Description
The documentation explaining on the basics of inventory management in detail.It also takes examples of SUN pharma and Ranbaxy.
FINANCIAL ACCOUNTING AND ANALYSIS
Inventory Management
Inventory Management
CONTENTS
TITLE Ratio Analysis Of Ranbaxy Sun Pharma Introduction On Inventory Management ABC Method EOQ Model Order Point Safety Stock Pricing of Raw Materials Just-In-Time Inventory Management of Ranbaxy Inventory Management of Sun Pharma Inventory Ratio Analysis Of Sun Pharma And Ranbaxy Criteria For Judging The Inventory System Role of a Finance Manager Reference PAGE NO. 2 4 6 7 10 11 13 14 16 18 19 22 24 25
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Inventory Management
RATIO ANANLYSIS
Ratio Current ratio Quick Ratio Debt Equity Ratio Debtors Turnover Ratio Total Assets Turnover Ratio Interest Coverage Inventory Turnover Ratio Gross Profit Margin Net Profit Margin Return On Asset Return on Equity
Ranbaxy 1.4 0.99 1.04 5.77 0.63 (12.13) 3.5 (3.6) (13) (8.7) (27.48)
Sun Pharma 6.3 5.12 0.02 2.47 0.58 206.27 3.9 46.2 44.3 18.71 21.97
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Inventory Management
Rationale for de-growth of Ranbaxy in 2008
? Ranbaxy recorded a net growth of 9% in sales, recording revenue of Rs. 72,954 millions in 2008. Sales continued to grow despite US operations getting impacted due to US FDA Import Alert in respect of some of the products of the Company. ? The US FDA had issued two warning letters to Ranbaxy Laboratories and an import alert for generic drugs produced by the company's Dewas and Paonta Sahib plants in India. The warning letters identify the Agency's concerns about deviations from US cGMP requirements, while the import alert covers more than 30 different generic drug products produced in multiple dosage forms at these two locations. ? The growth was largely driven by change in sales mix skewed towards more profitable and emerging markets, which now contribute 54% of global sales. Overseas markets constituted 80% of the total sales of the Company. Profit after tax registered a sharp decline at Rs. (9,349) millions mainly due to rupee volatility coupled with provisions for inventory and sale return pursuant to the Import Alert by FDA. Consistent depreciation of the rupee in 2008 and large exposure of the Company's business in the international markets has resulted in unprecedented foreign exchange losses of Rs. 10,856.24 millions on derivatives and loans represented in foreign currency. Besides as a matter of prudent accounting practice, the Company voluntarily adopted Accounting Standard 30 on "Financial Instrument: Recognition and Measurement" issued by the Institute of Chartered Accountants of India though the standard is mandatory only in respect of accounting period commencing on or after April 1, 2011.
? As a result of early adoption of the said Accounting Standard the Company had to
recognize a net loss of Rs. 7,702.14 millions on fair valuation of Financial Instruments. The combined impact of this stand at a loss of Rs.18,558.38 millions which has adversely impacted the financial performance of the Company. The Company continues to focus on sustaining growth in the emerging markets, cost optimization and efficient management of working capital. The Company has been taking various steps for early resolution of the issues raised by US FDA.
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Inventory Management
INVENTORY MANAGEMENT – AN INTRODUCTION
Inventories form a link between the production and sale of a product. A Manufacturing company must obtain a certain amount of inventory, known as work in progress, during production. Although other types of inventory- in transit, raw materials, and finished goods inventories- are not necessary in the strictest sense, they allow the firm to be flexible. Inventory in transit- that is inventory between various stages of production or storage- permits efficient production scheduling and utilization of resources. Without this type of inventory, each stage of production would have to wait for the preceding stage to complete a unit. The possibility of resultant delays and idle time gives the firm an incentive to maintain in-transit inventory. Raw material inventory gives the firm flexibility in its purchasing. Without it, the firm must exists on a hand-to-mouth basis, buying raw materials strictly in keeping with its production schedule. Finished-goods- inventory allows the firm flexibility in its production scheduling and in its marketing. Production does not need to be geared directly to sales. Large inventories allow efficient servicing of customer demands. If a certain product is temporarily out of stock, present as well as future sales to the customers may be lost. Thus there is an incentive to maintain stocks of all types of inventory. The traditionally extolled advantages of increased inventories, then, are several. The firm can affect economies of production and purchasing and can fill orders more quickly. In short, the firm is said to be more flexible. The obvious disadvantages are the total cost of holding the inventory. An additional disadvantage is the danger of obsolescence. Because of the benefits, however, the sales manager and production manager are often biased towards relatively large inventories. Moreover, the purchasing manger can often achieve quantity discounts with larger orders, and there may be a bias here as well. It falls on the financial managers to dampen the temptation for large inventories. This is done by forcing consideration of the cost of funds necessary to carry inventories as well as perhaps of the handling and storage costs. In recent years, additional support for the financial manager?s questioning of the maintenance of large inventories has come from an understanding of a Japanese inspired inventory control system called Just In Time or JIT. JIT breaks with the conventional wisdom of maintaining large inventory stocks as buffers against uncertainties. The basic objective of JIT is to produce (or
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Inventory Management
receive) a required item at the exact time needed, or “Just In Time”. Inventories of all types would thus be reduced to a bare minimum (in some cases zero). Reductions in inventory-carrying costs are one of the more obvious results of the JIT systems. However, additional hoped- for results include improvement in productivity, product quality and flexibility. Like accounts receivable, inventories should be increased as long as the resulting savings exceed the total cost of holding the added inventory. The balance finally reached depends on estimate of actual savings, the costs of carrying additional inventory, and efficiency of inventory control. Obviously, this balance requires a co ordination of the production, marketing, and finance area of the firm in keeping with the overall objective. Our purpose is to examine various principles of inventory control by which an appropriate balance might be achieved.
Types of Cost There are three types of cost in the context of inventory management, Ordering Cost relating to purchased items would include expenses on the following: requisitioning, preparation of purchase order, expediting, transport, and receiving and placing in storage. Ordering cost pertaining to items manufactured in the company would include expenses on the following: requisitioning, set-up, and receiving and placing in storage. Carrying Cost includes expenses on the following: interest on capital locked up in inventory, storage, insurance, obsolescence, and taxes. Carrying cost generally are about 20 percent of the value of inventories held. Shortage costs arise when inventories are short of requirement for meeting the needs of the production or the demand of customers. Inventory shortages may result in one or more of the following: High costs concomitant with „crash? procurement, less efficient and uneconomic production schedules and customer dissatisfaction and loss of sales. When a firm orders large quantities in a bid to reduce the total ordering cost, the average inventory, other things being equal tends to be high thereby increasing the carrying cost.
