INVENTORY MANAGEMENT

26.1. INTRODUCTION
An eftectve management is
of all the categories of necessary to ensure adequate
inventory supplies at optimum cost. The stuay
is carried out in detail with
the various orders that must
be placed. Additional regard to its size and frequency of
stocks. controls must be exercised on higher value
Since inventory is money, and makes a
attention inventory control.
to heavy demand of working capital, it
requires special
Inventory
Inventory can be defined as follows:
) Inventory is a detailed list of
movable goods.
() Inventory is a physical stock
of items that a business or
hand for efficient
running affairs or its production. production enterprise keeps in
of
(u) Inventory is the quantity of
given point of time.
goods, raw materials or other resources that are
idle at any
(u) Usable but idle resource.
Inventories consist of raw materials,
which are component
parts, supplies or finished assemblies etc.
purchased from an outside source, and the goods
Ihsimple words, 'inventories' refer to stocks held the manufactured in the enterprise itself.
by firm.
When the demand for
commodities increases, the
the inventory level increases. Howeverinventory
level decreases, while with
eplenishment
de not changes in the demand for a
the
under the control of the firm, but the amount commodity
and time of
Inventories are of following types: replenishment is controllable.

.Production Inventories. Raw materials, parts and

product in the production components which enter the firm's
procesS.
4Maintenance, repair, and operating supplies which are consumed but do
part of the not become
product.
n-process Inventories. Semi-finished products found at various stages
produetion operation. of the
4nished Goods
Inventories. Completed products ready for shipment.

599
 INDUSTRIAL ENGINEERING AND
600 MANAGEAMS
EMENT
Inventory v/s Stores
The words, inventory and stores are some times confused, these must therefore ho
clea
understood. Stores means all those articles which are kept in store, while inventory co-arly
stores as well as materials in transit, materials in process, finished products and stock
at distribution centres which have not been sold out.
at
company's show rooms and
Need for Inventory
Inventories in a business serve as the suspension system of an automobile. Ups and doun
sales are absorbed by inventory of finished goods. It enables a constant rate of production fod
firm, even if the source of supply are not too reliable, may be due to power shortage,
the
port
problem, labour unrest etc.
There are five reasons why a firm carries inventories:
) To gain economnie in purchasing beyond current requirements.
() To level out production cycles by producing to inventory.
() To carry a reserve in order to prevent stock-out or lost sales.
in transit.
w) To maintain service stocks while replacement stocks are

() Protection against variations in demand.

Thus an inventory helps in maintaining production rate and lowering manufacturing costs.
Acompany can have substantial savings by using a rational procedure for inventory management.
These savings are realised in several forms, depending on the particular situation. Some of the
common sources of such savings are:
) lower purchase cost,
(2) lower interest expenses,
Cui) increase in the availability of internal funds.
(w) lower operating costs (clerical, expediting, transportation, receiving etc.),
() dependable delivery schedules, and
(vi) better customer service in the supply of goods.
But keeping inventory also leads to :
a) Blocking working capital.
(6) Occupying space.
(c) Increasing risks of obsolescence, spoilage, theft, pilferage etc.

(d) Increasing maintenance and preservation costs.

Increasing insurance premium etc.

26.2. TYPES OF INVENTORIES

Inventories can be classified in two ways, namely: () according to needs, (i) accordingto tne
functions.
1. Clasification According to Needs
a) Economic lot Inventories: Since there is a fixed cost in ordering, hence
economical to order beyond the immediate needs and divide the fixed orderu hom
costs among a larger number of units. In addition, the manufacturer, from w
ada

purchases are made, gains from producing and shipping in large quantities, a scount.

portion ofthis gain can be passed on to the purchaser through quantity ais 2atch

(6) Fluctuation or Stabilizing Inventories: Since it is not always possible the o the

the timing of production and sales, some inventories are accumulated

 MANAGEME 601
ENORY
MEND me
tim lag between production and sales. Since
demand is also not aceura
aredicted,
pre
some reserve stocks are
necessary. These safety gtocks are fluctuabo
or stabiliz-ing inventories.

ticipation Inventories: These inventories are reguired to meet (i) season

c) demand and are produced and stocked throughout the vear in order to mee
high demand during the season,
(ii) the high demand during promo
nrogrammes launched by the firm, and (iii) the demand during temporary
sn
down of the plant tor repair or maintenance.
Transportation Inventories: These are also known as transit inventories. These
are () raw materals and supply inventories which are in transit and have alreau
been paid tor, and ( ) iished goods despatched to buyer and payments or
not received. wDic

9 Classification As Per Functions

Production Inventories: Raw materials, parts, and components required during
the production process are called production
inventories.
6) Maintenance, Repair, and Operation (M.R.O.) Inventories: These items are
consumed in production process and do not become a part of product, e.g,
lubricating oils, fuels, spare parts etc.
c)Inprocess Inventories:These are the items which are semi-finished and are waiting
for their turn at work place for further processing.
d) Finished Product Inventories: These are the finished goods and are completed
products ready for sale.
Materials in transit Inventories: Asdiscussed at 1 (d) above.

26.3. SYMPTOMS OFPOOR INVENTORY MANAGEMENT

Pollowing are the symptoms of poor inventory management
1. High rate of order cancellations.
2. Excessive machine down-time due to materials shortages.
3. Periodic lack of storage space.
adequate
4. Large scale inventories written-down because of price declines, distress sales, disposal of
obsolete or slow moving items.
.
Widely varying rate of inventory losses.
Large written-downs at the time of physical inventory taking.
.Continuous growing inventory quantitieS.
. Inability to meet delivery schedules.
.
Uneven production rate.

