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Chapter 9: Inventory Management

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Synopsis:
 Meaning of Inventory
 Objectives/ Importance of Logistical Network Analysis
 Functions of inventory Management
 Selective Inventory control Techniques
 Modern Inventory control Techniques
 P and Q Systems of Inventory
 MRP and DRP
 EOQ with Numericals
 Reorder level with Numericals
 Theory Questions and Objectives

1. Inventory Management: Meaning and Introduction

Inventory refers to the stock of any commodity that is usable but an ideal resource.
Inventory can be in the form of Raw materials, finished goods, parts etc. Inventory
management refers to the process of ordering, storing and using the inventory.

2. Objectives/Importance of Inventory Management

The objectives of inventory management are mentioned below:

1. To supply the required materials continuously

There should be a continuous available of materials in the factory or finished goods for
trade. The main objective of inventory management in to maintain required inventory so
that production and sales process run smoothly

2. To minimize the risk of under and over stocking of material

If a company keeps inventory without proper analysis, there will be a chance of
overstocking, which will increase the cost of carrying the inventory or under stocking of
inventory that create problem in smooth operation of a business. So one of the main
objectives of the inventory management is to minimize the risk caused due to under and
over stocking of inventory.

3. To maintain systematic record of inventory

Management needs different information regarding inventory for planning and decision-
making. A systematic recodes of inventory helps provides such information to the
management. It also assists to evaluate the current inventory management policy.

4. Reduction in losses, damages and misappropriation of materials

Inventory management aims to reduce or remove the losses and misappropriate of
materials. This is done by maintaining the proper stocks of materials with utmost care.
5. Minimize the cost associated with inventory
The proper maintenance of the information regarding inventory helps to make decisions
like whether to take discounts or not, the size of order to be placed, when to order etc. the
total cost associated with inventory may be minimized by analyzing the lot size to be
acquired, the offer of discount on variable lot size and the timing of order. Such analysis
helps to reduce the unnecessary inventory in inventories.

6. Stability in price
An effective inventory management system minimizes the effects of regular price
fluctuation. This is turn helps to gain the stability is selling price.

3. Functions of Inventory Management

The main functions of Inventory are as follows;

1) Geographical Specialisation
Geographical Specialisation for Single operating units are allowed by inventory. The
need for geographical specialisation as various factors of production are at a distance for
markets. Hence for economies of scale the manufacturing operations are situated to the
sources of these factors of production. And the manufactured goods from various
locations are collected at a particular place for assembling into final product.
Geographical specialisation results into Inventory thereby increasing the Inventory cost
and Transportation cost.

2) Decoupling
The Process of decoupling allows the product to be manufactured and distributed in
economic lot sizes that are greater than the market demand. There may not be the
demand for the entire lot size but the production was carried on keeping into mind the
future demand of the product and also for the economies of scale. It is also send to the
market in large shipments with full load capacity to get the benefits of transportation.
This results in excess inventory.

3)Balancing Demand and Supply

• Goods are produced at one point of time but are consumed in near future.
• There is always a time Gap between the Demand and supply of goods.
• There are certain goods which are consumed for a particular period of time but are
produced throughout the year E.g. Woollen Clothes
• Similarly there are certain goods which are consumed throughout the year but are
produced in a particular period of time E.g. Agricultural products.
• So In both the cases Inventory plays a very important role.

4) Buffer Uncertainties.
• Buffer uncertainties is also known as Safety stock.
• Safety stock ensures continuity in operations.
• Safety Stock protects against uncertainties like Excess demand made by the customer,
Delay in processing the order, Delay in transportation etc.

4. Selective Inventory Control Techniques

1) ABC Analysis
 • ABC Analysis inventory control technique is based on Pareto's Law i.e.Vital
Few versus trivial many.
• In this approach the classification of inventory is done in three categories,
called 'A' items, 'B' items and 'C' items.
• It is revealed by the statistics that few number of items account for bulk of
annual expenditure on materials where as other many items account for less
expenditure.
• The items are
'A' items- It is usually found that hardly 5% to 10% of the total items
account for 70% to 75% of the money spent on the materials. These items are
called as 'A' items. These items require tight control
'B' items- It is usually found that generally 10% to 15% of the total items
account for 10% to 15% of the money spent on the materials. These items are
called as 'B' items. These items do not require tight control as 'A' items.
'C' items- It is usually found that 70% to 80% of the total items account for
5% to 10% of the money spent on the materials. These items are called as 'C'
items. These items should be procured in sufficient quantities and infrequently.