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Inventory Management
ABC METHOD
What to Control? Different types of inventory exist for a typical manufacturing firm- raw materials, work-inprogress, in-transit, and finished goods inventories. Another way to classify inventory is by dollar value of the firm?s investment. If the firm was to rank inventory items by decreasing value per item, we might get a cumulative distribution that looks like fig1, we find that, as a group, “A” items reflect the fact that roughly 15% of the items in the inventory account for 70% of inventory value. The next 30% of items, group “B”, account for 20% of inventory value. And more than half, or 55%, of he items explain only 10% of total inventory value.
Based on this typical breakdown, in which a relatively small proportion of the items account for most of the total inventory value, it seems reasonable for the firm to devote more care and attention to controlling the more valuable items. This can be accomplished by assigning them an “A” classification and reviewing these items more frequently. “B” and “C” items might warrant increasingly less rigorous, less timely reviews. This system is often referred to, appropriately enough, as the ABC method of inventory control. Factors other than the dollar value may also need to be considered when developing the classification plan- for example, whether something is a critical, or bottleneck items, or may soon become obsolete. The bottom line is, however, is to classify inventory items in such a fashion that we ensure that most important inventory items are reviewed more often. Thus a valid method of inventory classification forms the first leg in the construction of a solid inventory control system.
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Inventory Management
EOQ MODEL
How much to order? EOQ is an important concept in the purchase of raw materials and in the storage of finishedgoods and in-transit inventories. We determine the optimal order quantity for a particular item of inventory, given its forecast usage, ordering costs, and carrying cost. Ordering means either the purchase of the item or its production. Assume for the moment that the usage of a particular item of inventory is known with certainty. This usage is at a steady rate throughout the period of time being analyzed. In other words, if usage is 2600 items for 6 months period, 100 items are used each week. We assume that ordering costs per order, O, are constant regardless of the size of the order. In purchase of raw materials or other items, the costs represent the clerical costs, involved in placing an order together with certain costs of receiving and checking the goods once they arrive. For finished-goods inventories, ordering costs involve scheduling a production run. When the setup costs are large- as they are in producing a machined piece of metal, for example- ordering costs can be quite significant. For in-transit inventories, ordering costs are likely to involve nothing more than record keeping. The total ordering costs for a period is simply the cost per order items the number of orders for that period. Carrying costs per unit, C, represents the cost of inventory storage, handling, and insurance, together with required return on investment in inventory over the period. These costs are assumed to be constant per unit of inventory, per period of time. Thus the total carrying cost for a period is the carrying cost per unit times the average number of units of inventory for the period. In addition, we assume that inventory orders are filled when needed, without delay. Because out of stock items can be replaced immediately, there is no need to maintain a buffer or safety stock. Though the assumptions made up to now may seem overly restrictive, they are necessary for an initial understanding of the conceptual framework that follows. If usage of an inventory item is at a steady rate over a period of time and there is no safety stock, average inventory (in units) can be expressed asAverage inventory = Q/2 [Eq. 1]
Where Q is the quantity ordered and is assumed to be constant for the planning period. Although the quantity demanded is a step function, we assume for analytical purposes, that it can be
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Inventory Management
approximated by a straight line. We see that when a zero level of inventory is reached, a new order of Q items arrives. Once again the carrying costs of inventory is the average number of units of inventory times the carrying costs per unit, or C(Q/2). The total number of orders over a period of time is simply the total usage (in units) of an item of inventory for that period, S, divided by Q, the quantity ordered. Consequently, total ordering costs are represented by the ordering costs per order times the number of ordered, or O(S/Q). Total inventory costs, then, are the sum of the total carrying costs plus ordering costs, or Total inventory cost (T) = C(Q/2) + O(S/Q) [Eq. 2]
We see from the above equation that higher the order quantity, Q, the higher the total carrying costs, but the lower the total ordering costs. The lower the order quantity, the lower the total carrying costs, but the higher the total ordering costs. We are, therefore, concerned with the trade-off between the economies of increased order size and the added costs of carrying additional inventory. Assumptions of the basic EOQ model are: 1. Only one product is involved. 2. Annual demand requirements are known. 3. Demand is spread evenly throughout the year so that the demand rate is reasonable constant. 4. Lead time does not vary. 5. Each order is received in a single delivery. 6. There are no quantity discounts.
Optimal Order Quantity: The optimal order quantity of an inventory item to order at any one time is that quantity, Q*, that minimizes the total inventory cost over a planning period. We can
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Inventory Management
use calculus to find the lowest point on the total inventory cost curve described by equation 2 and solve for Q. the resulting optimal quantity, or EOQ, is Q* = ?2(O)(S)/C
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Inventory Management
ORDER POINT
When to Reorder with EOQ Ordering The reorder point (ROP) occurs when the quantity on hand drops to a predetermined amount. That amount generally includes expected demand during lead time and perhaps an extra cushion of stock, which serves to reduce the probability of experiencing a stock out during lead time. Note that in order to know when the reorder point has been reached, a perpetual inventory is required. There are four determinants of the reorder point quantity: 1. The rate of demand (usually based on a forecast). 2. The lead time. 3. The extent of demand and/or lead time variability. 4. The degree of stockout risk acceptable to manager. If demand and lead time are both constant, the reorder point is simply [Eq. 3] Where, d = demand rate (units per day or week) LT = lead time in days or weeks
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Inventory Management
SAFETY STOCK
In practice, the demand or usage of inventory is generally not known with certainty; usually, it fluctuates during a given period of time. Typically, the demand for finished goods inventory is subject to the greatest uncertainty. In general, the usage of raw materials inventory and in-transit inventory, both of which depend on the production scheduling is more predictable. In addition to demand, the lead time required to receive delivery of inventory once an order is placed is usually subject to some variation. Owing to these fluctuations, it is not usually feasible to allow expected inventory to fall to zero before a new order is anticipated, as the firm could do when usage and lead time were known with certainty. Therefore, when we allow for uncertainty in demand for inventory as well as lead time, a safety stock becomes advisable. However, treating lead time and daily usage as average, or expected values, rather than as constants, causes us to modify our original order point equation as follows. Order Point [OP] = Average lead time x Average daily usage ? Safety Stock [Eq. 4] In other words, the order point determines the amount of safety stock held. Thus, by varying the order point, one can vary the safety stock that is held. The proper amount of safety stock to maintain depends on several factors. The greater the risk of running unit of stock, the larger the unforeseen fluctuations in usage. Similarly, the greater the uncertainty of lead time to replenish stock, the greater the risk of running out of stock, and the more safety stock the firm will wish to maintain, all other things being equal. Another factor influencing the safety stock decision is the cost of running out of inventory. The cost of being out of raw materials and in-transit inventories is a delay in production. The cost of running out of finished goods comes from lost sales and customer dissatisfaction. Not only will the immediate sale be lost but future sales will be endangered if customers take their business elsewhere. Although this opportunity cost is difficult to measure, it must be recognized by management and incorporated into the safety stock decision. The greater the costs of running out of stock, of course, the greater the safety stock that management will wish to maintain, all other things staying the same. The final factor is the cost of carrying additional inventory. If it were not for this cost, a firm could maintain whatever safety stock was necessary to avoid all possibility of running out of inventory. The greater the cost of carrying inventory, the more costly it is to maintain a safety
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Inventory Management
stock, all other things being equal. Determination of the proper amount of safety stock involves balancing the probability and cost of stock-out against the cost of carrying enough safety stock to avoid this possibility. Ultimately, the question reduces to the probability of inventory stock out that management is willing to tolerate. Management will not wish to add safety stock beyond the point at which incremental carrying costs exceed the incremental benefits to be derived from avoiding a stock-out. While deciding the safety stock, apart from the certain simplified assumptions, some additional considerations ought to be taken in the account. These are as follows: 1. Anticipated scarcity : When a certain raw material or product is likely to be scarce in the future, it may make sense to carry a larger inventory then what is required otherwise to protect against scarcity or non- availability in future. 2. Expected price change: If a price change is in the offing, the level of inventory carried may be adjusted according to the direction of the expected price change - an expected increase in price may warrant and increase the level of inventory carried and an expected fall in price may justify decrease in the level of inventory carried. 3. Obsolescence risk: The presence of this risk suggests a reduction in the level of
inventory carried – the degree of reduction would of course depend on how serious the risk is. 4. Government Restrictions: If the government imposes restrictions on the level of inventory that can be maintained directly or indirectly ( through the policies of commercial banks ), then this becomes a constraint in inventory management. 5. Marketing Considerations: If the market is highly competitive and the behavior of consumers is unpredictable, large inventory may have to be carried to ensure that selling opportunities are fully exploited.
