STOCK CONTROL

      STOCK CONTROL

Stock levels are maintained in such a way that there is no overstocking, so that chances of  loss through damage, deterioration in quality, risk of obsolescence, etc. are avoided along with unnecessary blocking of capital or paying interest on borrowed funds. At the same time, there shall be no stock-out situation, leading to interruption of production and loss of sale and profit. The production planning and control or material control department looks after this aspect of stores-management by fixing maximum, minimum and ordering level and reorder quantity for stock items i.e. standardised items of regular use. Within these guidelines noted in each bin card/stock control card, the storekeeper places requisitions with the purchase department for replenishment of stock. But, how these levels are  determined?

Reorder level

This is the level at which the Scorekeeper initiates purchase requisition for fresh supplies of materials. Reorder level takes into account the maximum consumption during lead time and unexpected delay in receiving fresh supply. Lead time means time necessary to obtain delivery of materials from date of order. In case of unusual delay, stock should not reach zero level. Reorder level is, therefore, calculated as maximum reorder period multiplied by maximum consumption.

Minimum level

This represents a level which the stock will reach with fresh delivery of material provided the fresh delivery is made within the reorder period and usage remains normal during the period. Stock is normally not allowed to fall below this level. This is considered as buffer stock for use in emergency. If however stock level falls below minimum level it will be called Danger Level, when emergency measure should be taken to replenish stock. Otherwise, there will be stock-out  situation,  with  consequential loss of  production. Minimum  level is, therefore, computed as reorder level less normal consumption during normal reorder  period.

Maximum level

This represents stock level above which stock should not be allowed to rise. The main purpose of this level is to ensure that capital is not blocked up unnecessarily in stores. The maximum stock level is computed as reorder level plus reorder quantity minus minimum consumption during reorder period. This level is a control indicator and if the stock exceeds this level, the consumption pattern and reorder period should be reviewed. The maximum stock  level is fixed after considering the following factors  also:

i)            Storage facilities available.

ii)            Cost of maintaining stores including insurance  cost.

iii)            Availability of funds.

iv)             Possibility of loss by deterioration, evaporation, etc. and risk of   obsolescence.

v)             Possibility of price fluctuation. For instance, in case of seasonal materials, price may be low in season and high in  off-season.

vi)             Government restriction on import or   procurement.

vii)             Economic order quantity.

It is important to note that setting of stock levels requires correct projection of usage pattern, lead-time and estimate of reordering quantity, stock-levels, therefore, cannot be established where:

(a)      rate of consumption is  erratic,

(b)      material is not in common use,

(c)      market of the particular material is  uncertain

Stock Turnover and Average  Stock–holding

Stock turnover ratio indicates how many times stock is  rotated, on  an average, during       a particular period, say a year. This is calculated for different groups of materials separately   in the following way:

Stock turnover ratio = cost of materials used during the period divided by average stock of materials held during the period.

Average stock holding is obtained by –

(a)              Averaging opening and closing stocks,

(b)              Averaging maximum and minimum levels of stock, or

(c)               Minimum stock plus half of reorder quantity.

Reorder Quantity

This refers to the quantity to be covered in a single purchase order. While deciding the reorder quantity, the following factors are  considered:

(a)      Consumption pattern of the material.

(b)      Nature of the material i.e. risk of deterioration, evaporation,   etc.

(c)      Risk of price-fluctuation.

(d)      Seasonal consideration as to the price and availability of supplies.

(e)      Storage space availability.

(f)      Quantum of discount.

(g)      Carrying cost and ordering  cost.

Carrying Cost and Ordering  Cost

Cost of carrying stock includes rent, insurance and other cost of storage, interest on capital blocked, losses and pilferage, risk of obsolescence, etc. Cost of ordering consists of the cost  of placing an order, setting up of production-run, transportation and receiving cost. Carrying costs are mostly variable, while ordering costs are mostly fixed and partly variable with the number of orders. Carrying cost increases with the increase in reorder quantity, while ordering cost decreases with the increase in number of orders. Thus, carrying cost and ordering cost move in opposite direction.

