Inventory management in

manufacturing systems
Unit HBC 2402 ; BBIT-BCOM 4.2
POM
CHARLES NTHIWA

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Introduction; Definition of Inventory

1. Inventories means the stock of the product of a

company and components thereof that makes up the
product. It includes the raw materials, work in progress
and finished goods.
2. It is the physical stock of items a business or
production organization keeps at hand for the efficient
running of business or its production.

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Inventories are :-
1. Items in stock.
2. Usable but idle resoumrces.
Inventory control
Process of maintaining optimum needed quantity of
inventories for the smooth operation of an organization.

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Classification of inventories
• Raw material inventory
• In process inventory
• Indirect inventory

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Objectives of inventory control

The basic managerial objectives are 2 fold:-

1. Avoid over/under investment in inventories.
2. To provide right quantity and quality goods at right time at
proper value.
The objectives can also be classified into
3. Operational and or
4. Financial bjectives

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Operating objectives

1. Availability of Materials: All type of material available

at all time so that production may not be held up for
want of supply of materials.
2. Minimizing the wastage : permit only uncontrollable
wastage. Avoid wastage by leakage theft,
embezzlement, spoilage( rust, dust , dirt)

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3. Promotion of manufacturing efficiency:
• When right type of raw material is available at the right time.
4. Better service to the customers:
• Maintain proper production flow to produce sufficient finished goods
to meet the demand of the customers
5. Control of production level:
• To increase or decrease the production as per the demand as well as to
maintain proper buffer stock to meet any eventuality in difficult times.

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6. Optimal level of inventories:
• It is done in view as per the operational requirements. It also avoids
the out of stock danger.

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Financial objectives

1. Economy in purchasing:
• management makes every attempt to purchase the raw materials in bulk
quantity and to take advantage of favorable market condition.
2. Optimum investment and efficient use of capital:
• The finance management should set up maximum and minimum levels of
stocks to avoid deficiency or surplus of stock position.
3. Reasonable price:
• Management should ensure supply of raw materials at a reasonable low
price without sacrificing the quality of it thereby helping the cost of
production and quality of finished goods.
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Advantages of inventory

1. Delivery in time:
• stored inventory aids smooth production, for the manufacturing
company in order to earn reputation as a reliable supplier.
2. Possibility of discount on bulk purchase
3. Efficiently handle unforeseen circumstances.
4. No idling of workers and machineries.

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Disadvantages of inventory

1. Working capital tied up:

cannot utilize the amount for other purposes nor does it yield any interest.
2. More space required:
With more inventories, more space is needed and space accounts for rent.
3. Increase insurance charges:
Increased cost of handling and manufacturing.
4. Increased over head expenses:
Security personnel required to guard inventory.
5. Chances of damage: Pilferage, replacement, etc more.
6. Increased chance of obsolesce
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Inventory control
•Inventories constitute a significant part of the working capital.
•Inventory control is used in unit/physical control (purchase and
production unit) and value control (Accounts unit)
•When a firm feel shortage of finance it should take
more care in its inventories rather than anything else.

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Classification of inventories cost:
PURCHASE COST:
For items that are purchased from outside the firms, this is usually
the unit price that the firm pays to its vendor. As an item moves
through the logistics system of the firms, it purchase cost in the
inventory analysis should reflect its fully landed cost, by which is
meant the cost to acquire and moves the item to that point in the
system.

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ORDERING COST:
In addition to the per unit purchase cost, there is usually an additional cost
which is incurred whenever we order, reorder or replenish the inventory. If
we produce items internally then there will be an organization set up cost.
This happens because we have to shut down the manufacturing line and
change over, reconfigure the line to make a specific item.
This is the cost involved with processing the order, involving paying the bill,
auditing, and so forth.

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HOLDING COST:
The cost that accrue due to the actual holding of the inventory over a time
period. Many different kinds of cost can be considered as holding cost. The
key characteristics of holding cost varies with the amount of inventory being
held and the time that the inventory is held. The holding cost can further be
classified as follows:
• Storage cost
• Service cost
• Risk cost
•Capital cost.

