Inventory Management

Prof. (Dr.) Sandeep Nemlekar

PHONE # 91 9987209747
EMAIL: [email protected]

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 Inventory
 A complete listing of merchandise or stock on hand.
 Stock in order to meet an expected demand or distribution in the
future.
 The term includes …
 Raw materials,
 Work-in-process,
 Semi-finished goods
 Finished goods,
 Packing Materials
 MRO Goods (Spares, Tools, etc.)
 It is an idle resource of an enterprise.
** **

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 Reasons for Carrying Inventories
a) It helps in smooth & efficient running of business.
b) It provides adequate service to customers.
c) It reduces the possibilities of multiple orders.
d) It improves the cash flow by timely shipment of customer orders.
e) It acts as a buffer stock for incoming / outgoing rejections .
f) It takes advantage of price discounts by bulk purchasing.
g) It reduces the cost of product.
h) It improves the manpower, equipment, & facility utilization by better
planning & scheduling.
** **

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 To provide buffer between successive operations
(e.g. during equipment break down )
(Decoupling Inventory or
Fundamental use. Work-in-process Inventory)
To satisfy expected
customer demand
(Anticipation Inventory)

Types / Uses To satisfy periods of

To protect against seasonal high demand
price increases & to / Objectives
(Seasonal Inventory)
take advantage of of Inventory
Quantity Discounts
To act as a buffer between various
elements of Supply-Chain
To avoid stock outs
(Suppliers-Producers-Distributors-
when demand fluctuates or
Wholesalers-Retailers-Customers)
lead-time increases abruptly
(Pipeline or Transit Stock)
(Safety Stock or Buffer Stock)

To minimize total inventory cost by ordering

Economic Order Quantity (Cycle Stock)
Cycle is from receipt to consumption of the lot.
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 Types of … Inventory Management Systems

Independent Demand Dependent Demand

Inventory Management Systems Inventory Management Systems

For Retailers For Manufacturers Just-In-Time Material

(JIT) Systems Requirements
ABC Classification Manufacturers’ EOQ Planning
Items Model (MRP)
Systems

Category A Items Category B Items Category C Items Hybrid MRP-

JIT Systems

Basic Economic Order Periodic Review

Quantity (EOQ) Model System

EOQ Model with EOQ Model EOQ Model with EOQ Model with
Quantity with Safety Differential Intentional
Discounts Stock Discounting Shortages 5
 Types of Inventory Costs
1) Two types (OC) Ordering Cost (CC) Carrying or Holding cost
2) OC is cost of placing order/s including following costs of purchasing function
as orders are placed by purchasing function.
a) salary to employees
b) Cost of stationary, postage, etc.
c) Cost of telephone bills, electricity bills, internet expenses, etc.
d) Rent of office space or opportunity cost (loss of rent) if owned office space
e) Opportunity cost of furniture, computers, soft-wares, hard-wares, etc.
 Unit OC = (∑all costs of purchasing function) ÷ (# of orders)…. in the period
3) CC is cost of storing inventory in warehouse. It consists of
a) Rent of warehouse or opportunity cost (loss of rent) if owned warehouse
b) Cost of capital tied in inventory – interest cost or opportunity cost
c) Maintenance cost of warehouse – electricity, air-conditioning, security, etc.
d) Cost of damages (by mishandling)
e) Cost of obsolescence
 Unit CC = (∑all costs of storing inventory) ÷ (average inventory) ÷ (duration)

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Retailer’s Model of Inventory Management
Economic Order Quantity (EOQ) Model
Assumptions 1. Annual demand of the item is constant & known
2. Annual demand is uniformly distributed throughout
year (constant consumption rate)
3. Lead time is zero
Inventory decreases
Inventory Level

at a constant rate Level of Maximum Inventory

Q 2nd 3rd 4th

1st
Inventory Inventory Inventory
Inventory
Cycle Cycle Cycle
Cycle

0
cycle time = t t t
Time
1st order is placed 2nd order is placed 3rd order is placed
& immediately & immediately & immediately
goods are received goods are received goods are received
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 of Inventory
EOQ can also be
called as lot size
problems.

Demand is
assumed to be
fixed & completely
predetermined.

Minimum cost occurs at the point where the O.C. & C.C. are equal

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 EOQ Formula
Let A = Annual Demand, o = ordering cost per order,
c = carrying cost per unit per year
Q = Economic Order Quantity
Q = optimal size of order for which total inventory cost is minimum.