Economic Order Quantity  (EOQ)

The concept of Economic Order Quantity or EOQ has emerged out of this behaviour of carrying cost and ordering cost. EOQ is the quantity fixed at a point where total cost of ordering and the cost of carrying the inventory will be the minimum. EOQ may be arrived at by tabular method by preparing purchase order tables, showing the ordering cost, carrying cost and total cost of various sizes of purchase orders, or can be established by algebraic equation or by graph.

Let us take an illustration:

Material: Airtight box                   Code No.: P 3002 Monthly usage :250 pcs.

Cost of placing and receiving one order Rs. 60. Cost of materials per unit Rs. 10

Carrying cost = 10% of inventory value. Find out EOQ by i) tabular method, & ii) eqn. method.

Solution :

EOQ   =

=                                       =                          =      600 units

The above formula can be developed in the following way  :

Let	E	=	EOQ
	RU	=	Annual requirement units
	CO	=	Cost per order
	CU	=	Cost per unit of material
Now,	CC	=	Carrying cost

Total number of orders to be placed   =RU ÷ E

    Total cost of placing the order in a year    = RU * CO ÷ E

EOQ model is based on the following assumptions  :

(i)     Material cost per unit remains unaffected by order  size.

(ii)     Orders will be received on the expiry of lead  time.

(iii)    Variable inventory carrying cost per unit and ordering cost per order remain constant throughout the order.

(iv)     Production and sales can be forecast   perfectly.

      PRICING  ISSUES OF MATERIAL

Materials issued from stores should be valued at the rate they are carried in stock. Materials are valued at cost and entry in the stores ledger is made with every receipt. Different lot of materials may be received at different prices. Hence, when issues are made from stock, it may happen that materials from more than one lot may have to be issued. Which price will be applicable in such case? Actual cost or average price, market price or notional price? Various methods for pricing materials issued from stores are classified in the following   manner:

A.      Cost price methods  :

i)                Specific price

ii)               First in, first out  (FIFO)

iii)                Last in, first out (LIFO)

iv)                Highest in, first out (HIFO)

v)                 Base stock price.

B.      Average  price methods:

i)                Simple average

ii)               Weighted average

iii)                Periodic simple average

iv)                Periodic weighted average

v)                 Moving simple average

vi)                Moving weighted average

C.      Current price  methods :

i)                Replacement price

ii)               Next in, first out  (NIFO)

D.      Notional price methods  :

i)                Standard price

ii)                   Inflated   price

iii)                Re-use price

A.(I)      Specific  Price Method

Specific price method is applicable to materials purchased for a particular job, order or process, and are identified when received either in stores or in the shop floor directly. Such materials are usually nonstandard and the actual cost is charged to the job or order or process concerned. No question of difference arises out of such   pricing.

A.(II)    First In, First Out   (FIFO)

This method assumes that materials are used in the order in which they are received in stores. Hence, the price of the first lot is charged to all issues till the stock lasts. In other words, the issues are priced in the chronological order of receipts. As a result, closing stock will be valued at latest purchase  price.

To illustrate, let us take an example. A manufacturing company has recorded the following transactions of material A-320 oil, during the month of September,   2001.

			Quantity	Unit	Rate (Rs.)
2001 Sept.	1	—          Opening Stock	300	Litre	9.70
	5	—          Purchase	250	”	9.80
	9	—          Issues	400	”
	14	—          Purchases	300	”	10.00
	16	—          Issues	200	”
	25	—          Purchase	150	”	10.50
	26	—          Issues	150	”

The consumption value of the material and closing stock as on 30.9.01 will be as follows under FIFO method :

                                                                Stores Ledger (FIFO  Method)                                                    

