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INVENTORY MANAGEMENT MODULE-4

• Determinations of inventory • Control levels: ordering. • ABC Analysis . • Pricing of raw material. danger level • EOQ model. reordering. • Monitoring and control of inventories.

What Is Inventory? “…Those stocks or items used to support production.…supporting activities.…and customer service…” —APICS Dictionary .

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MEANING OF INVENTORY MANAGEMENT • Inventory management is concerned with keeping enough product on hand to avoid running out while at the same time maintaining a small enough inventory balance to allow for a reasonable return on investment. • Excessive level of inventory. . results in large inventory carrying cost.

An efficient system of inventory management will determine (a) what to purchase (b)how much to purchase (c)from where to purchase (d) where to store .

Inventory and the Flow of Materials .

To ensure continuous supply of raw material.Objects of inventory Mgmt. To maintain investments in inventories at optimum level. To minimize losses through wastage and damages . spares and finished goods.  To avoid both overstocking and under stocking of inventory. To keep material cost under control. To facilitates finishing of data . To eliminate duplication in ordering or replenishing stocks.

Inventory Positions in the Supply Chain Raw Materials Works In Process Finished Goods Finished Goods in Field .

 Precautionary motive: The precautionary motive is to provide a cushion in case the actual level of activity is different than anticipated.Need for Inventories  Transaction motive: The transaction motive for holding inventory is to satisfy the expected level of activities of the firm.  Speculative motive: The speculative motive is to purchase larger quantity of materials than normal in anticipation of making abnormal profits. .

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Relevant inventory costs which change with the level of inventory are listed below: .COST OF INVENTORIES • • • The determination of inventory cost is essentially an income measurement problem.

Inventory Costs – Item costs – Carrying costs – Ordering costs – Stockout costs 6-11 .

Space. factory O/H. Lost customer costs 6-12 . Customs duties. direct labor. Receiving etc. Visits. personnel. Lost sales costs. insurance Ordering Costs . Risk costs. and equipment 3. Calls Production Set-up. Transportation. Cost of Capital – Interest paid on the money tied up 2.Obsolescence. Insurance Carrying costs – 1. Stock-out Costs Back-order costs. pilferage.P O Paper cost / Follow-up. damage.Item Cost - Direct material. Storage costs . Inspection.

Strategies for addressing risk must be formulated.or months. 2) Sources & level of risk: Where there are substantial uncertainties & where the costs of stockout are important . This lead times may be few min. .CHARACTERISTICS OF INVENTORY SITUATIONS 1) Lead time: Obtaining inventory usually requires a time lag from the initiation of the process until the inventory starts to arrive.

. they do not lose their value completely overtime. In dynamic inventory problems. there can be no carryover of goods from one period to next. the goods have a one-period life. the goods have value beyond the initial period.3) Static versus dynamic problems: In static inventory problems.

. • Reducing the amount of works-in process by using just-in-time production. • Reducing the amount of finished goods by shipping to markets as soon as possible.Zero Inventory? • Reducing amounts of raw materials and purchased parts and subassemblies by having suppliers deliver them directly.

ABC Analysis.Purpose • To determine the type & degree of control required for each type of inventories. ABC system is a widely-used classification technique to identify various items of inventory for purpose of inventory control The technique is based on the assumption that: A firm should not exercise the same degree of control on all items of inventory It has classified inventory into:  The most costly  The slowest-turning  Items that are less expensive. .

intensive & sophisticated inventory control CATEGORY-B: Stand midway.B &C •    •    • • • • CATEGORY-A: It involves the largest investment. Required most rigorous.VARIOUS TECHNIQUES TO CONTROL INVENTORY A-B-C ANALYSIS: The materials are divided into three categories viz. CATEGORY-C: Involves small investment But the number of items is fairly large Deserve Minimum attention . Deserves less attention than A but more than C Controlled by employing less sophisticated techniques. A .

of items & inventory value Group A B C No.Inventory breakdown b/w no. of items (%) 15 30 55 Inventory value (%) 70 20 10 Total 100 100 .

Of Suppliers High Consumption Items Medium Consumption Items Low Consumption Items Total Items 40 10% Purchase Value Category 470 Cr 70% A 80 20% 134 Cr 20% B 280 70% 68 Cr 10% C 400 100% 672 Cr 100% .ABC Analysis: Nos.

