INVENTORY

MANAGEMENT
 Inventory Management
It is the most important constituent of a
supply chain network of an organisation.
Inventory Management supervises the flow
of goods from manufacturers to warehouses
and from these facilities to point of sale.
 The act or manner of
managing, handling, directing
or controlling the flow of
inventory.
 Definition
• According to Donald Waters "Stock consists of all
the goods and materials that are stored by an
organization. It is a store of items that is kept for
future use. An inventory is a list of the items held
in stock".
• According to Gordon Carson ”Inventory control is
the process whereby the investment in materials
and parts carried in stocks is regulated, within pre-
determined limits set in accordance with the
inventory policy established by the management .”
Motives of Holding Inventory
1. Transaction Motive

2. Precautionary Motives

3. Speculation Motives
 1. Transaction Motive
a. To meet Unpredictable demand of the
Customer
b. To achieve Economies of Scale
c. Seasonal Availability
d. Favorable Market Conditions
 2. Precautionary Motives
a. Hedge for uncertainty
b. To maintain safety stock
c. To cover for Errors
 3. Speculation Motives
a. It is defined as an attempt to generate profit by
trading in inventory without processing it.
b. When raw material are available at favorable
market conditions, an organization buys more
than its requirement.
c. The surplus material so purchased is kept as
stock to be further sold when prices rise in
future.
 Objectives of Inventory Control

1. Reduction in cost

●
By ensuring smooth and uninterrupted flow of production
●
Guaranties economies of scale
●
Help in taking benefits of quantity discount

2. Ensure investment of optimum capital

●
Ensures that stock is kept only of required minimum quantity
●
Helps in increasing inventory turnover leading to minimum investment in inventory.
3. Classification of Inventory

●
Helps inventory manager to concentrate on the stock that constitutes highest
proportion of total cost

4. Smoothen the Production Process

●
Continuous supply of raw material is required
●
In absence of it, the production may stop which will lead to escalation of cost.
5. Help Reduce losses

●
Helps in proper maintenance of inventory an avoid losses due to
obsolescence, deterioration, leakage and evaporation

6. Systematic Record

●
Helps top management to make proper plan for its best usage and
maintenance
Components of Inventories
1. Raw material and purchased parts
- Raw materials are used by manufacturer to convert
them into components, sub assemblies and finished
goods.
2. Work in Progress
- The raw material in the incomplete production
process
- It includes the full cost of raw material that has
been partially converted and cost of labour and
overhead directly apportioned in it.
3. Finished Goods
The finished Goods are the product that
are the result of production process. The
stock of finished goods is maintained at the
following two levels:
• a. By Producer
• b. By Retailers
4. Maintenance, Repair and Operating
Equipment's (MRO)
a. MRO items are used in the production
process but does not become part of the
Finished goods.
b. They are required to keep machines and
plant in the working order.
Types of Inventory

1. Buffer Inventory

2. Seasonal Inventory

3. Cycle Inventory

4. De-Coupling Inventory

5. Pipeline Inventory
 1. Buffer Inventory
• Buffer Inventories are held to protect
against uncertainties of demand and
supply.
• It is defined as a supply of inputs held as
a reserve in case there are future demand
and supply fluctuations.
• Hence, It is a minimum level of
inventory maintained by the
organizations to meet unforeseen
demand.
• It is also known as Buffer Stock or Safety
Stock.
 2. Seasonal Inventory
• Seasonality in demand is
absorbed using inventory.
• These inventories are carried
to compensate for differences
in the timing of supply and
demand, and to smooth out the
flow of products throughout
the supply chain.
 3. Cycle Inventory
• When the same production process is used to
produce more than one category of products,
then an organisation has to manufacture or
decide a batch size that is sufficient to meet
the demand till the time production of that
product happens again in system.
 4. De-Coupling Inventory
• De-Couples means reducing the dependence
of one machine on the other in a sequential
production process.
• Complexity of production control is reduced
by splitting manufacturing into stages and
maintaining inventory between these stages.
 5. Pipeline Inventory
• Inventories that are still in transit that have yet
to reach their ultimate destination.
• The goods that are in transit means that are
travelling from production plant to
distributor’s location are not available for sale.
• Formula to calculate Goods in Transit are :
Goods in Transit (in units) = Transit Time (in
days) X Demand per day
Types of Inventory Costs

