Traditional Inventory System
Brijesh Patel
Definition
Inventory can be defined as a physical resource that a firm
holds in stock with the intent of selling it or transforming it
into a more valuable state.
There are many types of inventory:
Raw
Materials
Works-in-Process
Finished
Goods
Definition
Traditional inventory systems attempt to solve the inventory
management
dilemma
through
better
forecasting,
improvements in the order point / order quantity process, or by
adjusting safety stock levels.
However, order quantities, safety stock and lead time represent
only a minority of the sources of inventory problems.
Objectives
Improve customer service
Economies of production
Transportation savings
Hedge against future
To maintain independence of supply chain
Basic Features
Agreements
Agreement with supplier was basic part of traditional system
where focus was to avoid payment full price for incoming
inventory in advance.
It also involves demanding price contracts and discounts in
exchange of consistent orders for specific periods.
Today most of the interaction with suppliers is done in real
time with the on go payment options with suppliers as well as
delivery agents.
Manual monitoring of stock level
Simple eye assessment when a store manager would stand in the middle of store and
based on visual observations, decide which items are short in inventory and need
replenishment.
The system was also based on manual calculations being made on stock level using
Fixed Order Quantity
Inventory Storage
Large spaces were needed in warehouses to store inventory as at that time large
inventory only meant good delivery and service to customers.
Order placement
Orders were placed manually on a telephone, fax, mail, etc. unlike the modern
technology driven systems where integrated software system takes care of placing
and processing orders without employee input.
Classification Of Inventory
ABC
HML
XYZ
VED
FSN
SDE
SOS
ABC (Always Better Control)
This technique divides inventory into three categories A, B & C based on their
annual consumption value.
It is also known as Selective Inventory Control Method (SIM)
A Items: Very tight control, complete and accurate records, frequent
review.
B Items: Less tightly controlled, good records, regular review.
C Items: Simplest controls possible, minimal records, large inventories,
periodic review and reorder.
HML (High, Medium and Low )
The High, medium and Low (HML) classification follows the same
procedure as is adopted in ABC classification.
Only difference is that in (HML) High, Medium and low, the classification
unit value is the criterion and not the annual consumption value.
The items of inventory should be listed in the descending order of unit
value and it is up to the management to fix limits for three categories.
For example,
The management may decide:
All units with unit value of Rs. 2000 and above will be H items,
Rs.1000 to 2000 will be M items and less than Rs.1000 will be L items .
XYZ
On the basis of value of inventory stored
X High Value
Y Medium value
Z Least value
Aimed to identify items which are extensively
stocked.
FSN (Fast, Slow and Non)
Classification depends on the pattern of issues from stores
F Fast moving
S Slow moving
N Non Moving
It helps to avoid investments in non moving or slow items.
If there are no issues of an item during the period, it is N item.
Then up to certain limit, say 10-15 issues in the period, the item is S item
The items exceeding such limit of no. of issues during the period are F items.
The period of consideration & the limiting number of issues vary from organization
to organization.
SDE (Scare, Difficult and Easy)
Analysis is based upon the availability of items and is very useful in
the context of scarcity of supply
S refers to scarce items, generally imported, and those which
are in short supply.
D refers to difficult items, which are available indigenously but
are difficult items to procure.
E refers to items which are easy to acquire and which are
available in the local markets.
VED (Vital , Essential and Desirable)
VED classification is based on the criticality of the inventories.
Vital items Its shortage may cause havoc & stop the work in organization.
They are stocked adequately to ensure smooth operation.
Essential items - Here, reasonable risk can be taken. If not available, the
plant does not stop; but the efficiency of operations is adversely affected
due to expediting expenses. They should be sufficiently stocked to ensure
regular flow of work.
Desirable items Its non availability does not stop the work because they
can be easily purchased from the market as & when needed.
S-OS
Raw materials especially for agriculture units
S Seasonal
OS Off seasonal
EOQ (Economic Order Quantity)
EOQ or Fixed Order Quantity system is the technique of ordering
materials whenever stock reaches the reorder point.
Economic order quality deals when the cost of procurement and
handling of inventory are at optimum level and total cost is
minimum.
In this technique, the order quantity is larger than a single
periods requirement so that ordering costs & holding costs
balance out.
Assumptions
Demand for the product is constant
Lead time is constant
Price per unit is constant
Inventory carrying cost is based on average inventory
Ordering costs are constant per order
All demands for the product will be satisfied (no back
orders)
EOQ Model
Annual Cost
Holding Cost
Order Quantity
EOQ Model
Annual Cost
Holding Cost
Order (Setup) Cost
Order Quantity
EOQ Model
Annual Cost
Total Cost Curve
Holding Cost
Order (Setup) Cost
Order Quantity
EOQ Model
Annual Cost
Total Cost Curve
Holding Cost
Order (Setup) Cost
Optimal
Order Quantity (Q*)
Order Quantity
EOQ Formula Derivation
D=
C=
Q=
S=
I =
H=
Annual demand (units)
Cost per unit ($)
Order quantity (units)
Cost per order ($)
Holding cost (%)
Holding cost ($) = I x C
Total cost =
inv carry cost
Average inventory
units = Q / 2
$
= (Q / 2) x C
Cost to carry
average inventory = (Q / 2) x I x C
= (Q /2) x H
order cost
Take the 1st derivative:
d(TC)/d(Q) =
Number of Orders = D / Q
Ordering costs
= S x (D / Q)
(Q/2) x I x C + S x (D/Q)
(I x C) / 2
- (D x S) / Q
To optimize: set d(TC)/d(Q) = 0
DS/ Q = IC / 2
Q/DS = 2 / IC
Q= (DS x 2 )/ IC
Q = sqrt (2DS / IC)
Economic Order Quantity
2 D S
EOQ
H
D=
S=
C=
I =
H=
Annual demand (units)
Cost per order ($)
Cost per unit ($)
Holding cost (%)
Holding cost ($) = I x C
Problems
Poor execution
Poor communication
Poor decision-making
Poor execution, communication and decision making, coupled with
advanced inventory management systems leads to a vicious cycle,
ultimately reducing sales, profit margins and customer loyalty.
Thank You
