A SUMMER TRAINING PROJECT REPORT ON INVENTORY MANAGEMENT IN JUBILANT ORGANOSYS LTD.
I express my sincere gratitude to Mr XYZ (Senior Manager, Jubilant Organosys) under whose supervision has helped to clarify my concepts of Inventory Management, distinguished scholars and authors, whose work I heve used in this project. I would also like to thank to Mr. XYZ. No words of appreciation are good enough for the constant encouragement, which I have received from him. I thank Mr. YXZ (Head Accounts and Finance, Jubilant Organosys) for his unstinted support to the project. Finally, I would like to thank Mr. XYZ (Factory Manager, Jubilant Organosys) to give the opportunity to complete the project in the esteemed organization.
As a part of the partial fulfillment of the M.B.A. programme at IVS Institute of Management, , Summer Training was undertaken with the international company, JUBILANT ORGANOSYS LIMITED, Gajraula (J. P. NAGAR). This project is specially designed to understand the subject matter of Inventory Management of the company. This project gives us information and report about companyâ€™s Inventory Management. Throughout the project the focus has been on presenting information and comments in easy and intelligible manner. The purpose of the training was to have practical experience of working in a organization and to have exposure to the various management practices in the field of Finance. This training has also given me an on the job experience of Financial Management. This project is very useful for those who want to know about company and Inventory Management of the company.
PART- I *Objective of the Study *Introduction of Company * Company Profile * History * Board of Directors * Presence Across Value Chain * Awards * Products * Guiding Principals of Company * Structure of the Company * Research Methodology * Introduction of the Topic * Conceptual Discussions PART- II * Data Collection * Financial Statements * Data Analysis and Interpretation * Problems and Suggestions * Conclusions * Bibliography
OBJECTIVE OF THE STUDY Objective of The Study:
Inventories constitute the principal item in the working capital of the majority of trading and industrial companies. In inventory, we include raw materials, finished goods, work in progress, supplies and other accessories. To maintain the continuity in the operations of business enterprise, a minimum stock of inventory required.
However, the physical control of inventory is the operating responsibility of stores superintendent and financial personnel have nothing to do about it but the financial control of these inventories in all lines of activity in which they comprise a substantial part of the current assets is a frequent problem in the management of working capital. Management of inventory is designed to regulate the volume of investment in goods on hand, the types of goods carried in stock to meet the needs of production and sales while at the same time, the investment in them is to kept at a reasonable level.
INTRODUCTION OF COMPANY
Jubilant Organosys Limited is the largest specialty chemical company of India and a leading global manufacturer in defined chemical categories viz, second largest in pyridine and its derivatives, third largest in solid polyvinyl acetate and leading positions in acetyls and other specialty chemicals. These include pharmaceuticals and life science chemicals, performance chemicals, organic intermediates, agri products and a range of other specialty chemicals. It was incorporated in the year 1978 under the companies Act, 1956. The company is a part of Jubilant Corporation, which also includes Jubilant Enpro, Dominoâ€™s, Jubilant Biosys. The manufacturing facilities located at Gajraula in J.P.NAGAR District, U.P. The company estabilished an Research and Development Group in the year 1982 and Research and Development was recognized by the Department of Science and Technology. The groups have developed a number of products, which have been commercialized over a period of time. The various group of the Research and Development carryout research in the field of Polymers and Adhesives, â€˜Organic chemicals, Biotechnology and Environmentâ€™. The company differentiates itself in its manufacturing approach which is based on the use of a renewable resource as the main feed stock, the conserve energy requirement and a complete recycling and reuse of the final wastage at the plant. The main feed stock for jubilant's product line is Molasses, a renewable bio-mass, occurs as a by product in the sugar mill from which industrial alcohol is produced from the process of fermentationand distillation. This makes the manufacturing approach inheretantly eco=efficient. Industrial alcohol is further proccessed to produced a series of value added chemicals.
Jubilant Organosys Limited has historically, been a producer and leading manufacturer of acetyls in India for more than two decades. Jubilant Organosys also enjoy a global position in these products. Jubilant Organosys derive our strengths in this business from our molasses based production process. Jubilant Organosys use renewable biomass (molasses), as feedstock for manufacturing acetyls. Jubilant Organosys, therefore, are not impact by the cost cycle that affects the industry worldwide.
Globally Jubilant Organosys are the; *Largest Alcohol Distillery Outside Brazil. *Largest Acetic Acid Manufacturer From Renewable\Green Resources. *6th Largest in Acetaldehyde. *8th Largest in Ethyle Acetate. *9th Largest in Acetic Anhydride.
Jubilant Organosys owns distilleries at Gajraula and Nira. These are strategic to the business as they are located in two largest sugar belts of India ( U.P. & MAHARASHTRA ). Company has long term contracts with sugar mills to meet alcohol requirements while providing easy access to feed stock. Jubilant Organosys Limited is an integrated pharmaceutical industry player with a wide range of products and services for global life sciences companies. Company is one of the largest Custom Research and Manufacturing Services (CRAMS) and Drug Services Companies in India. Jubilant Organosys have presence across the pharmaceuticals value chain right from drug, discovery, medicinal chemistry and clinical research services to custom research and
manufacturing services for advance intermediaries and fine chemicals, Active Pharmaceutical Ingredients and Dosage Forms.
Jubilant Organosys Limited has a strong international presence having international subsidiaries in USA, BELGIUM and CHINA. Jubilant Pharmaceutical, Inc is a full service clinical research organisation providing clinical research, clinical data management, biostatics, QA/regulatory and contract staffing servicing.Our products are sold across the globe in more than 50 countries. Jubilant Organosys Limited is a collaborative, innovative provider of products and services to the global life sciences industry, striving to accelerate the process of pharmaceutical drug approval. Jubilant Organosys also enjoy leadership in Industrial products and Preformance Polymers products in India. It is headquarted in NOIDA, with net sales of - US $ 337 million in FY06 and more than 3300 employees.
We will carefully select, train and develop our people to be creative, empower them to take decisions, so that they respond to all customers with agility, confidence and teamwork
We stretch ourselves to be cost effective and efficient in all aspects of our operations and focus on flawless delivery to create and provide the best value to our customers
By sharing our knowledge and learning from each other and from the markets we serve, we will continue to surprise our customers with innovative solutions
With utmost care for the environment and safety, we will always strive to excel in the quality of our processes, our products and our services
HISTORY 2005 Acquires Target Research Associates, Inc., renamed Clinsys Inc.; a US based Clinical Research Organisation (CRO) Acquires Trinity Laboratories, Inc. and its wholly owned subsidiary, Trigen Laboratories, Inc., renamed Jubilant Pharmaceuticals, Inc., a generic pharmaceutical company in USA having a US FDA approved formulations manufacturing facility Enters Clinsys Clinical Research Ltd. business by setting up wholly owned subsidiary Jubilant Clinsys Ltd. 2004 Sets up medicinal chemistry services business through wholly owned subsidiary Jubilant Chemsys Ltd. Enters formulations and regulatory affairs businesses by acquiring Pharmaceuticals Services Incorporated, N.V. and PSI Supply N.V., the pharmaceutical companies in Europe. 2003 Sets up a new state-of-the-art Research & Development Centre in Noida, near New Delhi equipped with all latest scientific instruments. 2002
Acquires the Active Pharmaceutical Ingredients business
2001 New corporate identity: Jubilant Organosys Ltd. reflecting changed corporate and business profile 2000 Enters the Bio / chemo informatics arena by setting up Jubilant Biosys Ltd. 1998 Enters high value-added Pyridine derivates. Commissions Pyridine HBR and Cyano Pyridine plants. Forms marketing subsidiary in the USA. Acquires acetyl plant in western India. 1997 Commissions first Multi-purpose fine chemicals plant. Plant for food polymer commissioned. 1995 Gets ISO 9001 certification. 1990 Commissions Pyridine & Picoline plant.
1988 Launches its first branded product: Vamicol, an adhesive product. 1987 Introduces new products in Performance Chemicals segments: Poly vinyl acetate emulsion for paint, textile, paper & packaging and woodworking industry. 1985 Research & Development center gets recognition from Government of India. 1983 Commercial production of Vinyl Acetate Monomer (VAM). 1981 Initial Public Offering. Listing on leading stock exchanges of India.