4. ASYTEMS
AS APPROACH FOR INVENTORY MANAGEMENT
Tis Pproach emph
ohasises that inventory should be managed by developing and then following
er systems. The rentories should be viewed in terms of the total system of production and
keting. The air inver
er effectiveness
aim of the systems approach is to reduce the size of inventories without destroying
 INDUSTRIAL ENGINEERING AND
602 MANAGEGEMENT
this regard.
Followinmg are some of the steps in
1. Better forecasting/material planning.
2. Fewer varieties.
3. Centralised inventories.
4. Developing a batch of reliable vendors to cater to the needs of a variety of items enaiu-
the right quantity, in right place and particularly at right time. suring
5. Effective follow u.
6. Control through reports at a regular frequency.
7. Effective budgetary control.
S. Following the scientific tools, like "Economic Order Quantity", "Selective Canto
bl
Techniques" etc.

26.5. INVENTORY CONTROL

Inventory control is the means by which material of the corrent quantity and quality is made
available as and when required with due regard to economy in storage and ordering costs, and

working capital.
It may also be defined "as the systematic location, storage and recording of goods in such a way
that desired degree of service can be made to the operating shops at minimum ultimate cost".
The Need of Inventory Control. The necessity of inventory control is to maintain a reserve
the production plan based on sales
(store) of goods that will ensure manufacturing according to
from improper inventory control
requirements and the lowest possible ultimate cost. Losses
include purchases in excess than what needed, the cost of slowed up production resulting from
down for lack of materials
material not being available when wanted. Each time a machine is shut
or each time sale is postponed or cancelled for lack of finished goods a factory loses money
To promote smooth factory operation and to prevent piling up or idle machine time proper
control can reduce such
quantity of material must be on hand when it is wanted. Proper inventory
losses toa great extent.

Functions of Inventory Control

Following are the most important functions of Inventory Control:
shelves and opeu
a) To r u n the stores effectively. This includes layout, storing media (bins, etc.
space etc.), utilization of storage space, receiving and issuing procedures
levels.
(b) To ensure timely availability of material and avoid built up of stock
() Technical responsibility for the state of materials. This includes methods of stor
maintenance procedures, studies of deterioration and obsolescence icies

(d) Stock Control System. Physical verification (stock-taking), records, ordering Po

and procedures for the purchase of goods. ponent

e)Maintenance ofspecified raw materials; general supplies, work in-process anu

parts in sufficient quantitiesto meet the demand of production.
( Protecting the Inventory from losses due to improper handling or storingo
unauthorised removal from stores.
g Pricing all materials supplied to the shops so as to estimate material cos
 M E N T O R Y M A N A G E M E N T

603

tial Steps
in Inventory Control
B s s e n

caential that the necessary materials shall be on hand when required and it is just as
i a l that no more stores shall be carried than is necessary. The maximum and minimum
sential.

ntitiesofal lstores should, therefore, be fixed with much care. In several cases, theae limits can
R Only by experience and careful observation. It is found that this results in a great reduction
bese
ofinventory.

of Inventory Control
Advantage
1, It creates buffer between input and output.

2. It ensures against delays in deliveries.

3. It allows for possible increase in output.
4. It allows advantage of quantity discounts.
5. It ensures against scarcity of materials in the market.
6. It utilizes the benefit of price fluctuations.
Hence, in conclusion with a good Inventory Control, a firm is able to make purchase in economic
hts maintain continuity of operations, avoid time consuming small orders, and guarantee prompt
delivery of finished goods.

Objectives of Inventory Planning and Control

The objectives of Inventory Planning and Control are to ensure
1. Timely availability of required materials or acceptable quality (Planning)
2. To avoid build-up stock levels by inflow of materials much inadvance of requirements or
accumulation of unwanted items which though ordered earlier, but not required now.
Itis the duty of the Production Department to intimate Materials Management Department
about the changes. In case, such information are not passed on to the material management
department, the inventory build-up is unavoidable and it is difficult to take up preventive action in
advance.

26.6. INVENTORY BUILD-UP

tory build-up starts because of the reasons, either (i) items get ordered in excess of the
rement or (ii) they do not get used at the same rate at which they are received.
0 Overcome the first possibility, orders should be placed after consulting the production
Helent.Production and Materials Management departments must togetherwork out the
chedules, which must be decided after considering the past performances of the suppliers.
OrBves nventories, get build-up because excessive quantities are received at a particular time.
e i v e , receiving the years requirement spread over 4 quarterly deliveries, is different from
e Atime. n one lot. In the second case the organisation istorced to carry inventory of 12 months at
Theoother
e r da
danger is that such material deteriorates in storage or pilferred or damaged.
Now
draing to the second aspect, stores inventory is consumed by the production department
a do aterials from stores and converting it into finished goods. If the consumption rate
Yof
y of the
the hen inventory build-up takes place. The consumption rate may fall down because of
following reasons:
1
Due to change in production plans.
i) Due to
discon
ontinuance of manufacture ofa product.
u e to
change in design for a particular assembly or set of components.
 604 INDUSTRIAL ENGINEERING AND MANAGEME
ENT
In such cases rescheduling of the deliveries or reducing the quantities of the pending ord
must be assorted to. In case the item is not required at all, the further supplies must be ston
and pending orders be cancelled. opped

Delivery Schedule
In order to control build-ups this aspect is most important. Production and material managemend
departments must, together, workout delivery schedules. This must be done consideringthepast
experiences. Inventories get build-up not only because excess quantities are ordered and received
but also because excessive quantities are received at a particular time. For example, receiving the
year's requiremenmt spread over 6 bi-monthly deliveries is different from receiving a six-monthlv
lots. In second case 6 months inventory has to be carried at a time.
Next stage, while ordering and accepting the supplies is to ensure that material received onlv
as per requirement. For this purpose following precautions are taken:
1. Availability of material into stock and material awaiting inspection from the past supply
should also be taken into account.
2. Care should be taken to accept the supplies only as per delivery schedule since, the
natural tendency on the part of suppliers is to,take deliveries as early as possible and in
as few lots as he can. Further, there is general belief in personnel, that timely supply
means, it should not be late, may be early, whereas it should not be too early, i.e.,
much before its requirement.

