Noble Study Material 35

Tools and Techniques of inventory Management

Effective Inventory management requires an effective controi

sVStem for inventories.

A proper inventory control not only helps in
solving the acute problem of liquidity but also increases profits
and

causes substantial reduction in the working capital of the concern. The

following are the important tools and techniques of inventory
management and control:

Determination of Stock Levels

2 Determination of Safety Stocks.

3 Determination of Economic Order Quantity
4 A.B.C. Analysis
5. VED Analysis
6. Inventory Turnover Ratios
7 Aging Schedule of Inventories
8 Just in Time Inventory
Q3. Explain the various costs and risk associated with inventory.
Ans. Risk and Costs of Holding Inventories
The holding of inventories involves blocking of a firm's funds and
incurrence of capital and other costs. It also exposes the firm to certain
risks. The various costs and risks involved in holding inventories are
as below:
i) Capital costs: Maintaining of inventories results in blocking ot
the firm's financial resources. The firm has..therefore, to arrange
for additional funds to meet the cost of inventories. The funds niy
be arranged from own resources or from outsider. But in bot
cases, the firm incurs a cost. In the former casc. thhere is a
opportunity cost pf investment while in later case the firm has io
pay interest to outsiders.
i) Cost of Ordering: The costs of ordering include the cost oi
acquisition of inventories. It is the cost of preparation and erecution
of an order, including cost of paper work and com.nunmcating with
Supplier. There i s always minimum cot involve w : e v e r an orde

for replenishment of good is placed. The totai a cost

ordering is equal to cost per order multiplied by :lie number oi
order placed in a year.
36| NobleStudy Material
ii) Cost of Stock-outs: A stock out is a situation when the firm is ng
having units ofan item in store but there is demand for that eithe
from the customers or the production department. The stock ou
refer to demand for an item whose inventory level is reduced u
zero and insuflicient level. There is always a cost of stock out i
the sense that the firm faces a situation oflost sales or back orders
Stock out are quite often expensive.
iv) Storage and Handling Costs. Holding ofinventories also involves
costs on storage as well as handling of materials. The storage costs
include the rental of the godown, insurance charge etc.
v) Risk of Price Decline. There is always a risk of reduction in the
prices of inventories by the suppliers in holding inventories. This
may be due to increased market supplies, competition or general

depression in the market.

vi) Risk of Obsolescence. The inventories may become obsolete due
to improved technology, changes in requirements. change in
customer's tastes etc.
vii) Risk Deterioration in Quality: The quality of the materials may
also deteriorate while the inventories are kept in stores.

Q4. What do you mean by ABC analysis? State

the advantages of
ABC analysis.
Ans. ABC analysis (or Selective Inventory Control)
divides a
an inventory categorization technique. ABC analysis
control and
inventory into three categories- "A items" with very tight
accurate records. "B items" with less tightly controlled and good
and minima
records, and "C items" with the simplest controls possible
records.
The ABC analysis provides a mechanism for identifyingitemsthu
cost,"'while alst
will have a significant impact on overall inventory
different categories ofstoC
providing a mechanism for identifying
that will require different management and controls.
The ABC analysis suggests that inventories of an organization
not ofequal value. Thus, the inventory is grouped into three catego
(A, B, and C) in order of their estimated importance
 Noble Study Material |37
Under A-B-C analysis, the materialsare divided into three
catcgories viz. A, B and
C. Past experience has shown that almost 10
per cent of the items contribute to 70 percent of value of consumption
and this category is called 'A' Category. About 20 per cent of value of

consumption and this category is called A'

Category. About 20 per
cent of the items contr1bute about 20 per cent of value
of consumption
and this is known as category "B materials. Category 'C' covers about
70 per cent of items of materials which contribute only 10 per cent of
value of consumption. There may be some variation in different
organisations and an adjustment can be made in these
percentages.
The information is shown in the following diagram:
Class No. of Items (%) Value of Items (%)
A 10 70
B 20 20
C 70 10
A-B-C analysis helps to concentrate more efforts on category A
since greatest monetary advantage will come
by controlling these items.
An attention should be paid in
estimating requirements. purchasing.
maintaining safety stocks and properly storing of 'A' category materials.
These items are kept under a constant review so that substantial
material cost may be controlled. The control of 'C' items may be relaxed
and these stocks may be purchased for the year. A little more attention
should be given towards B° category items and their purchase should
be undertaken a quarterly or half-yearly intervals.
Advantages of ABC Analysis:
. It ensures a closer and a
more strict control over such
items.
which are having a sizable investment in there.
2. It releases
working capital, which would otherwise have been
locked up for a more
profitable channel of investment.
3. It reduces
inventory carrying cost.
4. It enables the relaxation
of control for the 'C' items and
thus
makes it possible for a sufficient buffer
stock to be created.
S. It enables the
maintenance of high inventory turn over rate.
38 Noble Study Material
Q5. The main theme of material resource planning (MRP)i
"getting the right materials to the right place at the right time
Comment. Also discuss the objectives of MRP.
Ans. The globalization of the economy and the liberalization of the
trade markets have formulated new conditions in the market place which
the busines
are characterized instability and intensive competition in
by
with respect to
nvironment. Competition is continuously increasing
of delivery.
price, quality and selection. service and promptness
Removal of barriers, international cooperation,
technological
innovations cause competition to intensify. In terms of manufacturing
quality. In
emphasis is placed on reducing cost while improving
addition. other factors such as timely delivery of
the product become
Time or JIT in short)
eritical (this is captured by emphasis in Just in
to a MRP is the number of times a
techniques. A key question process
within a year.
company replenishes (or turns around) inventory
There are accounts of inventory annual turnover ratios of greater
than 100, mainly reported by Japanese companies. One can readily

