Presented By:

Gaurav Wadhwa

Bharat Goyal

Vibha Taneja

BBA(Gen), Section-B

Preview

Inventory Management Techniques

• Inventory Turnover Ratio

• Ageing Schedule of Inventory

• Just In Time

• VED Analysis

Inventory Turnover Ratio

Inventory turnover is the ratio of cost of goods sold by a business to itsaverage inventory during a given accounting period.

It is an activity ratio measuring the number of times per period, abusiness sells and replaces its entire batch of inventory again.

Cost of goods sold figure is obtained from the income statement of abusiness whereas average inventory is calculated as the sum of theinventory at the beginning and at the end of the period divided by 2.

The values of beginning and ending inventory are obtained fromthe balance sheets at the start and at the end of the accounting period.

Why? Inventory Turnover Ratio

Inventory turnover ratio is used to measure the inventory managementefficiency of a business.

Higher value of inventory turnover indicates better performance and viceversa .

A lower inventory turnover ratio may be an indication of over-stocking whichmay pose risk of obsolescence and increased inventory holding costs.

However, a very high value of this ratio may be accompanied by loss of salesdue to inventory shortage.

Formulas and Illustration

Example : During the yearended December 31, 2010,Loud Corporation soldgoods costing 324,000 Rs.Its average stock of goodsduring the same period was23,432 Rs. Calculate thecompany's inventoryturnover ratio.

SolutionInventory Turnover Ratio

= 324,000 Rs. ÷ 23,432 Rs. ≈ 13.83 – Answer

(Average)

Practice Question

Cost of goods sold of a retail business during a year was84,270 Rs. and its inventory at the beginning and at the endingof the year was 9,865 Rs. and 11,650 Rs. respectively.Calculate the inventory turnover ratio of the business from thegiven information.

Solution: Average Inventory

= (9,865 Rs. + 11,650 Rs.) ÷ 2 = 10,757.5 Rs.Inventory Turnover

= 84,270 Rs. ÷ 10,757.5 Rs. ≈ 7.83

Aging Schedule of Inventory

According to time, inventory can be classified to find out those itemswhich are used in the production process at a slow rate or which aresold at slow rate.

By preparing aging schedule of inventory, the dates of their purchaseor manufacture are taken note of.

Classification of inventories according to the period (age) of theirholdings also helps in identifying slow moving inventories therebyhelping in in effective control and management of inventories.

Just in time (JIT)

The term JIT refers to a management tool that helps to produce only the neededquantities at the needed time.

According to the C.I.M.A, JIT is “a technique for the organization workflows, to allowrapid, high quality, flexible production whilst minimizing manufacturing work andstock level.”

There are two aspects of JIT (i) Just in time production and (ii) just in the timepurchase.

Just in time inventory control system involves the purchase of materials in such a waythat delivery of purchased material is assured just before their use or demand.

The philosophy of JIT control system implies that the firm should maintain a minimum(zero level) of inventory and rely on supplies to provide materials just in time to meetrequirements.

Objectives - JIT

The ultimate goal of JIT is to reduce waste and enhance productivity.

Minimum / zero inventory and its associated costs.

Minimum batch / lot size.

Zero breakdowns and continuous flow of production.

Ensure timely delivery schedules both inside and outside the firm.

Manufacturing right product at right time.

Features of JIT

It emphasizes that firm following traditional inventory control systemoverestimates ordering cost and underestimate carrying cost associatedwith the holding of inventories.

It advocates maintaining good relation with the suppliers so as to enablepurchase of right quality of material at right time.

It involves frequent production runs because of smaller batch/lot size.

It requires reduction in set up time as well as processing time.

Purchase of produce in response to need rather than as per plans orforecast.

Advantages of JIT

The right quantities of material are purchased or produced at right time.

Investment in inventory is reduced.

Wastes are eliminated.

Carrying or holding cost of inventory is also reduced because of reduced inventory.

Reduction in cost of quality such as inspection, cost of delayed delivery, early delivery, processing documents etc.

VED Analysis

The classification is based on ‘Vitality’ of the materials. In this analysis,V stands for “Vital” E stands for “Essential”D stands for “Desirable”Hence you classify materials according to the category- whether they are vital or essential or desirable. The difference it makes, depends on how efficiently you manage the inventory.

Introduction - VED

VED: Vital, Essential & Desirable classification

VED classification is based on the criticality of the inventories.

Vital items – Its shortage may cause havoc & stop the work in organization. They are stocked adequately to ensure smooth operation.

Essential items - Here, reasonable risk can be taken. If not available, the plant does not stop; but the efficiency of operations is adversely affected due to expediting expenses. They should be sufficiently stocked to ensure regular flow of work.

Desirable items – Its non availability does not stop the work because they can be easily purchased from the market as & when needed. They may be stocked very low or not stocked.

VED analysis can be better used with ABC analysis in the following pattern: