Inventory control mismanagement can break your business in one swoop. It doesn’t take much.
A missing piece of expensive inventory can leave you scrambling to cover your bills for the month.
But how do you keep this from happening to you?
Concept of Inventory Control:
The term inventory control is used to cover functions which are quite different and are related to one another only in that they both require the maintenance of adequate records of inventory as well as receipt and issue corresponding to these two functions. It is interpreted as accounting control and operating control.
Accounting control of inventories is concerned with the proper recording of the receipt and consumption of the material as well as the flow of goods through the plant into finished stock and eventually to customers.
It is also concerned with the safeguarding of the undertaking’s property in the form of raw materials, work-in-progress and semi-finished product. Operating control of inventories is concerned with maintaining inventories with the optimum level keeping in view the operational requirements and financial resources of the enterprise.
Importance of Inventory Control:
The aim of holding inventories is to allow the firm to separate the process of purchasing, manufacturing, and marketing of its primary products. Inventories are a component of the firm’s working capital and as such represent a current account.
Inventories are also viewed as a source of near all cash. The purpose is to achieve efficiencies in areas where costs are involved. The scientific inventory control results in the reduction of stocks on the one hand and substantial decline in critical shortages on the other.
In the following paragraph we can specify the various importance’s that accrue from holding inventories:
(i) Reducing Risk of Production Shortages:
Firms mostly manufacture goods with hundreds of components. The entire production operation can be halted if any of these are missing. To avoid the shortage of raw material the firm can maintain larger inventories.
(ii) Reducing Order Cost:
Where a firm places an order, it incurs certain expenses. Different forms have to be completed. Approvals have to obtained, and goods that arrive must be accepted, inspected and counted. These costs will vary with the number of orders placed. Smaller the inventories lesser the capital needed to carry inventories.
(iii) Minimise the Blockage of Financial Resources:
The importance of inventory control is to minimise the blockage of financial resources. It reduces the unnecessary tying up of capital in excess inventories. It also improves the liquidity position of the firm.
(iv) Avoiding Lost Sales:
Most firms would lose business without goods on hand. Generally a firm must be prepared to deliver goods on demand. By ensuring timely availability of adequate supply of goods, inventory control helps the firm as well as consumers.
(v) Achieving Efficient Production Scheduling:
The manufacturing process can occur in sufficiently long production runs and with preplanned schedules to achieve efficiencies and economies. By maintaining reasonable level of inventory production scheduling becomes easier for the management.
(vi) Gaining Quantity Discounts:
While making bulk purchases many suppliers will reduce the price of supplies and component supplies will reduce the price of supplies and component parts. The large orders may allow the firm to achieve discounts on regular basis. These discounts in turn reduce the cost of goods and increase the profits.
(vii) Taking the Advantage of Price Fluctuations:
When the prices of the raw materials are low the firm makes purchases in economic lots and maintains continuity of operations. By reducing the cost of raw materials and procuring high prices for its goods the firm maximises profit. This with the help of inventory control the firm takes advantage of price fluctuations.
(viii) Tiding over Demand Fluctuations:
Inventory control also helps the firm in tiding over the demand fluctuation. These are taken care of by keeping a safety stock by the firm. Safety stock refers inventories carried to protect against variations in sales rate, production rate and procurement time. Inventory control aims at keeping the cost of maintaining safety stock minimum.
(ix) Deciding timely Replenishment of Stocks:
Inventory control results in the maintenance of necessary records, which can help in maintaining the stocks within the desired limits. With the help of adequate records the firm can protect itself against thefts, wastes and leakages of inventories. These records also help in deciding about timely replenishment of stocks.
Methods of Inventory Control:
Inventory control is concerned with the periodic review of materials in stock to detect those not required for planned production or for other purposes not required and whether obsolete materials continue to occupy storage space until removed from stores.
The inventory control methods give us a means for determining an optimal level of inventory as well as how much should be ordered and when. There are several methods suggested for inventory controls.
The following are the most important systems used for inventory control:
(a) ABC System:
A firm using ABC system segregates its inventory in to three groups-A, B and C. The ‘A’ items are those in which it has the largest rupee investment. This group consists of the 20 per cent of the firm’s rupee investment. The B group consists of the items accounting for the next largest investment, i.e., the B group consists of the 30 per cent of the items accounting for about 8 per cent of the firm’s rupee investment.
