2.0 REVIEW OF
RELATED LITERATURE
This is a report summarizing the answers
to the research questions generated by researcher in the previous assignment.
It is a review of relevant literature that will explore the available and
existing information which had been covered by the various researchers. The
literature was reviewed from, Journals, the internet, reference books,
magazines, working papers, reports and periodicals. The long answer is that the
review of literature discusses techniques and equipment that are appropriate
for investigating your topic, and the review of literature, summarizes the
theory behind your experience.
2.1 THEORETICAL
FRAMEWORK.
2.2 RELATIONSHIP
MARKETING THEORY:
This is a theory that is used in the
various fields such as supply chain management, international marketing
relationships, networks, data base formation as well as in transactional
analysis (Traisa, 2010). This theory offers various dimensions such as
commitment and co-operation that are useful in studying the various
relationships that exists between different phenomenon that are related to the
relationship between the buyer and the seller especially in information sharing
(Wilson, 1995). The relationship marketing theory, explains the various.
Buyer-supplier relationships and its information sharing, (Toften and Olsen,
(2013) as well as offers explanation of the various streams in the said
relationship, the various dimensions in the relationship as well as the
relationale or the justification for the relationship such a as the structure and the process of
the relationship.
2.1.2
ASSIMILATION THEORY
Assimilation theory is based on the
dissonance theory by Festinger’s (1957). Dissonance theory states that
consumers make cognitive comparison between the expected product expectations
and the perceived performance of the product (Peyton, Pitts and Kamery, 1979).
According to Anderson (1993), customers try to reduce and avoid disagreement by
making adjustments concerning their perceptions about a certain product and try
to bring them more in line with their expectations (Peyton, Pitts and Kamery,
(1979). Consumers also try to reduce the worry between their expectations and
actual performance of the product by raising the level of satisfaction through
the minimization of the importance of the experience that have been
disconfirmed or by distortion of the expectations so that they can match with
the product performance perceived (Olson and Dover, 1979).
2.2.2 EMPIRICAL
REVIEW OF VARIABLES.
2.2.3 INVENTORY
MANAGEMENT
The main aim of inventory
management is to ensure that organizations hold inventories at the lowest cost
possible while at the same time achieving the objective of ensuring that the
company has adequate and uninterrupted supplies to enhance continuity of
operations (MP Wanya, 2005). A study carried out by Shausaneb and Routroy
(2010) shows that companies are keen in managing their inventory so as to
reduce costs, improve the quality of service, enhance product availability and
ultimately ensure customer satisfaction. Results of a study carried out by
Rosenfield and Simchi-levi (2010) shows that inventory management has a huge
financial implication on both the customer satisfaction and financial
performance of an enterprise.
Inventory
levels:
High levels of inventory
increases the probability that the customers are likely to get what they want,
increases sales and service levels (Cachon and Terwiesch, 2006). High inventory
levels however lead to both stock holding costs and in-store logistics errors.
This is because it becomes difficult for the employees to perform shelving and
replenishment which makes goods physically available in the store but the
employees cannot trace those (Phantorn products) , (Ton and Raman, 2005).
Maintaining optimum levels of inventory is important in an organization because
excess inventory results in stock holding costs, breakages, pilferage and
inadequate inventory (stock outs) is also costly as customers may leave to
competition (Beling, 2011). For each sale that an organization does loose as a
result of stock outs, the company not only loose profits but also customers who
may be dissatisfied and source for an alternative reliable supplier (knights,
2008). When inventory management (maintaining adequate inventory levels) is
carried out efficiently, it ensures that the materials needed in an
organization are available in the right quality, quantity thus avoiding issues
of overstocking and under stocking and ultimately guaranteeing customer
satisfaction and increased profits (Ewuolo, et al, 2005).
Inventory costs.
Inventory costs in an organization
comprise of inventory carrying costs (opportunity costs, insurance, and rent).
Ordering costs, (transport charges, insurance on goods in transit, inspection
of goods inwards) as well as the shortage costs (Idle machines, labor, loss of
sales). Members of the supply chain should find an optimum balance between
supply chain inventory costs and customer satisfaction (Bertrand, Poutre and
luin, 2006).
A study by Narkoty (2012) among the
Ghana health services found out that inventory is one of the largest assets in
the organizations and hence the need to manage it. Results of a study carried
out by Nordin (2002) shows that inventory costs can be reduced by
implementation of re-ordering points as well as appropriate economic order
quantities (EOQ).
Studies by Lee and Centinkaya (1998)
show that companies increasingly employ strategies such as vendor management
inventory (VMI) in an effort to control inventory carrying costs.
According to small business resource
(2013), Organization cash flows can only be improved through the reduction of
excess inventory and the optimization of inventory levels.
LEAD TIME
Today’s customer focused business
environments are facing the challenge of creating processes that are responsive
to the demand of the customers (Christopher, 2010). These demands for example
include, product diversification as well as pricing which must be well as
pricing which must be considered in order to remain competitor (Patel and
Tritirogh, 2001).
In addition, among these demands
also is the need for shorter lead-times especially among the customers who want
to receive the products as soon as they order them (Da Cunha, Agard and Kusiak,
2007) reduction in lead times means that products and information flow in a
seamless manner which allow all the supply chain members to respond to the
customer’s needs quickly while maintaining inventory to a minimum (Brewer,
2000). The increase in the distance from the suppliers premises and the
complexity in the logistical aspect often result in longer lead times and
higher levels of inventory (Ohno and Mae, 2012). However, it is often a
challenge for companies that strive to achieve costs reduction through lower lead times and reduced
inventory levels since it is difficult for logistics to achieve both goals (Rushton et al, 2006) Eckert (2007) asserts that better management of inventory
is directly proportional to customer satisfaction. Customers are said to be
more satisfied if their supplies are able to meat and fulfill their orders
within their required time (Widing, 2003).