1978 Incorporated as Vam Organic Chemicals Ltd.
BOARD OF DIRECTORS
Board Of Directors Shyam S Bhartia
Hari S Bhartia
Chairman & Managing Director
Co-Chairman & Managing Director
Executive Director & President â€“ Life S N Singh
Executive Director - Chemicals
Executive Director - Manufacturing & Supply Chain Ajay Relan
PRESENCE ACROSS VALUE CHAIN
PRESENCE ACROSS VALUE CHAIN:
AWARDS Jubilant's rapid progress across all corporate aspects has consistently been acknowledged by various industry bodies, government and non-government agencies in the form of awards and certifications. Golden Peacock award for Innovation Management - 2003 Six-sigma Quality Award at the All India CII Convention -2004 The Greentech Foundation Award for Environment Excellence The Energy Conservation Award (Chemical sector) from the Government of India for the Gajraula unit Best Managed Manufacturing Plant for Single super phosphate by FAI - 2003 Best HR Practices Award by Centre for International Businesses - 2004 P C Acharya Award for Development of Indigenous Technology by ICMA - 2004 Top 5 Best Managed Workforce in India - Hewitt Award
The DSIR Award for Innovation in Chemicals & Allied Industries
GUIDING PRINCIPALS OF JUBILANT ORGANOSYS LTD
1. We will conduct ourselves or business with the highest standards of honesty, integrity and professionalism.
2. We will recognize the positive contribution that individuals & our team members to produce business successfully. 3. We will encourage a learning environment where people can constantly grow, develop & contribute. 4. We will strive for excellence and seek continuous improve in everything. 5. We will respect all stockholders including employees, partners and suppliers & still them with a passion to deliver the highest quality goods services. 6. We will foster initiative &creative by empowering individuals to attain well defined objectives.
STRUCTRE OF THE COMPANY
Jubilant Organosys Ltd. act upon the rules & regul- ations of the Companies Act, 1948. The company have well defined structure .It have the following departments:
1. HR/ Personnel department 2. Accounts departments 3. Purchase departments 4. Store department 5. Quality department 6. Shipping department 7. Sales & Excise department
ORGANISATIONAL CHART OF JOL
Research methodology is the way to systematically solve the research problem. Objective of research study is Analysis of inventory of Jubilant Organosys Ltd. Analyzing of inventory, we determining following inventories1. Raw materials inventory. 2. Work in progress inventory. 3. Finished goods inventory & 4. Supplies inventory. In this section of inventories, we should analyze the annual investment in inventories, Valuation of inventory after closing balance of items in inventory. In this manner, we calculate reorder point, safety stock levels, minimum & maximum levels of inventory. Working hypothesis of the objective is that inventories are the stock piles of goods .The all organization on their inventories. JOL invests about 60%of total assets inventory should be analyzed their records. The analysis of inventory according to their data available in the company. The data collection of inventory for analysis by the direct store department. We should record primary and secondary data by the helps of assistants ledger books M R N etc. We went to the all inventories as raw material , work in progress inventory, finished goods inventory by the proper observation of dataâ€™s of the company. The particular method for data collecting used direct interview with assistants and telephone interview with friends to known about annual investment of inventories and other important data.
INTRODUCTION OF THE TOPIC
Inventories constitute the most significant part of current assets of a large majority of companies in India. On an average, inventories are approximately 60% of current assets in public limited companies in India. Because of the large size of inventories maintained by firms, a considerable amount of feuds is required to be committed to them. It is therefore, absolutely imperative to mĂŠnage inventories efficiently and efficiently in order to avoid unnecessary investment. A firm neglecting the management of inventories will be jeopardizing its long run profitability and may fail ultimately. It is possible for fore a company to reduce its levels of inventories to a considerable degree e.g. 10 to 20 percent, with out any adverse effect on production and sales, by using simple inventory planning and control techniques. The reduction in excessive inventory carries a favorable impact on a companyâ€™s profitability.
MEANING OF INVENTORY:Inventory is the physical stoke of goods maintained in an organization for its smooth sunning. In accounting language it may mean stock of finished goods only. In a manufacturing concern, it may includes raw materials, work-in-progress and stores etc. In the form of materials or supplies to be consumed in the production process or in the rendering of services. In brief, Inventory is unconsumed or unsold goods purchased or manufactured.
NATURE OF INVENTORIES :Inventories are stock of the product a company is manufacturing for sale and components that make up the product. The various forms in which inventory exist in a manufacturing company are raw materials, work in progress and finished goods.
Raw materials are those inputs that are converted into finished product though the manufacturing process. Raw materials inventories are those units which have been purchased and stored for future productions.
WORK IN PROGRESS:These inventories are semi manufactured products. They represent products that need more work before they become finished products for sales.
FINISHED GOODS:Finished goods inventories are those completely manufactured products which are ready for sale. Stock of raw materials and work in progress facilitate production. While stock of finished goods is required for smooth marketing operation. Thus, inventories serve as a link between the production and consumption of goods. The level of three kinds of inventories for a firm depend on the nature of its business. A manufacturing firm will have substantially high levels of all three kinds of inventories, while a retail or wholesale firm will have a very high and no raw material and work in progress inventories. Within manufacturing firms, there will be differences. Large heavy engineering companies produce long production cycle products, therefore they carry large inventories. On the other hand, inventories of a consumer product company will not be large, because of short production cycle and fast turn over. Firms also maintain a fourth kind of inventory, supplies or stores and spares.
SUPPLIES: It includes office and plant cleaning materials like soap, brooms, oil, fuel, light, bulbs etc. These materials do not directly enter production, but are necessary for production process. Usually, these supplies are small part of the total inventory and do not involve significant investment. Therefore, a sophisticated system of inventory control may not be maintained for them.
MANAGEMENT OF INVENTORY Inventories constitute the principal item in the working capital of the majority of trading and industrial companies. In inventory, we include raw materials, finished goods, work-in-progress, supplies and other accessories. To maintain the continuity in the operations of business enterprise, a minimum stock of inventory required. However, the physical control of inventory is the operating responsibility of stores superintendent and financial personnel have nothing to do about it but the financial control of these inventories in all lines of activity in which they comprise a substantial part of the current assets is a frequent problem in the management of working capital. Management of inventory is designed to regulate the volume of investment in goods on hand, the types of goods carried in stock to meet the needs of production, and sales while at the same time, the investment in them is to be kept at a reasonable level.
CONCEPT OF INVENTORY MANAGEMENT The term inventory management is used in two ways- unit control and value control. Production and purchase officials use this word in term unit control whereas in accounting this word is used in term of value control. As investment in inventory represents in many cases, one of the largest asset items of business enterprises particularly those engaged in manufacturing, wholesale trade and retail trade. Sometimes the cost of material used in production surpasses the wages and production overheads. Hence, the proper management and control of capital invested in the inventory should be the prime responsibility of accounting department because resources invested in inventory are not earning a return for the company. Rather, on the other hand, they are costing the firm money both in terns of capital costs being incurred and loss of opportunity income that is being foregone.
OBJECTIVES OF INVENTORY MANAGEMENT The basic managerial objectives of inventory control are two-fold; first, the avoidance over-investment or under-investment in inventories; and second, to provide the right quantity of standard raw material to the production department at the right time. In brief, the objectives of inventory control may be summarized as follows:
Operating Objectives: Ensuring Availability of Materials: There should be a continuous availability of all types of raw materials in the factory so that the production may not be help up wants of any material. A minimum quantity of each material should be held in store to permit production to move on schedule.
Avoidance of Abnormal Wastage: There should be minimum possible wastage of materials while these are being stored in the godowns or used in the factory by the workers. Wastage should be allowed up to a certain level known as normal wastage. To avoid any abnormal wastage, strict control over the inventory should be exercised. Leakage, theft, embezzlements of raw material and spoilage of material due to rust, bust should be avoided.