Distribution of ABC Class;

ABC Class Number of Total cost

items incurred
A 10% 70%
B 20% 20%
C 70% 10%
Total 100% 100%

Item Control
A High
B Moderate
C Low

2) X-Y-Z Analysis
• X-Y-Z Analysis approach is similar to A-B-C Analysis
• In this approach the classification of inventory is done on the basis of stock
on hand.
• Items whose value of Inventory is High are called as X items while those
whose value of Inventory is moderate are called as Y items and the items
with low value of Inventory are called as Z items.
Item Control
X High
Y Moderate
Z Low

3) HML analysis
 • In HML Analysis the Inventory is classified on the basis of Unit Price of items.
• The items are classified under three categories; H-High value items, M-Medium
value items and L-low value items.
• In this the items are arranged in descending order of their price. The cut off lines
for the unit prices is fixed by the management.
• The management may categorise as; Items with unit price of less than Rs 10000
may be classified as H items. Items with unit price between Rs 5000 to Rs 10000
may be classified as M items and the Items with unit price of Less than Rs 5000
may be classified as L items.

Item Control
H High
N Moderate
L Low

4) VED Analysis
• In VED Analysis, items are classified on the basis of its Criticality.
• The items are divided into three groups; V-Vital items, E-Essential items and
D-Desirable items.
• Vital items are those items in the absence of which the production is not
possible. If these items are not available than the production would be stopped.
Companies normally keeps a good stock of these items to avoid delay in the
production process.
• Essential items are those items whose cost of stock out is very high.
• Desirable items are those whose shortage do not cause a major interruption in
the production process.
Item Control
V High
E Moderate
D Low

5) FSN Analysis
• In FSN Analysis, the classification of items is done on the basis of consumption
of the items.
• In this the items are classified as F-Fast moving items, S-slow moving items
and N-Non moving items.
• Fast moving items refers to the items with high consumption level.
• Slow moving items refers to the items with very low consumption level.
• Non moving items refers to the items with no consumption since last two years.
Item Control
F High
S Moderate
S Low

6) GOLF Analysis/G-NG-L-F Analysis

 • In G-NG-L-F Analysis, the classification of items is done on the basis of nature
of Suppliers of the items.
• In this the items are classified as G-Government, NG-Non government, L-Local
suppliers and F-Foreign Suppliers
• 'G' group comprises of items purchased from Government suppliers and public
sector undertaking.
• 'NG' group comprises of items purchased from Non-Government suppliers or
ordinary suppliers.
• 'L' group comprises of items purchased from Local suppliers.
• 'G' group comprises of items purchased from foreign suppliers.
Item Control
G High
NG Low
L High
G Low

7) SDE Analysis
• In SDE Analysis ,the classification of items is done on the basis Availability of
items.
• In this the items are classified as S-Scarce items, D-Difficult items and E-Easy
items.
• Scarce items refers to those items which are not easily available. It normally
refers to the imported products.
• Difficult items refers to those items which are indigenously available but are
not easy to procure..It normally refers to the products from far off distance.
• Easy items refers to those items which are easily available. It normally refers to
the local products.
Item Control
S High
D Moderate
E Low

8) S-OS Analysis
• In S-OS Analysis ,the classification of items is done on the basis Seasonality of
items.
• In this the items are classified as S-Seasonal items and OS-Off Seasonal items.
• Seasonal items refers to those items which are available for a particular season.
For Eg. Mangoes are available for a particular season but can be stored for the
full year.
• The price of seasonal items is less during their particular season and for the
remaining time period the prices are high as storage cost is also included.
• Off Seasonal items refers to those items which are available throughout the year.
There is no particular season for such items.

Item Control
Seasonal but limited High
Seasonal but available Moderate
throughout the year
 Off-Seasonal Low

5.Modern Inventory Control Techniques

1) Just In Tim (JIT)

• Just-in-time (JIT) manufacturing, is also known as just-in-time production.
• It was developed by Taichi Ohno of Toyota Motor Corporation in 1950.
• It is a methodology aimed primarily at reducing flow times within production
system as well as response times from suppliers and to customers.
• Its origin and development was in Japan, largely in the 1960s and 1970s and
particularly at Toyota.
• JIT means making what is needed, when it is needed and in what quantity
needed. It states that the activity should be done as and when needed so that the
Inventory should be minimised.
• As keeping inventory incurs cost, however JIT considers inventory as waste and
focus on availability of materials in right quantity, at a right time and at a right
place.
• Thus it leads to reduction in wastages and improvement in the overall efficiency
of the organisation.