The desire to satisfy the customers
according to (Wang, 2007) makes the supply chain members to keep buffer
(Safety) stocks. The supplies also enter into long term relationships (which
require trust and commitment) with their suppliers to secure sustainability in
supplies.
2.2.4. CUSTOMER
SATISFACTION
Morgan and Rego (2006), Fornell et
al (2006) define customer satisfaction as a measure of a firm’s customer base
in terms of size, quality and loyalty. Customer loyalty and product repurchase
are as a result of customer satisfaction (Eckert, 2007). Among the several ways
that an organization can employ to service its customer are through information
management and customers collaboration
(Langty and Halcomb, 1992) satisfaction according to Eckert (2005) refers to
the quality of the products, services, price performance ratios as well as when
a company meets and exceeds the requirements of the customer. Manufacturing
organizations may identify customer satisfaction in terms of on-time delivery
as well as meeting customers specification needs (Eckert, 2005) variables such
as customer needs (having the products immediately and on hard to satisfy the
customer’s need) Vend ore partnerships (sharing of information regarding sales,
sales forecasts as well as amount of inventory) and data integrity (data on sku
and location which assists in overall inventory management) (Lee and Klener,
2001) often define customer satisfaction among the manufacturing sector. Firms
must respond to the changing customers needs in the increasing competition
environment (Zhang, 2005). Zerbini et al (2007) asserts that customer
satisfaction is one of a firm’s mile stone towards profitability. The main
focus of companies today is to satisfy the customer which as an impact on the
competitiveness of an enterprise (Rad, 2008). Customer’s expectations according
to (Howgego, 2002) are largely dependent on the flexibility of the supply chain
partners.
CUSTOMER LOYALTY
Customer loyalty is the act of
customers buying current brands repeatedly as opposed to choosing those of
competitors (Wyse, 2012). A study carried out by Michel (2004) shows that
customer satisfaction leads to customer’s retention which in turn generates a
loyal customer base in an organization. Customer loyalty requires that
manufacturing companies delivers on their customers expectations fully in a
predictable and an ongoing relationship (Campton, 2004). Customers often judge
the quality of the services that they receive using their perceived
expectations which often lead to customer satisfaction and loyalty (Colbum,
2013). According to Cacloappo (2000), an increase in customer loyalty by five
percent can lead to an increase in a company’s profits by 25 to 85 percent.
Loyal customers according to Eckert (2005) one six times more likely to purchase
or to recommend the purchase of a company’s products and services to someone
else. Various studies have also shown that dissatisfied customers are likely to
tell nine others while satisfied customers are likely to tell five other people
about the good service and treatment that they have received (Cacionappo,
2000). Manufactures need to provide customer purchase satisfaction before and
after a purchase since this is likely to lead to customer brand loyalty
(Agarwal, 2007).
REPEAT PURCHASES
Customer loyalty is often manifested in
repeat purchase (Allien and Wiburn, 2002) (Tuli and Bharadwa, 2009) observed
that satisfied customers are likely to adapt a behaviour of increase in
purchase as well as a continuous purchase from the firm. Agarwal, 2007.
Asserts that provision of customer purchase
satisfaction before and after a purchase results in repeat purchases. Provision
of satisfaction before the actual purchase by the customer would include
aspects such as provision of quality products, fair pricing of products as well
as flexibility (Amini et al, 2005) post purchase customer satisfaction on the
other hand would include activities such as provision of reverse logistics (Howgego, 2002).
ON-TIME DELIVERY
According to Wallin (2006), Customers
are more satisfied if the time taken to deliver their products is less than the
time they are willing to wait once they have placed an order.
Flexibility is paramount in
meeting the delivery deadlines (Gunasekara, 2001) and therefore information
sharing is required to enable the members of the supply chain meet specified
delivery dates by the customers (Elram, 1999). A study carried out by Yin-mei
(2013) shows that effective customer delivery influences customer satisfaction
and service quality. Customers are said to be more satisfied if their suppliers
are able to meet and fulfill orders within the required time (Widing. 2003).
Conceptual
Framework of Inventory Management (Eduardus Tandellin)
The Current
global economy, including national domestic economies, has undergone critical
changes in the last decade- over the last year’s low productivity and
efficiency becoming a major concern of both practitioners and academicians.
Thus a growing interest in developing models to increase productivity and
decrease production costs has been observed. Because of these developments.
Minifie and Davis, (1986) stated that one area that has become a focal point
since the 1960’s is inventories (material) management.
Inventories have formed a vital part
of business since these are only necessary for production and efficiency; these
also contribute to customer satisfaction.
Stevenson (1996) further the added
that although the amounts and dollar values of inventories carried by different
types of firms varies widely, a typical firm probably has about 30 percent its
current assets, and perhaps as much as 90 percent of its working capital
invested in inventory.
However, excess inventory diminishes a
firm’s ability to compete and particularly affects the competitive priorities
of price, quality, flexibility and time (Chase and Aquitano, 1995) It is for
this reason that Finch and Luebbe, (1995) stated that the Just in-time
philosophy describes excess inventory as one of the key wastes to eliminate.
Appropriate levels of inventory enhance all the competitive priorities because
they protect a business from disruptions that could hinder its operation.
Although the Just- in time philosophy has been considered an effective means of
inventory management Bahadur (1995) argued that, the main idea of Just-in time
was primarily to eliminate the inefficiencies caused by excess inventories.