Promotion of Manufacturing Efficiency: If the right type of raw material is available to the manufacturing departments at the right time, their manufacturing efficiency is also increased. Their motivation level rises and morale is improved.
Avoidance of Out of Stock Danger: Information about
availability of materials should
be made continuously available to the management so that they can do planning for procurement of raw material. It maintains the inventories at the optimum level keeping in view the operational requirements. It also avoids the out of stock danger. (5) Better Service to Customers: Sufficient stock of finished goods must be maintained to match reasonable demand of the customers for prompt execution of their orders.
(6)Highlighting slow moving and obsolete items of materials. (7) Designing poorer organization for inventory management: Clear cut accountability should be fixed at various levels of organization.
B. Financial Objectives: (1)
Economy in purchasing: A proper inventory control brings certain advantages and
economies in purchasing also. Every attempt has to make to effect economy in purchasing through quantity and taking advantage to favorable markets. (2)
Reasonable Price: While purchasing materials, it is to be seen that right quality of material is purchased at reasonably low price. Quality is not to be sacrificed at the cost of lower price. The material purchased should be of the quality alone which is needed.
(3) Optimum Investing and Efficient Use of capital: The basic aim of inventory control from the financial point of view is the optimum level of investment in inventories. There should be no excessive investment in stock, etc. Investment in inventories must not tie up funds that could be used in other activities. The determination of maximum and minimum level of stock attempt in this direction.
TYPES OF INVENTORY 1. Movement Inventories:Movement inventories are also called transit or pipeline inventories. Their existence owes to the fact that transportation time is involved in transferring substantial amount of resources.
2.Buffer inventories:In Buffer inventories are held to protect against the uncertainties of demand and supply. An organization generally knows the average demand for various items that it needs. Prod.deptt.
Demand Inventory in Hand
Purchase depâ€™t. Net order
3. Anticipation Inventories. Anticipation inventories are held for the reason that future demand for the product is anticipated. Production of specialized times like crackers well before dewily, umbrellas and raincoats before taints set in, fans while summers are approaching; or the piling up of inventory stocks when a strike is on the anvil, are all examples of anticipation inventories.
CONTROL OF MATERIALS : Rigid control over materials are necessary not only to guard against theft, but also to minimize waste and misuse from causes such as excessive inventories, over issue, deterioration, spoilage, and obsolescence. There are certain prerequisites to an effective control system for materials: 1.Materials of the desired quantity will be available when needed; 2.Materials will be purchased only when a need exists and in economical qualities; 3.Purchases of materials will be made at most favorable prices; 4.Vouchers for the payments of materials purchased will be approved only if the materials have been received in good condition; 5.Materials will be protected against loss by proper physical control; 6.Issue of materials will be properly authorized and accounted for; and 7.All materials, at all times, will be charged, as the responsibility of some individual. The control of materials, as an element of cost of production, is illustrated with reference to the purchase and issues procedures, inventory systems, and inventory control techniques.
IMPORTANCE OF INVENTORY CONTROL: The importance or necessity of inventory control is well explained in the terms of the objects of inventory control, which are obtained through it. A proper inventory control lowers down the cost of production and improves profitability of enterprise.
ADVANTAGES OF INVENTORY CONTROL:
Reduction in investment in inventory.
Proper and efficient use of raw materials.
No bottleneck in production.
Improvement in production and sales.
Efficient and optimum use of physical as well as financial resources. Ordering cost can be reduced if a firm places a few large orders in place of numerous small orders.
Maintenance of adequate inventories reduces the set-up cost associated with each production run.
Risk and cost Associated with Inventories: Holding of Inventories expose the firm to a number of risks and costs.
Major risks are: (a)
Price decline: They may be due to increase in market supply of the product, introduction of a new competitive product, price-cut by the competitors etc.
Product deterioration: This may due to holding a product for too long a period or improper storage conditions.
Obsolescence: This may due to change in customerâ€™s taste, new production technique, improvements in product design, specifications etc.
The Costs of holding inventories are as follows: (a)
Material Cost: This include the cost of purchasing the goods, transportation and handling charges less any discount allowed by the supplier of goods.
Ordering Cost: This includes the variables cost associated with placing an order for the goods. The fewer the orders, the lower will be the ordering costs for the firm.
Carrying Cost: This includes the expenses for storing and handling the goods. It comprises storage costs, insurance costs, spoilage costs, cost of funds tied up in inventories etc.
ESSENTIALS OF INVENTORY CONTROL SYSTEM For an efficient and successful inventory control there are certain important conditions that are a follows: (1) Classification and Identification of inventories: The usual
manufacturing firm includes raw-material, stores, work-in-progress and component etc. To facilitate prompt recording the dealing, each item of the inventory must be assigned a particular code number and it must be classified in suitable group or sub-divisions. ABC analysis of material is very helpful in this context. (2) Standardization and simplification of inventories: In order to facilitate inventory control, the inventory line should be simplified. It refers to the elimination of excess types and sizes of items. Simplification leads to reduction in classification of inventories and its carrying costs. Standardization, on the other hand, refers to the fixation of standards of raw material to be purchased and specification of the components and tools to be used. (3) Setting the Maximum and Minimum limits for each part of inventory: The third step in this process is to set the maximum and minimum limits of each item of the inventory. It avoids the chances of over-investment as well as running a short of any item during the cost of producing. Reordering point should also be fixed beforehand. (4) Economic Order Quantity: It is also a basic inventory problem to determine the quantity as how much to order at a time. In determining the EOQ, the problem is one to set a balance between two opposite costs, namely, ordering costs and carrying costs. This quantity should be fixed beforehand.
(5)Adequate storage Facilities: To make the system of inventory control successful and efficient one, it is also essential to provide the adequate storage facilities. Sufficient storage area and proper handling facilities should be organized. (6)Adequate Reports and Records: Inventory control requires the maintenance of adequate inventory record and reports. Various inventory records must contain information to meet the needs of purchasing, production, sales and financial staff. The typical information required about any class of inventory may be relating to quantity on hand, location, quantities in transit, unit cost, code for each item of inventory, reorder point, safety level etc. Statements forms and inventory records should be so designed that the clerical cost of maintaining these records must be kept a minimum. (7)Intelligent and Experienced Personnel: An important requirement of successful inventory control system is the appointment of qualified and experienced staff in purchase and stores department. Mere establishment of procedures and the maintenance of records would not give the desired results as there is no substitute for sincere and devoted as well as experienced hands. Hence, the whole inventory control structure should be manned with trained, qualified, experienced and devoted employees. (8)Coordination: There must be proper coordination of all departments involved in the process of inventory control, such as purchase, finance, receiving, approving, storage and accounting departments. These all departments have different outlook and objects in inventory management but financial manager has to coordinate them all. (9)Budgeting: An efficient budgeting system is also required. Preparation of budgets concerning materials, supplies and equipment to ensure economy in purchasing and use of material is also necessary.
(10)Internal Check: Operating of a system of internal check is also vital in inventory management so that all transactions involving material supplies and equipment purchase are properly approved and automatically checked.
FACTORS AFFECTING STOCK INVESTMENT LEVEL These factors can be put in two categories: General and Specific. General Factors: These factors include those factors, which affect directly or indirectly level of investment in any asset. These are as follows:
Nature of Business
Size and scale of Business
Expected Sales Volumes
Price Level Changes
Availability of Funds
Management view Point Specific Factors: These factors are directly related with investment in stock. Following are the main factors:
Seasonal Character of Raw Materials: If supply of raw material used in the firm is seasonal, the firm will require more funds for the purchase of raw material during season. Usually, raw materials are available at cheaper rates during is production season.
Length and Technical Nature of the production process: If production process is lengthy and of technical nature, higher investment is required in raw material. In the technical nature production process, quality control of raw material is given more emphasis.
Terms of Purchase: If some concessions or discount in price or facilities of credit are provided by suppliers on purchase of raw materials in huge quantity then the firm is inspired for excessive purchase of goods and hence comparatively more investment is required in inventory.
Nature of End Product: Nature of end product also influences investment in inventory. If the end product is a durable good, high investment will be required because durable goods can be stored for a long period. On the other hand, perishable goods cannot be stored for a long period. Hence, investment in inventory of such products is low.