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Inventory Management
PRICING OF RAW MATERIALS
Several methods are used for pricing inventories production. The important ones are: ? FIFO Method: This method assumes that the order in which materials are received in the stores is the order in which they are issued from the stores. Hence the materials which are issued first is priced on the basis of the cost material received earliest, so on and so forth. ? Weighted Average Cost method: Under this method, material issues are priced at the weighted average cost of materials in the stock. Valuation of Stocks: The valuation of work in process and finished goods inventory depends on, (i) (ii) The method used for pricing materials. The manner in which the fixed manufacturing overhead costs are treated.
The fixed manufacturing overheads costs are treated in two systems of costing, (i) Direct Costing: Fixed manufacturing overheads costs are treated as period costs and not as product costs. They are charged directly to the income statement. (ii) Absorption Costing: Fixed manufacturing overheads costs are treated as product costs and not as period costs. Hence, inventory valuation reflects an allocated share of fixed manufacturing overhead costs. The valuation of work in process and finished goods inventory is lower, under direct costing and higher under absorption costing. Further, when the inventory level increases, the reported profit under direct costing is lower than the reported profit under absorption costing. When the inventory level, the reported profit under direct costing is higher than what it is under absorption costing.
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Inventory Management
JUST-IN-TIME
The Management of inventory has become very sophisticated in recent years. In certain
industries, this production process leads itself to just in time (JIT) inventory control. As the name implies, the idea is that inventories are acquired and inserted in production at the exact times they are needed. The JIT management philosophy thus focuses on pulling inventory through the production process on an “as needed” basis, rather than pushing inventory through the process on an “as produced” basis. This requires very accurate productions and inventory information system, highly efficient purchasing, very reliable suppliers, and an efficient inventory handling system. Although raw materials inventory and in-transit inventory can never be reduced to zero, the notion of “just in time” is one of extremely right control so as to cut back on inventories. The goal of a JIT system, however, is not only to reduce inventories but also to continuously improve productivity, product quality and manufacturing flexibility. EOQ in a JIT world- At first glance, it might seem that a JIT system in which inventories would be reduced to a bare minimum and the EOQ for a particular item might approach one unit – would be in direct conflict with our EOQ model. However, it is not. As part of a JIT system, steps are continuously taken to drive these costs down. For example: ? ? ? Small sized delivery trucks, with predetermined unloading sequences, are used to facilitate economics in receiving time and costs. Pressure is placed on suppliers to produce raw materials with “no defects” thus reducing (or eliminating) inspection costs. Products, equipment and procedures are modified to reduce setup time and costs. By successfully reducing these ordering related costs, the firm is able to flatten the total ordering cost. This causes the optional order quantity, Q”, to shift to the left, thus approaching the JIT ideal of one unit. Additionally, continuous efforts to reduce supplier delays, production
inefficiencies, and sales forecasting errors allow safety stocks to be cut back or eliminated. How close a company comes to the JIT ideal depends on the type of production process and the nature of the supplier industries, but it is a worthy objective for most companies. JIT Inventory Control, Supply Chain Management and the Internet. JIT inventory control can be viewed as one link in the chain of activities associated with moving goods from the raw material stage through to the end user or customer. These activities are collectively referred to as
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Inventory Management
supply chain management (SCM). The advent of instant information through sophisticated computer networks has greatly facilitated this process. For standard inventory items, the use of the internet has enhanced supply chain management. A number of exchanges have developed for business-to-business (B2B) types of transaction. If you need to purchase a certain type of chemical for use in your production process, you can specify your exact need on a chemical B2B exchange. Various suppliers will then bid for the contract. This auction technique significantly reduces the paperwork and other costs involved in searching for the best price. This together with competition among suppliers, may significantly reduce your costs. A number of B2B exchanges already exist for a wide variety of products, and new ones are developing all the time. Again, the raw material in question must be relatively standardized for an Internet exchange to work well for you.
WHAT IS NEEDED TO MAKE A “JUST-IN-TIME” SYSTEM WORK:
1. Geographic concentration 2. Dependable quality 3. Manageable Supplier network 4. Controlled transportation system 5. Manufacturing flexibility 6. Small lot sizes 7. Efficient receiving and material handling
8. Strong Management commitment
\
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Inventory Management
INVENTORY MANAGEMENT OF RANBAXY
In the year 2008 stronger cash flows resulted due to the improved working capital position through improved receivable and inventory management, resulting in reduction in Gross Working Capital by about 5% of Moving Average Turnover.
Inventories Stores and spares Raw materials Packaging materials Finished goods Work in progress Total inventories
Rs. Million (2008) 181.49 6,689.18 795.20 8788.35 3188.92 19643.14
Inventories are valued as follows: Raw materials, stores and spares and packaging materials Lower of cost and net realizable value. However, materials and other items held for use in the production of finished goods are not written down below cost if the products in which they will be used are expected to be sold at or above cost. Cost is determined on a weighted average basis.