Excess inventory frequently exists and these not only disrupt and hinder operations but also could be a result
of poor decision making. Thus Ellran, (1995) notes that if all suppliers were
perfectly dependable, if machines never broke down, and if demand could be
forecasted with prefect accuracy, inventory needs would diminish. In the light
of the arguments cited concerning this production management strategy, this paper
aims to develop an alternative conceptual framework for inventory management
under the J I T philosophy.
Conceptually, Noori and Radford
(1996) defines inventory as the stock of any item or re-source used in
organization. On the other hand, an inventory system is the set of policies and
control that monitors levels of inventory and determines what level should be
maintained, when stock should be replenished, and how large order should be.
Stephenson (1996), Classifies
manufacturing inventory into:
1.
Raw
material and purchase parts
2.
Partially
completed goods called work-in-progress (WIP)
3.
Finished
goods inventories (manufacturing firms) or merchandise (retail stores).
4.
Replacement
parts, tools and supplies and
5.
Goods
in transport to warehouse or customers in service.
2.3 NEED FOR
INVENTORY MANAGEMENT AND CONTROL
Any stock one has should be
purposeful, planned and one’s policy should be to regulate this planned
inventory in such a manner to attain effectiveness and efficiency.
Unfortunately some companies which
are quite obvious of the importance and / or the benefit inherent in modern
scientific inventory control system, non-existent stock system are proved of
their so called system. They lack the essential core, a target or objective
which is to be achieved and so remain a more stock recoding system, a nervous
system without a guiding brain. In the opinion, Albert, (2001), there are three
people in an average, small, medium sized company whose actions and mental,
attitudes have a big effect on the general level of stocks.
First, the Sales manager’s job is to
make sure that every customer gets the goods he wants in the right quantity and
at the right time and at the right price. The sales manager will try to make
sure that goods are always available to meet any demand, however unexpected to
this end; he exerts pressure on the production department. The sales man’s
pressure will always be leading to drive stock levels upwards.
Secondly, The production manager’s,
when the plant needs to be changed over from one product to another, it will
have to hold, carry over or circle stocks and the total amount of such stocks
is directly proportional to the length of production run. Thirdly, the buyer,
the man with a big order to place is in a strong position when it comes to
negotiating terms advantageous to his firm.
In doing so, he may well be forcing
the sales manager of his suppliers to press for longer stock. From the above
illustration, it is understandable that the man responsible for selling,
producing and buying have directly control of stock levels and each of them in
trying to achieve efficiency within his own department may cause stocks to go
up.
In view of this, Harper and Lins,
(2000), stated that the need for stock control is in two perspectives. First,
to control the maximum number of items necessary to run a business efficiently,
but which need not be carried on stock and, Secondly, to establish sufficient
stock holding to keep the business running smoothly while ensuring that there
is a constant turnover of stocks.
Obviously, accepting the logical
conclusion would be to eliminate all stocks. But this is not possible because
of fear of late deliveries and the need to safeguard against peaks in demand
which market research has not been able to foresee. Hence in support of the
first reason, Prabhic and Baker, (1990) suggested that “it is important to use
all the techniques possible to avoid carrying stock wherever possible as it is
to ensure that stocks are available when they are necessary.
One technique, which is now gaining
ground in certain companies and which enables the stock controller to keep his
production lines flowing without having to carry stocks, is the introduction of
the consumption / depletion contract agreement. This is a method whereby the
stock controller will work very closely with purchasing in deciding which forms
and which ranges of stocks are best suited to this contractual arrangement.
Having jointly established this, it is the stock controller’s function to
determine the lead time of such stocks, added to which will possibly be a
safety stock margin. Quantities of these products will then be laid down in
stocks to cover period and the first consignment will be on
consumption/depletion basis, that is, the supplier will place these stocks in
the stock controller’s stores at his own expense, and the stock controller, by
arrangement, either fortnightly or monthly, will advise the supplier of the
quantity he has consumed by means of a letter or order (preferably a letter).
The supplier will take this document as an instruction to invoice to replenish
a similar quantity of material to the stock controller’s store. The quantity
used for month must be paid for, again, by arrangement with purchasing within
14 days or at the latest 28 days of the submission of the goods used.
Purchasing may enter into a two- or three years contract with the supply of his
range of products with a safeguard clause in the contract to the effect that
should be produced under contract diminish in quantity or the service
deterioration or for any reason whatsoever, the contract there will be three
months notice from either way, by which the arrangement can be terminated. Thus
stock controller is not tied to one contractor.
The second reason which is why a
business needs stocks was highlighted by Baily and Farmer, (1999) and they
categorized it into four.
1.
Raw materials
and components:
a.
To
purchase at optimum price or lowest cost. This sometimes means buyers in bulk
to take advantage of higher efficiency of bulk transport and handling, to
reduce administrative costs of purchasing receipts, and handling results in
fewer orders being placed for larger quantities.
b.
To
be able to supply the manufacturing process at short notices if batches of
production become necessary and new suppliers cannot be obtained without delay.
c.
To
ensure production against seasonal supplies, determined by geographical
features such as grouping.
2.
Work-in-progress:
a.
To
ensure in consecutive production process, that material is always available to
match work, which is machine availability.
b.
To permit long runs of machine work, which in
turn will avoid continuous re-setting? It may be found economical to produce a
batch equal to several months’ requirement to accomplish this.
c.
Process
time: The actual minimum time necessary to carry out the various processes from
raw material to finished product.
2.
Maintenance
parts and Consumable stores:
a.
This
is done to avoid loss of machine and labour time due to unforeseeable failure.
b.
To
avoid stoppage in main production flow due to the run
Out
of inexpensive consumable items.
4.
Finished and saleable product:
(a)
To be able to meet rapidly an unexpected demand.
(b)
To enable production to continue evenly when sales are seasonal.