Supply Conditions: If the supply of raw material is regular and there is no possibility of interruption in future, high investment in inventories is not required.
Time Factor: The lead time of raw material time token in production process and sale of product also influence investment in inventories. Longer the period, higher will be the investment in inventories.
Loan Facilities: If raw materials are purchased on credit or loan from the bank or other financial institution can be obtained on the security of raw material, lesser investment would be required. In the absence of such loan facility, higher investment would be required.
Price Level Fluctuations: If there are expectations of price rise in future then raw materials may be store in high quantity and so more investment would be required. On the contrary, if the prices of raw materials are expected to go down in future, then comparatively lesser investment would be required.
Other factors: Price control, rationing, change in taxation and export policy of governments etc. also influence investment in inventories.
TECHNIQUES OF INVENTORY CONTROL
TECHNIQUES OF INVENTORY CONTROL In managing inventories, the firmâ€™s objective should be in consonance with the wealth maximization principle. To achieve this, the firm should determine the optimum level of investment in inventory. To deal with the problems of inventory management effectively, it becomes necessary to be conversant with the different techniques of inventory control. Although the concepts involved in inventory management are production-oriented and are not strictly financial it is important that the financial manager understand them since they have certain built-in financial costs. The different techniques of inventory control may be summarized as follows: (1)
Inventory level Technique The main objective of stock control is to determine and maintain the optimum level of stock so that there is neither shortage of any material nor unnecessary investment in inventory. For this purpose, determination of maximum and minimum limits of inventory and ordering level is necessary.
Maximum stock Limit: This represents the quantity of inventory above which it should not be allowed to be kept. The main object of fixing this limit is to ensure that unnecessary working capital is not blocked in stores. The quantity is fixed keeping in view the disadvantages of overstocking.
The disadvantages of overstocking are: 1.
Capital is blocked up unnecessarily in stores so there will be loss of interest.
More godown space is needed so more rent will have to be paid.
There are chances of deterioration in quality because large stocks will require more time for use is the factory.
There is the possibility of loss due to obsolescence.
There is danger of depreciation in market values.
The maximum stock level is fixed by taking into account the following factors: (1) Amount of capital available for maintaining stores. (2) Godown space available. (3) Rate of consumption of the material. (4) The time lag between indenting and receiving of the material. (5) Length and technical nature of the production process. (6) Possibility of loss in stores by deterioration, evaporation etc. There are certain stores, which deteriorate in quality if they are for longer period. (7) Cost of maintaining stores.
(8) Likely fluctuation in prices. For instance, if there is a possibility of a substantial increase in prices in the coming period, a comparatively large maximum stock level will be fixed. On the other hand, if there is the possibility of decrease in price in the near future, stocks are kept at a much reduced level. (9) The seasonal nature of supply of material. Certain materials are available only during specific periods of year. So these have to be stocked heavily during these periods. (10)Restrictions imposed by the government or local authority in regard to materials which there are inherent risks, e.g. fire and explosion. (11)Risk of obsolescence, i.e., possibility of change in fashion and habit which will necessitate change in requirements of materials.
The following formula may be applied to calculate the maximum stock: (1) Maximum Stock = Minimum Inventory + Lot size (2) Maximum Stock = Reorder Level - Minimum consumption during Minimum lead time + Lot size
Minimum Stock Limit (Safety or Buffer stock) This represents the quantity below which stock should not be allowed to fall. It is maintained to save from the situation of stock out in the event of abnormal increase in material usage rate and/or delivery period. In fact determination of this quantity is significant because of uncertainty in respect to material usage rate and delivery period. The main purpose of this level is to ensure that production is not held up due to shortage of any material. This level is fixed for all items of stores and following factors are taken into account for the fixation of this level: (a)
Lead time i.e. time lag between intending and receiving the material.
Rate of consumption of the material during the lead time.
Re-order Level The following formula is applied to calculate Minimum Stock:
Minimum Stock = Re-order Level - Normal usage during Normal Lead time But if normal usage and normal lead time is not known then average usage will be treated as normal usage and average re-order will be treated as normal re-order period.
Re-ordering Level (Ordering Level) It is the point at which if the stock of the material in stores reaches, the storekeeper should initiate the purchase requisition for fresh supply of material. This level is fixed somewhere between maximum and minimum level is such a way that the difference of quantity of the material between the reordering level and the minimum level will be sufficient to meet requirements of production up to the time of fresh supply of the material. It is fixed after taking into consideration the following factors: (a)
Rate of material usage: Generally this rate is found out as usage rate per day, pre week or per month. The quantity of production fluctuates according to demand of the product which results in variation in usage rate.
Hence, the following three factors: (i)
Maximum usage rate: It implies quantity of material required at maximum capacity production.
Minimum usage rate: It implies quantity of material required at capacity production in most unfavorable business conditions.
(iii) Normal or average Usage Rate: It implies quantity of material required at capacity production under normal business conditions. (b)
Ordering Period: The time taken in preparing the order for purchase of material is called ordering period. In some concerns this period may be significant but in large concerns this period is significant because before placing the order the purchase manager has to trace out the best suppliers, after that only he places the order.
ÂŠ Delivery, Lead or Procurement Time: The time taken from the date of placing the order to the date of delivery by the suppliers is called procurement time. The maximum, minimum and average procurement time should also be determined. (D) Minimum Stock Level: This is the level of stock below which stocks should normally not be allowed to fall.
Calculation of Re-order Point: After taking into account the above facts re-order quantity is ascertained. For this purpose, the following formula is applied:
Situation1: When rate of usage and lead time are known with certainty; Re-order point = Rate of usage x lead time.
Situation2: When rate of usage is known with certainty and lead time is also known but is variable:
Re-order point = Minimum Inventory + Average usage during Normal lead Time.
Re-order point = Rate of usage x Maximum Lead Time.
Situation3: When rate of usage and lead time is known but variable and lead time is known with certainty: (i)
Re-order point = Minimum Inventory + Average usage during lead time.
Re-order point = Maximum Usage rate x Lead time.
Situation4: When the rate of usage and lead time are known and are variable; (i)
Re-order point = Minimum Inventory + Average usage during lead period.
Re-order point = Maximum Usage rate x Maximum Lead time.
Danger Level This means a level at which normal issues of the material are stopped and issues made only under specific instructions. The purchase officer will make special arrangements to procure the materials reaching at their danger levels so that the production may not stop due to shortage of materials. It is determined as follows: Danger level = Average Consumption x Maximum Re-order period for Emergency Purchase
ECONOMIC ORDER QUANTITY TECHNIQUE
One of the major inventory management problems to be resolved is how much inventory should be added when inventory is replenished. If the firm is buying raw materials, it has to decide lost in which it has to be purchased on replenishment. If the firm is planning a production run, the issue is how much production to schedule (or how much to make). These problems are called order quantity problems, and the task of the firm is to determine the optimum or economic order quantity (or economic lot size). Determining an optimum inventory level involves two type of costs: (a) ordering costs and (b) carrying costs: The economic order quantity is that inventory level that minimize the total of ordering and carrying costs.
Ordering costs: the term ordering costs is used in case of raw materials (or supplies) and includes the entire costs of acquiring raw materials. They include costs incurred in the following activities: requisitioning, purchase ordering, transporting, receiving, inspecting and storing (store placement). Ordering costs increase in proportion to the number of order placed. Ordering costs increase with the number of order; thus the more frequently inventory is acquired, the higher the firmâ€™s ordering costs. Ordering costs decrease with increasing size of inventory.
Carrying costs: Costs incurred for maintaining a given level of inventory are called carrying costs. They include storage, insurance, taxes, deterioration and obsolescence. The storage costs comprise cost of storage space (warehousing cost), stores handing costs and clerical and staff service costs (administrative
Table: Ordering and Carrying Costs Ordering Costs
(3) Clerical and staff
(4) Receiving inspecting and storing (4) Insurance (5) Clerical and staff
(5) Deterioration Obsolescence
Carrying costs vary with inventory size. The economic size of inventory would thus depend on trade-off between carrying costs and ordering costs.
