Allied Commerce Forum

MATERIALS CONTROL
INTRODUCTION

Inventory means the various kinds of goods that are kept in a store for the smooth flow of
production and sales activities. It comprises stock of raw materials, work-in-progress,
components and consumables for production activities and finished goods for sales. Material is
considered the most important factor of production. The term material includes raw materials,
consumable stores, tools, spare parts, components and maintenance materials. According to
Indian Association of Materials Management, 64% of the total cost of a product is represented by
the cost of material. Therefore, to have control over the cost of product, it is necessary to
exercise proper control over material.

Meaning of material Control /Inventory Control/ Stores Control:


Material control means regulating the availability of right materials of right quantities at
the right time with a view to maintaining an economic and uninterrupted flow of
production and maintenance of activities.

 Material control may be defined as a comprehensive system which ensures availability of

the required quantity of material of proper quality at the proper time and at the same time
avoiding the unnecessary blocked capital in stores.

 Systematic control over purchase, storage and utilization of material is referred to as

material control. It is a systematic control over the purchasing, storing and using of
materials.

The whole procedure of material control can be divided into three stages:
 Purchase control
 Storage control
 Issue control.
1. Levels of Material Control

There are two levels of material control:

(i)Quantity control: Quantity control aims at ensuring to see whether the required quantity of
material is available or not. Storekeeper and production executive are concerned with quantity
control.

(ii)Financial control: Financial control aims at avoiding the too much or undue investment in
materials and ensuring that every rupee spent in materials is efficiently utilized. It also includes
planning and maintaining proper record. Finance manager are concerned with financial control
activities related to material.

1
 Allied Commerce Forum

2. Aspects of Material Control

Material control has two broad aspects;

(a) Accounting control: Accounting Control focuses on the recording aspect. It deals with
recording of purchase, consumption and closing balance of each material.

(b)Operating control: The operating control is concerned with maintaining the optimum level
of physical stock according to production requirement and financial resources available.

3. NEED FOR MATERIAL CONTROL/OBJECTIVES OF MATERIAL CONTROL

Materials form a major part of the total cost and constitute one of the most important assets in the
majority of business enterprises. The success of a business enterprise depends to a large extent
upon efficient purchasing, storage, consumption and control of materials. A good system of
material control has the following objectives.

1. To achieve economy in. buying: Purchase is an important aspect of material control. It

should be done by a specialized person so that material can be purchased at the most favorable
price and other terms. As a result the purchaser can make valuable contribution to cost reduction.

2. To ensure continuity in production: Materials should be controlled so that they can be

available when required. As a result, production will not be held up. This is done by calculating
and maintaining various levels of stock such as minimum level, maximum level, reorder level,
etc.

3. To avoid over-stocking: Keeping more material than requirement not only locks up capital
but also involves more storage cost. So material control is necessary to avoid over investment in
material.

4. To do away with under-stocking: Keeping less material than requirement has the risk of
production stoppage. It may also call for urgent buying at higher cost. Therefore, material control
is necessary to avoid under-stocking.

5. To buy quality raw material: Quality of raw material affects the quality of the product.
Therefore, proper quality (quality as per specification) of material should be purchased which
can be possible through a good system of material control.

6. To protect material from losses: Material should be protected against loss by fire, theft,
damage, evaporation, etc. through proper storing. This can be done by keeping fire extinguisher,
constructing strong walls and making the store neat and tidy.

7. To reduce the chance of obsolescence: If material is stored for a long time, the chance of
obsolescence may arise i.e. ; the material may become out-dated due to new inventions. These
materials should be traced and used before they become obsolete.

2
 Allied Commerce Forum

8. To check misappropriation: There are instances of material misappropriation by employees

particularly when these are costly. A good material control system can suggest an efficient
system of internal check and internal audit to check such misappropriation.

9. To make correct payment to supplier: Another objective of material control is to see that
the supplier is paid the correct amount and that too at right time. This is done to win the
confidence of the supplier. Voucher should be approved for payment only if material has been
received and’ available for issue.

10. To get up-to-date information: The system of control should reveal complete and up-to-
date accounting information about the availability of materials. Sometimes lack of information
may cause new purchase even if materials are in stock.