It is now the duty of the management to
clearly strike a balance, a technique must be available for weighing the cost
of stocking against the loss of not stocking and while certain cost are easily
definable, and a loss in nevertheless a cost and it must be measured in the
same terms. Equally a cost saved or a loss avoided is a profit made, so it may
be argued that stocks earn profits if they are avoiding losses or reduce costs.
The appointment of one person, stock
controller, materials manager, call him what you will - who has the necessary
experience and who must be given overall responsibility for ensuring optimum
use of stocks, will help minimize the difficulty of stock control. The below
summarizes all the information needed by the material controller. In order to
optimize his control system he will have to produce every item to monetary
values even for goods which appears on the extreme right as implied costs of
run out and combine all the items in a single control function by performing
suitable control operation on them.
2.4 INVENTORY MANAGEMENT SYSTEM.
An inventory management system can be
described with reference to the method used for replenishing inventories. The
method adapted depends on the degree of uncertainty associated with the demand
made on stocks, and the degree of monitoring which can be affected in which can be affected in each case.
Frank and Broyles (1999) identified
four systems of inventory management:
Firstly, the re-order level policy which
is usually adapted to continuous or real time monitoring of stock where the
arrival of orders, follow a predictable pattern only that the prediction cannot
be taken as sacrosanct. This policy also requires an estimate of the
lead.-time. The lead time is the time lag between the days an order is placed
through the day the receipt is acknowledged.
When stock falls to the re-order
level or below, a replenishment order is placed. The re-order level is usually
set high enough so that if sales during the lead time is as expected, the
replenishment stock will arrive before the inventory by way of buffer or base
stock, if sales exceed the forecast during the lead time.
The two serious setbacks which the
re-order level policy suffers are:
a.
The
assumption of random arrival orders used against stock is inappropriate for a
number of cases. The system does not take advantage of the anticipated timing
of demand when replenishment orders are placed.
b.
The
re-order level policy requires costly continuous real-time monitory of every
item of stock. Another important system of inventory management is the periodic
review policy unlike the re-order level policy. The periodic review policy is
designated to operate without the continuous monitoring of stock.
This is because this policy itself
operates like continuous review policy except that the status of each item is
reviewed once for a period, when the re-order level is reached or is placed, to
replenish stock. However, in this system, the re-order level must be set high
in order to allow for expected demand during the re-order cycle, in addition to
the expected demand during the lead time. It should also be expected that the
base stock be increased in order to provide for variations in expected demand
over the addition time period.
Another type of periodic review system
provides a direct control on the stock which is to be carried. An order is
placed for replenishment in each cycle, for the precise quantity, that would be
the amount of stock and those already on order up to a predetermined limit.
This limit must be enough to meet up with demand.
2.5 INVENTORY
CONTROL METHODS
Inventory control is the operation
of continuous arranging receipts and issues so that inventory balances are
adequate to support the current rate of consumption with due regard to economy.
The aim of inventory control systems is to minimize the cost of having stock,
while at the same time maintaining a certain level of customer services.
The various method of inventory control
is as follows:
1.
ABC
classification:
In some companies, the same method of inventory control is used; all items in
stock may not be the best or most economical approach to inventory
control. It is worthwhile to examine the
features of the inventories themselves. The ABC method classifies inventories
into three groups, according to the relative proportion of the funds invented
in each group annually.
In many
instance, it will be found that about 10% of the number of the items of
inventory represent about 75% of the monetary value invested in inventories.
These items may be classified as the “A” category. Also another 25% of the
value may represent about 20% of the investment. This is the “B” class items.
The other which is classified as “C” items may numerically cover some 65% of
stock but it is just 50% of the monetary value committed into inventories. This
figures as mere hypothetical yet they are not far from what is obtainable in
the real system. The figure may vary
from one company to another.
The chart below shows clearly the discussion above.
CLASSIFICATION A B C
Relative % of total inventory 10 25 65
% of value of total investment 75 20 5
However, Sarpe and Schonberger, (2000),
discussed the most current inventory control method, that well established and
managed companies which is the Just –in-time (JIT) method. The
just –in-time inventory method means that the supplier delivers the components and parts to the production line “Just –in-time”
to be assembled. Here, the storekeeper does not process any inventory in stock. The stock are demanded and supplied immediately
they are needed for actual production to be processed. Welleigh, (2001), in his
article –“What’s your excuse for not using JIT”, identified the requirements
that must be fulfilled for the JIT method to work. The quality of the parts must be very high, a
defective part could hold up the assemble line. There must be dependable
relationships and smooth cooperation with suppliers ideally, the supplies
should be located near the company with dependable transportation available. No
matter how laudable this method may be,
its effective operations in the
developing countries is questionable and utterly inapplicable because
it requires a well civilized, sound and stable
economy for it to function. Hansen and Mowen (2001),
pointed out the two strategic objective of Just-in-time. They are to increase
profits and to improve a firm’s competitive position. These two objectives are
achieved by controlling costs (Enabling better price competition) and increased profits, improving delivery
performance, and improving quality. JIT represents the continue pursuit of
productivity through the elimination of waste. This is done or achieved by
producing a product only when it is needed and only in the quantities demanded
by customers. Hence, it is waste eliminating by compressing time and space.
The most deficiency of JIT is the
absence of inventory to buffer production interruptions, current sales are
constantly being threatened by an unexpected interruption pin production.
Another inventory control method is
the theory of constraints (TOC) methods which recognizes that lowering
inventory, decreases carrying costs and thus, decreases operating expenses and
improves profits. Hansen and Mowen (2001) stated that TOC, however, argues that
“lowering better products, lower prices, and faster responses to customer
need”. Essentially, low inventories allow detecting to be detected more quickly
and the cause of the problem assessed. Low inventories allow new product
changes to be introduced more quickly because the company has fewer old
products (in stock or in process). That would need to be scrapped or sold
before the new product is introduced.