Ordering and Carrying Costs trade-off: The optimum inventory size is commonly referred to as economic order quantity. It is that order size at which annual total costs of ordering and holding are the minimum. We can follow three approaches-the trial and error approach, the formula approach and the graphic approach-to determine the economic order quantity (EOQ).
Trail and Error Approach: The trail and error, or analytical, approach to resolve the order quantity problem can be illustrated with the help of a simple example. Let us assume the following data for a firm.
Estimated annual requirements, A
Purchasing cost (per order), (Rs)
Ordering cost (per order), (Rs.)
Carrying cost per unit, (Re)
Average inventory - (1200 + 0)/2 = 600 units Average value - Rs 30,000 (600*Rs50) If we choose the multiple order than we order 100units on monthly basis Average inventory - (100+0)/2 = 50units) Average value - 50 * Rs 50 = 2, 500 Many other possibilities can be worked out in the same manner. 1200 1000 800 Q/2 600 stock
400 200 50 0
Time Inventory level over time Order- formula approach: The trial error, or analytical, approach is somewhat tedious to calculate
the EOQ. An easy way to determine EOQ is to use the order-formula approach. Let
us illustrate this approach.
Suppose the ordering cost per order, O, is fixed. The total order costs will be number of orders during
the year multiplied by ordering cost per order. If a represents total annual
requirements and Q the order size, the number of orders will be A/Q and total order costs will be:
Total ordering cost = (Annual requirement * Per order cost) Order size TOC = AO/ Q Let us further assume the carrying cost per unit, c, is constant The total carrying costs will be the product of the average inventory units and the carrying cost per unit. If Q is the order size and usage is assumed to be steady, the average inventory will be.
Average inventory = order size = Q 2
And total carrying costs will be: Total carrying cost = Average inventory * Per unit carrying cost TCC = Qc 2 The total inventory cost, then, is the sum of total carrying and ordering costs: Total cost = Total carrying cost + Total order cost
TC = Qc + AO 2
Equation (4) reveals that for a large order quantity, Q, the carrying cost will increase, but the ordering costs will decrease. On the other hand, the carrying costs will be lower and ordering cost will be higher with the order quantity. Thus, the total cost function represents a trade-off between the carrying costs and ordering costs for determining the EOQ. To obtain the formula for EOQ, Equation (4)is differentiated with respect to Q and setting the derivative equal to zero, we obtain:
Economic order quantity = 2* quantity required * ordering cost Carrying cost EOQ = 2AO C
Graphic approach: The economic order quantity can also be found out graphically. Figure illustrates the EOQ function. In the figure, costs-carrying, ordering and total- are plotted on vertical axis and horizontal axis is used to represent the order size. We note that total carrying costs increase as the order size increasers, because, on an average, a larger inventory level will be maintained, and ordering costs decline with increase in order size means less number of orders. The behaviors of total costs line is noticeable since it is a sum of two types of cost which behave differently with order size. The total costs decline in the first instance, but they start rising when the decrease in average ordering cost is more than offset by the increase in carrying costs. The economic order quantity occurs at the point Q* where the total cost is minimum. Thus, the firmâ€™s operating profit is maximized at point Q*.
Minimum total Cost Carrying cost Costs
order size (Q)
Economic order quantity
Optimum productions run: The use of the EOQ approach can be extended to production runs to determine the optimum size of manufacture. Two costs involved are set-up costs and carrying costs. Set-up costs include costs on the following activities: preparing and processing the stock orders, preparing drawings and specifications, tooling machines set-up, handling machines, tools, equipment and materials, over time etc. Production runs but carrying costs will increase as large stocks of manufactured inventories will be held. The economic production size will be the one where the total of set-up and carrying costs is minimum. Reorder Point: The problem, how much to order, is solved by determining the economic order quantity, yet answer should be sought to be second problem, when to order. This is a problem of determining the reorder point. The reorder point is that inventory level at which an order should be placed to replenish the inventory. To determine the reorder point under certainty, we should known: (a) lead time (b) average usage, and (c) economic order quantity. Lead time is the normally taken is replenishing inventory after the order has been placed. By certainty we mean that usage and lead time do not fluctuate. Under such a situation, reorder point is simply that inventory level which will be maintained for consumption during the lead time. That is: Reorder point = Lead * Average usage
Safety stock: The demand for inventory is likely to fluctuate from time to time. In particular, at certain points of time the demand may exceed the anticipated level. In other words, a discrepancy between the assumed (anticipated/expected) and the actual usage rate of inventory is likely to occur in practice. The effect of increased usage and/or slower delivery would be shortage of inventory. That is, the firm would disrupt production schedule and alienate the customers. The firm would, therefore, be will advised to keep a sufficient safety margin by having additional inventory to guard against stock-out situation. Such stocks are called safety stocks. This would act as a buffer/cushion against a possible shortage of inventory.
Safety stock may, thus, be defined as minimum
additional inventory to serve as safety margin/buffer/cushion to meet unanticipated increase in usage resulting form unusually high demand and/or uncontrollable late receipt of incoming inventory.
The carrying costs are the costs associated with the maintenance of inventory. Since the firm is required to maintain additional inventory, in excess of the normal usage, additional carrying costs are involved. The stock-out and carrying costs are counterbalancing. The larger the safety stock, the larger the carrying costs and vice versa. Conversely, the larger the safety stock, the smaller the stock-out costs.
max. inventory average usage EOQ
re-order point----------------------------------------------------max.usage safety stock
re-order point under safety stock
VED Analysis: The VED analysis is used generally for spare parts. The requirement and urgency of spare parts is different from that of materials. A-B-C analysis may not be properly used for spare parts. The demand for spares depends upon the performance of the plant and machinery. Spare parts are classified as: Vital (V), Essential (E) and Desirable (D). The vital spares are a must for running the concern smoothly and these must be stored adequately. The non-availability of vital spares will cause havoc in the concern. The E types of spares are also necessary but their stocks may be kept at low figures. The stocking of D types of spares may be avoided at times. If the lead time of these spares is less, then stocking of these spares can be avoided. The classification of spares under three categories is an important decision. A wrong classification of any spare will create difficulties for production department. The classification of spares should be left to the technical staff because they know the need, urgency and use of these spares.
Assumptions: In applying EOQ formula, it is assumed that: (i)
Total demand is known with certainty.
The usage rate of material is steady.
Orders for replenishment on inventory are placed exactly when
ordering level. (iv)
The ordering cost per order and holding cost per unit are constant.
EOQ and Total Inventory Cost: At EOQ level total inventory cost is minimum. Total inventory cost is the sum of material purchase cost, ordering cost and carrying cost As per the formula: Total Inventory Cost (TIC) = Material Purchase Cost + Total
Ordering Cost + Total
Carrying Cost = (R x P) + (R/Po x Cp) + (Qo/2 x Ch) Discount Offer and Economic Order Quantity: Sometimes supplier offers different discounts on orders of large quantity. In such a situation, at fist we should calculate EOQ and find out TIC without considering discount offer. Then we should calculate TIC of each alternative offer. That quantity will be EOQ at TIC is the lowest.
PERPETUAL INVENTORY CONTROL TECHNIQUE
Perpetual inventory system implies maintenance of up-to-date stock records and in its broad sense it covers both continuous stock taking as well as up-to-date recording stores books. According to Weldon, It may be defined as â€œa method of recording stores balances after every receipt and issue to facilitate regular checking and to obviate closing down for sock-takingâ€?. The basic object of this system is to make available details about the quantity and value of stock of each item at all times. The system thus provides a rigid control over stock of each item of store can regularly be verified with the stock records in the bin cards kept in the stores and stores ledger maintained in cost office.
Advantages of Perpetual Inventory system: 1.
Saving in time: The long and costly work of stocktaking is avoided. Hence, interim and final financial accounts can be prepared with greater convenience.
Arrangement of proper verification: In this system a detailed and more reliable checking of the store is exercised because of the continuous and random checking.
Verification of Errors: Errors are easily located and rectified. This gives an opportunity for preventing a recurrence in many cases.