11. To ensure timely action for procurement of materials- Purchase of materials should be
made at proper time so that the advantage of favorable market can be achieved.

12. To maintain timely records for materials- The information about the availability of
materials should be available continuously by maintaining proper records for materials so that
production may be planned and the required materials are purchased in time.

TECHNIQUES OF MATERIAL CONTROL

Various techniques of material control are;

[Link] of Stock Levels -

2. Economic Order Quantity or Reorder Quantity
[Link]/Inventory Turnover Ratio
[Link] Analysis
[Link] Inventory System
[Link] Analysis of Material Control

A. FIXATION OF STOCK LEVEL:

Both overstocking and under stocking of materials are not desirable for a business organisation.

Overstocking leads to blocking of capital, blocking up space in the godown and dangers of
deterioration in quality.

On the other hand, under stocking leads to higher costs due to frequent purchases and there may
be disruption in production due to shortage of materials.
In order to guard against overstocking and under stocking, different stock levels are fixed
scientifically. These stock levels are:

(a) Re-order Level (b) Maximum Level (c) Minimum Level

(d) Average Level (e) Danger Level

(a) Re-order Level:

3
 Allied Commerce Forum

 Re-order level is a level of material at which the storekeeper should initiate the purchase
requisition for fresh supplies.

 This is normally the point lying between the maximum and the minimum levels.

 This level is fixed in such a way that the difference between the reordering level and
minimum level will be sufficient to meet the production requirements till fresh stocks
arrive.

 Reordering Level is also known as ordering Level.

Factors.
The following factors are taken into account for fixing the, re-order level:
(i) Rate of consumption of material
(ii) Lead time, i.e., time required to receive the delivery of fresh purchase.
(iii) Re-order quantity
(iv) Minimum level,

Formula
Re-order level can be calculated by applying the following formula:

1. Re-order level = Minimum level + consumption during period required toget fresh
delivery

2. Another formula for Re-order level is:

Re-order level = Maximums consumption x Maximum Re-order Period

(b) Maximum Level:

 The maximum level is that level of stock which can be held at any time.

 it is the level beyond which stock should not be maintained.

 If the stock exceeds this level, it leads to overstocking.

Note: Overstocking should be avoided as it results in blocking working capital, need for more
space, obsolescence of stock, deterioration of quality and depreciation in value of stock.

Objects: The followings are the main objects for fixing up the maximum level:
(I) To avoid overstocking.
(ii) To control unnecessary investment in stock.
(iii) To use working capital in proper way.

Factors:

4
 Allied Commerce Forum

Maximum stock level is fixed by taking the following factors into consideration:
(I) Availability of working capital
(ii) Rate of consumption of materials
(iii) Delivery time, i.e., time required to obtain the supply of materials from the date of order.
(iv) Re-order quantity
(v) Re-order level
(vi) Availability of storage space
(vii) Cost of carrying the inventory
(viii) Price fluctuations
(ix) Possibility of loss due to evaporation and deterioration
(x) Possibility of change in fashion and habit
(xi) Restrictions imposed by Government.

Formula:
The maximum level can be calculated with the following formula:
Maximum level = Re-order Level + Re-order Quantity - (Minimum rate of consumption ×
Minimum re-order period)
(c) Minimum Level:
 This is the level below which the stock of an item should not fall.
 This is known as safety or buffer stock.
 This level is fixed on the basis of the lead time i.e. the time lag between indenting and
receiving of the material.
 An enterprise must maintain minimum quantity of stock so that the production is not
hampered due to non availability of materials.
Factors:
(i) Average rate of consumption of material per day or per week.
(ii) Lead time, i.e., the time required to receive the material from the point of placing order.
(iii) Re-order level

Formula:
The minimum level can be determined by the following formula:
Minimum Level = Re-ordering level - (Normal rate of consumption × Normal delivery
period)

(v) Average Stock Level:

It means the average stock held by a concern.

Average level can be calculated in two ways basing upon the availability of information.

