Inventory Management

• Inventory is a detailed list of those

movable items which are necessary
to manufacture a product and to
maintain the equipment and
machinery in god working order .
The qty and value of every item is
also mentioned in the list.
 Characteristics of
Inventory
1. Inventory serves as cushions to
absorb shocks.
2. Inventories are necessary evil:- As
cost of not having inventories are
usually greater than the costs of
having them.
3. Mktg, prod’n, finance and
purchasing decisions directly
influence the level of inventory.
4. Inventory provides prod’n
economies i.e. discounts on bulk
 Importance of Inventory
1. Provides and maintains good customer
service.
2. Enables smooth flow of goods through the
prod’n process.
3. Provides protection against the
uncertainties of demand and supply.
4. Various prod’n operations can be performed
economically and independently.
5. Ensures a reasonable utilization of
equipment and labour.
6. With purchases in bulk discount can be
availed.
 Inventory Classification
• TRANSIT INV.:- As under this there is a need
to transport inventories from one point to
another larger the distance of supply source,
larger is the transit inventory. Work in
process transit inventories are determined by
process design and plant layout.
• BUFFER INV/Safety Stock.:-In any org. as a
result of uncertainties of demand and supply
some inventory is to be maintained.
• DECOUPLING INV.:- The existence of
inventories at major linkage points in a
prod’n process makes it possible to carry an
activities on either side of the point relatively
independent of each other.
• Inventory can also be classified
according to the nature of items
stocked namely raw materials,
in-process inventories, finished
goods inventories and spare part
inventories.
 INVENTORY CTRL
• Inv. Ctrl keeps track of inventories. It is
observed that ‘Too much', 'Too little’ or
badly balanced inventories are all to be
avoided because they cost too much on many
counts
2. TOO MUCH leads to undue carrying charges
in the form of taxes, insurance, storage,
obsolescence and depreciation and undue
proportion of total working capital is invested
in them.
3. TOO LITTLE implies of too frequent ordering,
loss of qty discounts and higher
transportation charges.

THE BALANCE B/W TOO MUCH AND TOO LOW

CAN BE DONE BY MEANS OF EFFECTIVE INV.
CTRL.
• Inventory ctrl is the technique of
maintaining the size of inventory
at some desired level keeping in
view the best economic interests
of an organization.
 Inventory ctrl means keeping a track of
inventories, so that items are available
when they are needed. This is achieved
by:-
• Purchasing items at economic price at a
proper time and in sufficient qty.
• Provision of suitable and secured
storage location with sufficient space.
• Inventory identification system.
• Up-to-date and accurate record keeping
by a responsible staff.
• Appropriate requisition procedures
 Objectives of Inventory
Ctrl
• Protection against fluctuations in demand:- If
sufficient items are available in the inventory,
then the fluctuations in demand can be easily
adjusted and the org. can protect from
unforeseen economic losses.
• Better use of Men, Machine and Material:-
The resources can remain engaged during
slack period of demand and there will be no
need of generating additional resources in
the boom periods as then the inventory
enlarged in slack period can be utilized. This
will lead to uniform and proper utilization of
resources available with the enterprise.
3. Protection against fluctuations in output:- It
helps to reduce the gap b/w actual and
scheduled production.
4. For production economies:-
5. Control of Stock volume:-Inv Ctrl is
concerned with the size and the value of
goods present in stock. It is responsible to
forecast the value of the stocks at regular
intervals so that,
• Capital invested in inventories does not
exceed the funds available for the purpose.
• The amt. invested in inventory is correctly
recorded I a/c’s book.
• Protection against theft is ensured.
6. Ctrl of Stock Distributions
• Stock analysis is done to be sure
that it is in balance and that
obsolescence and depreciation are
kept at the minimum possible
level.