Double control: Due to separate records in Bin card and stores ledger, double control is maintained.
Optimum size of material: Overstocking and under stocking can be avoided because perpetual inventory system covers verification of stock with regards to maximum, minimum and other levels.
Lack of misuse of Material: Under this system, effective control on issue of material is possible, thus misuse of material can be avoided.
Moral Check on Stores staff: Due to continuous checking, this system serves as a moral check on the stores staff. They are discouraged from committing dishonesty.
Loss of stock due to obsolescence: It is detected at an early stage and so timely action can be taken to prevent recurrence.
THE SELECTIVE INVENTORY CONTROL OR ABC SYSTEM OF CONTROL Most manufacturing firms find themselves confronted with virtually thousands of different inventory items. Most of these items are relatively inexpensive, while other items are quite expensive and account for a large portion of the firm’s investment. Some inventory items, although not expensive, turnover slowly and therefore, they require a high average investment. The firm should classify them into A.B.C category items. Category A will include more expensive items (in cost of product) with high investment and it will require more intensive control. The ‘B’ group will consist of the items accounting for the next largest investment.
The ‘C’ group will consist of a large number of items of inventory accounting for small investment. The ‘A’ items require intensive inventory control and most sophisticated inventory control techniques should be applied to these items. The ‘B’ items can be controlled using less sophisticated technique, and their level can be viewed less frequently than ‘A’ items. The ‘C’ items can receive the minimum attention: they will probably be ordered in large quantities in order to obtain them at the lowest price. Though the ABC technique is a good technique but it cannot be universally applied. Certain items of inventory may be inexpensive but may be critical to the product in process and cannot be easily obtained. Therefore, they may require special attention.
These types of items must be treated as “A” class items even though, using the broad framework, they would be “B” or “C” class items. Although, not perfect, the ABC system is an excellent method for determining the degree of inventory control efforts required to expand each item of inventory. The following points should be kept in mind for ABC analysis: (1)
Where items can be substituted
for each other, they should be preferably treated as one item. (2)
More emphasis should be given
to the value of consumption and not to price per unit of the item.
All the items consumed by an
organization should be considered together for classifying as A, B or C instead of taking item as spare, raw materials, semi-finished and finished items and then classifying as A, B and C. There can be more then three classes and the period of consumption need not necessarily be one year
Application of ABC Analysis: ABC analysis can be effectively used in Material Management. The various stages where it can be applied are: (1)
require higher degree of control. (2)
Priority treatment to different
Determination of safety stock
(2) Just-in-time (JIT) System: Japanese firms popularized the just-in-time (JIT) system in the world. In a JIT system material or the manufactured components and part arrive to the manufacturing sites or stores just few hours before they are put to use. The delivery of material is synchronized with the manufacturing cycle and speed. JIT system eliminates the necessity of carrying large inventories, and thus, saves carrying and other related costs of manufacturer. The system requires perfect understanding and coordination between the manufacturer and supplier in terms of the timing of delivery and quality of the material. Poor quality material or complements could halt the production. The JIT inventory system complements the total quality management (TQM). The success of the system depends on how well a company manages its suppliers. The system puts tremendous pressure on suppliers. They will have to develop adequate system and procedures to satisfactory meet the needs of manufacturers.
System of Accounting for Material Issued/Inventory Systems
Either the periodic inventory system or the perpetual inventory
system may be used to
account for materials issued to production and ending materials inventory.
Periodic Inventory System
Under the periodic inventory system, the purchase of materials is recorded in Purchase of Raw Materials Account. The opening/beginning inventory, if any, is recorded in a separate Materials Inventory- Opening Account. The materials available for use during a period equal purchases plus opening inventory. A physical count is made of the materials on hands at the end of the period to arrive at the closing/ending materials inventory. The cost of materials for the period is determined as shown in Exhibit:
Cost of Materials Issued
Materials inventory-opening + Purchases = Materials available for use - Materials inventory-closing (based on physical count) = Cost of materials issued
The entire book inventory is verified at a given date by an actual count of materials on hand. This physical inventory is usually taken near the end of the accounting year/period. This method provides for the recording of the purchases on a daily basis but does not provide for a continuous inventory-taking. Neither a physical count is made of the quantity of goods on hand, nor the value of the inventory in determined by using an appropriate pricing method and attaching costs
to units counted. It is assumed that goods not on hand at the end of the period have been sold. There is no system and accounting period, and they can be discovered only at the end.
INVENTORY TURNOVER RATE TECHNIQUE One important technique of inventory control is to use inventory turn over ratios. These ratios are calculated to asses the efficiency in use of inventories. Following control ratios can be computed for inventory analysis: (i)
Inventory Turnover Ratio = Cost of goods sold/ Average Inventory Where Average Inventory = (Opening Inventory + Closing Inventory)/2 Inventory Turnover Ratios ca be calculated separately for raw materials and finished goods.
Raw Material Turnover Ratio = Raw Material Consumed/ Average stock of Raw material.
Finished Goods Turnover Ratio = Cost of Goods Sold/ Average Stock of Finished Goods Average Age of inventory of inventory Turnover in Days = Days during the period/ Inventory Turnover Ratio
Average inventory to total cost of production = (Average Inventory/ total cost of production) x 100
Slow Moving Stores to Total Inventory = Average Cost of Slow Moving Stores/Average Inventory
Inventory Performance Index = (Actual Material Turnover Ratio/ Standard Material Turnover Ratio) x 100
These ratios provide a broad framework for the control and provide the basis for future decisions regarding inventory control. The ratios provide a tough indication of when Inventory levels are going to be high. Even if it appears from the ratio that the levels are too high there might be a perfectly good reason why the level of Inventory is being maintained. The ratios also indicate the situation and trend. However, the limitation of ratios should be kept in mind. They are not an end themselves, but only tools of sound Inventory Management.
FINANCIAL MANAGERâ€™S ROLE IN INVENTORY MANAGEMENT Inventory represents a large investment by manufacturing concern: therefore, great emphasis must be placed on its efficient management. Though, the operative responsibility for Inventory management lies with the inventory manager, the financial manager must also be concerned with all types of inventories- raw materials, work-in-progress and finished goods. He must monitor Inventory levels and see that only an optimum amount is invested in Inventory. He should be familiar with the Inventory control techniques and ensure that Inventory is managed well. He should try to resolve the conflicting view points of all the departments in order to have efficient inventory management. He has to act as a careful inspector levels. He should introduce the policies which reduce the lead time, regulate usage and thus, minimize safety stock. All these techniques of Inventory management lead to the goal of wealth maximization. VALUATION OF INVENTORIES OBJECTIVE:
A primary issue in accounting for inventories is the determination of the value at which inventories are carried in the financial statements until the related revenues are recognized. This statement deals with the determination of such value, including the ascertainment of cost of inventories and any write-down thereof to net realizable value. 1.
This statement should be applied in accounting for inventories other than:
(a) Work-in-progress arising under construction contacts, including directly related service contracts. (b) Work-in-progress arising in the ordinary course of business of service providers. (c) Shares, debentures and other financial instruments held as stock-in-trade. (d) Producerâ€™s inventories of livestock, agricultural and forest products and mineral oils, ores and gases to the extent that they are measured at net realizable value in accordance with well established practices in those industries.
The inventories referred are measured at net realizable value at certain stages of production. This occurs, for example, when agricultural crops have been harvested or mineral oils, ores and gases have been extracted and sale is assured under a forward contract or a government guarantee or when a homogenous market exists and there is a negligible risk of failure to sell. These Inventories are excluded from the scope of this statement.
DEFINITIONS The following terms are used in this statement with the meanings specified:
Inventories are assets: (a)
Held for sale in the ordinary course of business.
In the process of production for such sale, or
In the form of materials or supplies to be consumed in the production process or in the rendering of services. 1. Inventories encompass goods purchased and held for resale, for example, merchandise purchased by a retailer and held for resale, computer software held for resale, or land and other property held for resale. Inventories also encompass finished goods produced, or workin-progress being produced, by the enterprise and include materials, maintenance supplies, consumables and loose tools awaiting use in the production process. Inventories do not include machinery spares which can be used only in connection with an item of fixed asset and whose use is expected to be irregular; such machinery spares are accounted for in accordance with Accounting Standard (AS) 10, Accounting for Fixed Assets.
