INVENTORY CONTROL

Introduction:

 In majority of the organization, cost of the material is a main part of selling price of
the product. The interval between the receiving the purchased parts and
transforming them into final products varies from industries to industries depending
upon cycle time of manufacture.
 Materials are procured and held in the form of inventories.
 It acts as a buffer between supply and demand for efficient operation of the system.
 Stocking of anything that is tangible in order to meet the future demand is called
inventory theory.
Inventory:

 Inventory is a detailed list of those movable items which are necessary to

manufacture a product and to maintain the equipment and machinery in good
working order.
 It represents those items which are either stocked for sale or they are in the process
of manufacturing or they are in the form of materials which are yet to be utilized.
Ex – money kept in the shape of HSS bit MS rod milling
Inventory control:

 It may be defined as the scientific method of finding out how much stock should be
maintained in order to meet the production demands and be able to provide right
type of material at right time in the right quantities and at competitive prices.
 The objectives are
1. To minimize investment in inventory
2. To maximize the service levels to the firm’s customers and its own operating
department.

Types of inventories:
1. Raw inventories (raw materials):
 Raw materials and semifinished products supplied by another firm which are
raw items for present industry.
 Raw materials are those basic unfabricated materials which have not
undergone any operation since they are received from the suppliers. Ex –
round bars, angles, channels, pipes etc
2. Work-in-progress inventories:
 Semifinished products at various storages of manufacturing cycle
 The items or materials in partially completed condition of manufacturing
3. Finished inventories:
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 They are the finished goods lying in stock rooms and waiting dispatch.
4. Indirect inventories:
 The inventories refer to those items which do not form the part or the final
product but consumed in the production process.
Eg – machine spares, oil, grease, spare parts, lubricants
 For proper operation, repair and maintenance during manufacturing cycle.
Reasons for keeping inventories:

 To stabilize production
 To take advertise of price discount
 To meet the demand during replenishment period
 To prevent loss of orders
 To keep pace with changing market conditions
Inventory control:

 Keeping track of inventory

 It is a planned approach of determining what to order, when to order and how much
to order and how much to stock so that costs associated with buying and storing are
optimal without interrupting production and sales.
 When should an order placed
 How much should be ordered order quantity

Objective of inventory control:

 Purchasing material at economical price at proper time and in sufficient quantity as
not to run slow
 Providing a suitable and secure storage location
 To maintain timely record of inventories of all the items
 A definite inventory identification system
 Adequate and responsible store room staff
 Suitable requisition procedure
 To provide a reserve stock
Advantages or benefits of inventory control

 One does not face shortage of materials

 Materials of good quality and procured in time minimized defect in finished goods.
 Delays in production schedules are avoided
 Production forgets are achieved
 Accurate delivery dates
 Economy in purchasing

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Inventory control terminology:

1. Demand:
It is the no. of items (products) required per unit of time. The demand may be
either deterministic or probabilistic in nature.
2. Order cycle:
The time period between two successive orders is called order cycle.
3. Lead time:
The length of the time between placing an order and receipt of items is called
lead time.
4. Safety stock:
It is also called butter stock or minimum stock. It is the stock or inventory
needed to account for delays in materials supply and to account for sudden
increase in demand due to rush orders.
5. Inventory turnover:
It the company maintains inventories equal to 3 months consumption it
means that inventory turnover is 4 times a year i.e. the entire inventory is
used up and replaced 4 times a year.
6. Reorder level:
It is the point at which the replenishment action is initiated. When the stock
level reaches ROL the order is placed for the item.
7. Reorder quantity:
This is the quantity of material to be ordered at the reorder level. This
quantity equals to the EOQ.

Cost associated with inventory

1. Purchase (or production) cost:
The value of an item is its unit purchasing or production cost.

2. Capital cost:
The amount invested in an item is an amount of capital not available for
other purchases.
3. Ordering cost:
It is also known as procurement cost or replenishment cost or acquisition
cost.
Two type of costs- Fixed costs and variable costs.
Fixed costs don’t depend on the no. of orders whereas variable costs change
w. r. t the no. of orders placed.
I. Purchasing:
The clerical and administrative cost associated with the
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 purchasing, the cost of requisition material, placing the order,
follow up, receiving and evaluating quotations.
II. Inspection:
The cost of checking material after they are received by the
supplier for quantity and quality and maintaining records of
the receipts.
III. Accounting:
The cost of checking supply against a given level of hand and
this cost vary in direct proportion to the amount of holding
and period of holding the stock in stores.
This includes-
I. Storage costs (rent, heating, lighting etc.)
II. Handling costs (associated with moving the items. Such as labour cost,
equipment for handling)
III. Depreciation, taxes and insurance
IV. Product deterioration and obsolescence
V. Spoilage, breakage
Economic order quantity:
How much materials may be ordered at a time. An industry making bolts will
definitely like to know the length of steel bars to be purchased at any one time. i.e. called
EOQ.

An economic order quantity is one which permits lowest cost per unit and is most
advantageous.

Starting from an instant when inventory OA is in the stores, it consumes gradually

in quantity from A along AD at a uniform rate. We know it takes L no. of days between
initiating order and receiving the required inventory. As quantity reaches point B,
purchase requisition is initiated which takes form B to C that is time R. from C to D is the
procurement time P. At the point D when only resource stock is left, the ordered material
is supposed to reach and again the total quantity shoots to its maximum value i.e. the
point A’(A=A’)
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Maximum quantity- OA is the upper or max limit to which the inventory can be kept in
the stores at any time.

