Unit 4

Materials Management
And
Inventory Management

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 Topics
> Material Management
> Inventory Management
> ABC Analysis
> Economic order qunatity(EOQ)

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 Material Management
Material Management is the process of planning,
purchasing, receiving, storing and providing the
appropriate material with right quality, right
quantity, at right place, in the right time

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 Objectives of Material
Management
• To maintain steady flow of material for uninterrupted
production
• To ensure consistancy of quality and quantity of material
• To maintain record of purchase, storage, and supply
materials
• To preserve materials in stock in order to avoid
pilferage, deterioration
• To achieve economy in cost of material by using different
techniques like JIT, Kaizen, ABC analysis, etc.
• To reduce operating cost by eliminating wastages

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 Functions of Material
Management
• Material planning: Estimating demand and quality required and
preparing material budget
• Market research for purchase
• Purchasing: Selecting right method of purchasing, choosing right
source, Placing order, follow up
• Developing reliable suppliers
• Procurement: It refers to quality check, inspection and testing of
the purchased material
• Store management: conservation of materials in store, efficient
handling, proper stocking and maintaining store record
• Inventory control: Timely availability of materials at min. cost
• Value analysis of costly material
• Packaging
• Waste management

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 Inventory
Inventory is a detailed list of all kinds of goods
handled by the business.

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Different types of Inventory
1. Raw Material:
- Purchased raw items, semi-finished component, standard
sub-assemblies puchased from suplliers.
2. Components:
- parts or subassemblies used in final product
3. Work in Progress:
- All materials at various machines on shop floor.
- It include products at various stages of production, semi-
finished products
4. Finished goods:
- It is a material ready to be shipped to customer
5. Indirect Material:
- Tools, spare parts
- Consumables like lubricants, stationary etc.

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Types of Inventory

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 Inventory Management

Inventory management is the process of ensuring

that a company always has the products it needs
and that it keeps costs as low as possible.

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 Objectives of Inventory
Management
1. Operational Objectives
i. Service to customer: Prompt supply to customer
ii. Continuity of productive operations
iii. To avoid excess inventory
2. Financial Objectives
i. Effective use of capital
ii. Economy in buying
3. Property protection objectives
i. To keep inventory safe against wastage, damage and
theft
ii. To minimize losses due to deterioration and
obsolescence (uselessness)

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Inventory Investment Measures Example:
The Coach Motor Company has annual cost of goods sold of
$10,000,000. The average inventory value at any point in time is
$384,615. Calculate inventory turnover and weeks/days of supply.

Inventory Turnover:

Weeks/Days of Supply:

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 Relevant Inventory Costs

Item Includes price paid for the item plus other

Cost direct costs associated with the purchase

Holding Include the variable expenses incurred by the

Costs plant related to the volume of inventory held
(15-25%)
Capital The higher one-time expenses incurred on
Costs the purchase of land, buildings, construction,
and equipment used in the production of
goods or in the rendering of services.

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 Relevant Inventory Costs
Ordering Fixed, constant amount incurred for each
Cost order placed
Shortage Loss of customer goodwill, back-order
Costs handling, and lost sales

Risk Obsolescence, damage, deterioration,

costs pilferage (theft), and taxes

Storage Included the variable expenses for space,

costs workers, and equipment related to the
volume of inventory held 13
Determining Order Quantities
Lot-for-lot Order exactly what is needed
Fixed- Specifies the predetermined number of
order units to order whenever an order is
quantity placed

Min-max Places a replenishment order when the

system on-hand inventory falls below the
predetermined minimum level.

Order n Order enough quantity to satisfy total

periods demand for the next n periods
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 ABC Inventory Analysis
ABC classification is a method for determining level of
control and frequency of review of inventory items
 A Pareto analysis can be done to segment items into
value categories depending on annual dollar volume

 A Items – typically 20% of the items accounting for

80% of the inventory value
 B Items – typically an additional 30% of the items
accounting for 15% of the inventory value
 C Items – Typically the remaining 50% of the items
accounting for only 5% of the inventory value

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ABC Analysis

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 ABC Analysis
In ABC analysis all purchased items are classified in
different
categories.

