MIND NURTURE KRISHNA Page 1 of 6

INVENTORY CONTROL TECHNIQUES

❖ Inventory
• Inventory is the goods or materials a business intends to sell to customers for profit.
• Types of inventory
i) Raw materials
ii) Purchased parts and supplies
iii) Finished goods
iv) Working process (partially completed product)
v) Item being transported
vi) Tools and equipment
❖ Inventory control
• Inventory control is the process of managing inventory in order to meet customer demand at the lowest
possible cost and with a minimum of investment.
• Unlike many factors in pharmacy, inventory is controllable.
• The pharmacy decides how much inventory investment to make, when to reorder, and in what quantities.
• A successfully implemented inventory control program takes into account such things as purchasing goods
commensurate with demand, seasonal variation, changing usage patterns, and monitoring for pilferage. The
challenge of productive inventory management is to support an upward trend in sales while keeping the
investment at the lowest level consistent with adequate customer service.
❖ Inventory control techniques
Following techniques are used
i) ABC analysis
ii) VED analysis
iii) Economic order quantity (EOQ)
iv) Lead time
v) Buffer stock
vi) Reorder quantity level
vii) Inventory turnover
viii) Perpetual inventory system
ix) FEFO and FIFO methods

1. ABC analysis- ABC (Always Better Control) analysis is one of the most commonly used inventory management
methods. ABC analysis groups items into three categories (A, B, and C) based on their level of value within a
business

2. VED analysis- Divide drugs into three category vital, essential and desirable

3. Lead time- Lead time in inventory management is the lapse in time between when an order is placed to
replenish inventory and when the order is received.

4. Buffer stock- An inventory buffer is additional inventory kept on-hand in case of emergencies, transportation
delays or surges in demand

5. A perpetual inventory system is a program that continuously estimates your inventory based on your
electronic records, not a physical inventory
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6. Economic order quantity (EOQ) –

➢ What is EOQ?
• It is refer to the optimum order size that should be placed with a vendor to minimise blockage of
funds and holding and ordering cost or quantity of materials which can be purchased at minimum
costs.
• It is the size of the lot to be purchased which is economically viable.
• The framework used to determine this order quantity is also known as Wilson EOQ Model or Wilson
Formula.

➢ In determining EOQ, it is assumed that cost of managing inventory is made up solely of two parts i.e.,
a) Ordering costs/ Buying costs
b) Carrying costs/ Holding costs
a) Ordering Costs/ Buying Costs
• Costs which are associated with the purchasing or ordering of materials.
• These costs include:
i) Costs of staff posted for ordering of goods.
ii) Expenses incurred on transportation of goods purchased.
iii) Inspection costs of incoming materials.
iv) Cost of stationary, typing, postage, telephone charges, etc.
b) Carrying Costs
• Costs for holding the inventories.
• These costs include :
i) the cost of capital invested in inventories.
ii) cost of storage which could have been used for other purposes.
iii) the loss of materials due to deterioration and obsolescence.
iv) insurance costs.
v) cost of spoilage in handling of materials.
➢ Assumptions of EOQ Model
• The ordering cost is constant.
• The rate of demand is known, and spread evenly throughout the year.
• The lead time is fixed.
• The purchase price of the item is constant i.e. no discount is available.
• The replenishment is made instantaneously, the whole batch is delivered at once.
➢ EOQ Formula
2xDxO 2xDxO
EOQ = √ H
= √
i.c
D = Annual demands in units of products
O = Ordering cost per order
H = holding cost per unit of product
i.c = inventory carrying cost
H = i.c
𝑎𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑
No of order per year = 𝐸𝑂𝑄
➢ An Example on EOQ
The material DX is used uniformly throughout the year. The data about annual requirement, ordering
cost and holding cost of this material is given below:
• Annual requirement: 2,400 units
• Ordering cost: $10 per order
• Holding cost: $0.30 per unit
Required: Determine the economic order quantity (EOQ) of material DX using above data.
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Solution
EOQ calculation:

The economic order quantity for material DX is 400 units. Now, we can compute the number of orders
to be placed per year, annual ordering cost, annual holding cost and combined annual ordering and
holding cost as follows:
Number of orders per year
= Annual demand/EOQ
= 2,400 units/400 units
= 6 orders per year
➢ Limitations of EOQ
Unrealistic Assumptions
The most significant limitation is that the assumptions are unrealistic.
• It assume that the holding cost, ordering cost, demand, price, quality, etc., of the product or part to be
constant throughout the year. It is not realistic in the real world.
• Holding and ordering costs may vary due to changes in rentals, salaries of personnel, and other
overhead expenses.
• Constant demand, as well as the price of a product, can hardly be constant. They fluctuate a lot in the
real world.
• Consumer income, tastes, and preferences, prices of inputs and raw materials, seasonal variation in
demand, etc., are key factors that will affect demand as well as price.
• Similarly, the assumption of the constant quality of the product is not realistic. The quality of the
product generally changes with every production batch. The production process also does not remain
constant because of factors like an interruption in power supply, breakages, and repairs in plant and
machinery, overheating, changes in the quality of inputs and raw materials, etc

7. Reorder quantity level

• It indicates that level of material stock at which it is necessary to take the steps for the procurement of
further lots of material.
• The reorder level is slightly more than minimum stock level to guard against abnormal use of item and
abnormal delay in supply.
• Reorder level= Maximum lead time × Maximum reorder periods
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➢ Re-Order Level Vs Re-Order Quantity

Basis for
Re-Order Level Re-Order Quantity
Comparison
Re-Order Level implies the level at which new Re-Order Quantity implies the size of the lot for
Meaning order should be placed for the purpose of which the order is placed when the stock of
restoration of stock. material falls to re-order level.
Related to Time Quantity
How much quantity of materials are to be
Determines When to buy or place an order for materials.
purchased at a time.
Maximum consumption during lead time, lead
Factors Annual Carrying Cost, annual ordering cost,
time taken by supplier, safety level,
Involved quantum of discount, etc.
replenishment period, etc.