realize that the a ratio is likely to be conducive to

high inventory
lowering production cost since lesscapital is tied up to unusedinventory
to determine what material
MRP systems use four pieces of information
should be ordered and when:
. The master production schedule, which describes when each
product is scheduled to be manufactured;
2 Bill of materials, which lists exactly the parts or materials
required to make each product;
3. Production cycle times and material needs at each stage ofthe

production cycle time; and.

4. Supplier lead time. The master sechedule and bill of materials
indicate what materials should be ordered: the master schedule.
production cycle times and supplier lead times then jointly
determine when orders should be placed.

MRP objectives
The main theme of MRP 1s
"getting the right materials to the right
time".
place right
at the

Snecific
design
Spee organizational oojccives
and implementation often associated
may be identified among
ated three
with MRP
main

dimensions, amely: inventory, priorities and

capacity.
 Noble Study Material | 39
An MRP system is intended to simultaneously meet three

bjectives:
Ensure materials are available for production and products are

available for delivery to customers

Maintain the lowest possible material and product levels in
store Plan manufacturing activities, delivery schedules

and purchasing activities.

MRP Systems - Input and Output

Master
Production
Bill of Schedule Inventory
Materials Status

Material
Requirements
Planning System
Purchasing
Item Master Data
Planned Order
&Other Reports|

6 What do you mean by Just-in-time (JIT) inventory

management? Also state the benefits of JIT.
Ans.JIT:
Just-in-time (JIT) inventory management. also know as lean
manufacturing and sometimes referred to as the Toyota production
system (TPS). is the process of ordering and receiving inventory for
production and customer sales only as it is needed and not before. This
means that the company does not hold safety stock and operates with
low inventory levels. This strategy helps companies lower
their inventory carrying costs by increasing efficiency and deereasing
waste
This method requires producers to forecast demand accurately.
Just-in-time inventory management is a cost-cutting inventory
management strategy though it can lead to stockouts. The goal of JIT
s to improve return on investment by reducing non-essential costs
40
Noble Suly Muteriat
Competing inventory management systems arc
short-cyca
manufacturing (SCM), continuous-flow manufacturing
demad 1low (CFM)an
manulacturing (DFM)
This inventory system
represents a shift away from the older ju
in-case stategy, in which
producers carried large inventories in cam
higher demand had to be met.
Benefits of Just In Time (JIT):
-

Low month to month holding costs.

Low impact of the daily cost
of money (your money not tien
s
up in inventory so you can use it elsewhere in your business
Eliminate the problem of obsolete and outdatedinventory
Eliminate the problen of damage to inventory from holding
month to month.
JIT Inventory

JIT Inventory Tactics

Four Tactics
Replace Reduce
Setup
Costs Variability
4

Reduce 3 2Reduce
Lot Size Inventory

Q7. Explain the concept of KANBAN system in productio

managenment.
Ans. Kanban is derived from the combination of two Japanese works
Kan" meaning visual and "ban" meaning card or board. Kanban is
process relating to lean and just in time production, it is a schedulin,
system that helps determine what to produce, when to producean
how much to produce.
Kanban maintains inventory levels by sending visual signals
production and delivery of new shipment as material is consumed
and brira
The signals are tracked through the replenishment cycle
and buyer.
extraordinary visibility to suppliers
 41
Nnble Study Material
The Kanban system was developod by loyota after they observed
how supermarkets operated in United States Toyota observed that the
believed they could sell
items that they
supermarkcts only stocked
and the customers only took what they necded. Toyota decided to adapt
production system, considering themselves as
this process in the
would
customers oftheir suppliers and their suppliers as stores. Toyota
would
go to its suppliers and only get what it needed. and the suppliers
then restock
Kanban is scheduling system that issued and Just-In-Time
a

to help companies improve their

inventory replenishment programs
overall inventory.
production and reduce their
tell how much
In traditional kanban, employees use visual signals to
to run during a production process.
Visual signals also let them know when to stop or change
over.

with actual usage so that there

The process replaces forecasted usage
is very little work-in-progress ((WIP) material. thus reducing inventory.
Kanban is used to achieve efficiency-also a concept of Six Sigma.
it
The work or production job enters the process ard proceeds through
reduces re-work.
smoothly and continuously. The process reduces WIP,
and any other delays in the manufacturing process.