Finished goods Lower of cost and net realizable value. Cost includes direct materials and labour and a proportion of manufacturing overheads based on normal operating capacity. Cost of finished goods includes excise duty and other taxes, wherever applicable.
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Inventory Management
Work-in-process At cost up to estimated stage of completion. Cost includes direct materials and labour and a proportion of manufacturing overheads based on normal operating capacity. Net realizable value is the estimated selling price in the ordinary course of business, less estimated costs of completion and estimated costs necessary to make the sale. Where duty paid/ indigenous materials are consumed, in manufacture of products exported prior to duty-free import of materials under the Advance License Scheme, the estimated excess cost of such materials over that of duty free materials is carried forward and charged to profit and loss account on consumption of such duty-free materials.
There is an adequate internal control system commensurate with the size of the Company and the nature of its business for the purchase of inventory and fixed assets and for the sale of goods and services.
Costing of the inventories is done on the basis of FIFO method of costing. JUST IN TIME has not being implemented till now. But they are planning to implement to reduce the additional cost. Just-In-Time inventory systems provide for an attractive, cost-cutting production system as long as risks are weighed and mitigated. ERP implementation strategy worked very well and brought real value to the firm.
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Inventory Management
INVENTORY MANAGEMENT OF SUN PHARMA
Inventories
Consumable stores Raw materials Packaging materials Finished goods Work in progress Total inventories
Rs. Million (2008)
148.3 4229.7 307.3 881.4 2161.0 7,727.7
Inventories consisting of raw and packing materials, stores and spares, work in progress and finished goods are stated at lower of cost (absorption costing) on FIFO basis/specific identification basis and net realisable value.
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Inventory Management
INVENTORY RATIO ANALYSIS OF SUN PHARMA AND RANBAXY
Inventory Turnover Ratio (2008)
4 3.9 3.8 3.7 3.6 3.5 3.4 3.3 3.4 3.2 3.1 Avg of top 25* Ranbaxy Sun Pharma 3.5 3.9
Inventory Turnover Ratio
Inventory turnover ratio of sun pharma is higher than Ranbaxy and industrial average. This indicates efficiency in inventory management of Sun pharmaceuticals as compared to Ranbaxy.
*Inventory turnover of top 25 pharmaceutical companies in India.
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Inventory Management
INVENTORY TURNOVER IN DAYS
Inventory Turnover in Days (2008)
110
105
D A Y S
100 Inventory Turnover in Days 104
108 95
90 93
85 Avg of top 25* Ranbaxy Sun Pharma
Inventory turnover in days of Sun Pharma also is better than Ranbaxy. As a result, this clearly shows that Sun pharma is better than Ranbaxy in the aspect of inventory management.
*Inventory turnover of top 25 pharmaceutical companies in India.
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Inventory Management
*Inventory turnover of top 25 pharmaceutical companies in India For reference, an average of inventory turnovers is taken of the top 25 companies in Indian pharmaceutical industry. The average inventory turnover ratio was found to be 3.40 and days was 108 COMPANY Sun Pharma Cipla GSK DRL Ranbaxy Divis Lupin Piramal Glenmark Cadila Biocon Aventis Pfizer Matrix Astra Torrent Wyeth Aurobindo Novartis Wockhardt Dishman IPCA FDC Abbot Merck INVENTORY TURNOVER RATIO (2008) 3.9 2.45 4.04 3.00 3.5 2.03 2.84 4.45 2.24 2.73 2.73 3.24 3.86 2.29 5.93 2.99 3.83 2.73 4.49 2.91 2.14 2.79 3.45 5.58 5.05
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Inventory Management
CRITERIA FOR JUDGING THE INVENTORY SYSTEM
The criteria for judging the inventory system are:? Comprehensibility: Inventory systems range from utterly simple to weirdly complex. Irrespective of how simple or complex it is, regardless of whether it is automated or manual, it should be understood by all affected parties. The system must be properly explained to all concerned so that its purpose, logic and rational are transparent. This generates enthusiasm for the system and enhances its credibility. ? Adaptability: A certain degree of flexibility and adaptability must be designed into the system to make it versatile. It should be remembered that the design of any system should ordinarily take care of about 90% of the cases, leaving the balanced 10% to be handled by hand. ? Timeliness: Inventories may suffer loss in value on account of a variety of factors. The more common sources of value decline are: 1. Obsolescence caused by changes in technology and shifts in consumer tastes. 2. Physical deterioration with the passage of time. 3. Price fluctuation because of inherent volatility of certain commodities. The inventory system should be capable of inducing timely action. It should provide adequate forewarning which triggers appropriate corrective steps.
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Inventory Management
AREAS OF IMPROVEMENT
Inventory management in Ranbaxy and Sun Pharmaceuticals can be improved in various ways: ? Effective Computerization: Computers should not be used merely for accounting purposes but also for improving decision making. ? Review of the System: The tools and techniques used for monitoring and control of inventories should be periodically reviewed. ? Improved Coordination: Better coordination among purchase, production, marketing and finance departments will help in achieving greater efficiency in inventory management. ? Development of long term relationship: Companies should develop long term relationship with vendors. This would help in improving the quality and delivery. Procedures for disposal of obsolete/surplus inventories must be simplified. ? Adoption of challenging norms: companies should set benchmark with global competitors and use ideas like JIT to improve inventory management.
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Inventory Management
ROLE OF FINANCE MANAGER
Inventories represent the second largest asset category for manufacturing companies, next only to plant and equipment. The proportion of inventories to total assets generally varies between 15 and 30 percent. Given the substantial investment in inventories, the importance of inventory management cannot be overlooked. Although inventory management is usually not the direct operating responsibility of the financial manager, the investment of funds in inventory is a very important aspect of financial management. Consequently, the financial manager must be familiar with ways to control inventories effectively so that capital may be allocated efficiently. The greater the opportunity cost of funds invested in inventory, the lower the optimal level of average inventory, and the lower the optimal order quantity, all other things held constant. This
statement can be verified by increasing the carrying costs. The EOQ model can also be used by the financial manager in planning for inventory financing. When demand or usage of inventory is uncertain, the financial manager may try to effect policies that will reduce the average lead time required to receive inventory once an order is placed. The lower the average lead time, the lower the safety stock needs, and the lower the total investment in inventory, the greater the incentive to reduce this lead time. The purchasing department may try to find new vendors that promise quicker delivery, or it may pressure existing vendors to deliver faster. The production department may be able to deliver finished goods faster by producing a smaller run. In either case, there is a trade-off between the added cost involved in reducing the lead time and the opportunity cost of funds tied up in inventory. This discussion serves to point out the value of inventory management to the financial manager.
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Inventory Management
REFERENCES
? Fundamentals of Financial Management- Van Horne ? Financial Management- Prasanna Chandra ? Financial report of Ranbaxy-2008 ? Financial report of Sun Pharma-2008
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doc_777828842.docx
The documentation explaining on the basics of inventory management in detail.It also takes examples of SUN pharma and Ranbaxy.