Clas % of Total Fund

% of Purchase
s of number of Allocatio Importance
total cost items Rate
Item n

A 80 20 Frequent Highest Highest

B 15 30 Intermediate Medium Medium

C 5 50 Infrequent Lowest Lowest

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 Steps of ABC Analysis
a) Prepare the list of all consumed
items

b) Sort the list as per their value

c) Separate and count the number of

coslty, medium and low valued items

d) Find out % of high, medium and low

valued items

e) Plot the graph, % of items against

percent of annual consumption cost

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The XYZ Corp. is considering doing an ABC analysis
on its entire inventory but has decided to test the
technique on a small sample of 15 SKU’s. The annual
usage and unit cost of each item is shown below

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(A) First calculate the annual
dollar volume for each item

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B) List the items in descending order based on annual $ volume.
(C) Calculate the cumulative annual dollar volume as a % of total $.
(D) Classify the items into groups

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 Graphical solution for XYZ Corp showing
the ABC classification of materials
• The A items (106 and 110) account for 60.5% of the value and 13.3% of the
items
• The B items (115,105,111,and 104) account for 25% of the value and 26.7% of
the items
• The C items make up the last 14.5% of the value and 60% of the items
• How might you control each item classification? Different ordering rules for
each?

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 Advantages of ABC
Analysis
▧ Costly, medium and lowest priced items can be
easily identified
▧ Helps managers to have selective control and
focus attention only on important items
▧ Provides a tool to decide frequency of
purchasing
▧ Provides a tool to decide volume of pruchasing
▧ Results in reduction of inventory cost

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 Disadvantages of ABC
Analysis
▧ Costly items gets more importance and lowest cost
items gets least
▧ Item may not be costly but it may be critical for
production
▧ Seasonal variations have no consideration in the
analysis
▧ Periodic reviews and reports becomes difficult because
of the item cost variation

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 Mathematical Model for
Determining Order Quantity

Economic Order Quantity (EOQ)

• An optimizing method used for determining order
quantity and reorder points
• Part of continuous review system which tracks on-
hand inventory each time a withdrawal is made
• It is the quantity of the order which needs to be
inventoried that minimizes the total cost of inventory
management.

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 EOQ Assumptions
• Demand is known & constant - no safety stock is
required
• Lead time is known & constant
• No quantity discounts are available
• Ordering (or setup) costs are constant
• All demand is satisfied (no shortages)
• The order quantity arrives in a single shipment

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 Basic Fixed-Order Quantity Model
and Reorder Point Behavior
1. You receive an order quantity Q. 4. The cycle then repeats.

Number
of units
on hand Q Q Q

R
2. Your start using them L L
up over time. 3. When you reach down to a level
Time of inventory of R, you place your
R = Reorder point next Q sized order.
Q = Economic order quantity
L = Lead time
 Total Annual Inventory Cost with
EOQ Model
Total annual cost= annual ordering cost + annual holding cost

Holding cost – H, Ordering cost – S, Annual Demand – D, EOQ – Q

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Continuous (Q) Review System Example:
A computer company has annual demand of 10,000. They want
to determine EOQ for circuit boards which have an annual
holding cost (H) of $6/unit, and an ordering cost (S) of $75. They
want to calculate TC and the reorder point (R) if the purchasing
lead time is 5 days.

EOQ (Q)

Reorder Point (R)

Total Inventory Cost (TC)

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Economic Order Quantity (EOQ)

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 Cost Minimization Goal
By
Byadding
addingthe
theitem,
item,holding,
holding,andandordering
orderingcosts
costs
together,
together,we
wedetermine
determinethe
thetotal
totalcost
costcurve,
curve,which
whichin in
turn
turnis
isused
usedtotofind
findthe
theQQopt inventory order point that
opt inventory order point that
minimizes
minimizestotal
totalcosts
costs

Total Cost
C
O
S
T Holding
Costs
Annual Cost of
Items (DC)

Ordering Costs

QOPT
Order Quantity (Q)
Basic Fixed-Order Quantity (EOQ) TC=Total
TC=Totalannual
annual
cost
Model Formula cost
DD=Demand
=Demand
Total Annual Annual Annual CC=Cost
=Costperperunit
unit
Annual = Purchase + Ordering + Holding QQ=Order
=Orderquantity
quantity
Cost Cost Cost Cost SS=Cost
=Costofofplacing
placing
an
anorder
orderororsetup
setup
cost
cost
RR=Reorder
=Reorderpoint
point
LL=Lead
=Leadtime
time
H=Annual
H=Annualholding
holding
and
andstorage
storagecost
cost
per
perunit
unitof
ofinventory
inventory
 Advantages of EOQ
▧ Unnecessary storage of the raw material is
avoided
▧ EOQ avoids running out of stock
▧ Ensures pre-decided delivery dates
▧ EOQ avoids effects like proce fluctuations and
shortage of material in the market
▧ Material shortage and excess material
situation
can be avoided

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