2. Inventories should be valued at lower of cost net realizable value. 3. Cost of Inventories The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.
4. Costs of Purchase The costs of purchase consist of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight, inwards
and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase.
5. Costs of Conversion The costs of conversion of inventories include costs directly
related to the units of
production, such as direct labour. They also include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings and the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly with the volume of production such as indirect materials and indirect labour.
6. The allocation of fixed production overheads for purpose of their inclusion in the costs of conversion is on based on the normal capacity of the production facilities. Normal capacity is the production expected to be achieved on an average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance. The actual level of production may be used if it approximates normal capacity. The amount of fixed production overheads allocated to each unit of production is not increased as a consequence of low production or idle plant. Unallocated overheads are recognized as an expense in the period in which they are incurred. In periods of abnormally high production, the amount of fixed production overheads allocated to each unit of production is decreased so that inventories are not measured above cost. Variable production overheads are assigned to each unit of production on the basis of the actual use of the production facilities. 7. A production process may result in more than one product being produced simultaneously. This is the case, for example, when joint products are produced or when there is a main product and a by- product. When the costs of conversion of each product are not separately
identifiable, they are allocated between the products on a rational and consistent basis. The allocation may be based, for example, on the relative sales value of each product either at the stage in the production process when the products become separately identifiable, or at the completion of production. Most by- products as well as scrap or waste materials, by their nature, are immaterial. When this is the case, they are often measured at net realizable value and this value is deducted from the cost of the main product. As a result, the carrying amount of the main product is not materially different from its cost.
8. Other costs are included in the costs of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. For example, it may be appropriate to include overheads other than production overheads or the costs of designing product for specific customers in the cost of inventories.
9. Interest and other borrowing costs are usually considered as not relating to bringing the inventories to their present location and condition and are, therefore, usually not included in the cost of inventories. 10. Exclusions from the cost of Inventories In determining the cost of inventories in accordance with paragraph 3. It is appropriate to exclude certain costs and recognize them as expenses in the period in which they are incurred. Examples of such costs are;
1. Abnormal amounts of wasted materials, labour, or other production costs.
2. Storage costs, unless those costs are necessary in the production process prior to a further production stage. 3. Administrative overheads that do not contribute to bringing the inventories to their present location and condition, and 4.
Selling and distribution costs.
11. The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects should be assigned by specific identification of their individual costs. 12. Specific identification of cost means that specific costs are attributed to identify items of inventory. This is an appropriate treatment for items that are segregated for a specific project, regardless of whether they have been purchased or produced. However, when there are large numbers of items of inventory which are ordinarily interchangeable, specific identification of costs is inappropriate since, in such circumstances, an enterprise could obtain predetermined effects on the net profit or loss for the period by selecting a particular method of ascertaining the items that remain in inventories.
The cost of inventories, other than those dealt with in paragraph 11, should be assigned
by using the first-in, first-out (FIFO), or weighted average cost formula. The formula used should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition.
14. A variety of cost formulas is used to determine the cost of inventories other than those for which specific identification of individual costs is appropriate. The formula used in determining the cost of an item of inventory needs to be selected with a view to providing the
fairest possible approximation to the cost incurred in bringing the item to its present location and condition. The FIFO formula assumes that the items of inventory which were purchased or produced first are consumed or sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced. Under the weighted average costs formula, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The average may be calculated on a periodic basis or as each additional shipment is received, depending upon the circumstances of the enterprise.
15. Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail method, may be used for convenience if the results approximate the actual cost. Standard costs take into account normal levels of consumption of materials and supplies, labour, efficiency and capacity utilization. They are regularly reviewed and if necessary, revised in the light of current conditions. 16.
The retail method is often used in the retail trade for measuring inventories of large
numbers of rapidly changing items that have similar margins and for which is impracticable to use other costing methods. The cost of the inventory is determined by reducing from the sales value of the inventory the appropriate percentage gross margin. The percentage used takes into consideration inventory which has been marked down to below its original selling price. An average percentage for each retail department is often used.
17. The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling prices have declined. The cost of inventories may also not be recoverable if the estimated costs of completion or the estimated costs necessary to make the sale have increased.
The practice of writing down inventories below cost to net realizable value is consistent with the view that assets should not be carried in excess of a amounts expected to be realized from their sale or use. 18. Inventories are usually written down to net realizable value on an item-by-item basis. In some circumstances, however, it may be appropriate to group similar or related items. This may be the case with items of inventory relating to the same product line that have similar purposes or end uses and are produced and marketed in the same geographical area and cannot be practicably evaluated separately from other items in that product line. It is not appropriate to write down inventories based on a classification of inventory, for example, finished goods, or all the inventories in a particular business segment.
Estimates of net realizable value are based on the most reliable evidence available at the time the estimates are made as to the amount the inventories are expected to realize. These estimates take into consideration fluctuations of price or cost directly relating to events occurring after the balance sheet date to the extent that such events confirm the conditions existing at the balance sheet date.
Estimates or net realizable value also take into consideration the purpose for which the inventory is held. For example, the net realizable value of the quantity of inventory held to satisfy firm sales or service contracts is based on the contract price. If the sales contracts are for less than the inventory quantities held, the net realizable value of the excess inventory is based on general selling prices.
Contingent losses on firm sales contracts in excess of inventory quantities held and contingent losses on firm purchase contracts are dealt with in accordance with the principles enunciated in Accounting Standard (A.S) 4, contingencies and events occurring after the balance sheet date.
Materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost. However, when there has been a decline in the price of materials and it is estimated that the cost of the finished products will exceed net realizable value, the materials are written down to net realizable value. In such circumstances, the replacement cost of the materials may be the net available measure of their net realizable value. An assessment is made of net realizable value as at each balance sheet date.
Disclosure. The financial statements should disclose: The accounting policies adopted in measuring inventories, including the cost formula used, and
The total carrying amount of inventories and its classification appropriate to the
enterprise. 24. Information about the carrying amounts held in different
classifications of inventories
and the extent of the changes in these assets is useful to financial statement users. Common classifications of inventories are raw materials and components, work in progress, finished goods, stores, spares and loose tools.
DATA COLLECTIO N
DATA COLLECTION In analysis of inventory of JOL, We collect the data by the different sources. We collect the primary and secondary data. SECONDARY DATA â€“
The secondary data are those data the already in presence for
specific purpose we use the secondary data about inventory to looks old records of the company .For the daily information about the items We show the MRN, ledger register and daily issue slip of materials the purchase register and other documentary evidence used for the findings. In the analysis of inventory the secondary data are not sufficient .then We collect primary data. PRIMARY DATA â€“ Primary data are those data that are originated very first time or fresh data .with the help of primary data formulated the research objectives. are the accurate attainable reliable and useful data.