Firstly, this level is calculated by averaging the minimum and maximum level of stock. The
formula is:

5
 Allied Commerce Forum

Maximum stock level + Minimum stock level

Average Level¿
2

Alternatively, this level is equal to Minimum stock level plus half of the Re-ordering quantity.
The formula is

1
Average Level = Minimum Stock Level + of Re-ordering quantity
2

e) Danger Level:

 It is the level below which the stock should not be allowed to fall.
 It refers to a quantity level at which normal issues are stopped and issue is made only for
important jobs under specific instruction.
 When the material level approaches the danger level, urgent action must be taken to get
fresh issues so that production may not be held up due to shortage of materials.

The danger level can be calculated by applying the following formula:

Danger Level=Average consumption × Maximum Re-order period for emergency

purchases

Diagrammatic Representation of Different’ Stock Levels

B. ECONOMIC ORDER QUANTITY (RE-ORDER QUANTITY)

 Economic Order Quantity (EOQ) is that size of order which gives maximum economy in
purchasing the material and storing it.
 Economic Order Quantity may be defined as that level of inventory order that minimizes
the total cost associated with inventory management.
 In simple words, the ordering Quantity for which both ordering and carrying costs are
minimum and total cost is minimum is called Economic Order Quantity.

6
 Allied Commerce Forum

 It is helpful to determine in advance as to how much is the size of the order.

 The quantity to be ordered is called economic order quantity because the purchase of this
size of material is most economical.

NOTE: Sometimes, EOQ is also known as Re-order quantity or Ordering quantity.

ASSUMPTIONS IN THE CALCULATION OF ECONOMIC ORDER QUANTITY:

The economic order quantity is based on the following assumptions:

 Quantity of the item to be consumed during a particular period is known with certainty
 The pattern of consumption of material is constant and uniform throughout the period
 Cist per unit is constant and known and quantity discount is not involved.
 Ordering cost and carrying cost are known and they are fixed per unit and will remain
constant throughout the period.

FACTORS TO BE CONSIDERED WHILE DETERMINING EOQ:

While determining the economic order quantity, the following three cost factors are taken into
consideration:

 The cost of the material .

 The inventory carrying cost .
 The ordering cost

CARRYING COSTS: This is the cost of holding inventory in the store and it includes storage
cost, interest payable on invested funds, cost of handling, cost of obsolescence, clerical cost,
insurance cost, loss due to pilferage and deterioration, salaries and wages of store-keeping
department, Stationery used in the stores etc.
Carrying cost is generally expressed as a percentage of average inventory value.

All these carrying costs are directly proportional to the quantity ordered. If quantity ordered is
more, these costs will be more and vice-versa.

Ordering costs: it is the cost of placing an order for purchase of materials. It includes the cost of

7
 Allied Commerce Forum

comparative evaluation of quotations, cost of paper work, cost of inspection, cost of accounting,
cost of postage and telephone charges, transportation and receiving cost, etc.

if an order is placed for a large quantity at a time, the ordering cost is less. On the other hand, if
orders are placed for small quantities, the ordering cot is more.

DETERMINATION OF EOQ:

METHODS OF COMPUTATION OF EOQ :

1. Graphic Method
2. Mathematical Formula/Algebraic method
3. Tabular Method:

1. Graphic Method: The behavior of ordering cost, carrying, total cost and EOQ may be seen
from the following diagram.

From the diagram it is clear that the ordering cost curve moves from left to right downwards
indicating that it decreases as quantity per order increases.

The carrying cost curve moves from left to right upwards implying that it increases as quantity
per order increases.

These two cost curves intersect each other at point P. At this point both ordering cost and
carrying cost are equal. Now draw a perpendicular from P on X-axis to get the economic order
quantity. At this point, the total cost is the minimum (at point Q). Now draw a perpendicular on
Y-axis from Q to get the minimum total cost.

The graphic method discussed here may not

yield accurate result. So, EOQ is calculated by
the following, two methods.

8
 Allied Commerce Forum

2. Mathematical Method:
[Link]=
√2 CO
I
Where, C = Annual consumption• (either in units or value)
O=Cost of placing one order
I= Carrying cost unit p.a.
NB.: Carrying cost may be expressed as a percentage on the cost per unit.