A B C analysis 100 %By value C 5-10% 10-20% 70-80% A B % By units 0 % in values 100 .

B &C .  Rank the items in accordance with the total value. of units of each item to total units of all items & the ratio of total value of each item to total value of all items  Combine items on the basis of their relative value to form three categories – A. determining the expected use in units & the price per unit for each item  Determine the total value of each item by multiplying the expected units by its units price.Steps involved in implementing the ABC Analysis  Classify the items of inventories.  Compute the ratios (%) of no. giving 1st rank to the highest total value & so on.

Nil Safety Stock 4. Max. B items Moderate value Medium control C items Low value Loose control High consumption 2.. Central storage/ 8.2 sources Guestimmates Site storage No efforts for.A items 1. . Very strict control 3. Daily Deliveries 5. Accurate forecasts 7. Cost control Low safety stocks Weekly/ Monthly Few sources Estimates Storage in each plant Minimum efforts High safety st. Bulk/ Quarterly Max. Multi-sources 6.

 Price per unit of product is constant.Economic Order Quantity (EOQ)/Economic Lot Size (ELS) • EOQ refers to that level of inventory at which the total cost of inventory is minimum.  Inventory holding cost is based on average inventory.  Ordering costs are constant. ASSUMPTION  Demand for the product is constant & uniform throughout the period  Lead time (time from ordering to receipt) is constant. and  All demand for the product will be satisfied (no back orders are allowed) . • The total inventory cost comprising of ordering & carrying costs.

Determination of Optimum inventory Level Determination involves 2 types of costs:              Ordering costs: this cost includes: Requisitioning Purchase ordering Transporting Receiving Inspecting & storing. Clerical & staff . Carrying Costs: incurred for maintaining a given level of inventory. ordering cost increases with proportion the no. It includes: Storage insurance Taxes Deterioration & obsolescence. of orders placed.

on an average. a larger inventory level will be maintained. but they start rising when the decrease in average ordering cost is more than offset by the increase in carrying costs.EOQ: Carrying cost increases as the order size increases. cost Minimum total cost Carrying cost 2AO c Ordering Costs 2xquantity required x ordering cost Carrying cost Q* Order size Q . Total costs decline in the fist instance. & Ordering costs decline with increase in order size because a larger order size means less number of orders. because.

. .  • • • Costly Calculations: Cost estimating Cost of possession & acquisition & Calculating EOQ exceeds the savings made by buying that quantity. opportunity cost of capital.LIMITATIONS OF EOQ  Constant usage: unpredictably usage does not allow to predict -no formula will work well  Faulty Basic Information: Ordering & Carrying cost vary from commodity to commodity & with the co’s.

2. 3. needs to maintain optimum inventory level. i. 5.Order Point Problem At what level of inventory should the order be placed?  If the inventory level is too high it will unnecessary blocks the capital. &  If the level is too low.e. co. So. Minimum level Reorder level Maximum level Average stock level & Dangers level . Different stock levels are: 1. it will disturb production by frequent stock out &  Also involves high ordering cost. where there is no stock out & the costs re minimum. 4...

. (it lies b/w min.Formulas 1. Average quantity of raw materials consumed daily. Determinants: Lead time/procurement time : It is the no. & max. of days required to receive the inventory from the date of placing order.   Minimum Stock Level= Re-order level – [Average Usage x Average delivery time] 2.  Minimum Level: Minimum stock required for smooth flow of production. Reorder Level: the level of inventory at which an order should be placed for replenishing the current stock of inventory. stock level) Reorder Point = Lead time (in days) x Average Daily usage. Requirement of materials for normal or regular production or special order production.

Safety stock: To avoid stock out firm maintain safety stock. Re-order point = (Lead time (in days) X Averge usage ) + Safety stock 3. 5. Maximum Stock Level: its that level of stock beyond which a firm should not maintain the stock ( otherwise it will be overstocking) Maximum Stock Level = Reorder Level + Reorder Quantity – ( Minimum Usage x Minimum Deliver Time) 4. Average Stock Level= Minimum level + [Reorder Quantity / 2] Danger Stock Level: if the materials fall beyond the danger level it will disturb production. Danger Level= Average Usage x minimum Deliver Time (or emergency purchase) .