ABC System Of Inventory Management Case Study

ABC System of Inventory Management

Manufacturing firms uses hundreds of item of materials. This demands proper care and monitoring of materials. For proper monitoring of inventories, ABC system is used. Under this system, all the items of inventory are ranked in the descending order of their annual usage value. Under ABC system, inventories are segregated in to three groups A, B and C. Category `A ' inventory contains items which have the largest investments and represents approximately 70% of the total value of the inventory and about 10% of the total items. The Category `B ' represents the next highest investment and accounts approximately 20% of total value of inventory and 20% of the total items. The Category `C ' consists of large

Ordering cost is the cost relating to the placing of orders for the purchase of materials and includes: Cost of floating tenders, cost of paperwork, cost of inspections, telephone calls, etc. Total ordering costs vary with the number of orders. Total Ordering Cost = No. of Order x Cost Per Order. Carrying cost is the cost of holding materials and includes: Cost of storage space, cost of bins and racks, cost of spoilage, insurance cost, amount of interest payable on the money locked up in the material and similar other expenses. Carrying costs depends on the amount of investment locked in inventories and calculated as a certain percentage on the value of average stock. Total Carrying Cost = Average Level of Inventory x Price Per Unit x Percentage of Carrying

Stock levels keep on changing as and when materials are received and issued for production. At a certain point, materials need to be purchased when a certain stock level is reached. Therefore, different levels of inventories are generally set by the firms like reorder level, minimum level, maximum level and danger level, keeping in mind the lead period. Lead period refers to the period in between placing the order for material and receipt of the materials ordered. At reorder level, order should be placed. The store department will initiate the purchase of materials at this point. The level lies in between the maximum and minimum limits. Reorder level is calculated by multiplying the maximum usage with the maximum lead period. Minimum level implies the limit below which stock is not allowed to fall. The main objective behind fixation of this level is to protect against stock out of a particular item. This is calculated by deducting the product of normal usage and average lead time from the reorder level. Maximum level is the upper limit beyond which the quantity of any item is not allowed to rise, to ensure that unnecessary working capital is not blocked in excessive stock items. Maximum level can be expressed as _ Reorder Level + Economic Order Quantity _ (Minimum Usage x Minimum Lead Time). Finally, the danger level, which is fixed below the minimum