FINANCIAL ACCOUNTING AND ANALYSIS
Inventory Management
Inventory Management
CONTENTS
TITLE Ratio Analysis Of Ranbaxy Sun Pharma Introduction On Inventory Management ABC Method EOQ Model Order Point Safety Stock Pricing of Raw Materials Just-In-Time Inventory Management of Ranbaxy Inventory Management of Sun Pharma Inventory Ratio Analysis Of Sun Pharma And Ranbaxy Criteria For Judging The Inventory System Role of a Finance Manager Reference PAGE NO. 2 4 6 7 10 11 13 14 16 18 19 22 24 25
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Inventory Management
RATIO ANANLYSIS
Ratio Current ratio Quick Ratio Debt Equity Ratio Debtors Turnover Ratio Total Assets Turnover Ratio Interest Coverage Inventory Turnover Ratio Gross Profit Margin Net Profit Margin Return On Asset Return on Equity
Ranbaxy 1.4 0.99 1.04 5.77 0.63 (12.13) 3.5 (3.6) (13) (8.7) (27.48)
Sun Pharma 6.3 5.12 0.02 2.47 0.58 206.27 3.9 46.2 44.3 18.71 21.97
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Inventory Management
Rationale for de-growth of Ranbaxy in 2008
? Ranbaxy recorded a net growth of 9% in sales, recording revenue of Rs. 72,954 millions in 2008. Sales continued to grow despite US operations getting impacted due to US FDA Import Alert in respect of some of the products of the Company. ? The US FDA had issued two warning letters to Ranbaxy Laboratories and an import alert for generic drugs produced by the company's Dewas and Paonta Sahib plants in India. The warning letters identify the Agency's concerns about deviations from US cGMP requirements, while the import alert covers more than 30 different generic drug products produced in multiple dosage forms at these two locations. ? The growth was largely driven by change in sales mix skewed towards more profitable and emerging markets, which now contribute 54% of global sales. Overseas markets constituted 80% of the total sales of the Company. Profit after tax registered a sharp decline at Rs. (9,349) millions mainly due to rupee volatility coupled with provisions for inventory and sale return pursuant to the Import Alert by FDA. Consistent depreciation of the rupee in 2008 and large exposure of the Company's business in the international markets has resulted in unprecedented foreign exchange losses of Rs. 10,856.24 millions on derivatives and loans represented in foreign currency. Besides as a matter of prudent accounting practice, the Company voluntarily adopted Accounting Standard 30 on "Financial Instrument: Recognition and Measurement" issued by the Institute of Chartered Accountants of India though the standard is mandatory only in respect of accounting period commencing on or after April 1, 2011.
? As a result of early adoption of the said Accounting Standard the Company had to
recognize a net loss of Rs. 7,702.14 millions on fair valuation of Financial Instruments. The combined impact of this stand at a loss of Rs.18,558.38 millions which has adversely impacted the financial performance of the Company. The Company continues to focus on sustaining growth in the emerging markets, cost optimization and efficient management of working capital. The Company has been taking various steps for early resolution of the issues raised by US FDA.
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Inventory Management
INVENTORY MANAGEMENT – AN INTRODUCTION
Inventories form a link between the production and sale of a product. A Manufacturing company must obtain a certain amount of inventory, known as work in progress, during production. Although other types of inventory- in transit, raw materials, and finished goods inventories- are not necessary in the strictest sense, they allow the firm to be flexible. Inventory in transit- that is inventory between various stages of production or storage- permits efficient production scheduling and utilization of resources. Without this type of inventory, each stage of production would have to wait for the preceding stage to complete a unit. The possibility of resultant delays and idle time gives the firm an incentive to maintain in-transit inventory. Raw material inventory gives the firm flexibility in its purchasing. Without it, the firm must exists on a hand-to-mouth basis, buying raw materials strictly in keeping with its production schedule. Finished-goods- inventory allows the firm flexibility in its production scheduling and in its marketing. Production does not need to be geared directly to sales. Large inventories allow efficient servicing of customer demands. If a certain product is temporarily out of stock, present as well as future sales to the customers may be lost. Thus there is an incentive to maintain stocks of all types of inventory. The traditionally extolled advantages of increased inventories, then, are several. The firm can affect economies of production and purchasing and can fill orders more quickly. In short, the firm is said to be more flexible. The obvious disadvantages are the total cost of holding the inventory. An additional disadvantage is the danger of obsolescence. Because of the benefits, however, the sales manager and production manager are often biased towards relatively large inventories. Moreover, the purchasing manger can often achieve quantity discounts with larger orders, and there may be a bias here as well. It falls on the financial managers to dampen the temptation for large inventories. This is done by forcing consideration of the cost of funds necessary to carry inventories as well as perhaps of the handling and storage costs. In recent years, additional support for the financial manager?s questioning of the maintenance of large inventories has come from an understanding of a Japanese inspired inventory control system called Just In Time or JIT. JIT breaks with the conventional wisdom of maintaining large inventory stocks as buffers against uncertainties. The basic objective of JIT is to produce (or
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Inventory Management
receive) a required item at the exact time needed, or “Just In Time”. Inventories of all types would thus be reduced to a bare minimum (in some cases zero). Reductions in inventory-carrying costs are one of the more obvious results of the JIT systems. However, additional hoped- for results include improvement in productivity, product quality and flexibility. Like accounts receivable, inventories should be increased as long as the resulting savings exceed the total cost of holding the added inventory. The balance finally reached depends on estimate of actual savings, the costs of carrying additional inventory, and efficiency of inventory control. Obviously, this balance requires a co ordination of the production, marketing, and finance area of the firm in keeping with the overall objective. Our purpose is to examine various principles of inventory control by which an appropriate balance might be achieved.
Types of Cost There are three types of cost in the context of inventory management, Ordering Cost relating to purchased items would include expenses on the following: requisitioning, preparation of purchase order, expediting, transport, and receiving and placing in storage. Ordering cost pertaining to items manufactured in the company would include expenses on the following: requisitioning, set-up, and receiving and placing in storage. Carrying Cost includes expenses on the following: interest on capital locked up in inventory, storage, insurance, obsolescence, and taxes. Carrying cost generally are about 20 percent of the value of inventories held. Shortage costs arise when inventories are short of requirement for meeting the needs of the production or the demand of customers. Inventory shortages may result in one or more of the following: High costs concomitant with „crash? procurement, less efficient and uneconomic production schedules and customer dissatisfaction and loss of sales. When a firm orders large quantities in a bid to reduce the total ordering cost, the average inventory, other things being equal tends to be high thereby increasing the carrying cost.