Average inventory = (maximum inventory + minimum inventory)/2 = Q/2

Annual CC = average inventory x CC per unit per year = Q/2 . c

Annual OC = # of orders per year x OC per order = A/Q . o

Annual Total Inventory Cost (T) = Annual OC + Annual CC = A.o/Q + Q.c/2

Minimum cost occurs at the point where the O.C. & C.C. are equal
Annual CC = Annual OC
Q/2 . c = A/Q . o
Q2 = 2.A.o/c
2.A.o
Q = √ c
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 Example - EOQ
A company uses annually 12,000 units of raw materials
costing Rs. 1.25 per unit.
Placing each order costs Rs. 15 &
the carrying costs are 15% per year per unit of the average inventory.
Find the economic order quantity.
Solution
A = 12,000 units, o = Rs. 15 per order,
c = 15% x 1.25 = Rs. 0.1875 per unit per year
2Ao 2 x 12000 x 15
EOQ = √ c
= √ 0.1875
= 1385 units

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 Lead Time & Reorder Level
Inventory decreases
at a constant rate
Inventory Level

Level of Maximum Inventory

Q
RE-ORDER LEVEL

500 units

0
Lead 2nd order 3rd order
1st Time
time is placed is placed
order is Goods are Goods are Goods are
(10
placed received received
days) received

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Excessive Consumption of Inventory During Lead Time

Inventory decreases
at a constant rate
Inventory Level

Level of Maximum Inventory

Inventory
decreases
at a faster
Q rate
RE-ORDER LEVEL

500 units Stock

out

0
Lead 2nd order 3rd order
1st Time
time is placed is placed
order is Goods are Goods are Goods are
(10
placed received received
days) received

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 Lead Time Stretched by Supplier
Inventory decreases
at a constant rate
Inventory Level

Level of Maximum Inventory

Q
Stock-out

REORDER LEVEL

500
units
0
Normal
Lead
2nd order Time
1st order
time is placed Goods are
is placed received
10 days
Goods are
received

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 Safety Stock
Excessive Consumption of Inventory During Lead Time

Inventory decreases
at a constant rate
Inventory Level

Level of Maximum Inventory

Inventory
decreases
at a faster
Q rate REORDER LEVEL

500
units

200 2nd order

1st order is placed SAFETY STOCK
units
is placed
0 Time

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 Lead Time Stretched & Safety Stock
Inventory decreases
at a constant rate
Level of Maximum Inventory
Inventory Level

Q
REORDER LEVEL

500
units

200 Normal
units Lead time SAFETY STOCK
1st order (10 days) Goods are
is placed received
Time

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Example – Reorder Level, Max & Avg. Inventory
 With the data from last example. It operates 300 days per year.
 Procurement time is 14 days & safety stock is 400 units.
 Find the re-order point, maximum inventory & the average inventory.
Solution
Average demand per day = 12000/300 = 40 units
Hence, lead time demand = demand per day x procurement time
= 40 x 14 = 560 units
Hence, reorder level = safety stock + lead time demand
= 400 + 560 = 960 units
Maximum inventory = Safety stock + economic order quantity
= 400 + 1385 = 1785 units
Average inventory = safety stock + EOQ/2
= 400 + 1385/2 = 1093 units

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 Example - EOQ
 XYZ manufacturing company has determined from an analysis of its
accounting & production data for part # 625 that its cost to purchase is Rs.
36 per order & Rs. 2 per part. Its inventory carrying charge is 18% of the
average inventory. The demand of this part is 10,000 units p.a.
a) What should the economic order quantity be ?
b) What is optimum # of day’s supply per optimum order?
Solution
A = 10,000 units, o = Rs. 36 per order,
c = 18% x 2 = Rs. 0.36 per unit per year
2Ao 2 x 10000 x 36
EOQ = √ c
= √ 0.36
= 1414 units

