Assignment On

Inventory management & Working Capital management

Submitted To:k.m kumar P.K Aggarwal PROFESSOR

Submitted By:-

navneet singh PGDM-IB/10-12/23

Defining Inventory Inventory is an idle stock of physical goods that contain economic value, and are held in various forms by an organization in its custody awaiting packing, processing, transformation, use or sale in a future point of time. Any organization which is into production, trading, sale and service of a product will necessarily hold stock of various physical resources to aid in future consumption and sale. While inventory is a necessary evil of any such business, it may be noted that the organizations hold inventories for various reasons, which include speculative purposes, functional purposes, physical necessities etc. From the above definition the following points stand out with reference to inventory:

All organizations engaged in production or sale of products hold inventory in one form or other. Inventory can be in complete state or incomplete state. Inventory is held to facilitate future consumption, sale or further processing/value addition. All inventoried resources have economic value and can be considered as assets of the organization.

Different Types of Inventory:Inventory of materials occurs at various stages and departments of an organization. A manufacturing organization holds inventory of raw materials and consumables required for production. It also holds inventory of semi-finished goods at various stages in the plant with various departments. Finished goods inventory is held at plant, FG Stores, distribution centers etc. Further both raw materials and finished goods those that are in transit at various locations also form a part of inventory depending upon who owns the inventory at the particular juncture. Finished goods inventory is held by the organization at various stocking points or with dealers and stockiest until it reaches the market and end customers. Besides Raw materials and finished goods, organizations also hold inventories of spare parts to service the products. Defective products, defective parts and scrap also forms a part of inventory as long as these items are inventoried in the books of the company and have economic value.

Types of Inventory by Function:-

INPUT Raw Materials Consumables required for processing. Eg : Fuel, Stationary, Bolts & Nuts etc. required in manufacturing

PROCESS Work In Process Semi-Finished Production in various stages, lying with various departments like Production, WIP Stores, QC, Final Assembly, Paint Shop, Packing, Outbound Store etc. Production and Scrap Rejections Defectives

OUTPUT Finished Goods Finished Goods at Distribution Centers throughout Supply Chain

Maintenance Items/Consumables Packing Materials

Waste Finished Goods in transit and Finished Goods with Stockiest and Dealers Spare Parts Stocks & Bought Out items Defectives, Rejects and Sales Returns Repaired Stock and Parts Sales Promotion & Sample Stocks

Local purchased Items required for production

Reasons why organizations maintain Raw Material Inventory:Most of the organizations have raw material inventory warehouses attached to the production facilities where raw materials, consumables and packing materials are stored and issue for production on JIT basis. The reasons for holding inventories can vary from case to case basis.

1. Meet variation in Production Demand:Production plan changes in response to the sales, estimates, orders and stocking patterns. Accordingly the demand for raw material supply for production varies with the product plan in terms of specific SKU as well as batch quantities. Holding inventories at a nearby warehouse helps issue the required quantity and item to production just in time. 2. Cater to Cyclical and Seasonal Demand:Market demand and supplies are seasonal depending upon various factors like seasons; festivals etc. and past sales data help companies to anticipate a huge surge of demand in the market well in advance. Accordingly they stock up raw materials and hold inventories to be able to increase production and rush supplies to the market to meet the increased demand.

3. Economies of Scale in Procurement:Buying raw materials in larger lot and holding inventory is found to be cheaper for the company than buying frequent small lots. In such cases one buys in bulk and holds inventories at the plant warehouse.

4. Take advantage of Price Increase and Quantity Discounts:If there is a price increase expected few months down the line due to changes in demand and supply in the national or international market,

impact of taxes and budgets etc. the companys tend to buy raw materials in advance and hold stocks as a hedge against increased costs. Companies resort to buying in bulk and holding raw material inventories to take advantage of the quantity discounts offered by the supplier. In such cases the savings on account of the discount enjoyed would be substantially higher that of inventory carrying cost.