2) Just In Time II
• JIT II is similar to JIT with a difference that SUPPLIER-CUSTOMER
relations are further strengthened.
• There is a representative of the supplier present with the customer who is
present at the site and keeps a check on the demand of the customer.
• This in-plant representative is authorized to purchase material for the customer.
• Though he works for the customer but he is paid by the supplier.
• Thus the customers staff need not look into inventory management the entire
work is done by the supplier's staff.
• In JIT II the suppliers are provided with the entire authority by the customer.

3) Vendor Managed Inventory

• Vendor Managed Inventory is also known as Continuous Replenishment
Strategy.
• In this the customer does not places the order with the supplier for the goods.
• The customer just shares the information with the suppliers about the actual
usage of the products ,current stock in hand ,maximum and minimum stocks.
• On the basis of the information provided by the customer the supplier takes the
responsibility of customers inventory. It becomes the duty of the supplier to
maintain the inventory of the customer.

4) Quick Response
• Quick response is a co-operative efforts of suppliers and retailers to increase the
velocity of inventory by the use of technology.
• Here when the retailer places an order for replenishment, the supplier with the
help of Electronic data interchange finalizes the details of delivery and
communicates them in advance to the customers.
• With the fast and quick response ,inventory can be ordered as required resulting
in increased turnover and improved availability.
 5) Automatic Replenishment (AR)
• Automatic Replenishment refers to the technique where inventory management
is in the hands of supplier.
• Here supplier gets the benefit of visibility of inventory and effective
management to reduce total cost.
• AR enables the supplier to anticipate the requirement of the customer in advance
to make replenishment.

6. Q and P SYSTEM/ Replenishment Systems

One of the most important aspect of Inventory management is to decide when to place and
order and how much to order. This depends on the type of Inventory. In this two different
methods are used these are
Fixed Order Quantity System (Q System or Perpetual Review system)
Fixed Order Interval System (P System or Periodic Review system)
Fixed Order Quantity System (Q Fixed Order Interval System (P
System ) System)
1. In Q system the order Quantity is In P system the review period is
fixed fixed
2. In Q system the review period is In P system the order quantity is
variable variable
3. There are less chances of Stock outs There are High chances of Stock outs
4. Safety stock is not required Safety stock is required
5. It is suitable for critical items like A It is suitable for non critical items
items like B and C items
6. It is also known as Perpetual It is also known as Periodic Review
Review system system
7. In this system supplier has to hold In this system supplier need not has
more inventory as he will not know to hold more inventory as he will
when the orders will be placed. know when the orders will be placed.
8. It is suitable when continuous It is suitable when periodic review is
monitoring is possible. necessary.

7. MRP and DRP

MRP (Material Requirement Planning)
• Material requirements planning (MRP) is a production planning, scheduling,
and inventory control system used to manage manufacturing processes.
• The concept of MRP was introduced by Dr Joseph Orlicky in the year 1960.
• Materials requirements planning (MRP) is one of the first software-based
integrated information systems designed to improve productivity for businesses.
• MRP provides answers to three key questions:
✓ Which products are needed?
✓ How many are needed?
✓ When are they needed?
• The inputs in MRP system comes from three main resources like Bills of
Materials, Master production schedule and Inventory records file.
• An MRP system is intended to simultaneously meet three objectives:
✓ To Ensure materials are available for production and products are available
for delivery to customers.
✓ To Maintain the lowest possible material and product levels in store.
✓ To Plan manufacturing activities, delivery schedules and purchasing activities.

MRP II (Manufacturing Resource Planning)

• Manufacturing resource planning (MRP II) is an integrated method of
operational and financial planning for manufacturing companies.
• MRP II serves as an extension of MRP
• MRP II is also known as closed loop manufacturing resource planning, also
abbreviated as CLMRP.
• The MRP II process is carried out by a synergistic combination of computer and
human resources.
• MRP II includes production planning, machine capacity scheduling, demand
forecasting and analysis modules, and quality tracking tools.
• MRP II also has tools for tracking employee attendance, labour contribution
and productivity.