Supply per day = Annual Demand ÷ # of days in a year

= 10,000 / 365 = 27.397 units
Thus the optimum # of days supply per optimum order will be
= Optimum Order Quantity ÷ Supply per day
= 1414 / 27.40 = 52 days
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 Example – EOQ & Total Minimum Cost
 A company requires 1000 units p.m. Order cost is estimated to be Rs. 50
per order. In addition to Rs. 1 the carrying costs are 10% per unit average
inventory p.a. The purchase price is Rs. 10 per unit.
 Find the economic lot size to be ordered & the total minimum cost.
Solution
A = 1,000 units p.m. x 12 = 12,000, o = Rs. 50 per order,
c = 1+ 10% x 10 = Rs. 2 per unit p.a.
2Ao 2 x 12000 x 50
EOQ = √ c
= √ 2
= 775 units

Average size of inventory = EOQ / 2 = 775 /2

Hence, total minimum cost = Procurement cost + cost of material + storage cost
= (12000 / 775) x 50 + 12000 x 10 + (775/2) x 2
= Rs. 1,21,549

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 Example: EOQ , ROL, Max & Avg Inventory
 A company uses annually 48000 units of a raw material costing Rs. 1.25
per unit. Placing each order costs Rs. 45 & carrying costs is 15% of the
average inventory. Find the economic order quantity.
 Suppose the company follows EOQ purchasing policy & it operates for 300
days a year & the procurement time is 12 days with safety stock of
500units, find the re-order point, the maximum & average inventory.
Solution
A = 48,000, o = Rs. 45 per order, c = 15% x 1.25 = Rs. 0.1875 per unit p.a.
2Ao 2 x 48000 x 45
EOQ = √ c
= √ 0.1875
= 4800 units

Average daily demand = 48000 / 300 = 160 units per day

Lead time demand = Avg. daily demand x procurement time = 160 x 12 = 1920 units
Reorder Level = safety stock + Lead time demand = 500 + 1920 = 2420 units
Maximum inventory = safety stock + EOQ = 500 + 4800 = 5300 units
Minimum inventory = safety stock = 500 units
Average inventory = safety stock + EOQ/2 = 500 + 4800/2 = 2900 units

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 Example - Syringe
Trinity Hospital at Bangalore sources 20,000 disposable syringes per year.
OC per order is Rs. 100 & CC is Rs. 1 per unit per year.
Price of a syringe is Rs. 5.
The supplier offers 5% discount if purchasing lot >= 10,000 syringes.
Determine whether discount model is better than EOQ model in this case.
Solution
A = 20,000 units, o = Rs. 100 per order, c = Rs. 1 per unit per year
2Ao 2 x 20000 x 100
EOQ = √ c
= √ 1
= 2000 units

At EOQ, OC = CC = Qc/2 = 2000 x 1/2 = Rs. 1000

Total cost, TEOQ = cost of syringes + OC + CC = 20000 x 5 + 1000 + 1000 = Rs. 102,000
Discount Model
Q = 10,000. So, # of orders = A/Q = 20,000 / 10,000 = 2
Annual OC = # of orders x unit OC = 2 x 100 = Rs. 200
Average Inventory = Q/2 = 10,000 / 2 = 5,000 units
Annual CC = Q/2 . c = 5,000 x 1 = Rs. 5,000
Total cost, Tdiscount = 20,000 x 5 x 95% + 200 + 5000 = Rs. 100,200
Tdiscount < TEOQ. Hence, discount model is better to follow. 20
 Inventory Control
a) It is a system of ordering based on the maintenance of the stock in …
a store using re-order rule based on the stock level.
b) It is the technique of maintaining the size of the inventory at …
some desired level keeping in view …
the best economic interest of an organization.
c) It is concerned with various items stocked …
at predetermined level or within some safe limits.
d) It is that part of a production program which specifies …
the materials requirements & schedules the order of work to be done.
e) Stock control is often said to be an exercise …
in the art of compromise, balancing the conflicting needs of …
(1) Economical Production (2) Quick delivery (3) Low Inventory Level
f) Inventory control means keeping a track of inventories, so that …
items are available when they are needed. … 21
 Inventory Control
g) It is achieved by ..
1) Purchasing items …
at economic price at a proper time & in sufficient quantity
2) Provision of suitable & secured storage location with sufficient space
3) Inventory identification system.
4) Up-to-date & accurate record keeping by a responsible staff.
5) Appropriate requisition procedures.