The C group typically consists of a large number of item accounting for small rupee investment. C group consist of approximately 50 per cent of all the items of inventory but only about 2 per cent of the firm’s rupee investment.
The common procedure for categorisation of items into ‘A’, ‘B’ and ‘C’:
(i) The categorisation can be made by comparing the cumulative percentage of items with the cumulative percentage of usage value.
(ii) All the items are to be ranked in the descending order of their annual usage value.
(iii) The cumulative percentage of items to the total number of items is also marked in another column.
(iv) The cumulative totals of annual usage values of these items along with their percentages to the total annual usage value are to be noted along-side.
The advantages of this system are listed below:
(i) It helps in achieving the main objective of inventory control at minimum cost.
(ii) It helps in developing a scientific method of controlling inventories.
(iii) It gives closer control on costly items.
Limitation of ABC Analysis:
(i) The system analyses the items according to their value not according to their importance in the production process.
(ii) The analysis to be effective needs to be constantly undertaken and periodically reviewed by management.
(iii) Generally hundreds of items fall in category ‘C’ as a result a lot of time is spent on managing inventory.
(b) Budgetary Control System:
Budgetary control is a tool of management used to plan, carry- out and control the operations of business. It establishes pre-determined objectives and provide the basis for measuring performance against these objectives. Under this system the number of units of the materials to produce a finished product and the level of inventory to be maintained and the quantities to be purchased during the period are all pre-determined.
When these plans are projected in advance they are called budgets. Control over inventories is exercised on the basis of budgeted figures. Successful inventory budgeting depends upon the sales forecast. The budget on control system has the advantage of the co-ordination on the inventory consumption level and the expected consumption.
This system integrates and ties together all activities of the enterprise right from the planning to controlling. Control helps to eliminate or reduce unproductive activities and minimising waste. It is an effective method of controlling activities of the business unit since it provides standards against which actual performance is measured.
(c) Minimum-Maximum System:
This is one of the oldest methods used in most of the business for controlling inventories. It is essential that proper control should be exercised on the level of the inventory to be maintained. Efficient management of inventory demands that both over and under investment in stock be avoided.
If higher levels of inventories are maintained stock level will be influenced by obsolescence, change in fashion and improvements in technicalities. Too much capital tied up in inventories results in the lower rate of return and the possibility of substantial loss from decline in market value.
Too small a quantity is likely to reduce the value of the business and proper servicing of the customers. According to this, a maximum level of inventory based upon the demand and the minimum level to prevent out of stock conditions for each item of stock are established. An order is placed when the minimum level is reached which will bring the quantity to the maximum level.
(d) The Economic Order Quantity Approach:
The Economic order quantity (EOQ) refers to the optimal order size that will result in the lowest total of order and carrying costs for an item of inventory given its expected usage, carrying cost and ordinary cost. By calculating an economic order quantity, the firm attempts to determine the order size that will minimise the total inventory costs.
(i) Constant or uniform demand.
(ii) Independent orders.
(iii) Instantaneous delivery.
(iv) Constant ordering costs.
(v) Constant carrying costs.
(vi) Constant unit price.
Finding Economic Order Quantity:
The EOQ model assumes that the finished goods are sold at a constant rate overtime. The important decision in inventory management is to balance the cost of holding inventories with the cost of placing inventory replenishment orders. When the holding costs and ordering costs are balanced, the inventory costs are minimised and resulting order quantity is called the economic order quantity.
Total inventory cost = Ordering cost + Carrying cost
Total ordering cost = Number of orders x Cost per order
= Rs.U/Q x F
u = Annual usage
Q = Quantity ordered
f = fixed cost per order
Total carrying cost = Average level of inventory x price per unit x carrying cost.
Total carrying cost = Rs. Q/2 x P x C
= Rs. QPC/2
Q = Quantity ordered
P = Purchasing Price per unit
C = Carrying cost.
Inventory Level and Order Point for Replenishment:
From Fig. 1., it can be noticed that the level of inventory will be equal to the order quantity (Q units) to start with. It declines to level 0 by the end of period 1. At that point an order for replenishment will be made for Q units. In view of zero lead time the inventory level jumps to Q and the same procedure follows in the subsequent periods. As a result of this the average level of inventory will remain at Q/2 units, the simple average of the two end points Q and Zero.