DRP(Distribution Requirement Planning)

• Distribution Requirement Planning is a process which is used to determine which
goods or materials will be required at which location and at what time to meet the
anticipated demand.
• DRP connects current inventory and forecasts of field demand to
manufacturing’s MPS and MRP.
• DRP can anticipate future requirements in the field.
• DRP Match material supply to demand, match inventory to customer service
requirements.
• DRP Increases the speed, the firm can react to the marketplace
• DRP Provide savings by better aggregation of transportation and dispatching

DRP II
• Distribution Resource Planning (DRP-II) is an extended version of Distribution
Requirement Planning (DRP-I).
• DRP -II enables on time delivery to customers and helps to reduce the complaints
of the customers.
• It facilitates better inventory and co-ordination with other functions of enterprise.
• It helps in Introduction of new products.
• DRP-II includes maintaining the provision for major non-inventory items and
resources such as labour, material handling systems, and storage space. It may
include other resources such as finances, trucks, freight cars, etc.
 • The main goal of DRP-II is to eliminate or at least minimize the shortages and at
the same time, reduce the costs incurred during ordering, transporting and storing
or holding goods. It is also called as Distribution Replenishment Planning.
• It is a time based approach which estimates when inventory is expected to be
depleted and accordingly replenishes the same on time.

Distinguish Between MRP and DRP

Sr Points MRP DRP
No
1 Meaning MRP is Material Requirement DRP is Distribution
Planning Requirement planning
2 Factor MRP is guided by Master DRP is guided by customer
Production schedule demand
3 Control MRP is under the control of DRP is based on Customer
the firm demand.
4 Demand MRP operates in dependent DRP operates in independent
Situation demand situation demand situation
5 Scope MRP is concerned with DRP is concerned with
Inbound logistics Outbound logistics
6 Movement MRP involves movement of DRP involves movement
raw materials to finished finished goods to customers
goods

8. Economic Order Quantity (EOQ)

The economic order quantity is the optimum quantity of goods to be purchased at one time
in order to minimize the annual total costs of ordering and carrying or holding items in
inventory. EOQ is also referred to as the optimum lot size.

Assumptions of EOQ Model;

• The Demand for the product Demand is uniform, constant and continuous over time.
• The Price per unit is fixed ,independent of the size of order.
• The lead time for the product is constant.
• The cost of placing an order is fixed.
• There is no limit on order size due either to stores capacity.
• The cost of placing an order is independent of size of order.
• The cost of holding a unit of stock does not depend on the quantity in stock.
• The product has a long life and the chances of Deterioration or spoilage are minimum.

Limitations of EOQ Model:

• The product may not be produced in desired quantities.
• The product may not necessarily have a long life.
• The cost of placing an order may vary with the size of order.
• Lead time can never be zero. As there is always a time gap between the placement and
delivery of the order.
• The demand for the product may not be same throughout the year.
• The price of the product may not be fixed. It may vary with the size of order.

Formula of EOQ:
EOQ =
Where, A = Annual Demand, Co = Cost of placing an order,
C = Cost per Unit, I = Inventory Carrying Cost

Numerical Problems on EOQ

Problem No. 1
The Annual demand of an item is 4200 units. The unit cost is Rs 8/-.The inventory carrying
rate is 30%.The cost of procurement is Rs 200/-. Calculate EOQ.

Solution:
Given: A=4200 units, C= Rs 8 p.u, Co=Rs 200 and I=30% = 0.30

EOQ = = = 837 units

Problem No. 2
The Annual demand of an item is 5400 units. The unit cost is Rs 10/-.The inventory carrying
rate is 20%.The cost of procurement is Rs 150/-. Calculate EOQ.

Solution:
Given: A=5400 units, C= Rs 10 p.u, Co=Rs 150 and I=20% = 0.20

EOQ = = = 900 units.

Problem No. 3
The Annual demand of a chair=54000 units. The unit cost of a chair is Rs 1000/-. The
inventory carrying rate is 20%. Ordering cost is Rs 500/-. Calculate EOQ.

Solution:
Given: A=54000 units, C= Rs 1000 p.u, Co=Rs 500 and I=20% = 0.20
EOQ = = = 1039 units

9. Reorder Level

• The Reorder level (or reorder point) is the inventory level at which a company would
place a new order .
• It is the minimum amount of an item which a company holds in stock such that when
the stock falls to this amount the item must be reordered.
• The reorder level is the point at which stock on a particular item has diminished to a
point where it needs to be replenished.
• In short as the stock in hand equals to lead time consumption plus the safety stock, it is
the time for the company to avoid stock outs and place a fresh order.
• Reorder level=Lead time x Demand per day/week/month+ Safety Stock

Numericals on Reorder level

Problem No. 1
In ABC ltd the average lead time for procurement is 2 weeks with the average demand of
1500 units per week. The safety stock is assumed to be 2000 units. Calculate the reorder
level.