1. Purchase Price of Material or Components

2. Carrying Cost

3. Ordering Cost

4. Shortage Cost
1. Purchase Price of Material or Components

• The first cost involved in inventory is price

paid for the raw material or Components
purchased from outside.
• The purchase price includes the cost of freight,
insurance and taxes.
• In case of technical nature, it includes cost of
testing, certification and inspection.
 2. Carrying Cost
It is the cost of holding the inventory in the
store. It includes:
• Opportunity cost of money locked up in inventory
• Cost of handling material
• Cost of storage
• Cost of obsolescence, theft, breakage and
shrinkage
• Depreciation of warehouse and equipments
 3. Ordering cost
It is the cost of placing a new order. Every time when
material reaches the reorder level, a new order of the same
is to be placed with suppliers. This cost includes:
• Cost of Preparing order
• Cost of Communication
• Cost of Indentifying the supplier
• Cost of Transportation and unloading at the store
• Cost of documentation, receiving, testing and
certification
 4. Shortage Cost
Sometimes demand exceeds supply and company is
not in a position to immediately fulfill the demand.
This is known as shortage situation. It involves:
• Higher cost of Transportation
• Loss of customer/ profits
• Loss of Brand and Goodwill
• Higher prices for additional supplies
• Penalty depending upon the urgency of the goods
or requirements
 Inventory Management Fundamentals

Inventory Management system is the process

of monitoring and controlling that right material
in right form at right costs, reaches the right
customers at the right time and place.
Inventory Management System Comprises

• Economic Order Quantity (EOQ)

• Quantity Discount
• Price Break Method
• Maintenance of Stock Level in the Organization
• Knowledge of Lead time
• Just in Time Inventory (JIT) System
• EOQ when shortages are allowed
• Inventory Classification System
 EOQ ( Economic Order Quantity)
EOQ is a number of units that an organization
should order each time a requisition of
material is to be made to the supplier.
EOQ is that amt. of quantity ,if ordered will
result in minimization of total cost keeping in
view certain assumptions.
Assumptions…
• Annual demand is uniform , constant and continous.
• The lead time is constant and known.
• There is no constraint about how many times an order is
made.
• There is no constraint about the holding the purchased
inventory in the stock.
• The cost of order is constant and is not dependent on
the size of order.
• No quantity discount is available.
• As soon as the quantity reaches reorder level, an EOQ
order is placed.
a)Carrying or Holding Cost :
• It refers to the cost of holding the inventory
in store.
• Calculated as a %age of purchase price
• Higher the quantity ordered, higher will be
the carrying cost .

Total Carrying Cost : EOQ Carrying cost per unit

2
b) Ordering Cost:
• cost associated with placing an order
• Cost remain same regardless of the magnitude
of the order.

Total ordering cost = D Ordering cost per order

EOQ
EOQ MODEL
 QUANTITY
DISCOUNT
Discount offered by the supplier on buying a specific quantity of


material, is Quantity discount.


If discount is offered, it becomes important to compare the cost with
discount, without discount and with EOQ cost.


Objective of enterprise is to buy Quantity Of Material that minimizes
Total Cost.
NUMERICAL PROBLEMS
QUES.1
A Factory manufacturing Hard Disk buys
microchips at rs.1000 per unit from the supplier.
On Jan1, 2016, the factory received an offer of
20% discount on order of 300 or more units. The
Annuals Sales of Hard Disk is 600 units, the
Ordering Cost per order is rs.900 and the Avg.
Holding Cost per unit per annum is estimated to
be rs.108 per unit. Should offer of Discount be
accepted ?
QUES.2
A Company uses 8000 units of product as Raw Material,
costing rs.10 per unit. The Administrative Cost per
purchase is rs.40. The Holding Costs are 28% of Avg.
Inventory. The Company is following an Optimal
Purchase Policy and places orders according to EOQ. It
has been offered a Qty. Discount of 1% if it purchases
its entire requirements only four times a year. Should
the Company accept the offer of Qty. Discount of 1% ?
 PRICE BREAK
METHOD
 When Quantity Discount offers are available, then
while making an appropriate decision as to whether
the discount offer should be accepted or not, Price
Break Method is used.
 PRICE BREAKS
(discount available)

(a) (b)
One Price Break Multiple Price Break
(single discount (more than one
offer available) discount offer
available)
ONE PRICE BREAK
METHOD
●
Compute EOQ for each discount price,
STEP1 starting from the least cost price offer.

●
Now calculate EOQ using the next least cost price offer

STEP2 available (if EOQ < minimum quantity eligible for discount, in
step1)

●
Compare the cost in EOQ at Step2 with cost at Step1. The

STEP3 quantity corresponding to the minimum Total Cost will be the

Optimal Quantity to order.
QUES.1
Find EOQ for a product for which the price break is
given as:

Qty. Unit Cost (Rs.)

0 =< q < 400 10
400 =< q 9.25
MULTIPLE PRICE BREAK METHOD

• STEP1: Compute EOQ for each discount price, starting

from the least cost price offer.

# EOQ falls within quantity available for

discount , we will choose that and stop here.

# EOQ< Minimum qty. eligible for discount, then we

will move to next step.
• STEP2: Now calculate EOQ using the next least cost
price offer available ( at which max. discount offer is
available ).

