Inventory control systems are critical for businesses due to the importance of the inventory, which is a major asset. It is through the inventory that most of a business's operating activities take place. Therefore, it is crucial to establish effective control systems to safeguard the inventory (e.g., to minimize costs and to prevent fraud, theft, damages to physical units, and manipulation of inventory records). These control systems are known as inventory control systems. To address these requirements, enterprises generally introduce both internal control systems and management control systems for the inventory. Internal control systems relate to the types of control systems to be introduced by a business to protect the inventory from loss and to ensure the accuracy of inventory records. Internal control systems for the inventory may include various features. This section highlights several of these features. The signature of the responsible person should be recorded to ensure accountability and the accuracy of bills and invoices. If the goods are to be stored, the warehouse manager assumes the responsibility for goods transferred, attesting to the number and condition of any inventory received.What Is an Inventory Control System?
Internal control systems and management control systems are introduced to minimize costs and to prevent fraud, theft, damages, and manipulation of inventory records.
Internal Control Systems
- Third, the transfer report should be independent of the reporting department. This ensures a comparison of the items received and their quality and quantity.
- Fourth, only the authorized requisitions should be honored by the warehouse department for the transfer of goods. This ensures that the warehouse department is relieved of the responsibility and that it gets transferred to the requisitioning department.
- Fifth, proper fire control systems, alarm systems, guards, night watchmen, and other protective measures should be in place.
- Sixth, the general principle of the control system should be that no single individual (or group of individuals) should control the records and physical units simultaneously.
As such, the records department should have no access to the physical inventory, and these two departments should directly send the reports to the accounting department, enabling proper checks to be established.
- Finally, personnel in the accounting department should never have access to inventory units (and vice versa). This safeguards against fraudulent practices and maladjustments.
In a nutshell, the separation of duties when handling and accounting for inventory is critical to the integrity of a system of internal controls.
If robust internal control systems are not established, the inventory will fall easy prey to theft, fraud, and pilferage.
Management Control Systems
Management control systems are needed to ensure that an optimal inventory size is maintained.
This is because overly large inventories lead to high carrying costs and reduced income. Likewise, carrying low inventory levels leads to loss of business, which again reduces income.
Management control systems must be able to achieve two things:
- To determine the optimal quantity of the inventory to be purchased or manufactured
- To decide on the optimal price for items in the inventory
Maintaining proper inventory levels plays a significant role in cutting inventory costs and increasing business income.
If proper management control systems are not established, then the enterprise runs the risk of carrying an excessive inventory.
An excessive inventory will lead to substantial carrying costs in the form of higher property taxes, higher insurance premiums, higher handling, and storage costs, and other administrative costs.
If an enterprise carries too little inventory, it will lose sales and customers.
In this way, just as an overly large inventory produces high carrying costs that lead to unnecessary losses, an overly small inventory causes loss of business, resulting in lost or lower income.
Evidently, then, carrying unsuitably high or low levels of inventory is dangerous to an enterprise as they act as a double-edged sword.
For this reason, management control systems are used to ensure an optimal inventory size. If such a system is not introduced, the internal control system may break down.
This can lead to theft, pilferage, damage, and obsolescence, which in turn causes heavy losses.
In management control systems, various mathematical models are used to identify two key metrics:
- Economic order point (EOP): The level of inventory that triggers a new order
- Economic order quantity (EOQ): The quantity to be ordered to minimize handling costs while maximizing quantity discounts and other savings
As such, through the careful introduction of a model tailored to the enterprise, it is possible to establish proper management control.
This prevents the enterprise from risking losses due to a suboptimal system for carrying inventory.
At the same time, choosing an appropriate model that requires no modification helps the enterprise to maintain the optimal level of inventory.
Wrap Up: Inventory Control System
- To ensure proper control, an inventory may be classified as ABC, VED, FSN, or SDE. This classification assists 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 should be able to prevent theft, damage, pilferage, and obsolescence.
- Management control systems should provide tools to determine optimal levels of inventory to enhance the efficiency of inventory management.
Inventory Control System FAQs
An inventory control system or management control system is a set of policies, practices, and procedures designed to effectively manage the quantity and movement of items in stock. This includes monitoring surrounding conditions such as demand, lead time, price, level of competition, product life cycle stage, reliability of forecasts and the organization's ability to respond to change.
An inventory control system sets policies, practices, and procedures that help managers monitor and measure responses to fluctuating market conditions. This helps ensure the right amount of inventory is available for sale at the right time, and can be moved quickly into the production process. It also helps optimize inventory holding costs, identifies excess or obsolete inventory and reduces waste. A management control system is an integral part of an organizations internal control structure.
The three most common methods are min-max, economic order quantity (EOQ), and ABC analysis.MIN-MAX is the most simple of these three Inventory Management methods. It requires that you track your cost of carrying inventory, average demand for an item over a period, minimum safety stock level to maintain, maximum reorder point to replenish, and associated holding cost for each item in inventory The EOQ method is for those who have little data on their inventory needs. It calculates the ideal order size based on inventory costs, demand rate, replenishment time, and safety stock level. The ABC method is the most commonly used method in Inventory Management today. It requires that you track your cost of carrying inventory by product, average demand for an item over a period, and associated holding cost by product.
A safety stock is the amount of extra inventory carried to provide for unexpected demand or supply chain disruptions. For example, if you ordered 100 units from your supplier and expected to sell 75 units in two weeks, you would carry 25 units of safety stock.
It is used to control inventory levels on hand and to maintain the fewest number of units in your storage facilities. This can result in increased Cash Flow and lower holding costs.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.