A
2. Total number of orders to be placed =
EOQ
365
3. Time after which an order is to be placed (Frequency of order) in days =
No of orders
12
in months =
No of orders

3. Tabular Method:

Economic order quantity can also be calculated with the help of a table. Such table shows the
ordering cost, carrying cost and total cost at different ordering quantities. The following data are
arranged in this table for determining EOQ:

(i) Annual usage

(ii) Number of orders
(iii) Units per order
(iv) Buying cost or ordering cost
(v) Average Inventory
(vi) Carrying cost
(vii) Total of ordering cost and carrying cost.

(i) Annual (ii) (iii) Units (iv) Buying (v) (vi) (vii) Total
usage Number of per order cost or Average Carrying of ordering
orders ordering Inventory cost cost and
cost carrying
cost.

9
 Allied Commerce Forum

As per this table, The ordering quantity where total cost is the minimum and ordering cost equals
carrying cost is the EOQ.

C. INVENTORY CONTROL RATIOS

Various ratios are used by the management for exercising control on the inventories. Some of the
important ratios are:
1. Material Turnover Ratio/ inventory Turnover ratios
2. Input-Output Ratio or Productivity Ratio
3. Wastivity Ratio

These ratios are discussed below:

1. Material/Inventory Turnover Ratio:

Inventory turnover ratio is also one method of exercising material control. Material turnover
refers to movement of material in and out of an organisation.

It is the ratio of the cost of materials consumed during a period to the average cost of inventory
during the period.

It is used to compare the turnover of different kinds of material to find out the items which are
first moving or slow moving or dormant and thus helping management to exercise proper control
over materials and to keep minimum capital investment in undesirable stock.

Material Turnover is a means of detecting slow moving items.

Material turnover ratio indicates how many times the investment in average stock has been
turned over during the period.

If the ratio is high, it indicates that the stock is moving fast and low ratio indicates that the stock
is moving slowly. Thus,

Material turnover ratio can be calculated as follows:

Cost of material consumed during the period

(a) Material Turnover Ratio (in times) ¿
Average stock of materials held during the period
10
 Allied Commerce Forum

(b) Material Turnover Ratio can also be expressed in terms of days.

The formula is:

Days during the period
Material Turnover Ratio (in days) ¿
Material Turnover Ratio

Average Stock
¿ Days during the period ×
Cost of materials consumed

Different formulae are used to calculate the average stock of materials held during the period.
They are given below:

Opening Stock +Closing Stock

(i) Average Stock¿
2

A high turnover ratio is an indication of fast moving stock and less investment in stock.

On the other hand, low material turnover ratio is an indication of slow moving stock and alarms
the organisation to avoid over-stocking of that item in the stores and should be immediately
disposed of otherwise the quality of the item will deteriorate.

Note:

(i).‘Inventory Turnover Ratio’, ‘Stock Turnover Ratio’ and ‘Material Turnover Ratio’ are
one and same.

(ii).Slow moving items have been classified in the following three categories:
(a) Slow Moving Stocks: These stocks are issued at a very slow speed.
(b) Dormant Stocks: Dormant stocks are such material items which do not have any demand at
present and consumption of such items is almost nil. Such stock may be demanded in future. For
example, spare parts may be needed when machinery goes out of order.
(c) Obsolete Stocks: These items are not to be further used. Such items are no longer in demand
and they should be disposed off immediately to reduce the carrying cost and losses due to
deterioration in quality.

D. ABC Analysis
ABC technique of inventory control is also known as Always Better Control method or
Proportional Parts Value Analysis method. ABC analysis is an analytical method of control

11
 Allied Commerce Forum

which aims at concentrating efforts on those areas where attention is needed most. This is a
principle of selective control.
The emphasis of ABC analysis technique is that the management should concentrate its energy in
controlling those items that mostly affect the organizational objects.
Manufacturing concerns find it useful to group the materials into three classes on the basis of
investment involved.
This technique divides materials into three categories:
(i) In the first category, those items are included on which major portion of total cost of materials
is spent. High priced materials, items falling in this category are treated as ‘A’ items.
(ii) In the second category, those items are included which have moderate consumption value.
Medium priced materials, items falling in this category are treated as ‘B’ items.

