Objectives Of This Presentation

 Identify functions and characteristics of inventory.

 Understand the nature and objectives of inventory management.
 Know the motives of holding inventory in a manufacturing firm.
 Reveal undesirable consequences of excessive levels of inventory.
 Explain the techniques and strategies of inventory management.

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 What is Inventory?

 Many understand the word inventory, as a stock of goods.

 In a manufacturing organization, in addition to the stock of

finished goods, there will be a stock of partly finished goods,
raw materials, and stores. The collective name of these entire
items is ‘inventory’.

 A physical resource that a firm holds in stock with intent of

selling it or transforming it into more valuable state.

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 Types Of Inventories

Raw material: Basic materials that are converted into finished

products ready for consumption.
Work- in- process: The stage at which further process is required to
reach the final stage of production.
Finished goods: The stage of the products which are ready for
dispatch for consumption.
Stores and Spares: It is a marginal portion of the total inventory.

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 Motives for Holding Inventory

1. Transaction Motive

2. Precautionary Motive

3. Speculative Motive

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 Benefits of Holding Inventory

 Continuous production
 Continuous supply market
 No stock-out problem
 Cost saving
 More margin of profit
 Scarcity

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 Costs Associated with Inventory
 Ordering costs:
Costs incurred in placing order with suppliers of raw materials,
consumables and other inputs are called ordering costs.
Larger the order size lower the cost per unit.

Cost(Rs.) Ordering Cost

Size Of Inventory
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 Carrying costs:
It consists of:
• Warehousing
• Insurance
• Handling
• Deterioration

These costs are more as the level of stock is higher. These costs are
also known as holding costs.

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 Consequences of Excessive Inventory

 Unnecessary tie up of funds

 Interest burden
 Low profitability
 Deterioration in quality of goods
 Excessive carrying costs

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 Inventory Management

 Inventory management is the process of ordering, handling, storing,

and using a company’s non-capitalized assets - AKA its inventory.

 Inventory management all comes down to balance - having the right

amount of stock, in the right place, at the right time.

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 Objectives of Inventory Management

The primary objectives of inventory management are:

 To minimize the possibility of disruption in the production schedule

of a firm for want of raw material, stock and spares.

 To keep down capital investment in inventories.

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 The effective inventory management should:

 Ensure continuous production.

 Anticipate price changes and take advantage of it.
 Control investment and keep inventory at optimum level.
 Maintain sales operations and delivery commitments.
 Increase operational efficiency and production levels.
 Minimize the carrying cost and time.

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 Inventory Control Techniques

To achieve this objective the firm should determine the optimum level
of inventory by answering the following two questions. They are:
* How much should be ordered?
* When should it be ordered?
The first question, how much to order, relates to the problem of
determining the economic order quantity and the second one is
identification of reorder point.

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 EOQ(Economic Order Quantity)

Definition: The EOQ model attempts to determine the order size of an

item that will minimize the total inventory costs* and also ensuring
availability of that item whenever needed.

 Total inventory cost = Total carrying cost + Total ordering cost

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 Components of EOQ

D: Annual Quantity Demanded

Q: Volume per Order
S: Ordering Cost (Fixed Cost)
C: Unit Cost (Variable Cost)
H: Holding Cost (Variable Cost)
I :  Carrying Cost (Interest Rate)

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Graphical Representation

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 Assumptions of EOQ

 Demand is constant and uniform

 The lead time is zero

 Only ordering & carrying costs are associated with inventory

 Carrying cost is fixed & cost per order is constant

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 Re-Order Point

 Level at which firm places fresh purchase order

 Depends upon:
• Lead Time or Delivery Period
• Rate of Consumption of Inventory

Reorder Point =(Average daily unit sales * Delivery Lead Time) + Safety
Stock

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 Safety Stock

Inventory held to accommodate against unforeseen circumstances.

Counter delays in shipping, inventory loss or sudden increase in
demand.

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Example

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 Inventory Management Control Systems

ABC Analysis

Just-in-Time System Approach

Out-sourcing

Computerized Inventory Control System

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 ABC (Always Better Control) Analysis
• It is an analytical approach that tends to measure the significance of
each item of inventories in terms of its value.

The ABC analysis concentrates on important items and is also known as

control by importance and exception (CIE).
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 Graphic Presentation of ABC Analysis
120

Percentage of Inventory Values

100

80

60
(Value) Item A Item B Item C

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20

0
10 20 30 40 50 60 60 80 90 100

Percentage of Inventory items

(Quantity)
 Advantages of ABC Analysis

 Control on costly items

 Scientific method

 Help in Utilization

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 Companies that use ABC-Analysis

H&M

Amazon

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 Just-in-time (JIT) System

It is a form of inventory management that requires working closely with

suppliers so that raw materials arrive as production is scheduled to
begin, with a goal to maintain minimum inventory on hand and reduce
costs.

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 Advantages of Just in Time

 Reduction of wastage and overproduction

 Reduction in obsolete inventory and stock
 Minimizes raw material on hand
 Lowers cost
 Reduces work-in-progress goods
 Improves cash flows

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 Companies that use JIT

Toyota

Dell

Harley Davidson

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 Out-sourcing

 Out-sourcing is a system of buying parts and components from

outside rather than manufacturing them internally.

