Inventory management techniques, worked in rupees.

Why stock needs a method

Stock is cash on a shelf. Keep too much and money sits in the godown, losing value to rent, interest, damage and expiry. Keep too little and a customer leaves with nothing, or a production line waits for one missing part.

Inventory management techniques are simple rules that answer three questions for every item: how much to keep, when to reorder and how much to order. They need no special software, only honest figures for usage and supplier lead times.

ICAI’s study material for CA students groups the methods into four kinds. This guide works through them in rupees, then adds counting, godowns and expiry dates.

• Setting levels: the re-order, minimum, maximum and danger levels, and how much to order.
• Classifying items: ABC, FSN, VED and HML.
• Ratios: inventory turnover and days of stock.
• Physical control: the two-bin system, perpetual records and continuous counting.

ABC analysis: sort by value

ABC analysis sorts items by the money they take up in a year, not by how many units you hold. A few items usually carry most of the value. Those deserve tight control. The rest can run on routine.

To do it, take a year’s usage of each item and multiply it by the cost of one unit. Sort the list from the highest value to the lowest and add a running total. The items at the top that make up about 70% of the value are A, the next 20% or so are B, and the long tail is C.

The table below does this for an electrical goods distributor in Pune. A real store has hundreds of items and the split is usually more lopsided, but the steps are the same.

Copper wire and ceiling fans are 2 of the 10 items but 70% of the value: they are A. LED panels, MCBs and switches add 20.4%: B. The last five items are half the list and 9.6% of the value: C. Tape and cable ties move in the largest numbers and still land in C, because ABC counts rupees, not units.

The cut-offs are a choice: percentages of the running total, as here, or rupee limits. What matters is that each class gets different attention:

• A items: set re-order, minimum and maximum levels, review them every week, buy against a budget and count them often.
• B items: review them on a fixed cycle, say once a month, and order what the review shows.
• C items: order in bulk once or twice a year and spend as little time on them as you can.

VED, FSN and HML, in brief

ABC looks only at money. Three other classifications look at other risks. They work best alongside ABC, not instead of it.

Combine them. A cheap spare part can be C by value and vital by need: it still gets a re-order level and safety stock. A slow-moving A item is the first stock to clear, because it ties up the most money.

To find slow movers, work out the days of stock you hold for each item. A year of stock on the shelf, when the rest turn over in a month, needs a decision.

• FSN, fast, slow and non-moving: by how often an item is used or sold. Keep fast movers near the dispatch point and review them often. Check slow movers for obsolescence. Report non-moving stock and plan to clear it.
• VED, vital, essential and desirable: by what happens if you run out. Vital items stop a sale, a machine or a service when they are missing. Desirable items can wait.
• HML, high, medium and low cost: by the price of one unit, not the year’s value. High-cost items get the closest control.

EOQ: how much to order at a time

Every order costs money to place: paperwork, follow-up, receiving the goods and freight paid per order. Every unit in stock costs money to hold: interest, godown space, insurance, damage and expiry.

Order big and seldom, and holding cost goes up. Order small and often, and ordering cost goes up. The economic order quantity, EOQ, is the order size at which the two together are lowest.

EOQ = √(2 × A × O ÷ C). A is the annual requirement in units, O the cost of placing one order and C the cost of holding one unit for a year. C is often stated as a percentage of the unit cost.

Take a distributor in Nagpur that sells 3,000 cartons of biscuits a year. An order costs ₹960 to place. A carton costs ₹600, and holding it for a year costs 20% of that.

The table below works it through: order about 219 cartons, roughly every 27 days. At the EOQ, ordering and holding cost are equal. Rounding to 220 for a pack of ten changes the total by paise, because near the EOQ the cost curve is flat. The EOQ calculator does these steps with your own figures.

The formula rests on simple assumptions, so check these before you rely on it:

• Seasonal demand: if Diwali or the wedding season doubles sales, work out an EOQ for each season.
• Quantity discounts: compare the total cost, goods included, at the EOQ and at each price break.
• Shelf life, godown space and a supplier’s minimum order can set the quantity for you.
• Leave out GST you claim back as input tax credit. GST you cannot claim is part of the cost.

Re-order, minimum, maximum and danger levels

EOQ says how much to order. The re-order level says when. ICAI’s study material sets four levels for each item from its usage and lead time. The lead time, which ICAI also calls the re-order period, runs from placing an order to the goods reaching your store.

ICAI’s Illustration 6 works them out for one item. Usage is 15 units a day on average, 20 at most and 10 at least. Delivery takes 10 days on average, 15 at worst and 5 at best, and 4 days for an emergency purchase. The EOQ, used as the re-order quantity, is 200 units.

The formulas are below, and the results under them. Read the levels as alarms. At 300, place the order. If stock falls below 150, the delivery is late or usage is up: chase the supplier. Above 450, someone over-ordered. At 60, stop normal issues and buy urgently.

Use the same unit of time throughout: days with days, weeks with weeks. The reorder point calculator has a tab for these levels.

