To maintain profitability in small enterprises, the most important requirement is preventing wastage of time and raw material, not leaving the machine capacity idle and underutilisaton of labour force.The major asset in the enterprise which affects efficiency of operations is inventory. Both excess of inventory and its shortage affects the productive activity and the profitability of the enterprise whether it is manufacturing, trading or the services business. A small entrepreneur has to exercise utmost care from the very first stage of stepping into the business to determine the exact quantity of the inventories needed in the business, carefully locate and select suppliers who will maintain the supply schedule, the quality of the raw material or merchandise, and honour the terms negotiated and settled. Every time, an inventory is received from the supplier, the entrepreneur should exercise a close check over the quality and quantity and mark the goods as per the grades adopted by him.
These arepreliminary steps in the direction of inventory control. These steps do not suggest the ways and means of controlling the various costs associated with maintaining the inventories. These costs, interalia, cover interest on capital invested in inventories, insurance cost, obsolescence and wastage resulting from storing the inventories, etc.
On the other hand, there are costs which could be attributed to not-holding the inventories. These costs may include re-ordering cost, lost sales cost, lost production cost which occur in the absence of adequate inventories as a result of which the productive activity stops, orders are not executed, there is customer dissatisfaction and threat to lose the market share increases, despite the burden of fixed costs and wage payment to idle workforce, underutilised machine capacity, incurrence of other productive overheads.
Such a situation can be avoided by selecting the right level of inventory where the cost of holding a particular size of inventory is lowest.The figure(see graph) shows the cost of holding inventory of 10 units is Rs 10 and when the quantity increased, the cost reduced. This trend continues till the quantity of 70 is reached. At 70 the cost is Rs 4. As more quantity is added to inventory, the cost starts increasing presenting a V shape curve. Beyond the quantity 70, the cost of holding the inventory is increasing because more quantity of inventory requires more investment causing more interest on excess borrowed capital, increase in rent for usage of excess space to store added inventories, more costs towards insurance plus various costs associated with handling the added stores and increased wastage and obsolescence.
To control and maintain a right level inventory of retailers, wholesalers and small manufacturers should use suitable methods covered in the following discussion:
Inventory control in retail business must suit the peculiarities of the business viz. diversity of merchandise, stability of demand, regularity of sale and biggest investment inmerchandise. In such trade, profitability is high when inventories are at optimum level. At all times, efforts are made to balance the inventories to match the demand of customers for the merchandise.
For inventory control, in retail business, the following steps are needed viz. (i) classify the goods into merchandise, departmentise the store, group similar and related items following the standard classifications; (ii) keep track of inventories by perpetual inventory record, physical counts through physical inventory tally sheets; (iii) use dating code to preserve freshness of stock (iv) exercise control by regulating the amount of money invested in inventories to achieve the desired level of sales.
Some retailers keep a daily running record of sales and stocks of each item within the line or class of goods. This system is known as Unit Control System. Retail shops engaged in shopping goods, fashion merchandise etc. follow this system. Some salesmen tag the goods and after sale remove the tags to count atthe close of business hour. They also keep track of the variety, shade, colour and quantity sold to be replaced in the inventory.
Inventory control in wholesaling is different. The Unit Control System might not suit a wholesaler who maintains large lots and heavy inventories. There is high inventory turnover. Some wholesalers follow the Unit Control System and some keep track of inventories by observation. The more scientific method which meets the need of accuracy and frequent movement of goods is the Perpetual Inventory System. It is based on certain standards to control stock level to act as safeguard against out-of-stock or overstock situation. Such standards include order points which indicate when to buy and how much to buy for each item in the stock.
Wholesalers, throughout the world, use the Perpetual Inventory Record System. It can be modified suitably before adoption. For using this system, the following things have to be borne in mind viz. (1) Maximum stock is the quantity of old stock to beon hand when a new shipment is received plus the standard order quantity; (2) Minimum stock is computed by subtracting the average sales during the time required to fill an order from the quantity established as ordering point; this is the margin of safety against out-of- stock situation; (3) Order point is based on the average time lapse that occurs between purchase and receipt of the merchandise and the maximum rate of sales during that interval so that sufficient stock will be in the warehouse at the time of ordering to avoid out-of-stock situation.