 Many companies develop a single source of supply, and many others

help developing small and middle size suppliers of components that
they require.

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 Companies that use Out-Sourcing

Apple

Nike

Tata Motors

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 Computerized Inventory Control System

 It is an automatic system of counting inventories, recording

withdrawals and revising the balance.
A computerized inventory control system enables a company to easily
track large items of inventories.
 There is an in-built system of placing order as the computer notices
that the reorder point has been reached.
The computer information systems of the buyers and suppliers are
linked to each other. As soon as the supplier’s computer receives an
order from the buyer’s system, the supply process is activated.

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Companies that use Computerized Inventory Control
System

Amazon

Walmart

D-Mart

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 Some Other inventory control systems
Two-Bin System-
This is a simple method used usually in warehousing where in an item is
stored in two locations or bins in a warehouse and the stock is
replenished in the first bin from the second bin once the first bin is
consumed completely. The required quantity to be filled in the second
bin is placed for ordering.
Three-Bin System-
It is similar to two bins system with a third bin at the suppliers' location.
The supplier will not manufacture spare parts for the manufacturer until
the reserve bin is emptied.

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Fixed order quantity-
The Fixed Order Quantity is the inventory control system, wherein the
maximum and minimum inventory levels are fixed, and maximum and fixed
amount of inventory can be replenished at a time when the inventory level
reaches the auto set reorder point or the minimum stock level.

Fixed Period Ordering-

The Fixed Period Ordering is an inventory control system, wherein the
order for the replenishment of inventory items is sent periodically or
after a fixed time interval. 

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Measures to assess the inventory management :

• Work in process turnover ratio :

(Cost of completed work)/(Average work in progress)

• Finished goods turnover ratio :

(Cost of goods sold)/(Average stock of finished goods)
Measures to assess the inventory management :

• Average age of inventory :

(Average inventory) / (cost of goods sold (COGS))*365

• Inventory turnover ratio

 Inventory Turnover Ratio

An accounting ratio that establishes a relationship between the revenue cost,

more commonly known as the cost of goods sold and average inventory
carried during the period.

• It signifies how much of stock held by the business has been converted into
sales.

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 Calculation of Inventory Turnover Ratio

Inventory turnover ratio = (Cost of goods sold)/(Average Inventory)

Inventory turnover days = 365/(Inventory turnover ratio)

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 Analysis of High Inventory Turnover Ratio

Merits :
Augmented sales
Reduces chances of going obsolete
Fewer blockages of funds

Demerit in the form of augmented operating costs.

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 Inventory Turnover Ratio (Automobile Industry)
except calculated ratios and days

Cost of Change in Inventories

of Finished Goods, Cost of Inventory Inventory
Opening Closing Average materials Work-in-Progress and Revenue from Turnover Turnover
Company Inventory Inventory Inventory consumed Stock-in-Trade Operations Ratio Days

Hero
MotoCorp 1470 1123 1296 20846 29 20874 16.1 22.7

Bajaj Auto 1494 1231 1362 22170 188 22358 16.4 22.2

Maruti
Suzuki 30500 35331 32916 397387 (919) 396468 12.0 30.3
Inventory turnover ratio between 8 to 12 is considered good.
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 Observations

Maruti Suzuki’s inventory turnover ratio is comparable.

Hero Motocorp and Bajaj Auto have high inventory turnover ratios.

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 Inventory Turnover Ratio (FMCG Industry)
except calculated ratios and days

Cost of Change in Inventories

of Finished Goods, Cost of Inventory Inventory
Opening Closing Average materials Work-in-Progress and Revenue from Turnover Turnover
Company Inventory Inventory Inventory consumed Stock-in-Trade Operations Ratio Days

Nestle 14165 15802 14984 61541 (627) 60914 4.1 89.8

Hindustan
Unilever 338 389 364 1587 (2) 1585 4.4 83.7

ITC 947 1000 973 1606 (57) 1550 1.6 229.3

Inventory turnover ratio between 4 and 6 is considered good.
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 Observations

Nestle and Hindustan Unilever have comparable inventory turnover

ratios.
ITC’s inventory turnover ratio is far below from what is considered
good.

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 Inventory Turnover Ratio (Paint Industry)
except calculated ratios and days

Cost of Change in Inventories

of Finished Goods, Cost of Inventory Inventory
Opening Closing Average materials Work-in-Progress and Revenue from Turnover Turnover
Company Inventory Inventory Inventory consumed Stock-in-Trade Operations Ratio Days

Asian
Paints 2970 4480 3725 13838 120 13958 3.7 97

Berger
Paints 1847 2385 2116 5769 180 5949 2.8 130

Nerolac
Paints 1117 1608 1363 4013 281 4294 3.2 116
Inventory turnover ratio between 2 and 4 is considered good.
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 Observations

Inventory turnover ratio of all the companies is comparable.

Berger Paints included manufacturing expenses along with avg
inventory.
Asian paints has the highest revenue from sales.

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 References

Pandey, I.M., Financial Management, Vikas publishing Home, New

Delhi.
 R.S. Chadda, Inventory Management in India, (Mumbai Allied
publishes,1971).
 Prasanna Chandra, Financial Management : Theory and Practice, Tata
Mc Graw Hill, New Delhi.
 Inventory data from annual reports of respective companies

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THANK YOU.

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