• Re-order level = maximum usage × maximum lead time.
• Minimum level = re-order level − average usage × average lead time.
• Maximum level = re-order level + re-order quantity − minimum usage × minimum lead time.
• Danger level = average usage × lead time for an emergency purchase.

Safety stock, worked out two ways

Safety stock is what you keep on top of the stock you expect to use while an order is on its way. It covers the busy week and the late truck. Reorder point = usage over the lead time + safety stock.

Maximum minus average. Safety stock is the busiest usage over the longest lead time, less normal usage over the normal lead time. With Illustration 6’s figures: 20 × 15 − 15 × 10 = 150 units, and the reorder point is 150 + 150 = 300, the same as ICAI’s re-order level. It needs no statistics, but it plans for the worst day and the worst delivery at once, so it can carry more stock than you need.

Service level. Decide how often you can accept running out while an order is on its way, and measure how much your daily usage swings. Safety stock = Z × the standard deviation of daily usage × √(lead time in days). Z comes from the normal distribution: 1.645 for 95%, 2.326 for 99%.

Say daily usage of the same item has a standard deviation of 4 units. At 95%: 1.645 × 4 × √10 = 20.8, so the reorder point is 171. At 99%: 2.326 × 4 × √10 = 29.4, so it is 180. Each step closer to 100% costs more stock than the last.

This version treats the lead time as fixed; if deliveries swing a lot, keep more. For the standard deviation, put a few months of daily sales in Excel and use =STDEV.S. Use maximum minus average for vital items and unreliable suppliers, and a higher service level for A items than for C items.

Cycle counting instead of one big count

An annual stock-take means closing the godown for days, counting everything at once and finding mistakes months after they happened. Cycle counting spreads the work: count a few items every day or week, in rotation, so every item is checked several times a year.

Let the ABC classes set how often. A sensible start: A items every month, B items every quarter, C items twice a year. Add any item whose count was wrong last time, and any item the records show at zero or below.

When a count differs from the book figure, find the reason before you correct it: a sale not entered, a receipt booked to the wrong godown, damage, theft, or a box entered as a piece. Then fix the cause, or the same difference comes back next month.

In PrimoERP, counts are made on a phone as you walk the aisles, even without signal, and a difference becomes an adjustment that is approved before it changes the books.

• Count without the book figure in front of you, so it cannot steer the count.
• Record each difference as an approved adjustment with a reason, never by overwriting the stock figure.

Several godowns, and stock on the road

With a second godown, a shop or a site store, “how much do we have?” needs a second question: where? Total stock can look healthy while one branch is empty and another overflows.

In a spreadsheet, stock in transit is where counts go wrong. It is counted twice, at both ends, or not at all. In PrimoERP, stock sent to another warehouse shows as in transit until the other side confirms it arrived. Transfers between warehouses come with the Growth plan and above.

• Keep stock and reorder levels for each godown. Usage at a busy city branch is not usage at a quiet one.
• Move stock between godowns with a transfer document, not by lowering one figure and raising another by hand.
• Treat stock in transit as its own place. It is on neither godown’s shelf, but it is still yours and still part of your stock value.
• Close a transfer only when the receiving godown confirms what arrived. A short delivery then becomes a difference to explain, not a silent loss.
• If your godowns sit under different GSTINs, ask your CA how transfers between them should be documented.

Batches, expiry dates and FEFO

For food, medicines, paints, adhesives, cosmetics or anything else with a shelf life, the oldest delivery is not always the one to send out first. What matters is the expiry date.

FEFO, first expiry first out, sends out the batch that expires first before a batch of the same item that expires later. It differs from FIFO when a later delivery carries an earlier date, as happens when a supplier clears old stock.

To run FEFO, record the batch number and expiry date when the goods arrive, not just on the label. Pick by date. Every week, check which batches expire in the next 30, 60 or 90 days, early enough to push them through sales or, where the terms allow, return them to the supplier.

FEFO is a picking rule. How you value stock, by FIFO or weighted average, is a separate accounting choice; the inventory valuation calculator compares the two.

In PrimoERP, a batch carries its expiry date, a watchlist shows batches close to expiry, and expired stock can be blocked from leaving the warehouse.

When spreadsheets stop working

A spreadsheet works out ABC classes, EOQ and reorder levels well. What it cannot do is keep up. Stock changes with every sale, purchase, transfer and return, and a sheet only knows what someone typed into it.

Past a point, the levels belong on each item, in a system that records every movement. In PrimoERP, each item has a reorder level. When stock falls below it, you get a note, and a purchase order is drafted for you to approve. Every receipt and issue carries a value at FIFO, weighted average or standard cost, so the stock report and the accounts agree.

Software can tell you when an item crosses its level. Setting the level is still your job, and the calculators below help.

The usual signs that you have reached that point:

• The sheet and the shelf disagree, and nobody knows which is right.
• Reorder alerts depend on someone remembering to check.
• You have more than one godown, and transfers are tracked in a chat group.
• Batch numbers and expiry dates are on labels, not in the records.
• The stock value in the accounts is worked out once a year.