UNIT-III

INVENTORY MANAGEMENT

LEARNING OBJECTIVES
Give meaning and definition of inventory. Define inventory management. List out components of inventory. Explain the motives for holding inventory. Identify the areas, objectives and need for balanced investment in inventory. Highlight inventory costs, risks and benefits of holding inventory. Explain the techniques of inventory management. Analyse the performance of inventory management

Meaning and Components of Inventory

Inventory: The aggregate of raw materials; work-in-process; finished goods and stores and spares Components of Inventory: 1. Raw materials 2. Work-in-process 3. Finished goods 4. Stores and spares

Motives for holding Inventory

Transaction motive Precautionary motive Speculative motive

Objectives of Inventory Management

Ensure continuous supply of materials Facilitate uninterrupted production Maintain optimum stock of inventory Minimize inventory cost

Need for Balanced Investment in Inventory

Consequences of Excessive Investment in Inventory
Block of funds Loss of liquidity Mishandling of inventory Increases carrying cost Physical deterioration

Consequences of inadequate investment in Innovation

Disturbs production Unable to deliver goods on delivery date Loss of customers

Counter balancing
Minimize investments in inventory Meet the demand for the product by efficiently organizing the production and sales operations Optimum level : An optimum level of inventory should be determined on the basis of trade-off between costs and benefits associated with the levels of inventory

Risks of Holding Inventory

Price decline Product deterioration Product obsolescence

Costs of holding Inventory

Ordering Costs: The costs associated with the acquisition or ordering of inventory. Cost of acquiring materials(inventory) = Clerical costs + Stationery costs of placing and receiving an inventory order. Total Ordering cost= No. of orders x Cost per order. Carrying Costs: The variable costs per unit of holding an item in inventory for a period . Carrying costs includes: Interest on capital, Losses due to pilferage , Cost of Storage space , Cost of Insurance , Depreciation , Salary of warehouse keeper and his associates , Obsolescence. Carrying cost varies with inventory size. Carrying cost = Cost per unit x percentage carrying cost Total Carrying Cost = Carrying cost x purchase price per unit x Quantity ordered____________________ 2

Tools of Inventory Control

ABC analysis EOQ Order point problem Safety stock VED classification HML classification SDE classification FSN classification JIT technique

ABC Analysis
ABC analysis: Inventory control tool that categories inventory into three groups A, B, and C, in descending order of importance of control.
Cumulative percentage of costs

100 80 60 40 20 0 10 20 30 40 50 60 70 80 90 100 Item A Item B Item C

Cumulative percentage of items/units in inventory

ABC System of inventory

Class A B C % of inventory Items 15-25 20-30 40-50 % of annual usage value 60-75 20-30 10-20

Economic Order Quantity [EOQ]

EOQ: The inventory control tool that determines optimum order at which inventory cost is minimum. Assumptions: Demand for the product is constant and uniform throughout the period. Lead time (time from ordering to receipt) is constant. Price per unit of product is constant. Inventory holding cost is based on average inventory. Ordering costs are constant.

EOQ [contd.]
EOQ =
2AB C

Where: A = Annual usage B= Buying cost per order C = Annual carrying cost per unit C = Price per unit x Carrying cost per unit in percentage The above simple formula will not be sufficient to determine EOQ when more complex cost equations are involved.

Analysis of Inventory
Size of inventory Inventory in terms of months of value of production Turnover of inventory Structure of inventory

ORDER POINT If the usage rate of materials and the lead time for procurement are known with certainty, then the

ordering level would simply be:

Lead time in days for procurement x Average daily usage

When the usage rate and lead time are likely to vary, the reorder level should be: Normal consumption + Safety stock

PRICING OF RAW MATERIALS The important methods of pricing inventories used in production are: FIFO (First in First Out) Method The material which is issued first is priced on the basis of the cost of material received

earliest, so on and so forth.

Weighted Average Cost Method Material issued are priced at the weighted average cost of materials in stocks

JUST-IN-TIME (JIT) INVENTORY CONTROL The JIT control system implies that the firm should maintain a minimal level of inventory and rely on suppliers to provide parts and components just-in-time to meet its assembly requirements. It is also called as Lean Production

JIT is a demand-pull manufacturing system

JIT is contrasted with the traditional inventory management system -a supply push system.

Computation of Total Cost

Total cost = Total ordering cost + Total Carrying cost TC = A x B + Q x P X C Q 2 Where ,TC=Total Cost U= annual usage Q= quantity ordered B=Ordering cost P= Price per unit C=Carrying cost percentage

Levels of Inventory
Re-order level=Maximum usage x maximum delivery time Minimum level = ROL-(Normal usage x average delivery in weeks) Maximum level = ROL-(minimum usage x minimum delivery time) +ROQ Average stock level = minimum level +(ROQ/2)

Stock out costs