No system of cost analysis and
control including a sound cost accounting system will automatically assure
business success. It is only through the application of such analysis and
control procedures that management has been developed. This inventory valuation
methods are First-in-First -out (FIFO), Last-in-First-out (LIFO) specific
identification method, average cost and so on. Where as, this valuation methods
are variously applied by companies more of them have been accepted as best
method because such has a different impact on the balance sheet and profit
declaration of the company. Hobbs and More (2001), the fact that “accounting
has developed several methods of identifying which cost will be reflected as
the ending inventory balance on the balance sheet”.
INVENTORY
VALUATION METHODS:
FIFO:
Pizey, (2000), defined FIFO as a situation where by the first goods purchased
or manufactured are the first, costed out upon sale of insurance. This means
that the output or raw materials that were first produced or purchased are
first sold or issued out, and those who came later, will be dispensed later.
Since the costs “flow out” in the same order they “flow in” cost of goods sold
or issued, are valued at the oldest unit cost, and goods remaining in the
inventory are valued at the newest cost/amount.
For instances, consider these stocks.
1
/1/ 2013 Purchase 10,000 units @
N20
3/1/203 Purchases 8,000 units @ N21
5/1/2013 Issues 4,000 units
8/1/2013 Issues 5,000
units
30/1/2013 Issues 3,000 units
Looking at the figure above, every stock
that was purchased on 1/1/2013 will be completely used up, before using the
ones that was purchased after that rate.
The Table below
explains more (Fig. 1)
Date
|
Purchase
unit cost
|
Qty
|
Amount
|
Issues
cost/
Unit
|
Qty
|
Amt
|
Cost/unit
|
Qty
|
Amt
|
1/1/13
|
N20
|
10,000
|
200,000
|
20
|
10,000
|
200,000
|
|||
3/1/13
|
N21
|
8,000
|
168,000
|
8,000
|
368,000
|
||||
5/1/13
|
-
|
-
|
-
|
20
|
4000
|
80,000
|
14000
|
288,000
|
|
8/1/13
|
-
|
-
|
-
|
20
|
5,000
|
100,000
|
9,000
|
189,000
|
|
30/1/13
|
-
|
-
|
-
|
20
|
1,000
|
20,000
|
8,000
|
168,000
|
|
30/1/13
|
21
|
2,000
|
42,000
|
21
|
6,000
|
126,000
|
Sources: Ezechukwu Field work
Many companies make use of the method in
valuating their stock because it gives a balance sheet valuation, which
approximate to current cost of stock if there has been no great time gap or no
significant change in cost since the last consignment of stock was received.
Also since the price based on the actual records are used, and not upon an
estimate, no profit or loss arises due to the use of this valuation common to
the specific identification method. It has been observed that FIFO method fails
to match current costs against current revenue and may lead to over-statement
of profit and the rising of capital. Where a large number of purchases are made
at different prices, the use of FIFO becomes complex and expensive.
Another inventory valuation method
is Last-in-First-out (LIFO) which keeps values of issue close to current
economic values.
Its valuation of stock on stock
balance is usually very conservative and no profit or losses arises. In other
words, the LIFO method uses stock of material supply as they comes in. Those
that are currently purchased are sent to the production department whereas,
early purchases are kept until when stock are in short supply. For instance: we
are using the above illustration, for LIFO method:
Date
|
Purchase unit
cost
|
Qty
|
Amount
|
Issues
cost/unit
|
Qty
|
Amt
|
Cost
/unit
|
Qty
|
Amt
|
1/1/13
|
N20
|
10,000
|
200,000
|
20
|
10,000
|
200,000
|
|||
3/1/13
|
N21
|
8,000
|
168,000
|
21
|
18,000
|
368,000
|
|||
5/1/13
|
-
|
-
|
-
|
21
|
4,000
|
84,000
|
14,000
|
284,000
|
|
8/1/13
|
-
|
-
|
-
|
21
|
4,000
|
84,000
|
10,000
|
200,,000
|
|
30/1/13
|
-
|
-
|
-
|
20
|
1,000
|
20,000
|
9,000
|
180,000
|
|
30/1/13
|
20
|
3,000
|
60,000
|
20
|
6,000
|
120,000
|
Fig.2
Sources: Ezechukwu Field work
Remember that the last units are sold
first; therefore, we leave the oldest units for ending inventory.
Hartley, (1999) Observed that “in times of inflation, the value of issues
are kept close to current economic values such that no profits or losses
arises” This is not always true because industrial harmony and existence have
shown that companies actualize their estimated profits with the application of
LIFO during inflation. With the inflation companies abandon the purchase of new
inventories and make use of their old inventories aim the production process
whereas the price associated with the old inventories will be based on the
current inflationary prices.
LIFO accentuates pilferage and
deterioration because as companies use new supply no adequate inspections are
given to hold one and as such employees easily prefer it. Again, it is not
realistic because it assumes physical issues to be opposite of that which is
actually followed by the store-keeper.
Meigs and Meigs, (2000) discussed
another method of valuating inventory which is specific identification method.
This is a method whereby the unit of the inventories will be identified as
coming from specific purchase and are priced at the amount listed on the
purchase invoices. Moich and Larsen, (2000), on their own view, stated that,
“each item of inventory should be identified with its cost and that the sum of
these by amounts should constitute the inventory value”. It has been observed
that method is useful in the actual physical flow of merchandise. It also gives
meaningfully results in the purchase and sale of such high-priced articles as
boats, automobiles and Jewelry.
Many companies fail to use this
method because it permits manipulation of income or profit by selecting which
items of goods to deliver in filling a sales order. Also, it may lead to faulty pricing decision by
implying that identical items of merchandise have different economic value.
