Inventory Management

Nature of Inventory
Stocks of manufactured products and the material that make up the product. Stock of goods necessary to do business. Components:
raw materials work-in-process finished goods stores and spares (supplies)

Need for Inventories
Transaction motive

Precautionary motive

Speculative motive

Objectives of Inventory Management
1. To maintain sufficient inventories for efficient and

smooth production and uninterrupted sales operations
2. To maintain a minimum investment in inventories to

maximise profitability.(Minimise total inventory costs)
Aim of inventory management: avoid excessive and inadequate levels of inventories and to maintain sufficient inventory for the smooth production and sales operations.

Objectives of Inventory Management
Ensur ntinuous suppl of r t ri ls to f ilit t unint rrupt production Maintain suffici nt stock of raw at rials in periods of short suppl and anticipate price changes Maintain sufficient finished goods inventor for smooth sales operations and efficient customer service Minimise the inventor costs Control inventor investment maintaining optimum inventor

Decision areas in inventory management
What should be the size of the order?
ECONOMIC ORDER QUANTITY (EOQ)

At what level should the order be placed?
RE-ORDER POINT

Inventory Management Techniques
Economic order quantity (EOQ) Reorder point

Economic order quantity (EOQ)
EOQ is the quantity ordered at a time and for which the total inventory cost (carrying and ordering costs) is minimum.

It is the quantity ordered for which the carrying cost is equal to ordering costs.

INVENTORY COSTS
Ordering costs: requisitioning, order placing, transportation, receiving, inspecting and storing, administration Ordering costs vary in direct proportion to No. of orders (and inversely to order size) and inversely to size of inventory.

INVENTORY COSTS
Carrying costs: Warehousing(cost of storage space and of bins and racks and cost of maintaining to avoid deterioration eg refrigeration), handling, clerical and staff, insurance, interest on funds invested in inventories, spoilage in storage and handling, and obsolescence

BEHAVIOUR OF INVENTORY COSTS
Costs Total costs

Carrying costs

Ordering costs Quantity ordered

Qty ordered should minimise carrying and ordering costs. Trade-off between ordering and carrying costs is required

Economic order quantity (EOQ)

E O Q =
A O

2A O P c

EOQ = Economic Order Quantity = Annual demand in units = Cost per order

C = Carrying cost as a fixed percentage of the average value of inventory P = Purchase price per unit

Economic order quantity (EOQ)
Assumptions
The total demand/usage for a given period (one year) is known and demand rate is even throughout the period. Inventory costs are categorized as ordering costs and carrying costs. Cost per order is constant regardless of the size of order. Cost of carrying is a fixed percentage of the average value of inventory

Reorder Point
Reorder point under certainty
Reorder point = Lead time x average usage

Reorder point under uncertainty (safety stock)
Reorder point = (Lead time x average usage) + safety stock SAFETY STOCK FOR FULL PROTECTION AGAINST STOCKOUT Safety stock =Maximum possible usage ± Normal usage Safety stock =Maximum daily usage ± average daily usage x Maximum lead time x average lead time

Inventory Control systems
ABC analysis Just-it-Time (JIT) Systems

ABC analysis
Selective inventory controls -Different degree of control on different items. Inventory is classified in descending order based on money value into: Category A: high price items Category B-medium priced items Category C ±low priced

Category A B C

% of no. of items 15 ± 25% 20-30% 40-60%

% of value of items
60-75%

20-30% 10-15%

Control by importance and exception: maximum attention and tightest control to ³A´ items

GRAPH OF CUMULATIVE PERCENTAGE OF ITEMS AND CUMULATIVE PERCENTAGE OF USAGE
Cumulative usage of items (percentage)
100 80 60 40 20
A B C

25

40

60

80

100 Cumulative

percentage of items

JUST-IN-TIME (JIT) INVENTORY CONTROL
‡ JIT aims at maintaining a minimal level of inventory and rely on suppliers to provide parts and components µjust-in-time¶ to meet its requirements. ‡ Objective ± procure materials as required for use or by a customer. ‡ Features: ± Minimum inventory ± Frequent and smaller orders ± Timely delivery by proven suppliers ± Aims for Zero defect - TQM ± Minimise lead time

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