Actions to be taken for Avoiding Inventory Build-up

1. Items with no issues and receipts in last one year should be identified in the beginning
of the financial year. In consultation with production control and research and designs
department, all the pending openpurchase orders, if any, items should be cancelled.
2. In the cases where, items have been received without any issues in the past, matter
should be investigated. These investigations may reveal either of the following:
aItems are for new project and utilisation is expected to be started in near future.
(6) Items are received for the production planned a few months later.
(c) The item is a replacement for an obsolete item, but will be issued only after
existing stock of the obsolete item is exhausted.
d)The item is for a product whose production has been suspended or delayed due
to a temporary slump in the demand.
(e) Item is supplied much ahead of the requirement.
(The item is not required.
No action is required in the cases of (a), (b) and (c), whereas immediate action is called
for in the case of (d) and (e), rescheduling the deliveries and reducing the total order
quantities. In case of ), immediate stoppage of further supplies and cancellation O
pending purchase order has to be done.
3. A list of items which are in excess of predetermined levels should be prepared ana
investigation is to be done as to why the level has gone up and whether their suppnes
need to be slowed down.
4. Donot accept the following reasons for early supplies:
(a) We need the material any way.
(b) What difference does it make if we have a little extra stock.
lot
c
of
)Let us not
harass the poor supplier. Taking back the material will mean a
extra expenditure to him.
 E N T O R YM A N A G E M E N T 605

I f w e return the mater1al today, he may mot supply i n time on the next occasIO

etc.
of causing some inconvenience to the supplier, goods if received
a t the.risk in
a. at the
Therefore,
intimated
gdvanceo fi n t
delivery schedules should be returned back.

1rplus Materials
Disposal
of

I study is necessary
periodical.
obsolete or surplus (not being used from a
for finding onsiderable

Aperoms. These items must then be re-examined for their alternative use. If they could not be
peronvwhere in the concern they must be disposed of. Mode of disposal must be decided in
folleingpriority..:
S e n d it back on resale to the original supplier, if they are, interested, or otherwise.
h) Sell them at the best possible price. Ifit is not possible then.
(e) Sell it at any available price even at scrap value. In case, if it could not be sold at scrap
value or at any other rate, then.
(dGive away free, as there 18 no use of preserving it year after year and blocking the space.

26.7. QUANTITY STANDARDS IN INVENTORY CONTROL

There are five important quantity standards used as tool to control Inventory. These are as follows
(seeFig. 26.1)
1. The Maximum Stores.
2. The Minimum Stores.
3. The Standard Order.
4. The Ordering Point.
5. Lead or Procurement Time.

Maximum
Order

Usage

Reorder Minimum
Point
Standard Stock
Order
Reserve Stock

Time
Procurement
Time

Fig 26.1
1. The Maximun
u m Stores. This term is applied to designate the
upper limit of the:
and
Kepresents the largest quantity which in the interest of economy should Inventory
2.
kept in stores.
The Minimur
generally be
and nimum Stores. This term is applied to designate the lower limit of the Inventory
epresents a reserve margin of safety to be used case of emergency. When
or in

requirements
quantity have been abnormal it is intended that there must always be atleast ihis
available in stores.
 INDUSTRIAL GINEERING AND MANAGEMENT

606 purchased at any e. Repeat ow

Repeat
time. order for
It is the quantity to be revised.
S t a n d a r d Order. until this is
3. The for this quantity
a r e always required to ensure
a given
product the quantity
This represents of an orde
Point. b e t w e e n the placement
Orderimg
4. The during the interval
that a new pure
exhaustion of the
supply it is a n
i n d i c a t i o n
ase
balance falls to this level,
the
delivery. When
stock to reach from Re-order
order m u s t be
placed. point.

the time which takes the between

Time. It is the time that elapses the
5. Lead be defined a s
Stock level. It may also the need. If one ordem
Minimum time taken to satisty 18
of a need for
anything and the period is lead time. Hence t
voicing is fulfilled, then 40 days
and after 40 days it Load time determines the amone
palced today be placed 40 days earlier.
decreases, the reserve stock alsn
order should
shows that the the lead time
in r e s e r v e . As
of material to be kept time analysis 1s very necessary,
and the
vice versa. Therefore, the lead
decreases and
be made to reduce this period.
attempts should
Lead Time Includes:
of materials.
1. Requisitioning the order.
the enquiries and to place
2. Time to process
the order to supplier.
3. Time to deliver
to fulfil the order.
4. Time for the supplier inspection etc.
time to reach the purchaser,
5. Transportation i.e., order
Buffer Stock). If every thing goes as per programme,
6. Reserve (Safety
or
rate remains s a m e
and material is
at Reorder level, consumption stock. But this
is placed exactly no need for
r e s e r v e or safety
time then there is
received within lead uncertainties in
Therefore to safeguard
the production against
seldom happens. maintained all along and
this is
lead-time, a n extra stock is
consumption rate and
r e s e r v e stock or
buffer stock.
called as safety stock,
lower level may lead to stock
levels should be decided very carefully, as tor
Safety stock The factors considered
level m e a n s blockage of capital.
out positions and higher
t h i s purpose are:

1. Variation in consumption expected during the lead-time. 10r

market conditions
2. Variation in lead-time expected considering the prevailing
that item.
data of maximum lead-time ad
Generally safety stock is fixed considering the past
the difference betw
een

then be sufficient to last for the periodic

normal lead-time. Safety stock should
maximum and normal lead-time periods. idered
be consiuc
minimum and re-order quantities each item should
In setting maximum,
separately in terms of the following factors
a) Economic size of each purchase order.
(6) Increased lock-up of capital
(c)The time required toreceive the goods after requisitioing.
d) The probable depreciation and obsolescence.
(e The rate of demand etc.
 R Y MANAGEMENT 607
wVENTO

26.8.
SELECTIVE CONTROL TECHNIQUES
active Inventory Management' or 'Selective Control Techniques' are based on the priniciple
gelee inpossible to manage and control every item in inventory holdings in the same way and
thatitis
skillsoasto meet the two broad objectives of inventory control, i.e., to reduce investment in
sEOries, and also to avoid stock-outs and shortages. This technique, therefore, concentrates
inve
on items where it is justified either due to essentiality or amount of money involved.
those item

Therefore, in other words the approach is to evaluate a trade off between the cost of inventories
ainst cost of control. For example, the inventory of high value items (in terms of annual
e ) is to be controlled carefully, because a small percentage decrease in inventory can savea
1while in case of low value items, the cost of control may be more than the possible savings.
lot,
of the common techniques used for exercising selective control being described
Some
under.
are

here

) A-B-C Control Policy

Itis difficult and very costly to give equal attention to all the items of inventory. A-B-C analysis
is meant for relative inventory control in which maximum attention can be given to items which
consume more money and a fair attention can be given to medium value items, while the
attention for low value items can be reduced to routine procedure only. This policy can also be
applied in various other aspects of materials management.
If all the store items of an undertaking are analysed in terms of annual consumption of each
item in rupees, it will be found that nearly 10 percent (sometimes even less) of the items are
responsible for about 70 percent of total annual consumption cost, about 20 percent items will
require about 25 percent of total consumption cost and rest 70 percent of the items require only
5 percent of the total annual consumption cost. The first
category, small number of high
consumption cost items, are called A items ; second category of medium consumption value
items are known as B items; while the third category, i.e., large number of items with small
annual consumption cost are C items.
It is necessary to clear that A-B-C analysis does not depend on the unit cost of the items but
on its annual consumption. Further it 100
1s also clarified that it does not indicate
mportance of any item or category, and
every item is equally important. For
example while installing a big machine
OT lacs of rupees, some foundation bolts
cost may be nearly Rs. 100 or 200 only)
are notavailable in stores then this
nachine cannot be erected. Thus those
Dolts are equally important as that of
30
nachine although one is in categoryA
andanother in category C. B

A-B-C analysis is a basic technique 105

materials management and can be
Pplied over almost all the aspects of 70 95 100
% OF TOTAL COST
aterials management suchh as
Fig. 26.2
Purchase, sales, inspection, inventory
Control, store-keeping etc.
 INDUSTRIAL ENGINEERING AND MANAGEMEA
608
items are based on two principles. na
Thus we see that control policies for A, B and C
(tu) to e n s u r e that all the mata
) to keep capital tied up inventories as low as practicable, these two principles are
erials
des ibed
would be available when required. Control policies based on

hereunder:
Policies for A items
value hence they should be orderad
) Since these items account for 70% of the total
more frequently, but in small quantities in order to reduce capital locked up at anvti
ime.
(i) The requirement of such items must be planned in advance for expected future
consumption, so that only the required quantities arrive aittle before they are required
for consumption.
() Purchase of A items should be looked into by the top executives in purchasing department.
Ciu) Since A items should be stocked as minimum as possible, maximum etforts should be
nade to expedite the delivery. Deliveries withina specified period of order must be adhered to.
()Two or more suppliers for each item may be engaged, so that dependence on one
supplier is eliminated to safeguard against failure by one supplier.
(ui) Ordering quantities, re-order point and minimun stock level should be revised
frequently.
Policies for B items
T h e policies for B items, in general, arein between those for A and C items.
i) Order for those items must be placed less frequently than for A items. Generally 3 to 6
orders per year are placed for B items.

Policies for C items

Since C items do not involve much capital tie up, the stock for such items may be kept
liberally (.e., stock for 6 months to one year)
(i) Annual or 6 monthly orders should be placed to reduce paper work and ordering costs
and to get advantage of quantity discounts for bulk purchases.

(2) VED Analysis

The items can be classified according to their use, consumption, values etc. A-B-C
classification
is an oldest and commonly used method, but now-a-days VED and SDE
used. VED analysis is done to consider essentiality of
analysis are also being
stocking spares.
V stands for Vital items, without which
production would come to halt.
E is for Essential items, without which dislocation of
production work occurs.
Dis for Desirable items. Remaining items which do not cause
any immediate loss in producthon
fall under this category.
Thus, according to this system of analysis basis is
analysis basis was consumption of values. criticality of items, whereas in A-B-C
(8) SDE Analysis
This analysis is based on availability
position of each item. In this analysis,
S- refers to Scarce items, which are in short
includes imported items. supply and their availability is scarce. TH
D-refers to Difficult items, which cannot be
E-refers to Easily available items.
procured easily.
 ENTORYMANAGEMENT
609

M N GA n a l y s i :

i nt h i sa n a l y s i s ,

refers to
loving
Mov items. These items are consumed from time to time.
MN- refers
fors to
to Non-moving items. These items are those items which are not consumed in

last one year.

ofers to Ghost items. These are those items which had nil balance, both at the beginning
G and at the end of the last financial year and there were no transactions (receipt or
issues) during the year. These are non-existing items for which the store-keeper keeps
bin-cards showing nil balance.
ove mentioned 4 control techniques are commonly used. However, following are some
Above
a rmethods which help the materials management to selectively control the large number of
s and effectively channelise his energy to problem areas resulting in optimal use of his
tems

ettorts.