Care should be taken by companies in
the valuation of inventories in any period because it has great impact on the
amount of profit declared for the period. If the value of the closing is
overstated, the profit for the period will be understated and the reverse will
be the case. If closing inventory is understated. Again if the value of the
opening inventory is understated, the profit for the period will be overstated,
and the reverses will be the case if opening inventory is overstated. To this
end, companies should at all time strike a balance between inventories.
2.6 INVENTORY COSTS AND DECISION MODEL:
In making any decision that will affect
inventory size, a number of costs have to be considered. These costs usually
affect inventory position directly, often these costs are combined in one way
or another but they shall first be considered separately.
Inventory costs can be cost of the
inventory items itself: this cost is the monetary value of the item of
inventory concerned.
It is usually equal to the purchase
price. In some cases, it may include other costs that vary, directly with each
item. Transportation receiving and inspection costs may be added to the cost
terms. Inspection costs may be added to the cost terms. The second type of
inventory cost is the ordering cost. These costs refer, to management and
clerical cost associated with preparing and placing purchases order. They vary directly with the number of
purchase order placed. Ordering cost include cost of postage, telephone call to
vendor, labour costs in purchasing and accounting receiving costs and
transportation costs, cost of stationary, follow up cost etc for good
manufactured internally the production set up cost are the cost associated with
production planning, preparing the labour force and the machinery for a
production run to make the batch of item required.
Some of these costs vary with the
number of order placed. The more frequently the inventory is required the
higher the company’s ordering costs. On the other hand, if the company
maintains large inventory levels, there will be few orders placed and the
ordering cost incurred will be relatively small. Therefore, ordering cost vary
indirectly with increasing size of standard order.
Fig.3 Standard
order size/Ordering cost.
2.6.2 INVENTORY
DECISION MODEL:
Briges, (2001), in his opined, “For the
purpose of this work, at least a decision model will be critically studied.
There is as yet, no single model which holds for all inventory problems. The
use of models helps us to understand the operation of inventory system and
behavior of the system under real or simulated operation condition. It should
be noted that in the real world, demand can almost never be predicted with
certainty. Instead they must be described in probabilistic terms. The use of
model goes a long way in helping to solve the most common inventory problems
faced by business management, that is of deciding order quantities and re-order
points. It is in view of the forgoing that the below model has been studied.
2.6.3 ECONOMIC ORDER QUANTITY (EOQ)
One of the major questions asked in
inventory management and control concerns the size of order to be placed when
the inventory is to be replenished. The optimum inventory is commonly known as
the economic order quantity. This is that size that will result in the lowest
total annual cost for the inventory item.
All relevant costs including the
ordering and carrying costs described earlier must be put into consideration in
computing the economic order quantity. For purpose of determining the economic
order quantity graphically, only ordering and carrying costs will be
identified, opportunity cost having been included in these two classes of cost
already;
This is time because the implicit
interest on funds invested in inventory will be considered as being part of the
total carrying cost
Below
is the graph that shows how economic order quantity can be determined by way of
the trade-off between ordering costs and carrying costs.
Fig.4 Economic
Order Quantity Function.
The economic order quantity can as well
be deduced by the use of a formula (Model) that incorporated the basic
relationships between order quantity and
costs. For the purpose of this work, the method of deriving the static formula
should be ignored. The formula is shown alongside some
assumptions upon which the formula is based. The formula is
EOQ
= 2DC
SP
Where:
D
= Demand per annum or Annual usage of material
C-
Ordering cost
S=
Carrying cost expressed as a percentage of inventory value.
P=
Purchase price per unit of inventory
The
basic assumptions of
economic order inventor are:
Firstly, that average demand is
continuously and constantly
represented by a
distribution that does not change with
time. Therefore, if there happens to be
a significant trend or seasonality in the average annual requirements ‘D’ in the above model, the
resulting cost will not be optimal and there may be other control problems as
well.
Secondly, it is assumed that supply time
is constant. Thus assumption may hold
in many cases, but supply lead times are variable. In most situations
the result of
variable lead time is
that the timing of the
receipt of the order
quantity produced excess inventories when times
are shorter than expected, and produces shortages when lead time are longer than expected.
Thirdly, it is assumed that there is
independence between inventory times. The economic order quantity model assumes
that the replenishment of an order inventory item. This assumption is valid in
many instances, but breaks down when a set of supply items are complied with a
common production plan.
Finally the use of EOQ assumes that
data on annual demand ordering costs and carrying cost are available and
definitely calculatedly in reality. These data can only be estimated.
2.6.4 PURCHASE
PRODUCTION:
In most manufacturing companies the
purchasing department is changed with the responsibility for placing ordering
with suppliers, or otherwise purchase orders may be duplicated. The buyer has
considerable responsibility and in a large concern much money can be lost or
saved by the departments. He requires a good technical knowledge of the
industry and excellent expertise of administrative and organizing ability. He
must keep in constant touch with market prices, reports and market tendencies,
and have a working knowledge of contract law and procedure together with a practical
understanding of the principles of economic laws.
Purchase requisition may be received
from the store keeper for inventories kept in regular stock, or for all
standard materials the stock of which requires replenishment. Also, purchase
requisition may originate from either the production department for all special
materials. Which are required directly delivery to work-in- progress or from
various departmental heads requiring special indirect materials. The procedure
would then be for the department concerned to prepare purchase requisition in
triplicate, giving one copy to the buyer, in the department. Typical purchase
requisition for stock form is shown here under:
PURCHASE
REQUISITION FOR STOCK.
Date …………………………… No ………………………………
Quantity
|
Description
|
Stock
condition
|
Purchase
order No
|
Supplied
|
Fig.
5 purchase requisition form.