• STEP3: Compare the cost of feasible EOQ (which falls

within the eligible qty. available for discount ) with
the cost of all adjusted EOQs.

The qty. corresponding to the min. total cost will be

the Optimal Qty. to Order.
 NUMERICAL
PROBLEMS
QUES.1
Find the Optimal Order Qty. ( EOQ ) for a product where Annual
Demand is 500 units, Cost of Storage per unit per year is 10% of
cost of a unit and Ordering Cost is rs.180. The units costs are:
QTY. UNIT COST (Rs.)
0 =< q < 500 25
500 =< q < 1500 24.80
1500 =< q < 3000 24.60
3000 =< q 24.40
QUES.2
Find EOQ for a product for which following data is
given:
• Annual Demand = 100 units per week
• Ordering Cost = Rs. 300 per order
• Carrying Cost = 10% per
Qty. (units) Unit Cost (Rs.)
q < 500 1
500 =< q < 1000 0.95
1000 =< q 0.90
Maintenance of Stock Level in the Organisation

(a)Maximu (b)Reorder
m Level Level

(c)Safety (d)Average
Stock Level Stock Level
 (a)Maximum Level
It is the maximum quantity of stock that an organization should
keep. The following points should be kept in mind while
fixing maximum level.
 Reorder Level
 Economic Order Quantity
 The rate of consumption of material
 Lead time
 Carrying cost of inventory
 Market Environment
 Availability of financial Resources
 Risk of evaporation, Deterioration or Obsolescence
 Stability or non stability of prizes of raw material
Maximum Level = (Reorder Level + Reorder Quantity)-(Minimum Consumption ×
Minimum Reorder Period)
OR
Maximum Level = Safety Stock+ Reorder Quantity
 (b)Reorder Level or Reorder Point
Reorder Level is a point at which fresh order for
the supply of the material should be placed.
Reorder level is always set above minimum level.
It is affected by factors:-
 Rate of consumption of material
 Lead Time
 Minimum Level

Reorder Level = Maximum Consumption × Maximum Reorder Period)

Or
Reorder Level = Safety Stock + (Average Consumption per day × Average Lead Time)
 (c)Safety Stock Level
It is the level below which the stock of an
organisation should not go. It must be present
with the organisation.
 Relationship with suppliers
 Minimum order size fixed by the suppliers
 Consumption rate of materials
 Time to get deliveries
Formulae for calculating safety stock level are:-
•In case of Variation in demand
Safety Stock Level = (Maximum consumption Rate –Average consumption Rate) ×
Lead Time
 Or
•In case of Variation in lead time
Safety Stock Level = (Maximum Lead Time-Average Lead Time)×
Average Consumption Rate

Or

•In case of variation in both demand and lead time

Safety Stock Level = (Maximum consumption Rate × Maximum
Lead Time) – (Average consumption Rate × Average Lead Time)
 Types of Lead Time

Raw Material Lead Time Finished Goods head Time

Pre Ordering Processing by Post Order Preproduction Production Post-

Process Raw Material Processing by process Process Production
Supplier Manufacturer Process
 A. Raw Material Lead Time
It is the total time taken by the supplier to deliver raw material and
components to the manufacturer.

(a) Pre Ordering Process-

It is the time taken by the manufacturer to order the goods to the suppliers .
It includes:-
• Receiving requisition
• Preparing details and receiving invoice from customers
• Making a contract

(b) Processing by raw material supplier-

After receiving the order, supplier will perform the following function-
• Preparing a Purchase order
• Order Entry in the system
• Production and Fabrication
• Packaging
• Transportation
(c) Post order processing by Manufacturer-
• Receiving the Goods
• Unloading
• Inspection and Testing
• Stacking in the Store

Raw Material Lead Time = Pre Ordering Process + Processing + Post Order
Processing
 B. Finished Goods Lead Time
It is the total time taken by the manufacturer to
deliver the finished goods to the retailer/customer.
(a) Pre Production Process-
It is the time taken by manufacturer after receiving
the order but before the start of the production.
(b) Production Process-
It is the time taken by the production process to
convert the raw materials into finished products.
(c) Post Production Process-
It includes the packing, transportation and
receiving of the finished goods by the warehouse.
Finished Goods Lead Time = Pre Production Process+ Production + Post Production
Process
 Just in Time Inventory (JIT) System
1. Just in time is a philosophy that concentrates on
supplying product of best quality in exact
quantity at a right time and place.
1. It ensures supply of goods and material in such a way that
total cost is minimized.
2. JIT is an inventory philosophy in which materials are bought
and processed at the demand of the customer.
3. The philosophy is different from traditional system as
traditionally a buffer or inventory is created between all the
stages of supply chain.
4. In JIT inventory model, goods and raw material are issued on
request and no stock is maintained in between.
5. JIT reduces the need of keeping inventory to a great extent.
 Traditional Inventory Model
Storage Storage
Supplier Raw Plant Finished Wholesaler
Material goods