The following example will clarify this concept: Suppose Order Point is 100 units i.e. the maximum amount likely to be sold during the time in which the order is being filled. To arrive at maximum stock, the average amount sold during the time in which the order is being filled is subtracted from order point. Suppose the average amount of sales is 50 units then the minimum stock would be (100-50) i.e. 50 units.
Similarly, to arrive at the maximum stockstandard, the minimum amount sold is deducted during time in which the order is being filled (say 25) from Order point (100), i.e. 100-25=75 units. This figure represents the maximum amount likely to be on hand when the new order is received. Add the figure for standard order (i.e. 200) then the maximum stock order is 100-25=75+200=275. Referring back to perpetual record, these figures once calculated will be filled in the said record. The physical count is to be done periodically for all the incoming stores.
For a small-scale manufacturer, inventory control is desirable to ensure continuity of productive activity. But the question is what system the small manufacturer should adopt based on the physical requirement of inventories. Assuming that there may not be a large requirement of raw material for small manufacturers, control must be exercised not only on raw material but on fabricated parts and finished goods.
For that purpose, the Perpetual Inventory Record System would be most suitable. This systemis commonly used in all the developed nations. Extra efforts are made for ensuring availability of raw material and parts by following the Material Reserve Slip System. Particularly, where manufacturing activity is repetitive type. For this purpose, balance-of-stores ledger sheets is maintained.
In the Material Reserve Slip System, those materials required for repetitive type of productive activity are reserved to ensure availability by putting a ‘‘Material Reserve Slip’’ depicting therein the description of item, quantity reserved, date of reservation and quantity in stock with signatures of production manager/foreman or entrepreneur to ensure authentication.
Another method suitable to the small manufacturer is the balance-of-stores-ledger sheet which resembles the Perpetual Inventory Record except for the top description portion.
The following drill is observed in maintaining balance-of-stores-ledger sheets viz.(a)When purchase order is made, entry is made in column (1) and (4);(b) When goods orderedare received, subtract from column (1) and add to column (2);(c) When goods are reserved, enter in column (3) and subtract from column (4); (d) When goods are issued out of reserved ones, subtract from column (2) and (3); (e) When goods not reserved are issued, entry is made by subtracting in column (2) and (4).
For example,(i) at 10 a.m on August 10, 1997, a small entrepreneur had 100 units of a particular raw material in the store. This was entered in column (2) and column (4); which indicates that the goods in stores are available for use; (ii) at 10.30 a.m. the manager had one production order (PO-1) for 50 units which he earmarked to PO-1. This increased the col (3) sub-col reserved 50 and sub-col balance 50 and in col (4) made available 50 units out of earlier 100; (iii) if balance in col (4) is equal to or less than ordering point cited in top of ledger then the manager will immediately make material purchase order (MPO) for specified amount cited in the top of order, say, if it is 200 with theresult in Col (1) sub-col ‘‘ordered’’ the figure 200 will be entered with sub-col balance showing 200 and in col (4) the figure will be 50+200=250 i.e. the balance of units of raw material available for future production; (iv) on receipt of this material at a future date, col (1) sub-col received will be added with 200 and col. (2) will show the total balance, whatever available on that date, and so on.These methods highlight the procedure mostly on identifying the available stock for business activity and keeping track on inventories, but has very little to suggest minimisation or reduction of costs associated with holding the inventories.
For the purpose, Economical Ordering Quantity or Economic Order Quantity (EOQ) is suggested to reduce the costs associated with acquiring and carrying the inventories. The size of the order should be such which ensures the desired level of inventory at minimum acquisition and carrying costs.Acquiring or procurement costs and carrying costs move in opposite directions.Bulk order will reduce the procurement costs but increase carrying costs. For certain small manufacturing units, as well as in retail shops the ABC inventory control method is more suitable. The inventories are categorised into three categories A, B & C depending upon identification and isolation of items requiring different degree of precision in control or demand from the customers.
Under category A, those items are placed which are valuable involving large financial stake, requiring greater attention for safety of stock or frequently in demand by the retailers’ clients; Category B signifies less costlier items or where demand is not as much as for category A goods; whereas ‘C’ may refer to inexpensive items not requiring much care and not much in demand. Thus A and B items will come under close personal supervision and help maintain the average level of inventory. Unwise investment in inventories affects the liquidity of the firm and hampers cash flow management.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