Applied Questions (Case Study)

Every commercial organization aims to produce, so from that it go
aims to establish chains or business relationships that
maximize their

profits. To this end, market studies that demonstrate the specific

situation of each sector, to thereby establish appropriate strategies
should be made. In this sense, the pharmaceutical industry, offers a
for humans, since they
range of products that are of essential nature
involve the strengthening or cure health client in this case is patient.
So should view the levels ofcompetitiveness of specific pharmaceutical
organization to increase productivity by avoiding the fewest possible

expenses.
and
The company under study is one of the main producers
in
distributors of pharmaceutical products in the world. with presence
44 countries, between this France. This in its continuous growth presents
In the last years an increase in the complexity of its commercial
operations, for which it is necessary to design and to develop
42 | Noble Study Material
applications within the information systems. In the same way. this

generates an increase in operational costs.

The logistics team is continuously optimizing and improving its
operations and processes in order to reduce transportation and
administrativecosts. The latter are the ones that have the greatest impact
on the annual budget of the department since they always have the
same value regardless of the volume or value of the order.
Within the pharmacy channel in France. there is a big difference
between all customers, from large pharmacies in major cities, medium-
sized in residential areas or small in agricultural villages. This generates
a fairly large order volume range and the only existing restriction is
the Minimum Order Value (MOV).
Because of this, the need to question the current model and
procedures arises. The main approach is to find a method that will
induce customers to spend less buying orders without generating a
financial impact.
In meetings with logistics management, the proposal for variations
of Minimum Order Value (MOV) is developed. It is proposed to observe
the possible scenarios that can be obtained by increasing or decreasing
this value. The main objective of this proposal is to seek savings in
total billing costs by reducing the number of annual orders and
alignment with business growth objectives. The two basic scenarios
are the decrease or increase of this value.
in the case of a decrease, this allows the search for new smll
Customers who do not have the capacity to make large orders. Although
this generates a sales growth, a direct increase in costs is seen as the
number of orders is increased, both new and old customers who prefer
to make small orders to decrease their inventories in pharmacies. On
the other hand, the profit margin is dinminished.
Questions
1. Discuss how the minimum value per order
(MOV) is
diagnosed and the implications of the current commercial
strategy allowing a reduction in administrative costs and
the reinvestment of these resources in the
search for new
clients.
2. Conclude the main objective of the
the case. company according to
 Noble Study Material 43
Ans. 1. Within the pharmacy channel in France. there is a big diflerence
between all customers, from large pharmacies in major cities. medium
SIZed in residential areas or small in agricultural villages. This generates
a tairly large order volume range and the only existing restriction is

the Minimum Order Value (MOV).

In this sense. the scenario is considered to increase the MOV, which
would force the clients to pass orders of greater volume and value. In
this case, it is taking a push strategy so that customer inventories will
be increased. Therefore. it is assumed that a reduction in purchase orders
will occur. Likewise, the possible loss of business or impact to the
adapt to the increased MOV
profits of clients who do not want or can
should be considered.
When a reduction occurs in the purchase orders. a saving in the
total costs is generated directly. It is proposed to invest these resources
to address new customers by offering them the possibility of placing
purchase orders with a new customers MOV (MOV-NC). This will
allow customers to know and evaluate the sales perfornmance of the
company's products under study, with the expectation that they will
become regular customers. With this strategy it is possible to recover
the impact to the profit and to generate incremental gains, therefore
this one is aligned with the objectives of growth.
The progressive implementation of the simplification of the
commercial strategy. Changes in trading conditions should be made in
the coming years. You can start with minor categories to carry out
impact assessments. In the case of the arrival of new categories. the
commercial strategy must be aligned with the simplification proposal.
in order to achieve a faster and more precise adaptation ofthecustomer
Ans.2 The Company under study is a leader in the mass consumer
market. specifically in the production of pharmaceutical products based
in France. It has developed all the organization necessary to get its
products from the factories to the consumer. through the establishment
ot alliances with providers of logistics and sales services.
LIKewise, it uses a system of contracts with pharmacies, which
CStablishes the commercial conditions and discounts that both parties
ust Comply with. The company considers that this strategy presentsa
Brear complexity and difficulty given the differences between the
ategories. Therefore, the obiective of this article is the design of
dcgies tor the reduction of logistics costs of the company.
44 Noble Study Material
The logistics team is continuously optimizing and improving its
operations and processes in order to reduce transportation and
adminstrative costs. The latter are the ones that have the greatest
impact
on the annual budget of the
department since they always have the
amc vaiue regardless
of the volume or value of the order.
The company under study is one of the main producers and
distributors of pharmaceutical products in the world. with
presence in
44 countries. between this France.
This in its continuous growth presents
in the last years an increase in the
complexity of its commercial
operations, for which it is necessary to design and to develop
applications within the information systems. In the same way. this
generates an increase in operational costs.