"
Pages 30 to 32 of 82
In one line
Control is selective: ABC analysis concentrates effort on the few items that carry most of the value, and perpetual inventory keeps the records right without stopping the factory.
ABC analysis
The idea. In almost any store, a small number of items account for most of the money. Treating every item alike wastes effort on the trivial and starves the critical.
| Class | Share of items | Share of value | Control |
|---|---|---|---|
| A | Few | Most | Tight: close monitoring, low stocks, frequent review, senior authorisation |
| B | Moderate | Moderate | Ordinary: routine review |
| C | Many | Little | Loose: large orders, infrequent review, simple reordering |
The proportions vary with the business and should not be quoted as fixed percentages. What is fixed is the shape: value is concentrated in few items.
The measure is annual VALUE, not price. An item costing a rupee, consumed a million times a year, is a class A item. An expensive item bought once is not.
Method, in four steps. Compute annual consumption value for each item; rank them descending; cumulate the value; draw the lines where the cumulative value justifies a change of treatment.
VED analysis
Classifies by criticality rather than value:
| Class | Meaning | Consequence of a stock-out |
|---|---|---|
| Vital | Production stops | Cannot be tolerated |
| Essential | Production is impaired | Serious |
| Desirable | Production continues | Tolerable |
VED and ABC answer different questions and are used together. A cheap gasket may be class C by value and vital by criticality, and it is the combination that decides the stock held.
Perpetual and periodic inventory
| Perpetual inventory | Periodic inventory | |
|---|---|---|
| Records | Continuously, as each receipt and issue happens | Only at the period end |
| Balance known | At any moment | Only after a count |
| Physical verification | Continuous, a few items at a time, all year | One annual count |
| Production | Not interrupted | Usually stopped for the count |
| Discrepancies | Found early, when the cause is traceable | Found late, when it is not |
Perpetual inventory is a system of records; continuous stock-taking is the physical verification that proves them. They go together and the phrase usually means both.
Why it matters more than it sounds. A discrepancy found in March, when the item was issued in June, cannot be investigated. Found in June, it can.
The other techniques named in practice
Two-bin system. Stock is kept in two bins; when the first empties, that is the signal to reorder, and the second carries production until delivery. Crude, cheap, and effective for class C items.
Just-in-time. Material arrives as it is needed, so stock approaches nothing. It lowers carrying cost to almost zero and raises the cost of any failure in supply, so it needs reliable suppliers and short, certain lead times.
Setting stock levels, which is the next chapter but one, and fixing the order quantity, which is the next chapter. Those two are the arithmetic of control; these are its policy.
Inventory Control Techniques
Material turnover ratio, and finding the slow movers
ABC analysis sorts material by value; the material turnover ratio sorts it by movement, and a firm needs both. An item can be cheap and still be dead money if nobody draws it.
Material turnover ratio = cost of material consumed divided by average stock held.
Cost of material consumed = opening stock plus purchases less closing stock. Average stock = half of opening plus closing stock.
Days of stock held = 365 divided by the ratio. It is the same fact stated in a way a storekeeper can act on.
A high ratio means fast movement. A low ratio means the item sits, and the money in it is doing nothing while it deteriorates, goes out of fashion or is superseded.
Worked example
For the year, material X had opening stock Rs 1,60,000, closing stock Rs 90,000 and purchases Rs 10,00,000; material Y had opening stock Rs 2,80,000, closing stock Rs 1,20,000 and purchases Rs 5,00,000. Compute the turnover ratio and the days of stock held for each, and say which is slow moving.
| Material X, Rs | Material Y, Rs | |
|---|---|---|
| Opening stock | 1,60,000 | 2,80,000 |
| Add: purchases | 10,00,000 | 5,00,000 |
| Less: closing stock | 90,000 | 1,20,000 |
| Material consumed | 10,70,000 | 6,60,000 |
| Material X | Material Y | |
|---|---|---|
| Average stock, half of opening and closing | Rs 1,25,000 | Rs 2,00,000 |
| Turnover ratio, consumed divided by average stock | 8.56 times | 3.30 times |
| Days held, 365 divided by the ratio | 43 days | 111 days |
Material Y is the slow mover. It turns over 3.3 times a year against X's 8.56, and sits in the store for 111 days against 43. Y is the item to question: is the reorder quantity too large, is the level set too high, has demand fallen away?
Look at the stock figures alone and you get it backwards. Y's average stock is the larger of the two in rupees, which tempts a reader to call it the important item. It is the important item to CONTROL, precisely because so little of it moves.
Slow moving, dormant and obsolete. A slow-moving item still moves, only rarely. A dormant item has had no movement at all for a stated period. An obsolete item can no longer be used, because the product it belonged to has been discontinued. The first calls for a lower stock level, the second for an enquiry, the third for disposal and for writing the loss off to profit and loss rather than burying it in cost.
Worked example
A store holds four items. Classify them by ABC analysis.
Inventory Control Techniques
| Item | Units consumed a year | Cost per unit, Rs | Annual value, Rs |
|---|---|---|---|
| P | 400 | 1,200 | 4,80,000 |
| Q | 8,000 | 6 | 48,000 |
| R | 60 | 400 | 24,000 |
| S | 30,000 | 0.40 | 12,000 |
| Total | 5,64,000 |
Item P is class A. It is one item of four and carries Rs 4,80,000 of Rs 5,64,000, which is about 85 per cent of the value. It gets tight control.
Item S is class C, although it is consumed thirty thousand times a year. Volume is not value.
Items Q and R fall in between and take routine treatment.
The lesson the question teaches is that the item handled most often is not the item worth controlling most closely.
What it does NOT mean
ABC is not about physical size.
Class C is not uncontrolled. It is controlled cheaply, by ordering plenty and looking rarely.
Perpetual inventory does not remove the need to count. It replaces one annual count with continuous verification.
VED does not replace ABC. They classify on different axes and are used together.
Quick revision
- ABC: classify by annual consumption value; few items carry most value; tight control on A, routine on B, loose on C.
- VED: classify by criticality - vital, essential, desirable - and use with ABC.
- Perpetual inventory: continuous records plus continuous stock-taking; balance known at any moment, discrepancies found early, production not stopped.
- Periodic: one annual count, production halted, errors found too late to trace.
- Two-bin for cheap items; just-in-time where supply is reliable.
Test yourself
1. On what basis does ABC analysis classify items? On annual consumption value, being units consumed multiplied by cost per unit, not on price or on physical quantity.
2. An item costs 40 paise and is consumed 30,000 times a year. Which class? Class C. Its annual value is small, however often it is handled.
3. What does VED classify by? Criticality: vital, essential and desirable, according to the consequence of running out.
4. Give two advantages of perpetual inventory over a periodic count. The stock balance is known at any moment without a count, and discrepancies are found early enough for the cause to be traced; production is also not interrupted for an annual count.
Answer in one sentence
What are the main inventory control techniques? Selective control by ABC analysis, which classifies items by annual consumption value so that tight control falls on the few items carrying most of the value; VED analysis, which classifies by criticality; perpetual inventory with continuous stock-taking, which keeps the balance known and finds discrepancies early; and simpler devices such as the two-bin system and just-in-time supply, alongside the fixing of stock levels and of the economic order quantity.
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.