(iii) In third category those items are included which have low consumption value. Low priced
materials, items falling in this category are treated as ‘C’ items.

From the above example. it is clear that more control should be exercised on material included in
category ‘A’. On the other hand, less control should be exercised on material included in
category ‘C’ and moderate control should be exercised on category ‘B’.
Advantages of ABC Analysis
(i) A strict control can be exercised on valuable materials.
(ii) Working capital can be used in a better way.
(iii) Storage cost is reduced.
(iv) Management can apply the principle of Management by Exception as only A category needs
better control.
(v) Clerical cost can be reduced and inventory is maintained at optimum level.
(vi) Scientific and selective control helps in maintenance of high stock turnover rate.

Features of ABC analysis:

‘A’ items ‘B’ items ‘C’ items
75% of value but 8% of total 20% of value but 25% of 5% of value but 67% of total
quantity total quantity quantity
1. Very strict control to be
Moderate control is needed Loose control
exercised

12
 Allied Commerce Forum

2. Maximum follow up is Periodic follow up is Only in exceptional cases

necessary required follow up ensured
3. Very low safety stocks Only low safety stocks High safety stocks
4. Must be taken care of by Can be handled by middle Can be delegated to lower level
top • management management of management.
5. Rigorous value analysis Moderate value analysis Minimum value analysis

E. Perpetual Inventory System:

Meaning:

 The perpetual inventory system is intended’ as an aid to material control. It is a system of

stock control followed by stores department. The system follows a method of recording
stores by which information about each receipt, issue and current balance of stock is
always available.
 In perpetual inventory system; the perpetual inventory records i.e., Bin Cards and Stores
Ledger are maintained which show goods received, issued and stock on hand at any time
and physical verification of the stores is made by a programme of Continuous stock-
taking.
 Thus, it is a system of ascertaining current balance after recording every receipt and issue
of materials through stock records. An important point which should be kept in mind is
that the perpetual inventory is usually checked by a programme of continuous stock-
taking.

Definition:

[Link] Institute of Cost and Management Accountants of England and Wales, defines
perpetual inventory as “A system of records maintained, by the controlling department, which
reflects the physical movement of stocks and their current balances.”

[Link] to Weldon, “Perpetual inventory system is a method of recording stores balances

after every receipt arid issue, to facilitate regular checking and obviate closing down of work for
stock-taking.”

Technique of perpetual inventory system:

Perpetual inventory system comprises of:

(a) Comparison of Bin Cards (quantitative perpetual inventory) and Stores Ledger
Accounts (quantitative-cum-valued perpetual inventory): Bin card is maintained by the store-
keeper and stores ledger account is maintained by stores accountant. Each item of stores is

13
 Allied Commerce Forum

recorded at these places simultaneously. Normally the balances shown by the two records tally.
However, there may arise some differences between these two records due to the following
reasons:

(i) Omission of. an item of store in bin card or stores ledger account.
(ii) Wrong posting of an item of store either in bin card or in stores ledger account.
(iii) Arithmetical error in working out their balances. Therefore, the balances of the two records
should be reconciled at frequent intervals and correct balances should be drawn.
(b) Continuous Stock-Taking (Physical perpetual inventory):Continuous stock taking means
the physical verification of the stock records with actual [Link] continuous stock taking
system, a permanent stock taking team is appointed and this team makes comparison between the
physical quantities shown in bin card and the stores ledger. This system comprises of counting
and verifying a number of items at random daily throughout the year so that all items of stores
are verified several times during the year. But -sometimes differences arise due to the following
reasons:

(i) Breakage and wastage of materials due to improper handling.

(ii) Shrinkage and evaporation.
(iii) Losses due to accident, fire, etc.
(iv) Losses arising out of breaking up bulk materials.
(v) Losses due to theft.
(vi) Misposting in bin card or stores ledger account.
(vii) ‘Over or short-issue.

From the above discussion we can conclude that the perpetual inventory system is comprised of
the following three:
1. Bin Card
2. Stores Ledger
3. Continuous Stock Taking.

