MBA II Semester FM GTU

LEARNING OBJECTIVES
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 Nature of inventories
 Need to hold inventories
 Objectives of inventory management
 Various costs associated with Inventory
 Inventory management techniques
 Selective inventory control

INVENTORY MANAGEMENT
CHAPTER 29

Nature of Inventory Need for Inventories

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 Stocks of manufactured products and the material  Transaction motive – (smooth production)
that make up the product.
 Components:  Precautionary motive (Risk of unpredictable
 raw materials changes)
 work-in-process
 finished goods
 Speculative motive (Decision to increase or
 stores and spares (supplies)
decrease inventory levels due to price
fluctuations)

Objectives of Inventory Management An effective inventory management should:

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“To determine and maintain optimum level of
inventory investment”
 To maintain a large size of inventories of raw
material and work-in-process for efficient and
smooth production and of finished goods for
uninterrupted sales operations.
 To maintain a minimum investment in inventories
to maximize profitability.
 ensure a continuous supply of raw materials, to facilitate
uninterrupted production
 maintain sufficient stocks of raw materials in periods of
short supply and anticipate price changes
 maintain sufficient finished goods inventory for smooth
sales operation, and efficient customer service.
 minimize the carrying cost and time, and
 control investment in inventories and keep it at an
optimum level.

Dr. Sarika Srivastava 1

MBA II Semester FM GTU

Various cost associated with Inventory Ordering cost

1. Ordering cost  Entire costs of acquiring raw materials.

2. Carrying cost  The costs occur from that time when the order is placed till
3. Opportunity cost the goods are received, inspected and counted by the firm.
4. Shortage/ Stock out cost
 Ordering costs: requisitioning, order placing,
transportation, receiving, inspecting and storing,
administration

Total ordering Cost = No. of order x cost per order

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Carrying Costs
• Costs for holding inventory

• Carrying Costs: warehousing, handling, clerical

and staff, insurance, depreciation and
obsolescence

 Total Carrying Cost = Average Inventory X Carrying

Cost Per Unit

Inventory Management Techniques

 Forefficient Inventory Management, two important
questions should be considered- Economic Order Quantity (EOQ)
Fixed Order Interval System (FOIS)
How much should be ordered? (EOQ) Fixed Order Quantity System (FOQS)

When should it be ordered? (Reorder

point)

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Dr. Sarika Srivastava 2

MBA II Semester FM GTU

Economic Order Quantity (EOQ)

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The EOQ is that inventory level which Assumptions

minimizes the total of ordering and  Total Annual demand is known with certainty
carrying costs.  Usage of material is steady
 Constant ordering cost per order

2AO  Constant carrying cost per order

EOQ =
c
Total Inventory cost
= TCC + TOC

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Important Terms
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 Where A= Annual requirement in units  Reorder point is that inventory level at which an
O = Ordering cost per order order should be placed to replenish the inventory.
 c =Carrying cost per unit
 Lead time is the time normally taken in
No. of orders = Annual demand / order size replenishing inventory after the order has been
placed.
=A/ Q

 Safety Stock – Some minimum or buffer inventory

Average inventory = Order size / 2 to meet unexpected delay / increased usage
= Q/2
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Inventory Management Techniques Cont…

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 Reorder point under certainty

 Reorder point under uncertainty
 lead time ( 3 weeks)
 safety stock
 average usage ( 50 units per week)
Reorder point = (Lead time x average usage) + safety stock
 EOQ ( 500 units)

Reorder point = Lead time x average usage

Dr. Sarika Srivastava 3

MBA II Semester FM GTU

INVENTORY CONTROL SYSTEMS

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 ABC Inventory Control System

 Just-in-Time (JIT) Systems
 Out-sourcing

Selective Inventory Control

ABC analysis
 classify inventory into three categories
according to value
 control by importance and exception: maximum
attention to “A” items
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Graphic Presentation of ABC Analysis Problem 1

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Annual material requirement (units) 2,500

Acquisition cost per order (Rs) 400
Carrying cost per unit (Rs) 50
EOQ (units): 200
Safety stock: 0.25 x EOQ 50
Daily usage 10
Lead time (days) 10
Usage during lead time (units) 100
Re-order point (units) 150

2  400 x 2 , 500
50

Problem 2 Problem 3
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Annual usage (units) 50,000 A company makes bicycles. It produces 450

Carrying cost per unit (Rs) 4 bicycles a month. It buys the tires for bicycles
from a supplier at a cost of $20 per tire. The
Ordering cost per order (Rs) 100 company’s inventory carrying cost is estimated
EOQ (units) : 1,581 to be 15% of cost and the ordering is $50 per
order.
2 100 x 50,000
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Dr. Sarika Srivastava 4

MBA II Semester FM GTU

Solution:
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In this problem: b. What is the number of orders per year?

 A = annual demand = (2 tires per bicycle) x (450  Number of orders per year = A / Q
bicycles per month) x (12 months in a year) = = 10,800 / 600
10,800 tires = 18 orders per year
 O = ordering cost = $50 per order
 C = carrying cost = (15%) x ($20 per unit) = $ 3.00
c. Compute the average annual ordering cost.
per unit per year
Total ordering Cost = No. of order x cost per order
 EOQ = Square root of { (2 x 10,800 x $50) / $3 =
Average annual ordering cost = (18 orders per year) x
Square root of 360,000 = 600 tires The company
($50 per order) = $900 per year
should order about 600 tires each time it places an
order.

d. Compute the average inventory.

Average inventory = Q / 2 = 600 / 2 = 300 tires Problem No. 4
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e. What is the average annual carrying cost?

Total Carrying Cost = Average Inventory X Carrying Cost Per Unit
Average annual carrying cost =
= (300 tires) x ( $3) = $900 per year

f. Compute the total cost.

Total cost = (Average annual ordering cost) + (average
annual carrying)
= ($900) + ($900) = $1,800

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Dr. Sarika Srivastava 5

MBA II Semester FM GTU

Problem 5
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 A company has Rs. 4 per year carrying cost on each Impact of Purchase
unit of inventory, an annual usage of 50000 units Discount:
and an ordering cost of Rs. 100 per order. Calculate Purchase lot 1,581 1,000 2,000
EOQ. Quantity discount 0.25 0.25 0.25
No of orders 32 50 25
Average inventory 791 500 1000
 Ifa quantity discount of 0.25 per unit is offered to Total ordering cost 3,163 5,000 2,500
the company when it purchases in lots of 1000 Total carrying cost 3,162 2,000 4,000
units, should the discount be accepted? Total cost 6,325 7,000 6,500
Savings in discount 12,500 12,500 12,500
Net savings 6,175 5,500 6,000

Dr. Sarika Srivastava 6