5. Reduce Transit Cost and Transit Times:In case of raw materials being imported from a foreign country or from a faraway vendor within the country, one can save a lot in terms of transportation cost buy buying in bulk and transporting as a container load or a full truck load. Part shipments can be costlier. In terms of transit time too, transit time for full container shipment or a full truck load is direct and faster unlike part shipment load where the freight forwarder waits for other loads to fill the container which can take several weeks. There could be a lot of factors resulting in shipping delays and transportation too, which can hamper the supply chain forcing companies to hold safety stock of raw material inventories.

6. Long Lead and High demand items need to be held in Inventory:Often raw material supplies from vendors have long lead running into several months. Coupled with this if the particular item is in high demand and short supply one can expect disruption of supplies. In such cases it is safer to hold inventories and have control. The Economic Order Quantity (EOQ) is the number of units that a company should add to inventory with each order to minimize the total costs of inventory such as holding costs, order costs, and shortage costs. The EOQ is used as part of a continuous review inventory system, in which the level of inventory is monitored at all times, and a fixed quantity is ordered each time the inventory level reaches a specific reorder point. The EOQ provides a model for calculating the appropriate

reorder point and the optimal reorder quantity to ensure the instantaneous replenishment of inventory with no shortages. It can be a valuable tool for small business owners who need to make decisions about how much inventory to keep on hand, how many items to order each time, and how often to reorder to incur the lowest possible costs. The EOQ model assumes that demand is constant, and that inventory is depleted at a fixed rate until it reaches zero. At that point, a specific number of items arrive to return the inventory to its beginning level. Since the model assumes instantaneous replenishment, there are no inventory shortages or associated costs. Therefore, the cost of inventory under the EOQ model involves a tradeoff between inventory holding costs (the cost of storage, as well as the cost of tying up capital in inventory rather than investing it or using it for other purposes) and order costs (any fees associated with placing orders, such as delivery charges). Ordering a large amount at one time will increase a small business's holding costs, while making more frequent orders of fewer items will reduce holding costs but increase order costs. The EOQ model finds the quantity that minimizes the sum of these costs. EOQ Formula

STOCK VALUATION:The process of calculating the fair market value of a stock by using predetermined formulas that factors in various economic indicators. Stock valuation can be calculated using a number of different methods. The most common methods used are the discounted cash flow method, the P/E method, and the Gordon model. Whichever method is chosen must be done accurately so that the price of stock can be valued properly.

Inventory Control is the supervision of supply, storage and accessibility of items in order to ensure an adequate supply without excessive oversupply. It can also be referred as internal control - an accounting procedure or system designed to promote efficiency or assure the implementation of a policy or safeguard assets or avoid fraud and error etc.

Inventory control may refer to:

In economics, the inventory control problem, which aims to reduce overhead cost without hurting sales In the field of loss prevention, systems designed to introduce technical barriers to shoplifting.

CRITERIA FOR JUDGING THE INVENTORY SYSTEM:While the overall objective of the inventory system is to minimize the cost to the firm at the risk level acceptable to management, the more proximate criteria for judging the inventory system are Comprehensibility Adaptability Timeliness

Areas of improvement:Inventory management in India can be improved in various ways. Improvements could be affected through.

Effective Computerization:Computers should be used merely for accounting purposes but also for improving decision making. Review of Classification: ABC & FSN c l a s s i f i c a t i o n m u s t b e periodically reviewed.

Improved Co-ordination:Better co-ordination among purchase, production, marketing a n d f i n a n c e department will help in achieving greater efficiency in i n v e n t o r y management.

Development of Long Term Relationships:Procedures for disposing obsolete/surplus inventories must be simplified. Companies should set benchmarks with global competitors and use ideas like JIT to improve inventory management. Valuation of inventories- methods of determination:Although the prime consideration in the valuation of inventories is cost, there are a number of generally accepted methods of determining the cost of inventories at the close of an accounting period. The most commonly used methods are First-in-first-out ( F I F O ) a v e r a g e , a n d L a s t - i n - f i r s t - o u t ( L I F O ) . T h e s e l e c t i o n o f t h e m e t h o d f o r determining cost of inventory valuation is important for it has a direct bearing on the cost of goods sold and consequently on profit. When a method is selected, it must be used consistently and cannot be changed from year to year in order to secure the most favorable profit for each year