Advantages: The significant advantages of perpetual inventory system with continuous stock-
taking system are as follows:

(i) Smooth flow of production: The work of stock-taking at the end of the year is avoided. So,
production as well as other transactions need not be stopped to carry out stocktaking.

(ii) Strict control over stores: Updating store records through perpetual inventory system along
with continuous stock-taking ensures a strict control over each item of stores.

(iii) Detailed internal check: On one side, the records, i.e., Bin Card and Stores Ledger,
are maintained simultaneously and on the other, the balances are continuously verified.
Thus, this system acts as a detailed and reliable internal check.

(iv) Easy to prepare interim financial statements: Stock figures can be promptly available
from the Stores Ledger. This helps preparation of quarterly, half-yearly and annual
Profit and Loss Account and Balance Sheet.

14
 Allied Commerce Forum

(v) Minimization of material losses: It facilitates detection of discrepancies and defects

quickly. Immediate corrective measures are initiated to adjust or minimize discrepancies like
breakage, pilferage and obsolescence.

(vi) Stock items are kept within predetermined limits: Continuous comparison of actual
stocks with predetermined stock levels, i.e., re-ordering level, maximum level and minimum
level, ensures keeping the stock within the specified limits.

(vii) Avoiding overstocking and under stocking: As actual stock is continuously compared
with the maximum level and minimum level, the possibility of overstocking and under stocking
is avoided. Thus, it ensures minimum investment of working capital.
(viii) Moral check on employees: This double control system acts as a moral check which
increases efficiency of staff working in the stores department. Keeping up-to-date stock records
for continuous stock-taking decreases dishonesty.

Types of stock taking:

(i) Periodic stock verification

(ii) Continuous stock verification

(i) Periodic stock verification:

 It refers to a system where physical stock verification is normally done periodically, i.e.,
once or twice in a year.
 Under this method, value of stock is determined by physical counting of the stock on a
particular date, usually at the end of the year.
 It is a simple and economical method of stock-taking and is adopted in small concerns.
 Stores may be closed down for a few days to facilitate stock-taking.
 There is possibility of fraud, discrepancy, etc.

(ii) Continuous stock verification:

 Continuous stock taking means the physical verification of the stock records with actual
records.
 Under continuous stock taking system, a permanent stock taking team is appointed and
this team makes comparison between the physical quantities and quantities shown in the
bin card and the stores ledger.
 This system comprises of counting and verifying a number of items at random daily
throughout the year so that all items of stores are verified several times during the year.
 Notice of the particular stock to be verified each day is given to the store-keeper only on
the date of actual verification.
 As there is an element of surprise check in this system of stock-taking, effective control
over the items of stores can be exercised.
 The system does not necessitate the closing down of the’ stores to facilitate stock-taking.

15
 Allied Commerce Forum

But -sometimes differences arise due to the following reasons:

(i) Breakage and wastage of materials due to improper handling.

(ii) Shrinkage and evaporation.
(iii) Losses due to accident, fire, etc.
(iv) Losses arising out of breaking up bulk materials.
(v) Losses due to theft.
(vi) Misposting in bin card or stores ledger account.
(vii) ‘Over or short-issue.

[Link] Analysis
VED stands for Vital, Essential and Desirable. VED analysis is used primarily to have control
of spare parts. Such spare parts, though being less valuable, can be of great importance for
production and need special attention. The spare parts can be divided into three categories - vital,
essential and desirable.
‘V’ - For vital spare parts: These are critical parts, the stock-out of which will stop
production immediately. In the first category such valuable spare parts are included, the non-
availability of which even for a short time can cause stoppage of production for longtime. These
spare parts are known as vital spares.
‘E’ - For essential spare parts: In the second category, those spares are included, the absence of
which can’t be tolerated for more than some hours or a day and it can cause big loss to
production. These spare parts are known as Essential parts.
‘D’ - For desirable spare parts: Those parts, the absence of which are bearable for a week or
more and will not lead to stoppage of production are known as desirable parts.
The prime aim of this control system is to trace the vital spare parts and store them to meet the
sudden production stoppage. The criticality of the parts is more important than their money
value.

16