Storage
Finished
goods

Retailer

Customer
 JIT Inventory Model

JIT JIT JIT JIT

Suppliers Plant Wholesaler Retailer Customers

 Elements of JIT
1. Pull Effect-
• In JIT the goods are transferred from one stage to another on
the basis of demand raised by it.
• The whole supply chain network should work backward , this
means customer to retailer to wholesaler to manufacturer to
suppliers.
2. Kanban-
• It is a card that is used to communicate message to the upper
work station to transfer a standardized quantity of a specific
unit mentioned on it to the next work station.
• No kanban means no supplies.
• Kanban’s are mainly of main types-
a) Withdrawal kanban’s
b) Production kanban’s
3. Eliminates wastes-
JIT system has identified Inventory waste, Transportation waste,
Waste of waiting time, Waste from overproduction, Waste of
motion, Processing waste, Waste from product defects.

4. The Uniform Plant Loading or Levelled Scheduling-

Traditional production schedule plant is producing different
products each day but uniform plant loading has resulted in the
uniform production schedule for a planned time period.

5.Short Set up Time-

• In JIT various equipments, methods and machines should be tried
to reduce the setup time as much as possible.
• Set up times include cleaning, oiling, changing and repairing the
machines.
6. Small Production Lots-
• It reduces the lead time and ensures prompt delivery of
goods to customers.
• Immediate feedback reduces the chances of defectives and
reduce losses.
7. Plant Layout-
• In this layout, the machines that produce homogenous
products are divided into various groups and separate section
or cells are assigned to each group.
• It reduces the work in progress and increases machine
utilization.
8. Respect for people-
Workers work in teams and are trained to operate various
machines. They are made aware that it is not about
performing a task but it is about making a world class
product at a lowest possible cost.
 Advantages of JIT
1. Less chances of obsolescenes
2. Reduction in lead time
3. Less requirement of working capital
4. Less carrying cost
5. Less storage space
6. Early detection of errors
 Limitations of JIT
1. Complicate system
2. Difficulty to handle big order
3. High dependence on suppliers
4. Employees attitude
Inventory Classification
System…
 1. ABC Classification…
Invented by : Pareto
According to him, a small fractions of items
accounts for a significant portion of total
inventory cost and a large proportion of
inventory constitutes a very small part of the
total cost . Hence inventory should be
classified on the basis of its usage value .
• `A’ category  items – 10% to 20% of the items
accounts for 70% to 80% of the annual
consumption value of the items.
• ‘B’ category  items – 25% to 35% of the items
accounts for 25% to 35% of the annual
consumption value of the items.
• ‘C’ category items - 50% to 60% of the items
accounts for 5% to 15% of the annual
consumption value of the items.
Advantages :
 It ensures control by exception.
 It helps in releasing money stuck in inventory .
 Leads to less requirement of manpower.

Limitations :
 It takes into account only usage or monetary
value of stock into account.
 It may lead to huge losses.
 It is not easy to categorize all the inventory
items in terms of their value.
 2.HML Classification…
In HML classification goods are classified on the
basis of their unit value. They are classified
into three categories :
a) H= High value items.
b) M= Medium value items.
c) L= Low value items.
 3.VED Analysis…
VED classify material on the basis of their
importance for the operation . This analysis is
done for spares and other goods critical for
continuous flow of operations . These are
divided into three categories :
a) V= Vital
b) E= Essential
c) D= Desirable
• V –Vital:
Vital are those components without which
production cannot even run for a second.
• E- Essential:
Essential are those spares without which
function can run for few hours .
• D- Desirable:
Desirable are those whose non supply even
for few days will not result in stoppage of
production .
 4.SDE Analysis…
SDE analysis is relevant when the organization is
facing a problem of procurement.
a) S- Scarce: The material that are scarce and
available for short span of time .
b) D-Difficult: The goods which are produced by
few suppliers that too are located at distant
place.
c) E-Easy: The goods that are easily available in
the market place.
 5.GOLF Analysis….
GOLF stands for
G= Government supplies
O= Open market supplies
L= Local supplies
F= Foreign supplies
 6.FNSD Analysis…
In FNSD analysis inventory is classified on the basis
of consumption as follows:
a) F- Fast moving stock : its consumption rate is
very high.
b) N- Normal moving stock : It is consumed
normally within the year .
c) S- Slow moving stock: It is consumed within
two years.
d) D- Dead moving stock: It is that stock which is
lying in store but is not being used.
 7.S-OS Classification…
In this items are classified on the basis of
season :
a) S-Seasonal items
b) OS-Off seasonal items (items available
throughout the year)