Working Capital management

A current asset is an asset on the balance sheet which can either be converted to cash or used to pay current liabilities within 12 months. Typical current assets include cash, cash equivalents, short-term investments, accounts receivable, inventory and the portion of prepaid liabilities which will be paid within a year. Characteristics of Current Assets:1. Cash includes bank balance and bank deposits. 2. Accounts receivable - some old items may be doubtful debts. 3. Temporary investments in stock, bonds, debentures - only short term 4. Inventories - raw materials, finished goods etc. old and non- sale able items are also included Factors Influencing Working Capital Management:Nature of Business:The working capital requirement of a firm is closely related to the nature of its business. In general businesses with short operating cycles will require lesser amount of working capital as compared to businesses with longer operating cycles. The firms engaged in manufacturing and trading will require more working capital as large amount of funds are locked in inventories and receivables. Business Cycle: During economic boom there is increased production which require higher amount of working capital, but this is partly off set by reduced operating cycle. At the time of economic recession again there would be need for

increased working capital, as large amount of funds would be locked in inventories and receivables. Seasonal Variations: Commodities with seasonal demand results in increased level of working capital requirement. This could be offset by scaling down operations during the lean part of the year and increasing production prior to demand period. Products manufactured with raw materials, the production of which is seasonal (agricultural products) would require higher amount of working capital. Size of Business: Size of the firm is also a determining factor in estimating working capital requirements. The size of a firm may be measured either in terms of scale of operations, or assets or sales. Large firms require more amount of working capital for investment in current assets and also to pay current liabilities than smaller firms. However, in some cases even a small firm may need more working capital as a cushion against cash flow interruptions. Change of Technology: Changes in technology generally leads to improvements in the efficient processing of raw material, decrease in wastages, higher productivity and more speedy production. All these improvements lead to reduction in investment in inventories, which in turn leads to reduction in working capital requirement. If changed technology results in shorter manufacturing process the lesser would be the requirements of working capital.

Current Asset Investment Policy:-

Everything else remaining the same, higher levels of current assets mean lower risk and lower expected return Lower Risk Greater ability to meet short-run obligations. Lower Return Cash and marketable securities typically yield low returns. Furthermore, when current assets are increased, additional financing costs will be incurred thereby lowering returns. Lower levels of current assets result in opposite effects.

LEVEL OF CURRENT ASSETS:Flexible conservation Policy Liquidity Investors Debtors High Large High Restrictive Aggressive Policy Low Small Low

A flexible policy result in fewer production stoppages, ensures quicker delivery to customer and stimulate sales But Higher investment in current assets. A restrictive policy result to more production stoppages, delayed delivery to customers and lost sales But Lower investment in current assets.

Profit Criterion for Current Assets:1. Investment in current assets is easily reversible. 2. For reversible investments, the criterion of net profit per period (which here

means residual income) is equivalent to the criterion of net present value. Operating Cycle:The Operating cycle definition, also known as cash operating cycle or cash conversion cycle or asset conversion cycle, establishes how many days it takes for a company to turn purchases of inventory into cash receipts from its eventual sale. Operating cycle has three components of payable turnover days, Inventory Turnover days and Accounts Receivable Turnover days.

ILLUSTRATION Financial Information for Horizon Limited Balance Sheet Data Profit and Loss Account Data Sales Cost of goods Sold 800 720 Inventory Accounts receivable Accounts payable 56 Beginning of 20X0 96 86 60 End of 20X0 102 90

(96 + 102) / 2 Inventory period = 720 / 365 (86 + 90) / 2 Accounts receivable period = 800 / 365 = 40.2 days = 50.1 days

(56 + 60) / 2 Accounts payable period = 720 / 365 = 29.4 days

Operating cycle

50.1 Inventory Period

40.2 Accounts

= 90.3 days

receivable period 29.4 = 60.9 days Accounts payable period

Cash cycle

90.3 Operating Cycle