INVENTORY

MANAGEMENT
Inventory control objectives
Benefits of inventory control
Types of
Inventories
1.Production Inventories
2.MRO Inventories
3.In-Process inventories
4.Finished goods inventories.
Classification of Inventory-
Cycle Inventory-
 Producing and purchasing in large lots to get economies
of scale results in lower cost / unit of product.
 It is the average Inventory in a supply chain either due to
production or purchases in lot sizes larger than that
demanded by customer
Safety Inventory-Safety inventory is the
inventory carried for the purpose of
satisfying demand that exceeds the
amount forecasted in a given period.
Seasonal Inventory-Inventory that is
used to absorb uneven rates of demand or
supply that businesses face.
Pipeline Inventory-Inventory moving from
one node to another in the materials flow
system is called pipeline inventory.
Inventory may be defined as sum of value
of raw materials, fuels and lubricants,
spare parts, maintenance consumables,
semi possessed materials & finished
goods at any given point of time.

These resources are called idle resources

since they are idle they are kept in the
stores.
These resources are maintained for
operational smoothness.

The size of inventory depends on internal

lead time, suppliers lead time, vendors
relation and availability of raw materials.

Finished goods inventory are maintained

to ensure free flowing supply of goods to
customers.
 Two factors which affect
inventories are:-

1. Accuracy & detail of final forecast.

2. Availability of storage space.

Forces Creating Various Types of
Inventory
Creating Forces Type of Inventory
Uncertainties Safety Stocks
Batch / Lot Size Cycle Stocks
Economics
Time Transportation In-transit
Time-processing Work in Process
Seasonality Seasonal Stocks
Varying activity rates Decoupling Stocks
Three Components of Inventory
Management

Forecasting: How much do we need?

when will we need it?
Replenishment: How much should we
order? When should we order?
Inventory control: How much do we have on
hand? How much do we have on order?
How much have we sold?
Costs relevant for Inventory Decision

• Holding Costs : Capital costs, inventory service

costs, storage space and risk costs.
• Shortage Costs: Penalty for not having inventory
available when required.
• Acquisition Costs: Cost to order and acquire
inventory.
• Carrying cost: Carrying material in inventory is
expensive. The annual cost of carrying a
production inventory averaged approximately
25% of the value of the inventory.
Acquisition costs

1. A certain portion of wages and operating

expenses of such departments as purchase
and supply, production control, receiving etc.
2. The cost of supplies such as engineering
drawings, envelopes, stationery, and forms of
purchasing etc.
3. The cost of services such as computer time,
telephone, fax etc.
Inventory management techniques

Selective inventory management

EOQ
Sr No. Type of Control Criteria Application

1) ABC analysis Annual Consumption value of To control inventory

the item of raw material
& WIP inventory
2) XYZ analysis Inventory value of items in To review the
stores actual inventories
their uses, etc. at
scheduled intervals.
3) VED analysis Criticality of the item To determine the
stocking level of
spare parts for
machines &
equipments.

4) FSN analysis Consumption pattern of the To control

items obsolescence.
Sr No. Type of Control Criteria Application

5) HML analysis Unit price of the item To control the

purchases & to
develop vendors.

6) SDE analysis Purchasing problem Lead time analysis

in regard to availability & purchasing
strategies.

7) SOS analysis Nature of supplies & Procurement &

seasonality holding stratergy
for seasonal term.

8) GOLF analysis Source of supply of Procurement

material strategy.
Advantages of selective control system

 Helps the material manager to exercise selective

control and focus attention only on few vital
items.
 Able to control inventories and thereby achieve
management objectives.
 Results in proper inventory analysis & obsolete
stocks are pinpointed.
 Results in reduced administrative costs &
improve inventory turnover.
 Powerful approach in the direction of cost
reduction as it is helps to control items with
selective approach.
ABC Analysis

What is ABC analysis?

 ABC analysis is a basic analytical management
tool which enables top management to place the
effort where the results will be greatest.
 The techniques tries to analyze the distribution
of any characteristic by money value of
importance in order to determine it’s priority.
ADVANTAGES OF ABC ANALYSIS

 This approach helps the material manager to

exercise selective control and focus his attention
only on few items when he is confronted with
lakhs of stores items.
 By concentrating on ‘A’ class items, the material
manager is able to control inventories and is
able to show ‘Visible’ results in a short span of
life.
 By controlling the ‘A’ items, and doing a proper
inventory analysis, obsolete stocks are
automatically pinpointed.
MECHANICS OF ABC ANALYSIS

The mechanics of classifying the items

into ‘A’, ‘B’ and ‘C’ categories is
described here:
1. CALCULATE
2. SORT
3. PREPARE A LIST
4. COMPUTE A RUNNING TOTAL
5. COMPUTE AND PRINT
C 100
u
m 90
u
l
a 75
t
i
v
e
%
v
a
l
u
e
A B C
0 100
10 30
Cumulative % number
Basic principles of ABC analysis are:

1. The analysis does not depend upon the unit

cost of the items but only on its annual
consumption value.
2. It does not depend on the importance of the
item.
3. The limits of ABC categorization are not
uniform but will depend upon the size of the
undertaking, its inventory as well as the
number of items controlled.
PURPOSE OF ABC ANALYSIS
 A items: High consumption value
1. Very strict control
2. No safety stocks
3. Frequent ordering or weekly deliveries
4. Weekly control statements
5. Maximum follow-up and expediting
6. Rigorous value analysis
7. As many sources as possible for each item
8. Accurate forecasts in material planning
9. Minimisation of waste, obsolete and surplus
10. Individual postings
11. Central purchasing and storage
12. Maximum efforts to reduce lead time
13. Must be handled by senior officers
 B items: moderate value
1. Moderate control
2. Low safety stocks
3. Once in three months
4. Monthly control report
5. Periodic follow-up
6. Moderate value analysis
7. Two or more reliable sources
8. Estimates based on past data on present plans
9. Quarterly control over surplus and obsolete items
10. Small group postings
11. Combination purchasing
12. Moderate
13. Can be handled by middle management
 C items : low consumption value
1. Loose control
2. High safety stock
3. Bulk ordering once in six months
4. Quarterly control reports
5. Follow-up and expediting in exceptional cases
6. Minimum value analysis
7. Two reliable sources for each other item
8. Rough estimates for planning
9. Annual review over surplus and obsolete material
10. Group positioning
11. Decentralized purchasing
12. Minimum clerical efforts
13. Can be fully delegated
Objectives of ABC analysis
Exhibit 1
Item no Annual consumption No of orders Value per Average
value (Rs) order inventory

1 60,000 4 15,000 7,500

2 4,000 4 1,000 500

3 1,000 4 250 125

Total inventory Rs 8,125

Exhibit 2
Item no Annual consumption No of orders Value per Average
value (Rs) order inventory

1 60,000 8 7500 3750

2 4,000 3 133 667

3 1,000 1 1000 500

Total inventory Rs 4,917
Limitations of ABC analysis

ABC analysis is based on grading the

items according to the importance of the
performance of an item, that is V.E.D.-
Vital Essential and Desirable- analysis.
Some times, through negligible in
monetary value, may be vital for running
the plant, and constant attention is
needed.
ECONOMIC ORDERING QUANTITY(EOQ)
INTRODUCTION

• EOQ can be defined as that quantity which should be

ordered during the lead time so that it becomes economic
to order and the inventory carrying cost becomes
minimum.
• When ordering quantity is less than EOQ, ordering cost
will increase.
• When ordering quantity is more than EOQ, inventory
carrying cost will increase
• Thus, EOQ refers to the quantity in which the ordering
cost is equal to the holding cost (Inventory carrying cost)
GRAPHICAL DERIVATION OF EOQ

TC
HERE:
EOQ = Economic ordering quantity
TC = Total Cost

COST ICC ICC = Inventory Carrying Cost

OC = Ordering Cost

OC

O EOQ X
ORDER QUANTITY
 PROBLEMS ON EOQ

1. Annual Demand = 20,000 units

Ordering Cost = Rs. 100
ICC = 20 %
Unit Price = Rs. 20

A. EOQ = 2 x A x Co
I x Cc

EOQ = 2 x 20,000 x 100

20 x 0.20

EOQ = 1,000 units

2. In a leading biscuit manufacturing organization, the annual
demand for corrugated boxes is 20,000. The cost of placing an
order is Rs. 100 and the inventory carrying cost is 20 per cent.
The price per box is Rs. 10. The supplier offers 1 per cent
discount if 4,000 corrugated boxes or more are purchased and
3.5% discount if 10,000 units or more are purchased. What
should be the ordering quantity and would you accept the
discount?
A.
EOQ = 2 x A x Co
I x Cc

EOQ = 2 x 20,000 x 100

10 x 0.20

EOQ = 1,414 units

Stock Reorder Level, Purpose & Formula:
Stock reorder level indicates to the stock controller when it is
necessary to reorder certain raw materials or components.
The purpose of using this stock reorder level is to enable
management to ensure there is sufficient stocks to meet demands
from the production department.
Formula=Maximum usage x Maximum lead time
Illustrated Example on how to compute Reorder Stock Level
Company X which is a manufacturer has a maximum usage of
5,000 units of component TX1 per week. The supplier of this
component has a maximum lead time of 5 weeks.
Required: Compute the reorder level for component TX1.
Suggested Solution:
Reorder level=Maximum usage x Maximum lead time
= 5,000 x 5= 25,000 units.
MAXIMUM Stock Level
•To avoid cash being tied up in holding unnecessary high levels of stocks, some
businesses set up MAXIMUM level of stocks to be held at any one time. The formula
to determine the maximum level of stocks to be held is:
Formula=Reorder level-{Minimum usage x Minimum lead time} + reorder
quantity.
Illustrated Example on how to compute MAXIMUM level of stock
Continued from above-reorder stock level is 25,000 units. Say the business has a
minimum usage of 1,000 units per week. The minimum lead time is 3 weeks. The
reorder quantity is 12,000
Required: Compute the maximum level of stocks of TX1 to be held at any one time.
Suggested answer:
Maximum level of stock to be held
=Reorder level –{minimum usage x minimum lead time} + reorder quantity
=25,000- {1,000 x 3 } + 12,000 = 34,000 units of TX1
MINIMUM Stock Level
Purpose of keeping minimum stock level is to enable the stock controller to avoid running out
stock.
Formula=Reorder level-{average usage x average lead time}
Illustrated Example on how to compute MINIMUM level of stock
Continued from above-reorder stock level is 25,000 units. Say the business has an average usage
of 1,200 units per week. The average lead time is 4 weeks.
Minimum level of stock to be held
= Reorder level-{average usage x average lead time}
= 25,000-(1,200 x4) =20,200 units of TX1
SAFETY Stock level
Purpose to ensure that the business NEVER runs out of stock, a safety stock level should be
maintained. Safety stocks are also known as BUFFER stock.
Above example, assuming the business required a buffer stock of 2,800 units, then the minimum
level stocks to be held would increase to 23,000 units