• Inventory is maintained b’coz………

…………………..?
1. To carry reserves in order to
prevent stock outs or cost sales
i.e. never to run out of any thing.
2. Never having much of anything
on hand.
3. To gain economies in purchase by
buying items beyond the desired
amount.
4. To maintain reserves in stock for
the period of replenishment.
 Factors affecting Inv. Ctrl
Policy
(A). Characteristics of the Manufacturing
system:
The nature of the production process, the
product design, prod’n planning and plant
layout have significant affect on inventory
policy. Some of these factors are:
• Degree of specialisation and
differentiation of the product at various
stages:
The degree of changes in the nature of
the product from raw material to final
product at various stages of
transformation determines the nature of
 2. Process Capability &
flexibility

• Process capability is characterised by

processing time of various operations
e.g. the replenishment lead-time
(length of delay in execution after
issuance of replenishment order)
directly influences the size of inventory.

• Inv. Policy should aim towards

balancing the prod’n flexibility,
capability, inventory levels and
customer service needs
2. Process Capacity and storage
facility

3. Quality requirements and

obsolescence
risks.
 (B) Amount of protection against
shortages
• There is always variation in demand and supply of the product. The
protection against such unpredictable variations can be done by
means of buffer stocks. The factors responsible for such variations
are:

3. Change in size and frequency of orders.

5. Unpredictability of sales.

7. Physical and economic structure of distribution i.e. longer the

channel of distribution the more is the inventory requirement.

9. Costs associated with failure to meet order/demand.

11.The accuracy, frequency and detail of demand forecasts

13.Protection against breakdown or other interruptions in prod’n.

 (C.) Organizational
factors
• There certain factors which are
related to the policies, traditions and
environment of any enterprise. Some
of these are:-
2. Labour relation policies of the
organisation.
3. Amount of capital available for stock.
4. Rate of return on capital available if
invested elsewhere.
 (D) Other factors

• These are related to the overall

business environment of the region :-
• Inflation
• Strike situation in communication
facilities.
• Wars or some other natural calamities
like famines, floods etc.
• Difference b/w input and output.
 Limitations of Inventory
Ctrl
1. Efficient inventory ctrl methods can reduce
but cannot eliminate business risk.
2. The objectives of better sales through
improved service to customer, reduction in
inventories to reduce size of invt. And
reducing cost of prod’n by smoother prod’n
operations are conflicting with each other.
3. The ctrl of inventories is complex because
of the many functions it performs. It
should be viewed as a shared
responsibility.
Costs in Inventory system
• Purchase/Procurement cost:- Purchase
cost in the inventory analysis shd.
Reflect its fully landed cost, means cost
to acquire and move the item to that
point in the system. Thus landed cost
include transportation costs, tariffs,
taxes and any other cost incurred to
make the item available at that point.
• Ordering Costs:- If we produce the item
internally, there may be an organization
set-up cost. For an item, which is
purchased from outside the firm, there is
an administrative cost, which is incurred
in the purchasing function.
3. Holding Cost:-
• Storage costs:- Occur due to warehousing the
inventory . Storage cost are usually function of land
and labour costs associated with running a
warehouse, and thus can be expected to vary
considerably from location to location.
• Service costs:- are out of pocket expenses that
arise in addition to the physical storage costs. Two
typical examples are insurance and taxes.
• Risk costs:- are intended to recognize that there can
be considerable financial risk associated with holding
an item in inventory, because the item may become
lost, stolen, damaged etc.
• Capital costs:- inventory ties up funds, which the
firm could be using for other productive purposes.
• Shortage costs:-When a demand arises which
cannot be satisfied from available inventory an
inventory shortage occurs.
 Shortage Costs may exists as:-
• BACK ORDERS occur when the customer is willing
to wait for inventory to be made available. Costs
accrue because the firm must maintain a system to
record the backorder, maintain it and fill it when
stock becomes available. The customer may
eventually retaliate by reducing the number of
orders, demanding compensation, or finding a new
source.
• LOST SALES occur when the customer responds to
an out-of-stock situation by canceling the demand.
• LOST CUSTOMER COSTS as it is very difficult to
retain loyal customers.
• DISRUPTION COSTS occur in a production process
when a shortage of raw material or component
parts causes an interruption to the
 A B C Analysis
• Always Better Control is an analytical
techniques for classification of
inventory items was first introduced
by an AMERICAN FIRM- GENERAL
ELECTRIC COMPANY.
• According to this analysis, there are
three categories of inventory items
A, B and C type . Depending upon
their percentages of consumption.
• The significance of this analysis is
that a very close ctrl is exercised
over the items of ‘A’ group which
account for high percentage of costs
• Less stringent ctrl is adequate for
category ‘B’
• Very little ctrl would be sufficient for
Category ‘C’.
Criteria A type B type C Type

