INVENTORY MANAGEMENT

What is inventory?
A physical resource
that a firm holds in
stock with the intent of
selling it or
transforming it into a
more valuable state.

Purpose of
inventory
management
• How many units to
order?
• when to order?
discount
Types of Inventories
 Reasons To Hold Inventory
 Meet variations in customer demand:


Pricing related:

 Temporary price discounts
 Hedge against price increases

 Take advantage of quantity discounts

Process & supply surprises

 Internal – upsets in parts of or our own processes
 External – delays in incoming goods

12/10/09 6
 Objective of Inventory
Management
 To maintain a optimum size of inventory for
efficient and smooth production and sales
operations
 To maintain a minimum investment in inventories
to maximize the profitability
 Effort should be made to place an order at the
right time with right source to acquire the right
quantity at the right price and right quality

12/10/09 7
 An optimum inventory level involves
three types of costs
Ordering costs:- Carrying costs:-
 Quotation or tendering  Warehousing or storage

 Requisitioning  Handling
Order placing
 Clerical and staff


 Transportation  Insurance

Receiving, inspecting and

 Interest


storing  Deterioration,shrinkage,

Quality control Clerical and


evaporation and
 staff obsolescence
Stock-out cost 

 Loss of sale 

 Failure to meet delivery

commitments
12/10/09 9
Motives for Holding Inventory
Transaction Motive
Precautionary Motive
Speculative Motive
 Inventory
Costs

Carrying cost

•cost of holding an item in

inventory

Ordering cost

•cost of replenishing inventory

Shortage cost

•temporary or permanent loss of sales

when demand cannot be met
Economic Order Quantity (EOQ)
Models

•We want to determine the optimal

number of units to order so that
we minimize the total cost
associated with the purchase,
delivery and storage of the
product.
Let Q be Economic Order Quantity
A be Annual Requirements of material
in units
O be the cost of placing an order
C be cost of carrying one unit per
year

Q= √ 2 x A x O

C
From the following data, work out the EOQ of a
particular component.
Annual Demand : 5000 units
Ordering Cost : Rs. 60 Per order
Price Per Unit : Rs. 100
Inventory Carrying Cost : 15% on average inventory
A company has an expected usage of
50,000 units of certain product . The cost of
processing an order is Rs. 20 and the
carrying cost per unit is .50 for one year.
Lead time on an order is 5 days and the
company will keep a reserve supply of two
days usage. You are required to calculate
a)The economic order
 Inventory Order
Cycle

Order quantity, Q
Demand
rate

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
placed placed
receipt receipt
 Fixation of Inventory Levels
Maximum Level- It indicates the level above which the actual
stock should not exceed. If it exceeds, it may involve unnecessary
blocking of funds in inventory. While fixing this level, following
factors are considered
Maximum Usage
Lead Time
Storage Facilities
Prices & Nature of material
Availability of Funds
Minimum Level- it indicates the level below
which the actual stock should not reduce. It
may involve the risk of non-availabililty of
materials while fixing this level, following
factors are considered
•Lead Time
•Rate of Consumption
Re-Order level
It indicates the level of material
stock at which it is necessary to take
steps for procurement of further lots
of material.
Maximum Lead time X Maximum
Usage
ABC Analysis

Large firms have to maintain several types of

inventories. It is not desirable to keep the same
degree of control on all the items. The firms should
pay maximum attention to those items whose value is
highest. The firm should be selective in its approach
to control investment in various types of inventories.
This approach is called ABC Analysis.
Category % of Total % of Total Type of Control
Value Quantity

A 70 10 Strict

B 25 30 Moderate

C 5 60 Loose

Total 100 100

 ABC Analysis
Divides inventory into three
classes based on
Consumption Value
Consumption Value = (Unit price of an item) (No. of units
consumed per annum)

Class A - High Consumption

Value
Class B - Medium Consumption
Value
Class C - Low Consumption
Value
Steps involved in
implementation of ABC
Analysis
Classify the items of inventory, determining the
expected use in units and price per unit.
Determine the total Values of each item
Rank the items in accordance with the total value,
giving first rank to item with highest total value
Combine items on the basis of their relative value to
form three categories- A, B & C. Book 1
 ABC
Analysis
A
80 –
Items
70 –
60 –
50 –
40 –
30 –
20 – B Items
10 C Items
| | | | | | | | | |

– 10 20 30 40 50 60
70 80 90 100
% of inventory items