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Inventory Management
ABC METHOD
What to Control? Different types of inventory exist for a typical manufacturing firm- raw materials, work-inprogress, in-transit, and finished goods inventories. Another way to classify inventory is by dollar value of the firm?s investment. If the firm was to rank inventory items by decreasing value per item, we might get a cumulative distribution that looks like fig1, we find that, as a group, “A” items reflect the fact that roughly 15% of the items in the inventory account for 70% of inventory value. The next 30% of items, group “B”, account for 20% of inventory value. And more than half, or 55%, of he items explain only 10% of total inventory value.
Based on this typical breakdown, in which a relatively small proportion of the items account for most of the total inventory value, it seems reasonable for the firm to devote more care and attention to controlling the more valuable items. This can be accomplished by assigning them an “A” classification and reviewing these items more frequently. “B” and “C” items might warrant increasingly less rigorous, less timely reviews. This system is often referred to, appropriately enough, as the ABC method of inventory control. Factors other than the dollar value may also need to be considered when developing the classification plan- for example, whether something is a critical, or bottleneck items, or may soon become obsolete. The bottom line is, however, is to classify inventory items in such a fashion that we ensure that most important inventory items are reviewed more often. Thus a valid method of inventory classification forms the first leg in the construction of a solid inventory control system.
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Inventory Management
EOQ MODEL
How much to order? EOQ is an important concept in the purchase of raw materials and in the storage of finishedgoods and in-transit inventories. We determine the optimal order quantity for a particular item of inventory, given its forecast usage, ordering costs, and carrying cost. Ordering means either the purchase of the item or its production. Assume for the moment that the usage of a particular item of inventory is known with certainty. This usage is at a steady rate throughout the period of time being analyzed. In other words, if usage is 2600 items for 6 months period, 100 items are used each week. We assume that ordering costs per order, O, are constant regardless of the size of the order. In purchase of raw materials or other items, the costs represent the clerical costs, involved in placing an order together with certain costs of receiving and checking the goods once they arrive. For finished-goods inventories, ordering costs involve scheduling a production run. When the setup costs are large- as they are in producing a machined piece of metal, for example- ordering costs can be quite significant. For in-transit inventories, ordering costs are likely to involve nothing more than record keeping. The total ordering costs for a period is simply the cost per order items the number of orders for that period. Carrying costs per unit, C, represents the cost of inventory storage, handling, and insurance, together with required return on investment in inventory over the period. These costs are assumed to be constant per unit of inventory, per period of time. Thus the total carrying cost for a period is the carrying cost per unit times the average number of units of inventory for the period. In addition, we assume that inventory orders are filled when needed, without delay. Because out of stock items can be replaced immediately, there is no need to maintain a buffer or safety stock. Though the assumptions made up to now may seem overly restrictive, they are necessary for an initial understanding of the conceptual framework that follows. If usage of an inventory item is at a steady rate over a period of time and there is no safety stock, average inventory (in units) can be expressed asAverage inventory = Q/2 [Eq. 1]
Where Q is the quantity ordered and is assumed to be constant for the planning period. Although the quantity demanded is a step function, we assume for analytical purposes, that it can be
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Inventory Management
approximated by a straight line. We see that when a zero level of inventory is reached, a new order of Q items arrives. Once again the carrying costs of inventory is the average number of units of inventory times the carrying costs per unit, or C(Q/2). The total number of orders over a period of time is simply the total usage (in units) of an item of inventory for that period, S, divided by Q, the quantity ordered. Consequently, total ordering costs are represented by the ordering costs per order times the number of ordered, or O(S/Q). Total inventory costs, then, are the sum of the total carrying costs plus ordering costs, or Total inventory cost (T) = C(Q/2) + O(S/Q) [Eq. 2]
We see from the above equation that higher the order quantity, Q, the higher the total carrying costs, but the lower the total ordering costs. The lower the order quantity, the lower the total carrying costs, but the higher the total ordering costs. We are, therefore, concerned with the trade-off between the economies of increased order size and the added costs of carrying additional inventory. Assumptions of the basic EOQ model are: 1. Only one product is involved. 2. Annual demand requirements are known. 3. Demand is spread evenly throughout the year so that the demand rate is reasonable constant. 4. Lead time does not vary. 5. Each order is received in a single delivery. 6. There are no quantity discounts.
Optimal Order Quantity: The optimal order quantity of an inventory item to order at any one time is that quantity, Q*, that minimizes the total inventory cost over a planning period. We can
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Inventory Management
use calculus to find the lowest point on the total inventory cost curve described by equation 2 and solve for Q. the resulting optimal quantity, or EOQ, is Q* = ?2(O)(S)/C
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Inventory Management
ORDER POINT
When to Reorder with EOQ Ordering The reorder point (ROP) occurs when the quantity on hand drops to a predetermined amount. That amount generally includes expected demand during lead time and perhaps an extra cushion of stock, which serves to reduce the probability of experiencing a stock out during lead time. Note that in order to know when the reorder point has been reached, a perpetual inventory is required. There are four determinants of the reorder point quantity: 1. The rate of demand (usually based on a forecast). 2. The lead time. 3. The extent of demand and/or lead time variability. 4. The degree of stockout risk acceptable to manager. If demand and lead time are both constant, the reorder point is simply [Eq. 3] Where, d = demand rate (units per day or week) LT = lead time in days or weeks
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Inventory Management
SAFETY STOCK
In practice, the demand or usage of inventory is generally not known with certainty; usually, it fluctuates during a given period of time. Typically, the demand for finished goods inventory is subject to the greatest uncertainty. In general, the usage of raw materials inventory and in-transit inventory, both of which depend on the production scheduling is more predictable. In addition to demand, the lead time required to receive delivery of inventory once an order is placed is usually subject to some variation. Owing to these fluctuations, it is not usually feasible to allow expected inventory to fall to zero before a new order is anticipated, as the firm could do when usage and lead time were known with certainty. Therefore, when we allow for uncertainty in demand for inventory as well as lead time, a safety stock becomes advisable. However, treating lead time and daily usage as average, or expected values, rather than as constants, causes us to modify our original order point equation as follows. Order Point [OP] = Average lead time x Average daily usage ? Safety Stock [Eq. 4] In other words, the order point determines the amount of safety stock held. Thus, by varying the order point, one can vary the safety stock that is held. The proper amount of safety stock to maintain depends on several factors. The greater the risk of running unit of stock, the larger the unforeseen fluctuations in usage. Similarly, the greater the uncertainty of lead time to replenish stock, the greater the risk of running out of stock, and the more safety stock the firm will wish to maintain, all other things being equal. Another factor influencing the safety stock decision is the cost of running out of inventory. The cost of being out of raw materials and in-transit inventories is a delay in production. The cost of running out of finished goods comes from lost sales and customer dissatisfaction. Not only will the immediate sale be lost but future sales will be endangered if customers take their business elsewhere. Although this opportunity cost is difficult to measure, it must be recognized by management and incorporated into the safety stock decision. The greater the costs of running out of stock, of course, the greater the safety stock that management will wish to maintain, all other things staying the same. The final factor is the cost of carrying additional inventory. If it were not for this cost, a firm could maintain whatever safety stock was necessary to avoid all possibility of running out of inventory. The greater the cost of carrying inventory, the more costly it is to maintain a safety
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Inventory Management
stock, all other things being equal. Determination of the proper amount of safety stock involves balancing the probability and cost of stock-out against the cost of carrying enough safety stock to avoid this possibility. Ultimately, the question reduces to the probability of inventory stock out that management is willing to tolerate. Management will not wish to add safety stock beyond the point at which incremental carrying costs exceed the incremental benefits to be derived from avoiding a stock-out. While deciding the safety stock, apart from the certain simplified assumptions, some additional considerations ought to be taken in the account. These are as follows: 1. Anticipated scarcity : When a certain raw material or product is likely to be scarce in the future, it may make sense to carry a larger inventory then what is required otherwise to protect against scarcity or non- availability in future. 2. Expected price change: If a price change is in the offing, the level of inventory carried may be adjusted according to the direction of the expected price change - an expected increase in price may warrant and increase the level of inventory carried and an expected fall in price may justify decrease in the level of inventory carried. 3. Obsolescence risk: The presence of this risk suggests a reduction in the level of
inventory carried – the degree of reduction would of course depend on how serious the risk is. 4. Government Restrictions: If the government imposes restrictions on the level of inventory that can be maintained directly or indirectly ( through the policies of commercial banks ), then this becomes a constraint in inventory management. 5. Marketing Considerations: If the market is highly competitive and the behavior of consumers is unpredictable, large inventory may have to be carried to ensure that selling opportunities are fully exploited.