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SHORTAGE COST:
When a demand arises which cannot be satisfied from available
inventory an inventory shortage occurs. Purchase, ordering and holding
cost can be thought of as the cost of having inventories, while shortage
cost result for not having inventory, or for not having enough inventory
at the right place at the right time.

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Economic Order Quantity (EOQ)
• It is the particular quantity at which the sum of cost of both the
ordering and inventory carrying cost is minimum.OR economic order
quantity is the order quantity that minimizes the total holding costs
and ordering costs
• Total cost = carrying cost + procurement cost
• Consumption rate
It is the rate at which the raw materials are consumed.
If we plot a graph between time and level of inventory the slope of the
graph gives the consumption rate

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• Constant consumption rate.
If the raw material is consumed at same rate over the same period of
time.
• Actual / irregular consumption rate
There will be variation in the production which leads to
different consumption rates at different time intervals.
Also influenced by factors like power failure.

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Replenishment.

• The process of refilling the material as and when it is consumed so that the
inventory level is maintained within a range .
• Types:-
1. Instantaneous replenishment- refilling is done at one

time, at one instant for the one full lot size.

2. Replenishment at constant rate- Usually practiced in industries especially the ones which
manufacture its own raw material.

3. Replenishment at irregular rate.- The inventory is not mrefilled at regular interval of

time.

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Lead time

Lead time is the time gap between starting or initiating the process of
ordering and receiving the ordered quantity in stores.
This is estimated by the past experience.
Lead time includes the following:-
1. Time taken to prepare purchase requisition and placing the order.

2. Time taken to deliver purchase order to vendor.

3. Time taken for the vendor to manufacture.

4. Time taken for transportation from vendors place to the stores.

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Reorder point

• This is the point which indicate that it is high time we place the order
failing which the stokes may get exhausted.
• Reorder point = lead time – predicted point of exhaustion.
E.g. If we order once in every 10 days and the lead time is 3 days then
ROP = 10 – 3 = 7 days.

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Lead time analysis
Lead time depends on :-
1. The urgency or importance of the components in the
manufacturing process.
2. Reliability of the vendors.

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Safety stock/Buffer stock
• To guard against disturbances of production process
either due to uncertainties in consumption rates or lead
times some extra stock is maintained.
•It serve the purpose of minimizing the chances of running
out of stock.
•It should not be very low or excess.
Safety stock come to play when there is :-
1. An excess rejection or wastage in production process than normal.
2. Rejection at the time of receipt due to
-Poor production quality by vendor.

- Damage to raw material.

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Uncertainty Factor
Uncertainty is the main reason for having safety stock.
It may be due to:-
1. Uncertainty of demand
2. Uncertainty of delivery.
3. Uncertainty of quantity.

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•Uncertainty of demand: there will be a difference between the
expected demand and the actual demand which is known as the
forecast error. It is mainly dependent on the buyers side.
•Uncertainty of delivery: depends on how long the lead time is going
to be. If something goes wrong with the suppliers production the lead
time may prolong.
•Uncertainty of quantity: this depends on how many scrap or
imperfect items the ordered quantity is going tocontain.

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Determination of safety stock
The level of safety stock to be maintained depends on various factors
like:-
-Cost of item in question
-Uncertainties in demand
-Negative fall out of stock of this item
-Spoilage due to long storage , etc.
Optimum safety stock = maximum lead time in amount normal
lead time in amount

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Disposal of obsolete and surplus material
Obsolete material:
Those materials or equipments which are not damaged and which have
economic value but are no longer useful for the company’s operations due to
change in production line. The term can be associated with equipments,
materials, stocks, techniques, etc.
Causes
1. Adoption of standardization: lead to elimination of non standard
varieties.
2. Adoption of new technology.
3. Changes in production design
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4. Cannibalization: when a machine breaks down, it is, sometimes
rectified by using components of an identical machine which is
already not functional.
5. Faulty purchases : it the purchases are made in bulk so that they
can last for a very long time.

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CALCULATING EOQ

A- Annual Consumption
O- Ordering cost per unit
I- Carrying cost per unit

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