Quantity 10% 20% 70%

Annual Usage 75% 15% 10%

Control Very Moderate Less

strict
Ordering Daily/we Monthly Yearly
ekly
Safety stock Less Moderate High
 Policies for ‘A’ group items
1. They should be ordered more frequently
to reduce capital lock up at a time in
inventories as 15 percent of items cost
65 percent of total value.
2. The purchasing department shd. Make
the maximum efforts to expedite and
delivery of these items are to be stored
as few in number as possible.
3. The purchase of these items shd. Be with
top officials to ensure prompt services
from the supplier.
4. The stock report of ‘A’ items shd. Be sent
more frequently, say at least once in 15
days.
 Policies for ‘B’ group items
• These account for 20 percent of total
quantity and 20percent of the total
value.
• Order quantities, re-order stocks and
safety stock shd. Be fixed and
revised for ‘B’ items at least one in
every 4 to 6 months.
• B items shd. Be ordered less
frequently than A items
 Policies for ‘C’ group items
• C group of items account for 65
percent of quantity and hardly 15
percent of value.
• Large quantities can be brought at a
time, as total investment will be
least.
• Paper work can be reduced
considerably if orders are placed
once or twice a year.
• The source of supply can be one or
two based on their reliability.
EXAMPLE OF ABC ANALYSIS
• Suppose three items P, Q, R have been used and
their consumption is Rs. 2,40,000, Rs 24,000 and
Rs. 2400 resp. Let us presume that ABC
classification is not done and annual orders are 12 in
number. Each item will be ordered 4 times and
average inventory will be:

Item Annual No. of Average

consp Orders Working
(Rs.) Inventory
P 2,40,000 4 60,000
Q 24,000 4 6,000
R 2,400 4 600
Total 2,66,400 12 66,600
• Suppose A-B-C analysis followed and the number
of orders will be according to the importance of
the items. If the number of orders are 8, 3 and 1,
for items P, Q and R resp, Then the average
inventory will be as follows:

Item Annual No. of Avg.

Consp’n orders working
inventory
P 2,40,000 8 30,000
Q 24,000 3 8,000
R 2,400 1 2,400
Total 2,66,400 12 40,400
 Advantages Of ABC Analysis
1. It helps the material manager to exercise selective
control and focus his attention only on a few items
when he is confronted with lakhs of stores items.
2. Strict control over items involving good deals of
investment.
3. Better alternative use of available working capital
based on weightage of items.
4. Minimum of inventory costs-both procurement and
carrying.
5. Reduced losses arising out of obsolescence.
6. Sufficient safety of low value or C group of items.
 Limitation
• ABC analysis in order to be fully effective
shd. Be carried out with standardization
and codification. ABC analysis is based on
grading the items according to the
importance of performance of an item that
is by VITAL, ESSENTIAL and DESIRABLE
(VED ANALYSIS) analysis. Some items,
though negligible in monetary value may
be vital for running the plant and constant
attention is needed.
 Conclusion

• When A-b-C analysis was not

followed the average inventory was
Rs. 66,600 and after following A-B-C
analysis the average inventory came
down to Rs. 40,400.
 Economic Order Quantity
(EOQ)
• How much inventory should be bought in
one lot under one order on each
replenishment? Should the qty. to be
purchased be large or small? Or, should
the requirement of materials during a
given period of time (say six or one year)
be acquired in one lot or shd. It be
acquired in installments or in several small
lots?