S.No.
Title Basis Application
1. F.S.N. (Fast, Slow, Non Issues from stores Obsolescence control
moving)

2. H.M.L. High, Medium, Low) Unit price of material To delegate purchasing powers
3. V.E.I.N. (Vital, Essential. Equipment criticality Maintenance
Important, Normal)
4. F.A.N. (Failure Analysis) Design and Issue of Reliability Engineer-ing
spares

5. G.O.L.F. (Govt. Ordinary, Source of origin of Purchase strategy

Local, Foreign) material
6. S.O.S. (Seasonal Off Nature of supply To decide stock level
seasonal1)

26.8. CODIFICATION
ltis an
effective tool of inventory control. Today it is used to
properly classify equipments, raw
aterials, components and spares to suit the particular needs of any organisation. Codification is
Bpful to prevent
Ormal practice of
duplication and multiplicity of stores and the mistakes which are
caused by the
describing the material.
The main features
of rationalised code are:
I t describes an article objectively
() It is an all-numeric
8-digit code and
) t describes an article progressively from general to particular.
For example:
(1) 03 01 15 15 Radian 12 SWg (size)
First two digits 03 indicate Arc Welding electrodes
Second two digits 01 Indicate Manual electrodes (local-M.S.)
Third two digits 15 indicate
Radian
Last two
digits 15 indicate 12 SWg (size)
PRO The COde has got enough flexibility to absorb all the materials of the
Sions for foreseen concern and has the
contingencies also.
 610
INDUSTRIAL ENGINEERING AND
First two digits indicate the main MANAGEMET
MENT
group, that is all the materials are divided
groups, say for instance 10 gases, 20 chemicals, 42 into 100
Third and fourth digit indicate the
screws, 64 hand tools etc. main
type of article. For example
21 XX Iron and Steel
21 10 Steel-Mild
21 01
Steel-Alloy WJQ
Fifth and sixth digits indicate the
shape and metallurgical conditions.
For exanmple:
21 10 10 XX Wire, Mild, steel
21 10 10 10 Wire, Mild, steel 0.116"
Thus, last two digits indicate the size.
In this way with the
help of codification materials are specified at every stage that is
main groups, types, in the
shapes and metallurgical conditions and sizes. For all the
length is constant and is useful for the use of materials, the code
punched cards and computers.
Now codification is
applied to all purchased items, i.e., raw materials, semi-finished
finished products, saleable and
products
and components.
26.10. ECONOMIC
ORDERING QUANTITY (E.0.Q.)
The evaluation of the most economic
two costs:
quantity to bepurchased involves calculation of the following
(a) Procurement cost or buying cost. Set up cost in case of manufacturing.
(b) Inventory carrying cost.
A. Procurement Cost or Buying Cost:
This cost includes the expenditure made on:
Calling quotations.
(i) Processing quotations,
(ii) Placing purchase orders.
(iv) Receiving and inspecting.
() Verifying and payment of bills.
(ui) Other incidental charges etc.
Set-up cost in case of manufacturing:
Itincludes
( Cost of setting up the process or equipment etc.
(i) Cost of scrap which may occur at the beginning of new operation.
(ii) Cost of planning production and controlling.
(iv) Cost of machine idle time during set up etc.
(b) Inventory Carrying Cost
This consists of expenditure made for:
) Insurance.
(ti) Storage and handling.
WENTORYMANAGEMENT
I 611
u) Obsolescence and Depreciation.
(iv) Deterioration.

(u) Taxes.
(Ui) Interest etc.

Rot manufacturing it will imclude, unit material, unit direct labour, all the unit burden

cepting
items affected by lot size.
This cost varies between 10 to 20% of the product cost.
is
The economic ordering quantity is obtained by the quantity whose procurement cost
cost.
Qual to inventory carrying
A = Total items consumed per year.
Let
P Procurement cost per order.
e = Annual Inventory carrying cost per unit.

= Unit cost x Inventory carrying charges =C xI

and Q Economic order quantity.

Let y Total cost of one year's requirement
Then, Total cost
= (number of lots) x procurement cost + (consumption

quantity X variable cost per unit) + (average inventory

cost Inventory carrying charges).

. (1)
y PtAxC+xCx1
be used to determine the total
cost.
This equation can
(1) to zero, the economic purchase order is
By differentiating w.r.t Q and equating equation
obtained.

APCxL =0 or 2
Thus 2

CxI =e
Therefore,
Q = 2 A P

or e

Q e2AP C
2AP . (2)
Or

by Mr. F.W. Harris in 1915.

ng formula w a s developed the most economical purchase
order size and the minimum
Equations (1) and (2),
hus using be obtained.
total
COst fora given set of
conditions can

by plotting the relevant cost against the

can be obtained
h e Economic Ordering Quantity
26.3)
E der
quantity, as below (Refer Fig
612 INDUSTRIAL ENGINEERING AND MANAGEMENT

.Total Cost

Inventory Carrying Cost

Ordering Cost

Y EOQ
Quantity per order
Fig. 26.3. Economic ordering quantity

Since the total cost curve is flat at the bottom we can deviate upto 25 percent on either side
of the economic ordering quantity, without any significant extra cost, depending upon the
circumstances. Therefore, for perishable items order can be reduced by 25 percent from E.0.Q,
where quantity discount is available, we can enhance the order by 25 percent over the E.0.0
Important assumptions in applying the E.O.Q. model:
1. Demand is continuous and constant, and does not change with time.
2. Lead-time is constant.
3. Delivery of all the items is instantaneous.
4. Replenishment of one item has no effect on the replenishment of any other item of
inventory.
5. Purchase price and their cost parameters, i.e., P and C are constant.
Problem26.1Aplantproducing a kineofhydraulic valves can supply the factory warehouse
attherate of 750/ month. The warehouse ship, 3000 valves per year at a unit selling price of R.
250. Considering the plant's ordering and set up cost of Rs. 300 and the inventory carrying cost
rate of 20%. What quantities should the warehouse order from the plant?
Solution.
Let Q= the quantity, the warehouse should order from the plant.
A No. of items consumed/year = 3000
P Ordering and set up cost/order = Rs. 300
C Annual inventory carrying cost/itemn