Solution:
Given: Lead time = 2 weeks, Demand per week = 1500 units, Safety stock = 2000 units

Reorder level = Lead time x Demand per week + Safety Stock

= (2 x 1500) + 2000 = 3000 + 2000 = 5000 units.

Problem No. 2
Daily consumption of material is 500 units. The time taken by supplier is 4 weeks to deliver
the material. Calculate the reorder level.

Solution:
Given: Lead time = 4 weeks, Demand per week = 500 units, Safety stock = 0 units
Reorder level = Lead time x Demand per week + Safety Stock
= 4 x 500 + 0 = 2000 + 00 = 2000 units.

Problem No. 3
Daily consumption of material is 100 units. The lead time to deliver the material is 3 weeks
.It is the policy of the company to keep a safety stock of 2 weeks. Calculate the reorder
level.

Solution:
Given: Lead time = 3weeks, Demand per week = 100 units, Safety stock=2 x 100=200
Reorder level = Lead time x Demand per week + Safety Stock
= (3x 100) + 200 = 300 + 200 = 500 units.

Problem No.4
Annual demand of the product is 72000 units. The lead time to deliver the product is 3
months .It is the policy of the company to keep a safety stock of 500 units. Calculate the
reorder level.

Solution:
Given: Lead time=3 months, Demand per month = 72000/12=6000 units, Safety
stock=500 units
Reorder level = Lead time x Demand per week + Safety Stock
= (3x 6000) + 500 = 18000+500 = 18500 units.

Theory Questions:

1) What is Inventory Management? What are objectives of Inventory Management?

2) Write a note Modern Inventory Control Techniques.
3) Discuss in detail the Selective Inventory control techniques.
4) Explain in detail the functions of Inventory Management.
5) Explain the P and Q systems of Inventory.
6) Write a note on EOQ.
7) Explain Reorder level with eg.
8) Distinguish Between MRP and DRP.

Objectives

(I) Multiple Choice Questions

1) The main functions of Inventory are_______

(a) Geographical (b) Balancing demand and supply
(c) Decoupling (d) All of above

2) ______ is not selective inventory control technique.

(a) ABC analysis (b) VED analysis
(c) Q system (d) FSN analysis

3) JIT leads to _______in wastages.

(a) reduction (b) increase

4) In JIT II the suppliers are provided with the entire authority by the customer.
(a) responsibility (b) liability
(c) permissibility (d) authority

5) Q system is suitable for ______items.

(a) A (b) C
(c) B (d) None of above

6) Automatic Replenishment refers to the technique where inventory management is in the

hands of _______.
(a) Customer (b) Supplier
(c) Retailer (d) Wholesaler

7) ______ Increases the speed, the firm can react to the marketplace
(a) DRP (b) MRP
(c) MRP II (d) DRP II

8) The inputs in MRP system comes from the __________resources.

(a) Bills of Materials (b) Master production schedule
(c) Inventory records file (d) All of above

(II) State whether the following statements are True or False

1) The Reorder level Reorder level (or reorder point) is the inventory level at which a
company would place a new order .

2) The economic order quantity is the optimum quantity of goods to be purchased at one
time.

3) MRP II is also known as closed loop manufacturing resource planning

4) DRP operates in dependent demand situation.

5) In Q system the review period is variable.

6) In P system the order quantity is Fixed.

7) In JIT II the suppliers are provided with the entire authority by the customer.

8) Inventory refers to the stock of any commodity that is usable but an ideal resource.

9) In 'B' items it is usually found that generally 20% to 25% of the total items account for
20% to 25% of the money spent on the materials.

10) Scarce items refers to those items which are easily available

Ans: 1) True, 2) True, 3) True, 4) False, 5) True, 6) False, 7) True, 8) True,9)False,10)False

(III) Match the following:

Group “A” Group “B”

1 Decoupling a New Order
2 H items b Introduction of new products
3 JIT c Continuous Monitoring
4 Vendor Managed Inventory d Safety stock
5 P System e Continuous Replenishment strategy
6 Q System f Reduction in wastages
7 DRP-II g High value items
8 Reorder level h Function of inventory

Ans. 1-h, 2-g, 3-f, 4-e, 5-d, 6-c,7-b,8-a

-.-.-.-.-.-.-.-.-.-