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Inventory Management
PRICING OF RAW MATERIALS
Several methods are used for pricing inventories production. The important ones are: ? FIFO Method: This method assumes that the order in which materials are received in the stores is the order in which they are issued from the stores. Hence the materials which are issued first is priced on the basis of the cost material received earliest, so on and so forth. ? Weighted Average Cost method: Under this method, material issues are priced at the weighted average cost of materials in the stock. Valuation of Stocks: The valuation of work in process and finished goods inventory depends on, (i) (ii) The method used for pricing materials. The manner in which the fixed manufacturing overhead costs are treated.
The fixed manufacturing overheads costs are treated in two systems of costing, (i) Direct Costing: Fixed manufacturing overheads costs are treated as period costs and not as product costs. They are charged directly to the income statement. (ii) Absorption Costing: Fixed manufacturing overheads costs are treated as product costs and not as period costs. Hence, inventory valuation reflects an allocated share of fixed manufacturing overhead costs. The valuation of work in process and finished goods inventory is lower, under direct costing and higher under absorption costing. Further, when the inventory level increases, the reported profit under direct costing is lower than the reported profit under absorption costing. When the inventory level, the reported profit under direct costing is higher than what it is under absorption costing.
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Inventory Management
JUST-IN-TIME
The Management of inventory has become very sophisticated in recent years. In certain
industries, this production process leads itself to just in time (JIT) inventory control. As the name implies, the idea is that inventories are acquired and inserted in production at the exact times they are needed. The JIT management philosophy thus focuses on pulling inventory through the production process on an “as needed” basis, rather than pushing inventory through the process on an “as produced” basis. This requires very accurate productions and inventory information system, highly efficient purchasing, very reliable suppliers, and an efficient inventory handling system. Although raw materials inventory and in-transit inventory can never be reduced to zero, the notion of “just in time” is one of extremely right control so as to cut back on inventories. The goal of a JIT system, however, is not only to reduce inventories but also to continuously improve productivity, product quality and manufacturing flexibility. EOQ in a JIT world- At first glance, it might seem that a JIT system in which inventories would be reduced to a bare minimum and the EOQ for a particular item might approach one unit – would be in direct conflict with our EOQ model. However, it is not. As part of a JIT system, steps are continuously taken to drive these costs down. For example: ? ? ? Small sized delivery trucks, with predetermined unloading sequences, are used to facilitate economics in receiving time and costs. Pressure is placed on suppliers to produce raw materials with “no defects” thus reducing (or eliminating) inspection costs. Products, equipment and procedures are modified to reduce setup time and costs. By successfully reducing these ordering related costs, the firm is able to flatten the total ordering cost. This causes the optional order quantity, Q”, to shift to the left, thus approaching the JIT ideal of one unit. Additionally, continuous efforts to reduce supplier delays, production
inefficiencies, and sales forecasting errors allow safety stocks to be cut back or eliminated. How close a company comes to the JIT ideal depends on the type of production process and the nature of the supplier industries, but it is a worthy objective for most companies. JIT Inventory Control, Supply Chain Management and the Internet. JIT inventory control can be viewed as one link in the chain of activities associated with moving goods from the raw material stage through to the end user or customer. These activities are collectively referred to as
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Inventory Management
supply chain management (SCM). The advent of instant information through sophisticated computer networks has greatly facilitated this process. For standard inventory items, the use of the internet has enhanced supply chain management. A number of exchanges have developed for business-to-business (B2B) types of transaction. If you need to purchase a certain type of chemical for use in your production process, you can specify your exact need on a chemical B2B exchange. Various suppliers will then bid for the contract. This auction technique significantly reduces the paperwork and other costs involved in searching for the best price. This together with competition among suppliers, may significantly reduce your costs. A number of B2B exchanges already exist for a wide variety of products, and new ones are developing all the time. Again, the raw material in question must be relatively standardized for an Internet exchange to work well for you.
WHAT IS NEEDED TO MAKE A “JUST-IN-TIME” SYSTEM WORK:
1. Geographic concentration 2. Dependable quality 3. Manageable Supplier network 4. Controlled transportation system 5. Manufacturing flexibility 6. Small lot sizes 7. Efficient receiving and material handling
8. Strong Management commitment
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Inventory Management
INVENTORY MANAGEMENT OF RANBAXY
In the year 2008 stronger cash flows resulted due to the improved working capital position through improved receivable and inventory management, resulting in reduction in Gross Working Capital by about 5% of Moving Average Turnover.
Inventories Stores and spares Raw materials Packaging materials Finished goods Work in progress Total inventories
Rs. Million (2008) 181.49 6,689.18 795.20 8788.35 3188.92 19643.14
Inventories are valued as follows: Raw materials, stores and spares and packaging materials Lower of cost and net realizable value. However, materials and other items held for use in the production of finished goods are not written down below cost if the products in which they will be used are expected to be sold at or above cost. Cost is determined on a weighted average basis.