From the above we know that as order quantity increases the total ordering costs will decrease while the total carrying cost will increase in proportion to the magnitude of the order quantity.
From Fig. 2 it can be seen that the total cost curve reaches its minimum at the point of intersection between the ordering cost curve and the carrying cost line. The value of Q corresponding to it will be the economic order quantity Q0.
That being said, there are two different types of inventory control systems available today: perpetual inventory systems and periodic inventory systems. Within those systems, two main types of inventory management systems – barcode systems and radio frequency identification (RFID) systems – used to support the overall inventory control process:
- Main Inventory Control System Types:
- Types of Inventory Management Systems within Inventory Control Systems:
Inventory control systems help you track inventory and provide you with the data you need to control and manage it. No matter which type of inventory control system you choose, make sure that it includes a system for identifying inventory items and their information including barcode labels or asset tags; hardware tools for scanning barcode labels or RFID tags; a central database for all inventory in addition to the ability to analyze data, generate reports, and forecast demand; and processes for labeling, documenting, and reporting inventory along with a proven inventory methodology like just-in-time, ABC analysis, first-in, or first out (FIFO), or last-in-first-out (LIFO).
Read on to learn more about the types of inventory and the types of inventory control systems and inventory management apps that can help companies more efficiently manage their inventory.
What Are the 4 Types of Inventory?
Before getting into details about the types of inventory control systems, it’s important to understand the different types of inventory.
Generally, inventory can be grouped into four primary classifications:
- Raw materials – Raw materials are inventory items used in the manufacturing process to create finished goods. What is considered a raw material to one company may be considered finished goods to another. For example, a company that creates parts or components for machinery or equipment would consider those components finished goods. A manufacturer that purchases those components for use in their manufacturing process would consider the same components raw materials. Raw materials may consist of things like paper or steel, nuts and bolts, chemicals, wheels, and other items.
- Work-in-progress – Work-in-progress (WIP) inventory includes items that are currently being processed. WIP inventory can include raw materials and components that are going through the manufacturing process to produce finished goods as well as finished items that are waiting for final inspection or quality control. After those final steps are complete, these finished items would be considered finished goods.
- Finished goods – Finished goods are comprised of all completed items that are ready for sale to the final customer.
- MRO goods – MRO stands for maintenance, repair, and operating supplies. MRO inventory consists of items necessary to operate, such as equipment and machinery, and the items needed for maintaining equipment and infrastructure. That means MRO inventory can also include items that are sometimes considered raw materials but in this case are essentially spare parts. Nuts and bolts are a good example. When nuts and bolts are on hand to assemble finished products, they’d be classified as raw materials. Extra nuts and bolts a company keeps in storage to repair equipment, on the other hand, are classified as MRO. Other examples of MRO inventory include janitorial supplies such as cleaning solutions, mops, and brooms, tools, packaging materials, uniforms and gloves, and office supplies such as paper, pens, calculators, printer ink, and other items.
Inventory can be further classified in several ways depending on the industry, the company’s operations, and the types of inventory the company manages. Companies that purchase finished goods and sell them to customers at a markup have just one type of inventory called merchandising inventory.
Some companies, such as manufacturers, need to manage a variety of inventory in different classifications, making efficient inventory tracking a must. To effectively manage inventory, an inventory tracking solution is paired with an inventory control app or inventory management app.
How Do Inventory Control Systems Work?
Inventory control systems, such as inventory control apps, offer a variety of functions that help companies manage various types of inventory. Inventory control systems typically consist of inventory management apps paired with barcode tagging to identify inventory assets, and information about each item is stored in a central database. Barcode labels serve as inventory trackers, allowing users to bring up information about the item on a computer system, such as the item’s price, the number of items in stock, the location of an item within a warehouse, and more.
The best inventory control apps are mobile-compatible, with companion apps that allow users to track and manage inventory while they move throughout a facility or from site to site. There are many inventory tracking apps for smartphones, some of which are mobile-exclusive, while others have desktop applications to allow users to track inventory from any device. There are also many inventory tracking apps designed specifically to meet the needs of warehouse managers. When looking for an inventory management app, look for features that accommodate your company’s needs, such as trigger alerts when inventory levels reach pre-defined thresholds, re-ordering capabilities, and analysis and reporting to support functions such as forecasting.
The 2 Types of Inventory Control Systems
Now that we’ve covered the basics of inventory and how inventory control systems work in general, let’s discuss the two main types of inventory control systems.
