What is an inventory control system?
Inventory Control system is critical to business enterprise because of the importance of the inventory which is a major asset. It is through inventory that most of the operating activities take place. Therefore, there is a need to establish better control systems to safeguard the inventory, i.e., to prevent fraud, theft, damages to physical units, and manipulation of inventory records and to minimize costs. To address these requirements, enterprises generally introduce (1) internal control system and (2) a management control system.
Internal control system and management cintrol systems introduced to prevent fraud, theft, damages manupulation of inventory records and to minimize costs.
Internal Control Systems
Internal control systems relate to the type of control systems to be introduced by the business enterprise to protect inventory from loss and to ensure the accuracy of inventory records. The internal control systems for inventory include the following measures:
- Separating the responsibility of the personnel relating to the staff handling the inventory from the staff maintaining the records of inventory.
- An individual or a section of the staff should be made responsible fully for inventory and its condition, i.e., a control system for accountability be designed and implemented. This should ensure that the chances of damaged inventory going unnoticed or inventory being stolen is prevented. If not, at least it should be reduced.
- A control should be introduced making the receiving department to assume the responsibility for checking the quality and quantity of the inventory received. The signature of the concerned person responsible for inventory be affixed to ensure the accuracy of bills and invoices and to fix the responsibility. If the goods are to be stored, the warehouse manager assumes the responsibility for goods transferred attesting to the number and condition of the inventory received.
- The transfer report should be independent of the reporting department to ensure comparison of the items received and their quality and quantity.
- Only the authorized requisitions should be honoured by the warehouse department for transfer of goods, so that the warehouse department is relieved of the responsibility and it gets transferred to the department which had requisitioned the goods (may be selling department, manufacturing department, transporting (shipping) department).
- Proper fire control systems, alarm systems, guards, night watchmen and other protective measures should form an integral part of the control system.
- The general principle of the control system should be that no single individual or group of individuals should control the records and simultaneously the physical units. In this sense, the records department should have no access to physical inventory handling units and these two departments should directly send the reports to the accounting department, so that proper checks and balances could be established.
- The accounting department personnel should never have access to inventory units and vice versa to prevent fraudulent practices and maladjustments.
- Proper control systems should be introduced to monitor procurement, storage, issue, usage and rejected inventory.
In a nutshell, separation of duties in handling and accounting for inventory is critical to the integrity of a system of internal controls. If tested internal control systems are not established, inventory would be ‘easy prey’ to theft, fraud and pilferage.
Management Control Systems
The management control system is necessary to facilitate the carrying of optimum levels of inventory. This is because carrying high inventory levels causes high carrying costs or lower income. On the other hand, carrying low inventory levels causes loss of business again resulting in lower-income.
Management control systems relate to the systems to be designed to determine the optimum quantity of the inventory to be purchased or manufactured and deciding on the optimum price for the same. Maintaining proper inventory levels plays a significant role in cutting the costs of inventory and increasing the income of the business enterprise. If proper management control systems are not established, then the enterprise would run into the risk of carrying excessive inventory which results in substantial carrying costs in the form of higher property taxes, higher insurance premiums, higher handling and storage costs, and other administrative costs.
Bothered of the heavy carrying costs, if the enterprise carries too little inventory, it loses sales and customers. If carrying high inventory levels causes the high carrying costs resulting in loss or lower-income, then carrying low inventory levels causes loss of business resulting in loss or lower income. That means, carrying higher levels or lower levels of inventory is dangerous to the enterprise as they act as a double-edged blade. Therefore, there is a need to introduce management control systems ‘to facilitate carrying of optimum levels of inventory’. If such a management control system is not introduced there is a danger of breakdown of internal control system leading to theft, pilferage, damage’ obsolescence, etc., which in turn causes heavy losses to the enterprise.
There are number of mathematical models deployed to identify the economic order point (EOP), i.e., the level of inventory that triggers a new order and the economic order quantity (EOQ), i.e., the quantity to be ordered to minimize the handling costs but take advantage of quantity discount and other savings. By carefully introducing a model suitable to the enterprise, a proper management control can be established so that the enterprise does not run into the risk of loss due to improper system of carrying inventory. Choosing of an appropriate model that requires no modification helps the enterprise to maintain optimum level of inventory.
Finger Tips: Inventory Control System
- To ensure proper control, inventory may be classified as ABC, VED, FSN and SDE. This classification helps in decision making.
- The efficiency of inventory management is measured by calculating the inventory turnover ratio or average inventory holding period.
- Inventory control systems are classified as internal control systems and management control systems.
- Internal control systems established should be able to prevent, theft, damage, pilferage, obsolescence, etc.
- Management control systems should provide tools to determine optimum levels of inventory to enhance the efficiency of inventory management.