1. Inventory control techniques used by the company 2. Inventory systems as perpetual and periodic systems. 3. Stock levels etc. 4. Companies website
Profit & Loss Account FY 2006 16242.9 1189.4 15053.5
FY 2005 12737.0 1034.3 11702.7
FY 2004 9456.7 864.7 8592.0
FY 2003 7853.9 719.5 7134.4
FY 2002 6598.2 649.4 5948.8
Other Income Total Income
Expenditure Cost of materials Manufacturin
Particulars Gross Sales Excise Net Sales Domestic Sales
g expenses Selling, general and administrative expenses Total Expenditure
Depreciation PBIT Interest PBDT PBT Tax PAT
513.4 1854.0 172.7 2194.7 1681.3 392.4 1288.9
381.4 1861.6 220.4 2022.6 1641.2 431.6 1209.6
326.2 1323.9 357.6 1292.5 966.3 179.0 787.3
237.5 1044.2 402.5 879.2 641.7 160.6 481.1
255.8 623.9 411.1 468.6 212.8 -19.4 232.2
Share of Profit / (Loss) in Associate Minority Interest PAT after share of profit / loss in associate and minority interest
Cash Flow FINANCE -CONSOLIDATED CASH FLOW - Jubilant Organ. (Curr: Rs in Million) 2006.3
Cash Flow Summary Cash and Cash Equivalents at Beginning of the year Net Cash from Operating Activities Net Cash Used in Investing Activities Net Cash Used in Financing Activities Net Inc/(Dec) in Cash and Cash Equivalent Cash and Cash Equivalents at End of the year
Financial Ratios Ratio Debt : Equity Ratio Current Ratio Working Capital Days TURNOVER RATIOS Assets Inventory Debtors Interest Cover Ratio Earning Before Interest Tax and Depreciation Margin (%) Profit Before Interest and Tax Margin (%) Profit Before Depreciation and Tax Margin (%) Net Profit (after minority interest) Margin (%) Return on Capital Employed (%) Return on Net Worth (%)
FY 2006 0.87 2.33 90
FY 2005 0.74 1.79 61
FY 2004 2.01 2.31 80
FY 2003 2.79 2.40 85
FY 2002 3.09 2.51 84
0.90 4.83 6.07 10.74
1.21 6.04 6.63 8.45
1.21 6.54 6.05 3.70
1.16 5.28 8.75 2.59
1.23 5.77 7.74 1.52
DATA ANALYSIS AND INTERPRETATION
INVENTORY TURN OVER RATIO-
Total sales Inventory turn over ratio = Average inventory
The sales of JOL in year 2007 is 720 million & its investment on inventory is 126 million . Then inventory turn over ratio = 720/126 = 5.71 JOL used Rs. 6 million worth inventory for operation. It could generates additional sales, sales Sales = 6 million * 5.71 = 34.26 million
If JOL increases investment more on their inventories , then company increases their sales.
Inventory turn in year 2006Total sales in 2006 = 670 million Investment on inventories = 118 million Turn over ratio
= 670/118 = 5.67
Inventory turn over in year 2005-
Total sales in 2005 = 620 million Investment on inventories = 110 million Turn over ratio
= 620/ 110 = 5.63
Inventory turn ratio in year 2004 Total sales in 2004 = 615 million Investment on inventories = 100 million Turn over ratio
= 615 / 100 = 6.15
Investment of inventories & sales on wards 2004-
Investment on inventories in million 100 110 118 126
2004 2005 2006 2007
total sales in million 615 620 670 720
Jubilant Organosys Ltd. increases investment on their inventories. Every year, then total sales increases year by year.
Sales EMBED Excel.Chart.8 \s
VALUE UNDER FIFO METHOD Date Jan 1
1000 0 1100
12 27 Feb 10 16 March 3
May 12 24
Jun 10 30
Where @ is 1000 1000 2000 Total 4000
1000 0 6000 1000 0
1200 0 6000 0 1000 0
9000 1200 0
1100 0 1300 0
2210 2.31 2.41 -
0 9000 1000 0
2310 4820 9340
Interpretation The FIFO method of valuation of inventory is based on the assumption that the inventory consumed in chronological order . that is received first are issued / consumed first and value fixed accordingly . From the table with an opening inventory of 10000 units at rs 2.10, the first 10000 units issued are charged to the cost of goods sold at this opening inventory rate rs 2.10 . the April 18 issue or consignment of 4000 units is costed on the basis of first received of the year . January 9 ,1000 units at rs 2.21, January 27 1000 units at rs 2.31 , and February 16 ,2000 units at rs 2.41. the 1000 each issued on May 12 and June 10 are costed on the basis of the 2000 units received on March 3 . therefore the cost of the 13000 inventory on June 30 is composed of the received of March 29 April 4 and 23 ,May 24 and June 30 and the value is the sum of the cost of these receipts.
Valuation under perpetual inventory systemDate 1Jan 6Jan 8Jan 9Jan 15Jan 25Jan 27Jan 31Jan
Receipts Q R 1100 8.50 300 9 400
Issues Balance A Q R A Q A 200 1400 100 7 700 100 700 9350 1200 10050 200 8.50 1700 1000 8350 400 8.50 3400 600 4950 2700 900 7650 300 8.50 2550 300 240 300 9 2700 0 3680 700 6080
The value of inventory after 31 January is 6080 /rs
Interpretation :The value of inventory under periodic & perpetual inventory system is different. The value of inventory under perpetual system is more than periodic system.
DETERMINATION OF STOCK LEVELS
Data of concentrate at JOL is as follows –
= 65 units per day
= 55 units per day
= 59 units per day
= 10-15 days
= 878 units
Normal re-order period
= 12 days
= Maximum consumption * Maximum Re-order period
Minimum stock level
= re-order level – (normal consumption * Normal re-order period) = 975 - (59 units * 12 days) = 267 units
Maximum stock level
= (re-order level + re-order quantity ) ( min. consumption – order period)
65 units * 15 days 975 units
= ( 975 units + 878 units ) - (55 units * 15 days) = 1028 units Average stock level = minimum stock level + ½ of Re-ordering
Quantity = 267 units + Â˝ * 878 units = 267 units + 439 units = 706 units
Interpretation of result : 1.
After calculation the re-order level of JOL is 975 units but the actual re-order quantity is 878 units.
The minimum stock level of JOL is 267 units.
The maximum stock level of JOL is 1028 units.
The average stock level must be 706 units.
Calculation of expected stock out cost â€“ Safety stock level
500 400 250
0 100 250 150
prob. Of stock cost(40/unit) out 0 4000 10000 0.01 0.02
300 150 450 350 200 50
16000 12000 0.02 6000 18000 0.01 14000 0.02 8000 2000
500 400 250 100
20000 0.01 16000 0.02 1000 4000
expected stock out expt. cost
0 40 100 120
0 40 220
180 280 0.03 0.04
200 320 0.03 0.04
Expected stock out cost == stock out cost * probability of stock out .
PROBLEMS AND SUGGESTION S
PROBLEMS FACED BY THE ORGANITION JOL faces the following problems1. Jubilant Organosys Ltd. faces the problem of competition. 2.
Organization facing the problem of proper skilled employees in the production
There is no proper sequence &acknowledgement board for certain items in store
department .It is not good when external auditing held in company. 4. Organization have no record of wastage items. It is not
good for operating profit of the
In organization store assistants have no proper knowledge about engineering goods &
There is no proper staff in HR/ Personnel department for listening grievances of
employees. So employees get rid of the organization without any notice. It is not good for any organization.
SUGGESTIONS TO THE ORGANISATION: . 1.
The organizations give proper knowledge & training for unskilled employees about their work.
In store department items should placed their proper sequence & acknowledgement. 3. There should be proper record of wastage. It is good for the company. 4. Store manager give the proper knowledge about engineering & raw materials.
Organization should have proper staff in HR/Personnel department. 6. Personnel manager should listen grievances of the employees personnel .So employees could not left the organization.
CONCLUSION The goal of the wealth maximization is affected by the efficiency with which inventory is managed. Inventories constitutes about 60% of current assets of companies in India. The manufacturing companies hold inventories in the form of raw materials , work in progress and finished goods. Inventories facilitate smooth production and sales operation (transaction motive), to guard against the risk of unpredictable changes in usage rate and delivery time ( precautionary motive ) , & to take advantage of price fluctuations (speculative motive ). Inventories represent investment of a firmâ€™s funds. The objectives of the inventory management should be the maximization of the value of the firm. therefore the firm should consider: 1. cost
3. risk factors
In inventory maintenance two types of costs are involved carrying cost & ordering cost .the firm should minimize the total cost ( carrying plus ordering cost ).The firm follows inventory control techniques as A-B-C technique EOQ & JIT techniques for better holding inventories.
Advanced Accountancy Ninth Edition S N Maheshwari , S K Maheshwari Vikas Publishing House Pvt. Ltd.
Financial Management Ninth Edition I M Pandey Vikas Publishing House Pvt. Ltd
Third Edition M Y Khan,
P K Jain
Tata Mc-Graw Hill Publishing Company Ltd.
Purchase , Sales Boucher & Other Documents of the Company Moon Beverage Ltd. Sahibabad