➢ Definition of Re-Order Level (ROL)

• Re-Order level represents the level of
material lying between the minimum and
maximum stock level, means before the
stock of material ordered is delivered by
the supplier and received into the stores, a
sufficient quantity of material should be
there to cover both normal as well as
abnormal consumption situation.
• If the firm has an idea about the lead
time, EOQ, and consumption pattern,
Reorder level can be determined easily.
• Reorder Level is set in such a manner that
by reordering, when the stock of material
reaches this point or level, then in normal
circumstances, fresh supplies will come to
the store, just before the level falls to a
minimum level.
• So, at the time of fixing this level following factors are considered:
→ Consumption rate
→ Minimum level
→ Delivery time, and variations in delivery time

➢ Formula for Re-Order Level

In general, Re-Order Level is calculated using the following formula:
• Re-order Level = Maximum Consumption × Maximum Reorder Period
Further, if the maximum consumption is not known, Re-Order Level can also be calculated using an
alternative formula:

• Re-order Level = Minimum Stock Level + (Average Rate of Consumption × Average Reorder Period)
If the company maintains safety stock it can be calculated as:
• Re-Order Level = Safety Stock + (Average Consumption per day × Average Lead Time)
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Let us understand these terms in detail

Maximum Maximum consumption implies the maximum rate of consumption of material during a production
Consumption activity.
Maximum Re- As the name suggests, it is the maximum time taken by the supplier to fulfill the order of materials,
order Period i.e. to deliver the stock to stores.
Minimum Stock Minimum stock level is the least quantity of stock of materials that need to be maintained by the
Level firm all the time.
Average Rate of
It is the normal rate of material consumption during production activity.
Consumption
Average Re-order The average time taken by the supplier to deliver the order to the factory’s stores is the average
Period reorder period.
Safety stock is the minimum additional inventory acting as a margin of safety or buffer stock, that
Safety Stock helps in meeting the unexpected rise in consumption, due to a sudden increase in demand or
uncontrollable delay in the delivery of the material.
Lead Time It is the time interval between the placement of the order and receipt of delivery.

➢ Definition of Re-Order Quantity (ROQ)

• Re-Order Quantity (ROQ) implies the size of the material lot, for which purchase requisition is prepared by
the company’s stores department.
• At the time of determining the quantity to be re-ordered these factors are to be taken into account:
→ Maintenance of the minimum level of stock
→ Re-order level
→ Minimum delivery time, and
→ Total cost
• Re-Order Quantity should be fixed in such a manner that the sum of carrying cost and ordering cost is the least.
And to do so, Economic Order Quantity (EOQ) is calculated.

8. Inventory turnover
• The term turnover means the rate at which the goods are sold or the pace at which goods moves from
the shelves.
• It is also defined as the number of times an article is sold and replaced in a given period usually a year.
• Inventory turnover ratio equation is the cost of goods sold divided by the average inventory for the
similar period
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
• Inventory turnover = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
•
This ratio represents how effectively the inventory is managed in an organization. The department
expects to maximize the inventory turnover ratio by reducing the storage and holding costs and by
increasing sales
➢ Advantage
• The patient will be able to obtain the fresh and new inventory
• The risk of inventory expired due to long storage is minimized
• The ratio represents how effectively the inventory is managed in an organization
➢ Disadvantage
• It can be manipulated
• It does not represent the slow moving item
• Low values of turnover are obtained in following cases: 1.Duplication of stock 2.Large purchase of slow
moving
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9. FEFO and FIFO method

i) FIFO method
• FIFO is an acronym for First In, the First Out.
• It is a simple, highly versatile management method, or the way of organizing, handling and prioritization
of movement of material, data or anything else.
• Stocks are handled in the order they entered into the system.
➢ Advantages
• FIFO method is easy to understand and operate
• FIFO method is useful where transactions are not voluminous and prices of materials are falling.
• FIFO method is suitable for bulky materials with high unit prices.
• FIFO method helps to avoid deterioration and obsolescence.
• Value of closing stock of materials will reflect the current market price.
➢ Disadvantages
• FIFO method is improper if many lots are purchased during the period at different prices.
• The objective of matching current costs with current revenues can not be achieved under FIFO
method.
• If the prices of materials are rising rapidly, the current production cost may be understated.
• FIFO method overstates profit especially in inflation.
ii) FEFO-
• FEFO is an acronym of the words First Expired, First Out. In practice, usually just the acronym FEFO is
used.
• This is a simple, highly versatile management method, or way of organizing, handling and prioritization
of moving of primarily material or other commodities.
• Material requirements are serviced in the order of items with the earlier date of expiry regardless of
the date of entry or acquisition.
• FEFO is mainly used in the food industry and where it is necessary to monitor the expiration date or
period of durability
➢ Advantage
• These methods are used to reduce the chances of product not selling before their expiration date
and becoming obsolete
• Warehouse cost will be lowered by not storing goods in the warehouse for a long time
• By active stock rotation in a warehouse the chances of customers receiving outdated or poor quality
goods decrease and their confidence in the company increases
➢ Disadvantage
• Same as FIFO
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