Total inventory carrying cost

Total No. of items consumed

3000x 250 x 20
= Rs. 50
3000x100
Now 2AP= 2x3000 x300
50
=
30,000
Q 189.7 say 190 units
Ans.
 NTORY VIANAGEMENT

hlem 26.2 The rate of a particular raw 613

d and receiving order is Rs. 40.
an material from stores is 20 units
rcent/year is 0.16 and it The cost of each unit is Rs. 100. Theper year. The cost
p l a c

entory in pDer
depends on the average stock. cost of
ntormine : () The econonic ordering
Dete
carrying
orderp o i n t . quantity (i) If the lead time is 3
Solution. Let months, calculate
Q Economic ordering quantity =?
A No.of units consunedlyear 20 =
P Ordering and set
C Annual inventory
up cost Rs. 40
carrying cost per unit
Total annual
inventory carrying cost
Total items consumed in a
year
20x100x0.16
20 Rs. 16

Q= 2AP 2x 20x 40
16
items. Ans. =
10
() To determine re-order point
Let Q Stock level at reorder point
a= Consumption rate
Lead time
Them a X to

Hence 20
a 19 items/month
12

to 3months
Q= ax to
20
x12 3 5 units.
hat is, when stock level reaches to 5 units, Reorder should be sent.
roblem 26.3 A company producing motors, decides to make a particular item
Thefollowing information isavailable. in batches.

setting-up machine and tools =Rs. 800

Annual rate ofdepreciation, interest etc. = 15%
onsumption of parts in assembly shop the100/month =

Processing of each item takes 8 hours

eSSLng machine
on

Lab
bour rate Rs. 10 per day (Assumme 8 hours in day)
= a
Matterial cost = Rs. 3 per kg Weight of each item = 15 kg.
hgtread expenses on each part is allocaled at 100% of the duration of machine run, assuming
nachine loading factor is about 80%.
 614 INDUSTRIAL ENGINEERING AND
MANAGEMEN
NENT
Solution.
Material cost of each part = 3x 15= Rs. 45

10
Labour cost of each part = x8 = Rs. 10

Prime cost of each part = 45 + 10 = Rs. 55

Overhead = 100% of 55 Rs. 55

Manufacturing cost = Rs. 45+ 10 +55 = Rs. 110

Now Economic lot size, 2 4 P

C
A = Annual items to be consumed
100 x 12 = 1200
P = Set up cost = Rs. 800

C Inventory carrying cost/unit

= 110x 0.15

2x 1200x 800
= 110x0.15

= 341Ans.

341x8
Running hours of machine 3410 hours. Ans.
0.80
Problem 26.4. Afactory is manufacturing Hubs in batches. The following details are
Cost of setting-up machine and tools = Rs. 1400
available
Annual rate of depreciation, interest etc. = 18%
Consumption of parts in assembly shop = 120/month

Processing of each item takes 6 hours on the machine

Labour rate = Rs. 20/ day for 8 hours
Material cost = Rs. 5 / kg

Weight of each item =4 kg.

Overhead on each item is allocated at 120% of the prime cost. Find out:
)Economic batch size for machining and
) Duration of machine run, assuming that the machine loading factor is about 90°%.
Solution.
Material cost = 5 x 4 = Rs. 20
Labour cost = Time for producton of each unit x hourly rate

20
=
6x
8
= Rs. 15.
Prime cost = Rs. 20 + 15 Rs. 35
Now overheads = 120% of prime cost
=
1.20 x
35 Rs. 42
Unit cost = Prime cost + Overheads
MENTORYMANAGEMENT
615

= Rs. 35 + 42 Rs. 77/ unit

N = 120 x 12 = 1440
C 77 Rs./unit, A = Rs. 1440, I =0.18
As,
2x 1440x 1400
7 7 77x0.18
144 x 4000x 100
11x18

144 x 40x 10*

= 11x18
= 534 (say)

Runnig hours of the machine

= 534x 6
3560 hours Ans.
0.90
Problem 26.5. Determine the economic order
cOnsunption rate is 80 units. The cost of each unit isquantity for a product whose average daily
Re. 0.50 and the inventory
is 0.20. The cost of placing and
receiving the order is Rs. 10. carrying charges
ear as 300, obtain the annual inventory Assuming total working days in a
capital also.
Solution.
) No. of units consumed/year,
A = 80 x 300

= 24,000 units

Ordering cost, P Rs. 10

Annual Inventory carrying charge/lunit,
C Re. 0.20
Economic ordering quantity,

Q C 2 4

2x 24,000 x 10
= 1549.2
0.20
say 1550 units.
=

0) Ans.
Annual Inventory capital Cost
=
of units consumed per year +Procurement cost/year +
Inventory carrying cost per year.
= 24,000+0.50 + +
xC
2

12,000 +24,000 x 10 + 1550x0.20

1550 2
=
12,000+155 +155 =Rs. 12,310Ans.
616 INDUSTRIAL ENGINEERING AND
MANAGEMENT
Problem 26.6.
(a)Explain the term economic order quantily.
(6) The total annual demand for an nventory ilem is 2,000 units. The Inventory carw
cost per rupee purchase value of Inventory per year is 10
paise. The order cost Der ord
is Rs. 5. The purchase price of the unit consists of two elements Rs. 2
40 as fixed charges per order.
per unit and Ro
Determine the economic order quantity and the order quantity per
year.
() If 100 more units are ordered over and above the economic order
order, what is the difference in total annual costs? quantity ner
2r