Material      : Code No.     :		A 320 oil							A/c      : Unit     :	Raw materia Litre	l
		Receipt				Issue				Balance
Date     SRN.		Qty.     Rate		Amt.	MRN.	Qty.	Rate	Amt.	Qty.	Rate	Amt.
No.		Rs.		Rs.	No.		Rs.	Rs.		Rs.	Rs.
2001 Sept. 1									300	9.70	2910
5	xx	250	9.80	2450					550*		5360
9					xx	300	9.70	2910
						100	9.80	980
						400		3890	150		1470
14	xx	300	10.00	3000					450		4470
16					xx	150	9.80	1470
						50	10.00	500
						200		1970	250		2500
25	xx	150	10.50	1575					400		4075
26					xx	150	10.00	1500	250		1575
				7025				7360

* Breakdown of closing  stock 100 @ 10.00 1000 150 @ 10.50 1575 250 2575

The consumption and closing stocks values are as follows   :

Opening stock	Rs. 2910
Add : Receipts	Rs. 7025	(2450 + 3000 +  1575)
Less : Consumption	Rs. 7360	(3890 + 1970 +  1500)
Closing stock	Rs. 2575

* Alternatively, the stocks can be shown chronologically as 300,250 separately in the balance column and FIFO or LIFO method can be followed.

Advantages :

a)      Simple method to understand and  operate.

b)      Material cost represents actual cost which should be charged to product or process.    c)   Stock value is closer to current  price.

Disadvantages:

a)      In fluctuating price and too many purchases and issues, this method will involve more calculations.

b)      It overstates profit at the time of rising   prices.

c)      If price changes frequently, comparison of one job with the other will not serve useful purpose. Similar jobs will have different costs because of price   change.

d)      Adjustment for rejection and returns become  complicated.

A.(III)   Last In, First Out  (LIFO)

This method assumes that the last receipt of stock is issued first. The method has advantage under inflationary condition of the market. Using the same data of the earlier illustration, the issue prices and closing stock valuation of the material will be as follows  :

                                                            Stores Ledger (LIFO  Method)                                                          

Material    : Code No.   :		A 320 oil							A/c     : Unit      :	Raw material Litre
Date   SRN.		Receipt Qty.    Rate		Amt.	MRN.	Issue Qty.	Rate	Amt.	Qty.	Balance Rate         Amt.
No.		Rs.		Rs.	No.		Rs.	Rs.		Rs.           Rs.
2001
Sept. 1									300	9.70	2910
5	xx	250	9.80	2450					550*		5360
9					xx	250	9.80	2450
						150	9.70	1455
						400		3905	150		1455
14	xx	300	10.00	3000					450		4455
16					xx	200	10.00	2000
									250		2455
25	xx	150	10.50	1575					400		4030
26					xx	150	10.50	1575	250		2455
				7025				7480

* Breakdown of closing stock                        150		@	9.70	1455
100		@	10.00	1000
250				2455
The consumption and closing stock values are as follows   :
Opening stock Add : Total receipts	Rs. 2910 Rs. 7025		(2450 + 3000 +  1575)
Less : Total consumption	Rs. 7480		(3905 + 2000 +  1575)
Closing stock	Rs. 2455
Advantages:

a)      Issues are charged at current price, which is more    appropriate.

b)      Profit is realistic.

c)      Since issues are charged at actual cost, no adjustment for profit or loss is necessary.

Disadvantages:

a)      Stock-value does not represent current market   price.

b)      Unfair comparison of job cost when price changes too   frequently.

c)      Like FIFO, this method also involves too many calculations, if frequent price changes occur and purchases are made in small  lots.

However, the method is useful for materials used, less frequently and under inflationary condition.

A.(IV)   Highest In, First Out   (HIFO)

Under this method, issues are valued at the highest price i.e. costliest items are issued first, and inventory is kept at lowest possible price. Thus, a secret reserve is created by undervaluing stock. This method is complicated to administer, if there are numerous purchases within short period.

In the previous, illustration, if last purchase on 25th September costs @ Rs.10.50 per unit,  then the consumption and stock value will be Rs.7480 and Rs.2455 as receipts will be valued at Rs.7025. (Try yourself following previous solution). HIFO method is mainly used by monopoly  products  or  cost-plus contracts.