Perpetual Inventory System
When you use a perpetual inventory system, it continually updates inventory records and accounts for additions and subtractions when inventory items are received, sold from stock, moved from one location to another, picked from inventory, and scrapped. Some organizations prefer perpetual inventory systems because they deliver up-to-date inventory information and better handle minimal physical inventory counts. Perpetual inventory systems also are preferred for inventory tracking because they deliver accurate results on a continual basis when managed properly. This type of inventory control system works best when used in conjunction with
a database of inventory quantities and bin locations updated in real time by warehouse workers using barcode scanners. Inventory management apps are perpetual inventory systems.
There are some challenges associated with perpetual inventory systems. First, these systems cannot be maintained manually and require specialized equipment and software that results in a higher cost of implementation, especially for businesses with multiple locations or warehouses. Periodic maintenance and upgrades are necessary for perpetual inventory systems, which also can become costly. Another challenge of using a perpetual inventory system is that recorded inventory may not reflect actual inventory as time goes by because they do not conduct periodic physical inventory counts, a necessary activity even when inventory trackers are used. The result is that errors, stolen items, and improperly scanned items impact the recorded inventory records and cause them not to match actual inventory counts.
Periodic Inventory System
Periodic inventory systems do not track inventory on a daily basis; rather, they allow organizations to know the beginning and ending inventory levels during a certain period of time. These types of inventory control systems track inventory using physical inventory counts. When physical inventory is complete, the balance in the purchases account shifts into the inventory account and is adjusted to match the cost of the ending inventory. Organizations may choose whether to calculate the cost of ending inventory using LIFO or FIFO inventory accounting methods or another method; keep in mind that beginning inventory is the previous period’s ending inventory.
There are a few disadvantages of using a periodic inventory system. First, when physical inventory counts are being completed, normal business activities nearly become suspended. As a result, workers may hurry through their physical counts because of time constraints. Periodic inventory systems typically don’t use inventory trackers, so errors and fraud may be more prevalent because there is no continuous control over inventory. It also becomes more difficult to identify where discrepancies in inventory counts occur when using a periodic inventory control system because so much time passes between counts. The amount of labor that is required for periodic inventory control systems make them better suited to smaller businesses.
Barcode Inventory Systems
Inventory management systems using barcode technology are more accurate and efficient than those using manual processes. When used as part of an overall inventory control system, barcode systems update inventory levels automatically when workers scan them with a barcode scanner or mobile device. The benefits of using barcoding in your inventory management processes are
numerous and include:
- Accurate records of all inventory transactions
- Eliminating time-consuming data errors that occur frequently with manual or paper systems
- Eliminating manual data entry mistakes
- Ease and speed of scanning
- Updates on-hand inventory automatically
- Record transaction histories and easily determine minimum levels and reorder quantities
- Streamline documentation and reporting
- Rapid return on investment (ROI)
- Facilitate the movement of inventory within warehouses and between multiple locations and from receiving to picking, packing, and shipping
Radio Frequency Identification (RFID) Inventory Systems
Radio frequency identification (RFID) inventory systems use active and passive technology to manage inventory movements. Active RFID technology uses fixed tag readers throughout the warehouse; RFID tags pass the reader, and the movement is recorded in the inventory management software. For this reason, active systems work best for organizations that require real-time inventory tracking or where inventory security has been an issue. Passive RFID technology, on the other hand, requires the use of handheld readers to monitor inventory movement. When a tag is read, the data is recorded by the inventory management software. RFID technology has a reading range of approximately 40 feet with passive technology and 300 feet with active technology.
RFID inventory management systems have some associated challenges. First, RFID tags are far more expensive than barcode labels; thus, they typically are used for higher value goods. RFID tags also have been known to have interference issues, especially when tags are used in environments with a lot of metal or liquids. It also costs a great deal to transition to RFID equipment, and your suppliers, customers, and transportation companies need to have the required equipment as well. Additionally, RFID tags carry more data than barcode labels, which means your system and servers can become bogged down with too much information.
When choosing an inventory control system for your organization, you first should decide whether a perpetual inventory system or periodic inventory system is best suited to your needs. Then, choose a barcode system or RFID system to use in conjunction with your inventory control system for a complete solution that will enable you to have visibility into your inventory for improved accuracy in scanning, tracking, recording, and reporting inventory movement.