Solution. () Here

2AP
Q =

C
= Economicordering quantity
A = 2000 units
P Order cost per order = Rs. 5
C = Inventory carrying cost

Rs. 2+ x0.1(given in the question)

n =
No. of orders placed per year

2x 2000x5
Q

N944 0.1
or Q
2x10Q
2Q +40
Squaring both the sides,

2x 10°Q
(2Q+ 40)
or 2Q+40Q-2 x 105 = 0
or Q2+20Q-10 =0
This is a quadratic equation
Q = 306. 5 or -326.5

Taking Q = 306.5 say 307

2000
=
6.5 say 7
307
Eeonomic ordering quantity, = 307 Units Ans.
No, ofunits ordered 307x 7 =
2149.Ans.
 A N A G EEMENT
MENTORY ME

617
annual cost in first c
Total
units + rocurement cost + Inventory carrying cost.
Pro
Cost of

2149 2 5x7+0.1|20x2149
307
4578+ 35+457.80 Rs. 5070.80
annual cost i n 2nd case
Tbtal
Here 307+100 407
n= 7
Annual demand = 407 x 7= 2849
Procurement cost = 5 X n = 5 x 7 = 35
cost
and Inventory carrying
= 0.1 2+ x2849= 597. 80
407
40
Cost of units = Rs. 2849 | 2+
407
Rs.5978
Total cost = 5978 +35 +597.80

Rs. 6610.80
. Difference in the total annual cost
6610.80-5070.80 Rs. 1540 Ans.

26.11. INVENTORY MODELS

the order size which minimises the
identify the relationship quantify
to
ne inventory models
models, we shall first discuss, the meaning of
otal cost. Before going into details of inventory
models.
Models
relationship which approximate the real world situation, These
DMels aim at creating a set of of computation and gives satistactory results. Models are very
Simple from the point of view are structures invoiving relationships among- concept."
gul in decision-making. "Models
the scientitic approach tor selecting a best alternative, and
DConomic theorv deals with ich laws describing regularities in economic
the basis of whicl on
Onstructs aSimplified
sin model ofreality dependent variable with
r e l a l o n s n p ot a given
deals with the
Vehaviour are derived. A model
our are
ne or more independent variables.
antitative models, Allocation models, Queuing or waiting line
models, Allocation
Quantitative
odlaples of
:
amples models are tory Network scheduling models.
models. Netwo
models a r e models. or
Inventory
Simulation models, be solved by concentrating only on some
world thus
can

Com problems of the practical This

of reaity, which we may construct in
approximatior
uplex
eyleatures detai
in many forms, and the particular form selected
insted of every M o d e l s existin:

variousi forms are r e called

as
'model.

The
d e c i s i o n - m

modification,
a k i n g
through models is (a) economical to construct
if required, (6) Convenient to analyse and
Pends upon the purpose.
and its
modificati,

Compared to a
situation

actual
 ING ANDANAGEMENT
618

experiment as compared to those with complex decision-making with these

situations, and (c) decision-making wi#
models is quick.
Types of Models
Models are of different types, some of them are:

Predicitive
() Descriptive
(u2) Nominative
(u) Inconic
() Analog
(U7) Symbolic
(7) Deterministic
( i ) Probabilistic
Predictive Models. This indicate that "If this occurs, then that will follow".
() Descriptive Models. These provide descriptive picture of a situation and do not predict
or recommend e.g. organisation chart.
)Nominative Models. These provide the best answer to a problem, e.g. economic lot size
model.
(w) Inconic Models. These retain some of the physical characteristics of the things they
represent, e.g., Three dimension scale models.
() Analog Model. These employ one set of properties to represent sonme other set o
properties which the system being studied possesses, e-g., frequency distribution charts,
flow charts etc.
(u) Symoblic Model. These use symbols to descibe the real world, e.g, quantitative
models, allocation models, queuing models, inventory models, simulation models and
network or scheduling models.
(ui) Deterministic Models. These determine the output (representing the solution) from
a set of input values, e.g, Profit = Revenue - Costs.

(uii) Probabilistic Models. These involve probability distributions for inputs and provide
a range of values of atleast one output variables with a probability associated with each
value. These models assist decision-making under conditions of risk (uncertainty).
Inventory Models
Inventory models mainly deal with two decisions, namely:
1. How much to order at one time, and
2. When to order this quantity to minimise total cost.
side,
These models are suitable both for (a) buying items for production purposes from ours
and (6) producing them with in the firm to meet the demand of customers. It is extre
difficult to form ulate one common model which takes into account all variations in real sys
s are
Even if such a model is developed, it will be difficult to solve it. Therefore, inventory mode
developed for specific purposes only. Inventory models, some times known as Economie r
Quantity Models', are of following two types:
(1) Deterministic models.
(2) Probabilistic (Stochastic) models.
 rORY M A N A G E M E N I

MENTORY
619
DETERMINISTIC MODELS
6.12. D E

(MODELS ASSUMING CERTAINTY)

nodels while
le while
determining Economic
hese

Lot Size' or "Optimum Lot Size' makeOrdering Quantity', which some times
onomic
following known as
(9 Exa demand
is known for given assumptions:
period.
Demand is uniform and constant (finite)
(i) Demand is
() Cost of order is same regardless of size.
over a
period of time.
Price of raw materials are stable.
Holding cost is proportional to the amount
nventory is held. E.0.G. models under of inventory as well as the time for
which
different situations are explained hereunder:

7
Time
Fig. 26.4

26.13. INSTANTANEOUS REPLENISHMENT MODELS

In this situation
supply is received
hold good. instantaneously. All other assumptions as mentioned above
26.13.1. No
Shortage Situation
In thistype of instantaneous
Let A =Annual
replenishment model, no
shortages are allowed.
P
consumption rate
Procurement cost per order.
C Annual Inventory carrying
and Q cost per item.
Economic ordering quantity.
Then,
Procurement cost/year No. of orders
placed in a year X Cost per order
AxP

and .(1)
Inventory carrying cost/year
Average value of Inventory in a year X Annual inventory carrying costitemn
C
.(2)
AxP
Total cost =
Q
QxC
2
(3)
620 INDUSTRIAL ENGINEERING AND
MANAGEMENT
This total cost will be minimum, when

AxP QxC
2

2 A P

or
C

1/2
OT

Hence most economic ordering quantity

2AP
4)
Notel: Some times, Cis given as H+ ip.
Where, H= Holding cost.
i = Interest rate.

p price per unit ofitem.