Finished goods Lower of cost and net realizable value. Cost includes direct materials and labour and a proportion of manufacturing overheads based on normal operating capacity. Cost of finished goods includes excise duty and other taxes, wherever applicable.
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Inventory Management
Work-in-process At cost up to estimated stage of completion. Cost includes direct materials and labour and a proportion of manufacturing overheads based on normal operating capacity. Net realizable value is the estimated selling price in the ordinary course of business, less estimated costs of completion and estimated costs necessary to make the sale. Where duty paid/ indigenous materials are consumed, in manufacture of products exported prior to duty-free import of materials under the Advance License Scheme, the estimated excess cost of such materials over that of duty free materials is carried forward and charged to profit and loss account on consumption of such duty-free materials.
There is an adequate internal control system commensurate with the size of the Company and the nature of its business for the purchase of inventory and fixed assets and for the sale of goods and services.
Costing of the inventories is done on the basis of FIFO method of costing. JUST IN TIME has not being implemented till now. But they are planning to implement to reduce the additional cost. Just-In-Time inventory systems provide for an attractive, cost-cutting production system as long as risks are weighed and mitigated. ERP implementation strategy worked very well and brought real value to the firm.
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Inventory Management
INVENTORY MANAGEMENT OF SUN PHARMA
Inventories
Consumable stores Raw materials Packaging materials Finished goods Work in progress Total inventories
Rs. Million (2008)
148.3 4229.7 307.3 881.4 2161.0 7,727.7
Inventories consisting of raw and packing materials, stores and spares, work in progress and finished goods are stated at lower of cost (absorption costing) on FIFO basis/specific identification basis and net realisable value.
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Inventory Management
INVENTORY RATIO ANALYSIS OF SUN PHARMA AND RANBAXY
Inventory Turnover Ratio (2008)
4 3.9 3.8 3.7 3.6 3.5 3.4 3.3 3.4 3.2 3.1 Avg of top 25* Ranbaxy Sun Pharma 3.5 3.9
Inventory Turnover Ratio
Inventory turnover ratio of sun pharma is higher than Ranbaxy and industrial average. This indicates efficiency in inventory management of Sun pharmaceuticals as compared to Ranbaxy.
*Inventory turnover of top 25 pharmaceutical companies in India.
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Inventory Management
INVENTORY TURNOVER IN DAYS
Inventory Turnover in Days (2008)
110
105
D A Y S
100 Inventory Turnover in Days 104
108 95
90 93
85 Avg of top 25* Ranbaxy Sun Pharma
Inventory turnover in days of Sun Pharma also is better than Ranbaxy. As a result, this clearly shows that Sun pharma is better than Ranbaxy in the aspect of inventory management.
*Inventory turnover of top 25 pharmaceutical companies in India.
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Inventory Management
*Inventory turnover of top 25 pharmaceutical companies in India For reference, an average of inventory turnovers is taken of the top 25 companies in Indian pharmaceutical industry. The average inventory turnover ratio was found to be 3.40 and days was 108 COMPANY Sun Pharma Cipla GSK DRL Ranbaxy Divis Lupin Piramal Glenmark Cadila Biocon Aventis Pfizer Matrix Astra Torrent Wyeth Aurobindo Novartis Wockhardt Dishman IPCA FDC Abbot Merck INVENTORY TURNOVER RATIO (2008) 3.9 2.45 4.04 3.00 3.5 2.03 2.84 4.45 2.24 2.73 2.73 3.24 3.86 2.29 5.93 2.99 3.83 2.73 4.49 2.91 2.14 2.79 3.45 5.58 5.05
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Inventory Management
CRITERIA FOR JUDGING THE INVENTORY SYSTEM
The criteria for judging the inventory system are:? Comprehensibility: Inventory systems range from utterly simple to weirdly complex. Irrespective of how simple or complex it is, regardless of whether it is automated or manual, it should be understood by all affected parties. The system must be properly explained to all concerned so that its purpose, logic and rational are transparent. This generates enthusiasm for the system and enhances its credibility. ? Adaptability: A certain degree of flexibility and adaptability must be designed into the system to make it versatile. It should be remembered that the design of any system should ordinarily take care of about 90% of the cases, leaving the balanced 10% to be handled by hand. ? Timeliness: Inventories may suffer loss in value on account of a variety of factors. The more common sources of value decline are: 1. Obsolescence caused by changes in technology and shifts in consumer tastes. 2. Physical deterioration with the passage of time. 3. Price fluctuation because of inherent volatility of certain commodities. The inventory system should be capable of inducing timely action. It should provide adequate forewarning which triggers appropriate corrective steps.
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Inventory Management
AREAS OF IMPROVEMENT
Inventory management in Ranbaxy and Sun Pharmaceuticals can be improved in various ways: ? Effective Computerization: Computers should not be used merely for accounting purposes but also for improving decision making. ? Review of the System: The tools and techniques used for monitoring and control of inventories should be periodically reviewed. ? Improved Coordination: Better coordination among purchase, production, marketing and finance departments will help in achieving greater efficiency in inventory management. ? Development of long term relationship: Companies should develop long term relationship with vendors. This would help in improving the quality and delivery. Procedures for disposal of obsolete/surplus inventories must be simplified. ? Adoption of challenging norms: companies should set benchmark with global competitors and use ideas like JIT to improve inventory management.
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Inventory Management
ROLE OF FINANCE MANAGER
Inventories represent the second largest asset category for manufacturing companies, next only to plant and equipment. The proportion of inventories to total assets generally varies between 15 and 30 percent. Given the substantial investment in inventories, the importance of inventory management cannot be overlooked. Although inventory management is usually not the direct operating responsibility of the financial manager, the investment of funds in inventory is a very important aspect of financial management. Consequently, the financial manager must be familiar with ways to control inventories effectively so that capital may be allocated efficiently. The greater the opportunity cost of funds invested in inventory, the lower the optimal level of average inventory, and the lower the optimal order quantity, all other things held constant. This
statement can be verified by increasing the carrying costs. The EOQ model can also be used by the financial manager in planning for inventory financing. When demand or usage of inventory is uncertain, the financial manager may try to effect policies that will reduce the average lead time required to receive inventory once an order is placed. The lower the average lead time, the lower the safety stock needs, and the lower the total investment in inventory, the greater the incentive to reduce this lead time. The purchasing department may try to find new vendors that promise quicker delivery, or it may pressure existing vendors to deliver faster. The production department may be able to deliver finished goods faster by producing a smaller run. In either case, there is a trade-off between the added cost involved in reducing the lead time and the opportunity cost of funds tied up in inventory. This discussion serves to point out the value of inventory management to the financial manager.
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Inventory Management
REFERENCES
? Fundamentals of Financial Management- Van Horne ? Financial Management- Prasanna Chandra ? Financial report of Ranbaxy-2008 ? Financial report of Sun Pharma-2008
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