Minimum quantity- OE is the lower or minimum limit of the inventory which must be
kept in the stores at any time.
Standard order (A’D) - It is the difference between maximum and minimum quantity and
is known as economical purchase inventory size.

Reorder point (B)- It indicates that it is high time to initiate a purchase order if not done
so the inventory may exhaust, even reserve stock utilized before the new material arrives.
From B’ to D’ it is lead time and it may be calculated on the basis of past experience.

It includes-

a) Time to prepare purchase requisition and placing the order.

b) Time taken to deliver purchase order to the seller
c) Time for seller to get or prepare inventory
d) Time for inventory to be dispatched from the vendor’s end and to reach the
costumer

Inventory procurement cost:

1. Receiving quotations
2. Processing purchase requisition
3. Following up and expediting purchase order
4. Receiving material and then inspect it
5. Processing seller’s invoice
Procurement cost decrease as order quantity increases.

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Inventory carrying cost:

1. Interest on capital investment

2. Cost of storage facility, up-keep of material, record keeping

3. Cost involving deterioration and obsolescence
4. Cost of insurance, property tax.
Carrying cost directly proportional to the order size or order quantity
Mathematical derivation of EOQ:
Let Q is the economic lot size or EOQ

C is the cost for one item.

I is the cost of carrying inventory in percentage per period

P is the procurement cost associated with one order

U is the total quantity used per period.

𝑇𝑜𝑡𝑎𝑙 𝑞𝑢𝑎𝑛𝑡i𝑡𝑦 𝑈
No. of purchase orders to be furnished = =Q
𝐸0Q

Total procurement cost = No. of orders × cost involved in one order

𝑈
=Q×𝑃

Average quantity = Q/2

Inventory carrying cost = average inventory × cost per item × cost of carrying inventory in %
Q
= 2×𝐶 ×𝐼

Total cost (T) = a + b

𝑈
=Q×𝑃 + Q ×𝐶×𝐼
2

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 𝑑𝑇
To minimize cost, =0
𝑑Q

 𝑑 (𝑈 𝑃 + Q 𝐶𝐼) = 0
𝑑Q Q 2
 - UQ-2P + CI/2 = 0
 Q2 = 2𝑈𝑃
𝐶𝐼

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 2𝑈𝑃
 Q= √
𝐶𝐼

Problem-1:

I. Annual usage (U) = 60 units

II. Procurement cost (P) = Rs 15
III. Cost per price (C) = Rs 100
IV. Cost of carrying inventory (I) = 10 %
Calculate EOQ.
Answer:

2𝑈𝑃
Q= √ 𝐶𝐼

2 ×60 ×15 ×100

=√ = 13.41
100 ×10

60
No. of orders per year = 13.41 = 4.47 ≅ 5
60
∴ EOQ = = 12 units (rounded)
5

Problem-2:
The rate of use of a particular raw material from stores is 20 units per year. The cost
of placing and receiving on order is Rs 40. The cost of each unit is Rs 100. The cost of
carrying inventory in percent per year is 0.16 and it depends upon the average stock.
Determine the order quantity. If the lead time is 3 month, calculate the reorder point.

Answer:

U = 20 units

P = Rs 40 /-

C = Rs 100 /-

I = 0.16

2𝑈𝑃 2 ×20 ×40

EOQ = √ = √ 100 ×0.16 = 10
𝐶𝐼

L = 3 months

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 12 months = 20 units
20
3 months = 12 × 3 = 5 units

Problem-3:
Find economic order quantity from following data.

Average annual demand = 30000 units

Inventory carrying cost = 12 % of the unit value per year

Cost of unit = Rs 2 /-

Answer:

Given, U = 30000

I = 12 %

P = 70

C = 2 /-

2𝑈𝑃 2 ×30000 ×70 ×100

EOQ =√ =√ = 4183.3
𝐶𝐼 2 ×12

30000
No. of orders = 4183.3 = 7.17 ≅ 7
30000
EOQ = 7
= 4285.7 ≅ 4286 (rounded)

ABC analysis:

ABC analysis helps differentiating the item from one another and tells how much
valued the item is and controlling it to what extent is in the interest of an organization.

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1. A-items:
A items are high valued but are limited or few in number. They need careful
and close inventory control and proper handling and storage facilities should
be provided for them.
A items generally 70-80 % of the total inventory cost and 10 % of the total
items.
2. B-items;
B-items are medium valued and their umber lies in between A and C items.
They need moderate control. They are purchased on the basis of past
requirements.
B-items generally 20-15 % of total inventory cost and 15-20 % of the total
items.

3. C-items:
C-items are low valued, but maximum numbered items. These items do not
need any control. These are least important items, like clip, all pins, washers,
rubber bands. No record keeping is done.
C-items generally 10-5 % of the total inventory cost and constitute 75 % of
the total items

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Advantage
I. Better planning and control
II. Increase inventory turn over
III. Effective management and control
Disadvantage

I. Periodic review to be dfdf

Procedure

1. Identify all the items used In industry

2. List all the items as per their value.
3. Count the no. of high valued, medium valued and law valued items
4. Find the % of high, medium and low valued items
High valued contribute – 70% of total inv. Cost
Medium valued contribute -20% of total inv. Cost
Low valued contribute-10% of total inv. Cost
5. A graph can be plotted between % of items and % of total inventory cost

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