Inventory Management

Introduction

• Inventories constitute most imp part of CA


• On an average they are 60% of CA in public
limited co’s in India
Nature of Inventories
• Raw Material
• Work-in-progress
• Finished goods
• Supplies, Stores and spares

• The level of these inventories for a firm
depend on the nature of its business.
Need to hold inventories

• Transaction Motive

• Precautionary Motive

• Speculative Motive
Objectives of Inventory
Management
• 2 conflicting needs
– To maintain a large size of inventories
– To maintain a minimum investment in inventories

• Excessive and inadequate inventory are not
desirable

• Objective shd be to determine and maintain
optimum level of inventory

• Major dangers of over investment
– Unnecessary tie-up of firm’s funds and loss of
profit
– Excessive carrying costs
– Risk of liquidity

• Consequences of under investment
– Production hold-ups
– Failure to meet delivery commitment
Inventory Management Techniques
• How much shd be ordered?

• When shd it be ordered?

• Economic order Quantity (EOQ)
– EOQ is that inventory level that minimises the
total of ordering and carrying costs
– Ordering costs include transportation, preparation
of pur order, inspecting, etc
– Ordering costs increase with the no of orders

– Carrying costs include storage, insurance
deterioration and obsolescence
– Carrying costs increase with the increase in the
inventory
– EOQ is that order size at which annual total costs of
ordering and holding are the minimum
– Three approaches to determine EOQ are trial and
error approach, formula approach and graphical
approach




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AO
TOC =
2
Qc
TCC=
Q
AO
2
Qc
TC + =
c
AO 2
EOQ =
1
2
3
4
Q*
C
o
s
t
s

Ordering Cost
Order Size Q
Minimum
Total Cost
• Quantity discount
– Dis savings + savings in ordering cost – Additional
Carrying costs

– Dis savings = d x P x A
– Savings in ordering costs =



– Additional Carrying Costs =


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(

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÷ = ÷ =
' Q
A
* Q
A
O
' Q
A
O
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c
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c ÷ = ÷ =


• Reorder Point
– It is that inventory level at which an order shd be
placed to replenish the inventory
– Reorder Point = Lead x Av usage

• Safety stock
– Reorder Point = lead x Av usage + Safety Stock
ABC Inventory Control System
• ABC analysis tends to measure the significance
of each item of inventories in terms of its
value.
• The high value items are classified as ‘A items’
and would be under the tightest control. ‘C
items’ represent relatively least value and
would be under simple control. ‘ B items’ fall
in between these two categories and require
reasonable attention of management.

• The ABC analysis concentrates on imp items
and is also known as Control by Importance
and Exception (CIE)

• As the items are classified in the importance
of their relative value, this approach is also
known as Proportional Value Analysis (PVA)