2.6.5 PROCEDURE FOR RECEIPT AND ISSUE OF
INVENTORIES
Inventories for which orders were placed
are usually taken delivery not or an evidence of dispatch. Inventories entering
the factory should be unloaded at special receiving center. This should be
cited near the road, railway, carnal or wharf, at same time accessible from any
part of the factory so as to reduce handling charges to minimum.
The receiving department would
receive the inventory and check them against the details of the purchase order.
Entries are then made on a goods received note, and distributed to the
purchasing department, accounts section, stores, inspection department and the
department that initiated the purchase requisition; one copy is retained in the
receiving department for reference purposes.
The goods received should be
inspected for quantity to ensure that they comply in all respects with the
specifications in the purchase order. In many large companies, an inspection
staff is attached to the receiving department, while in small companies, the
storekeeper is responsible for inspection. If any goods are rejected, the
inspector will state the reason for rejection on a special rejection report, so
that the buyer is informed immediately for the purpose of contacting the
supplier. The goods received note (GRN) format II prepared by the receiving
department is shown below.
GOOD RECEIVED
NOTE (GRN)
From ……………… C.
R. No ……………….
GOODS
|
QUANTITY
|
PACKAGE
|
ORDER NO
|
FOR OFFICE USE
RATE
|
Carrier:
Received by: Goods inspection report.
PURCHASE
REQUISITION
|
NOTE ON
PROGRESS CHART
|
BIN NO
|
INVOICES NO
|
AKS REF
|
Fig. (7)
After receiving and inspecting the
goods, the receiving department sends the goods, to stores along with the goods
received note. The storekeeper receives them and makes the necessary entries in
the books. Bin cards (Stock cards) and Store ledger are used. The bin cards are
written in the stores, but the store ledger is kept by the cost department or
store office.
The bin cards are used not only for
detailed receipts and issues of inventories but also to assist the storekeeper
to control the stock.
For
each inventory item, the maximum and minimum to be carried are stated on the
card. From time to time, the maximum or minimum may be altered to suit current
requirement.
To facilitate ordering of further
supplier the normal quantity to order is sometimes stated in the bin card. When
inventories are of the kind requiring advance ordering, an ordering level may
be specified on the bin card. The various receptacles in which inventories are
kept and numbered, the bin card for each being similarly numbered. The typical
layout of a bin card is as follows:
BIN CARD
Description
……………………… Maximum level……………………………
Bin
No……
Minimum level ……………………………….
Code
NO:…… Reorder
level …………………………..
Stores ledger folio: Normal
Quantity
date
|
Receipt QRN NO:
|
ISSUES QUANTITY
|
BALANCE
|
REMARKS
|
F.G 8: Bin card.
2.7
INVENTORY MANAGEMENT IN A MANUFACTURING
COMPANY:
It should be quite obvious that
policies, system and technologies of making and controlling inventories in
manufacturing or automobile industries would not be very much different from
those discussed in this work. This is largely because the aim(s) of inventory
management in all companies are almost the same. Inventories should be
maintained at the levels that are just relevant for smooth production and sales
operation. If this is done, much working capital would be saved. If on the
other hand, much money is surged into stock, it would decrease the working
capital of the company; this may affect the company adversely.
Controlling inventory does not have
to be an onerous or complex proposition. It is a process and thoughtful
inventory management. There are no hard and fast rules to abide by but some
extremely useful guidelines to help you’re thinking about the subject. A five
steps process has been designed that will help any business bring this
potential problem under control to think systematically through the process and
allow the business to make the most efficient use possible of the resources
represented. The final decisions, of course, must be the result of good
judgment, and not the product of mechanical set of formulas.
Step one:
Inventory planning:
Inventory control requires inventory
planning. Inventory refers to more than
goods on hand in the manufacturing operation, service business or retail
operation. It also represents goods that must be in transit for arrival after
the goods in the store or plant are sold or used. An ideal inventory control
system would arrange for the arrival of new goods at the same moment the last
item has been sold or used. The economic order quantity, or base order, depends
upon the amount of cash (or credit) available to invest in inventories, the
number of units that quality for a quantity discount from the manufacturer, and
the amount of time goods spend in shipment.
-
Step two:-
Establish Order Cycles:
If demand can be predicated for the
product or if demand can be measured on a regular basis, regular ordering
quantities can be setup that takes into consideration the most economic
relationships among the costs of preparing an order, the aggregate shipping
costs, and the economic order cost. When demand is regular, it is possible to
program regular ordering levels, so that stock-outs will be avoided and costs
will be minimized. If it is known that for so many weeks or months a certain
quantity of goods will be sold at a steady pace, then replacements should be
scheduled it arrive with equal
regularity. Time should be spent developing a system tailored to the needs of
each business. It is useful to focus on items whose costs justify such control,
recognizing that in some case control efforts may cost more the items worth. At
the same time, it is also necessary to included low return items that are
critical to the overall sales effort.
If the business experience seasonal
cycles, it is important to recognize the demands that will be placed on
suppliers as well as other sellers. A given firm must recognize that if it
begins to run out of product in the middle of a busy season, other sellers are
also beginning to run out and are looking for more goods. The problem is compounded in that the
producer may have already switched over to next season’s production and so not
interested in (or probably even capable of) filling any further orders for
current selling season. Production resources are likely to already be allocated
to filling orders for the next selling season. Changes in this momentum would
be extremely costly for both the supplier and the customer.
On the other hand, because suppliers
have problems with inventory control, just as sellers do, they may be
interested in making deals to induce customers to purchase inventories
offseason, usually at substantial savings. They want to shift the carrying
costs of purchase and storage from the seller to the buyer. Thus, there are
seasonal implications to inventory control as well, both positive and negative.