Note 2:If
L Lead-time in days.
R Inventory consumption rate in units per day.
Reorder Point = LR.

Note 3:
If Bis the buffer stock which is required to be maintained,
Reorder point =
B+ LR

Reorder Point

Buffer Stock

Fig. 26.5.

Example 26.7. Calculate E.O.Q. for an item, if its annual usage rate is 600 units, procureme
cost is Rs. 20 per order, cost per piece is Rs. 100, and inventory carrying cost is 10%.
Solution. As we know that,

2AP
Q C
where, A = 600
P= 20
and C 10% of 100 10.
MENTORY M A N A G E M E N T

621

Q = 2x 600 x 20
= 48.98
10
dtace the size of order is
of orders per year
preferred to be
same, each time
alumber therefore, first, we calculate the
600
48.9812(Say) (rounded)
Hence E.o.Q = 600
12
=
50 units. Ans.
Example 26.8.
Requirement of an
item in a
rie of
rce which Ks. 20
1s
manufacturing concern is 250,000 per year, the
per
thouSand, the cost of
dering is Rs. 12 per order.
Determine E.O.Q. holding stock is 10% per annum, and the
cost of
Solution.
Since E.O.Q = 2AP
where,
C
considering one unit of material as 1000
A= 250 pieces for simplifying the
p Rs. 12
calculations;
C= 10 % of 20 Rs.2

E.0.Q. = 2 250x12
2
54.77 or 54770
items
Therefore number of orders = 260,000
54770
=
4.56
=
Say 5 (rounded).
E.0.0. 250,000
50,000. Ans.
Example 26.9. A manufacturer is
prce of each item is Rs. 10. required to purchase 2500 pieces of an
funud out Ordering cost is Rs. 60 and inventory item per year. The
carrying cost is 20% per year,
a)What should be
ordering quantity?
6) Number of orders
issued per year.
) Order
interval, considering 300 working days in a
yeaar.
Solution. Since E.O.Q =
where, A= 2500
P Rs. 60
C 20 % of Rs. 10 =
Rs. 2

E.O.Q. = 2x 2500x 60
2
 INDUSTRIAL ENGINEERING AND MANAGEMENT
622

= 387.2. Ans.

Number of orders/year = 2500/387.2 = 6.46

(6)
s a y 6 Ans.
300
(c) Ordering interval 6 0 days. Ans.
6

2500
Note:Quantity to be ordered/order = 6
= 416.6 or between 410 to 420 (rounded)
Example 26.10. A manufacturing concern buys 60,000 items each year The cost of each item
is Re 1.00 and the ordering cost is Rs. 80 per-order. Holding cost per year is Re 0.20. Taxes,
nsurance and interest togather are charged at the rate of 15%. Determine

Order quantity
(6) Number of orders placed in a year
(c) Time between orders if working days per year are 300.

Solution. Since, E.0. C2AP

where A == 60,000 items
P 80
C H+Fip
= 0.20 + .15 x 1 = 0.35.

2x60,000x 80
E.O.Q. = 0.35
= 5237

60,000
In order to have full number of orders
5237
= 11.46, i.e. 12

60,000 5000 items Ans.

@) Order quantity
12
(6) Number of orders = 12Ans.

300
c) Order interval =
25 days Ans.
12
Example 26.11. A manufacturing concern has a demand of 10,000 pieces of a particular
item. Each item costs Rs. 2, ordering % cost is Rs. 80 per order and inventory carrying cost 13

25%. Past lead times are 15 days, I13 days, 26 days, 12 days and 10 days. Calculate
a) E.O.Q.
(6) Safety stock.
(c) Normal lead-time consumptlion.
(d) Average inventory.
Reorder level.
 ENTORY M A N A G E M E N T

Solutior As we know that, 623

2AP
E.OQ C
Whère, A = 10,000 items

P= Rs.80
C 0.25 x 2 0.50

(a) E.0.Q = 2x10,000x 80

2000 0.50
=
1788
= 1788

say considering full number of orders

b) Safety stock = (5) a year Ans. in
(Maximum lead tinme Normal
lead-time) x monthly consumption.
-

Normal lead-time +13+25+12 +10 1

=

5 30
15
30 months.

Safety stock=30
=26 30)
15 10,000
30 12
= 278
say= 280 to 300
(c) Normal lead-time units Ans.
consumption
16 10,000
30 12
=
417 units Ans.
(d) Average inventory

Maximum+ Minimum
2

(2000+300)+300
2
=
1300 units Ans.
e)Reorder level
=
Normal lead time consumption
=
417+ 300
717 +safety stock
unit =

One xample
ans.
26.12. A
Oder is Rs. 150 andparticular item in a factory has a demand of 10,000 units
O the holding cost is Rs. 2per unit per year. Cost of
per year: If
Shortages allowed, determine:
are replacement is instantaneous
(c) E.O.Q
S (b) Total cost per year if the cost of one unit is Re 1.
Solutiom. Since,