SUCH INVENTORY PROBLEMS ARE

CALLED ORDER QTY PROBLEMS
 Economic Order Quantity
(EOQ)
• EOQ is the size of the lot to be
purchased which is economically
viable. In determining EOQ it is
assumed that cost of managing
inventory is made up solely of two
parts i.e. ordering costs and carrying
costs.
 Ordering Costs
• These are the costs which are associated
with the purchasing or ordering of
materials.
• These costs are known as buying costs
and will arise only when some purchases
are made . These costs will include costs
of setting up machinery for manufacturing
materials, time taken up in setting , cost
of tools. Etc.
• The ordering costs are totaled up for the
year and then divided by the number of
orders placed each year's.
 Carrying Costs
• These are the costs for holding the
inventories. These costs will not be
incurred if inventories are not
carried.
• A firm shd. Place neither too large
nor too small orders. On basis of
trade-off between benefits derived
from the availability of inventory and
the cost of carrying that level of
inventory, the appropriate or
optimum level of the order to be
placed shd. Be determined. The
optimum level of inventory is
popularly known as the ECONOMIC
ORDER QTY also known as
ECONOMIC LOT SIZE..
 DEFINITION
• THAT level of inventory order that
minimizes the total cost associated
with inventory management.
 ASSUMPTIONS
• The firm knows with certainty the annual
usage (consumption) of a particular item of
item.
• The rate at which the firm uses inventory is
steady over time.
• The orders placed to replenish inventory
stocks are received at exactly that point in
time when inventories reach zero.
• Ordering and carrying costs are constant
over the range of possible inventory levels.
 The EOQ model can be illustrated by

3. The long analytical approach or trial

and error approach
And
2. The short cut or simple mathematical
approach
 Trial and Error (Analytical)
approach
• Given the total requirements during given period
of time depending upon the inventory planning
horizon, a firm has different alternatives to
purchase its inventories. For instance, it can buy
its entire requirements in one single lot at the
beginning of the inventory planning period.
Alternatively, the inventories may be procured in
small lots periodically.
• If the purchases are made in one lot, the average
inventory holdings would be relatively large
whereas it would be relatively small when the
acquisition of inventory is in small lots, The
smaller acquisition the lot, the lower is average
inventory and vice versa
• ACC. To this approach the carrying
and acquisition costs for different
sizes of orders to purchase
inventories are computed and the
order size with the lowest total cost
(ordering plus carrying ) of inventory
is the economic order qty.
 Mathematical (short cut
approach)
• It can be calculated thru following
equation:-

EOQ= √2 AB
C

A= Annual Usage of inventory (units)

B= Buying Cost per order
C= Carrying cost per unit.
 Limitations
• The assumptions of a constant consumption/usage
and the instantaneous replenishment of inventories
are of doubtful validity.
• Deliveries from suppliers may be slower than
expected for reasons beyond control.
• It is possible that there may be an unusual and
unexpected demand for stocks. To meet such
contingencies, firms have to keep additional
inventories which are known as safety stocks.
• There is a discrepancy b/w actual and the expected
demand, leading to a wrong estimate to the EOQ as
it says known annual demand for inventories.
 Order Point Problem or Re-
order level

• REORDER point may be defined as

the level of inventory when fresh
order should be placed with the
suppliers for procuring additional
inventory equal to the EOQ.
 Assumptions
• Constant daily usage of inventory
• Fixed lead time

reorder point= Lead time in days *

avg. daily usage of inventory
• The term LEAD TIME refers to the
time normally taken in receiving the
delivery after placing orders with the
suppliers. The lead time may also be
called as the procurement time of
inventory.
• The avg. usage means the qty. of
inventory consumed daily.
 EXAMPLE
• The avg. consumption (daily usage) of
inventory of a firm is 5000 units. The
number of days required to receive the
delivery of inventory after placing order
(lead i.e. processing and transit time) is
15 days. The re-order point=5000 units *
15 days=75000 units.
• The implication is that the firm shd place
an order for replenishing the stock of
inventory as soon as the level reaches
75,000 units.