The point is that these seasonable implications must be built into the planning
process in order to support an effective inventory management system.
Step Three:
Balance inventory levels:
Efficient or inefficient management of
merchandise inventory by a firm is a major factor between health profits and
operation at a loss. There are both market-related and budget-related issues
that must be dealt with in terms of coming up with an ideal inventory balance:
Is the inventory correct for the market
being served?
·
Does
the inventory have the proper turnover?
·
What
is the ideal inventory for a typical wholesaler in this business?
To answer the last question first, the
ideal inventory is the inventory that does not lose profitable sales and can
still justify the investment in each part of its whole. An inventory that is
not compatible with the firm’s market will lose profitable sales. Customer’s
who cannot find the items they desire in one store or from one supplier are
forced to go to a competitor. Customer will be especially irritated if the item
out of stock is one they would normally expect to find from such a supplier.
Repeated experiences of this type will motivate customers to become regular
customers of competitors.
Step Four: -
Review Stocks:
Items sitting on the shelf as obsolete
inventory are simply dead capital. Keeping inventory up to date and devoid of
obsolete merchandise is another critical aspect of good inventory control. This
is particularly important with style merchandise, but it is important with any
merchandise that is turning at a lowest rate than the average stock turns for
that particular business. One of the important principles newer sellers
frequently find difficult is the need to mark down merchandise that is not
moving well. Markups are usually highest when a new style first comes out. As
the style fades, efficient sellers gradually begin to mark it down to avoid
being stuck with large inventories, thus keeping inventory capital working.
They will begin to mark down their inventory, take less gross margin, and
return the funds to working capital rather than have their investment stand on
the shelves as obsolete merchandise. Markdowns are an important part of the
working capital cycle. Even though the margins on markdown sales are lower,
turning these items into cash allows you to purchase other, more current goods,
where you can make the margin you desire. Keeping an inventory fresh and up to
date requires constant attention by any organization, large or small. Style
merchandise should be disposed of before the style fades. Fades merchandise
must have its inventory levels kept in line with the passing fancy. Obsolete
merchandise usually must be sold at less than normal mark-up or even as loss
leaders where it is price more competitively. Loss leader pricing strategies
can also serve to attract more consumer traffic for the business thus creating
opportunities to sell other merchandise as well as the obsolete items.
Technologically obsolete merchandise should normally be removed from inventory
at any cost. Stock turnover is really the way businesses make money. It is not
so much the profit per unit of sale that makes money for the business, but
sales on a regular basis over time that eventually results in profitability.
The stock turnover rate is the rate at which the average inventory is replaced
or turned over, throughout a pre-defined standard operating period, typically
one year. It is generally seen as the multiple that sales represent of the
average inventory for a given period of time.
Turnover averages are available for
virtually any industry maintaining inventories and having sales. These figures
act as an efficient benchmark with which to compare the business in question,
in order to determine its effectiveness relative to its capital investment. Too
frequent inventory turns can be as great a potential problem as too few.
Too frequent inventory turns may
indicate the business is trying to overwork a limited capital base, and may
carry with it the attendant costs of stock outs and unhappy and lost customers.
Stock turns or turnover is the number of times “average” inventory of a given
product is sold annually. It is an important concept because it helps to
determine what the inventory level should be to achieve or support the sales
levels predicted or desired. Inventory turnover is computed by dividing the
volume of goods sold by the average inventory. Stock turns or inventory
turnover can be calculated by the following equations.
Stock
Turn= Cost of Goods Sold.
Average
inventory at cost
Stock
turn = Sales
Average
inventory at sales value.
If the inventory is recorded at cost,
stock turn equals cost of goods sold divided by the average inventory. If the inventory
is recorded at sales value, stock- turn is equal to sales divided by average
inventory. Stock turns four times a year on the average for many companies. A
further analysis of that inventory is needed. Is it too heavy in some areas?
Are there reasons that suggest more inventories are needed in certain
categories? Are these conditions peculiar to that particular company? The point
is that all markets are not uniform and circumstances may be found that will
justify a variation from average figures.
In the accumulation of comparative data
for any particular type of firm, a wide variation will be found for most
significant statistical comparism. Averages are just that and often most
companies in the group are some what different from that result. Nevertheless,
they serve as very useful guides for the adequacy of industry turnover, and for
other ratios as well. The important thing for each firm is to know how the firm
compares with the averages and to deter-mine whether deviations from the
averages are to its benefits or disadvantage.
-
Step Five:-
Follow-up and control:
Periodic reviews of the inventory to
detect slow- moving or obsolete stock and to identify fast sellers are
essential for proper inventory management.
Taking regular and periodic inventories
must be more than just totaling the costs. Any clerk can do the work of
recording an inventory. However, it is the responsibility of key management to
study the figures and review the items themselves in order to make correct
decisions about the disposal, replacement, or discontinuance of different
segments of the inventory base. Just as an airline cannot make move with its
airplanes on the ground, a firm cannot earn a profit in the absence of sales of
goods. Keeping the inventory attractive to customers is a prime prerequisite
for healthy sales. Again the seller’s inventory is usually his largest
investment. It will earn profits in direct proportion to the effort and skill
applied in its management.
Inventory quantities must be organized
and measured carefully. Minimum stocks must be assured to prevent stock out or
the lack of product. At the same time, they must be balanced against excessive
inventory because of carrying costs. In larger organizations and in many
manufacturing operations, purchasing has evolved as a distinct new and separate
phase of management to achieve the dual objective of higher turnover and lower
investment. If this type of strategy is to be utilized, however, extremely
careful attention and constant review must be built into the management system
in order to avoid getting caught short by unexpected changes in the larger
business environment.
Caution and periodic review of re-order
points and quantities are a must.