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 Objectives of Inventory Control
a) Protection against fluctuations in demand
b) Better use of men, machine & material.
c) Protection against fluctuations in output
d) For production economies
e) Control of Stock volume
f) Control of stock distribution
-------------------------------------------------
Situation where demand rate varies:
Buffer stock = Lead Time X (Max. Demand Rate – Avg. Demand Rate)

If lead time varies & demand rate is uniform,

Buffer stock = (Max. Lead Time- Avg. Lead Time) X Demand Rate

If both lead time & demand rate are fluctuating,

Buffer stock to meet abnormal demand =
= (Max. Lead Time X Max. Demand Rate) – (Avg. Lead Time X Avg. Demand Rate)
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 Example – Exide Batteries
Exide batteries offering discounted prices to its
retailers for quantities as tabulated. # of units Price Rs/unit
A retailer of Excide has annual demand of 2500 units. 50 – 99 2,000
Retailer’s CC = 10% of inventory value. 100 - 149 1,900
Retailer’s OC = Rs. 100 per order
Find order size for minimum total cost. 150 & above 1,800
Solution
A = 2500 & o = 100, for lowest price of Rs.1800, c = 10% of 1800 = 180
2Ao 2 x 2500 x 100
Q = √ c
= √ 180
= 52.7 = 53

Order size of 53 unit is not within corresponding range 150 & above.
So, it is unfeasible. Taking next lowest price of Rs. 1900, c = 10% of 1900 = 190
2Ao 2 x 2500 x 100
Q = √ c
= √ 190
= 51.3 = 52

Order size of 52 unit is not within corresponding range 100 - 149. So, it is unfeasible.
Taking remaining price of Rs. 2000, c = 10% of 2000 = 200
2Ao 2 x 2500 x 100
Q = √ c
= √ 200
= 50 24
Solution – Exide Batteries - Continued
Order size of 50 unit is within corresponding range 50 - 99.
So, it is feasible & EOQ = 50.

Now, calculating total cost for EOQ

T = price of a unit x A + Ao/Q + Qc/2
= 2000 x 2500 + 2500 x 100 / 50 + 50 x 200 / 2
= 5,000,000 + 5000 + 5000 = Rs. 5,010,000

Total cost for 100 units (lower limit of range100 – 149) @ price Rs. 1900
T = price of a unit x A + Ao/Q + Qc/2
=1900 x 2500 + 2500 x 100 / 100 + 100 x 190 / 2
= 4,750,000 + 2500 + 9500 = Rs. 4,762,000

Total cost for 150 units (lower limit of range150 & above) @ price Rs. 1800
T = price of a unit x A + Ao/Q + Qc/2
=1800 x 2500 + 2500 x 100 / 150 + 150 x 180 / 2
= 4,500,000 + 1,667 + 13,500 = Rs. 4,515,167

Hence, total cost is minimum for order size of 150 units.

So, the retailer shall order for 150 units 25
 ABC Analysis
 The ABC analysis / Selective Inventory Control is …
an inventory categorization technique in materials management.
 It provides a mechanism for identifying items with …
their significance in inventories based on their consumption value.
 It also provides a mechanism for identifying different categories of …
stock that will require different management & controls.
 Thus, the inventory is grouped into three categories (A, B, & C)
A. Class  10% of items  70% of the consumption value
B. Class  20% of items  20% of the consumption value
C. Class  70% of items  10% of the consumption value
 The basic principles in ABC analysis:
1) It does not depend upon the unit cost of the items.
But, it depends only on their annual consumption value.
2) It does not depend on the importance of the item.
3) It’s limits are not uniform. But, they will depend upon …
the size of the undertaking, its inventory & the # of items controlled.
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 ABC Analysis: Selective Control
A-Class Items B-Class Items C-Class Items
Very strict control Moderate control Loose control
Low safety stocks Moderate safety stocks High safety stocks
Frequent ordering or Once in three months Bulk once in 6 months
weekly deliveries
Weekly control statements Monthly control reports Quarterly control reports
Max. follow up & expediting Periodic follow up Follow up & expediting
by exception
Rigorous value analysis Moderate value analysis Minimum value analysis
As many sources as possible Two or more reliable sources Two reliable sources for each
for each item item

… … …

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 ABC Analysis: Selective Control
A-Class Items B-Class Items C-Class Items
Accurate forecasts in Estimates based on past data Rough estimate for planning
Materials planning on present plans
Minimization of waste, Quarterly control over Annual review over surplus
obsolete & surplus surplus & obsolete items and obsolete materials
(Review every 15 days)
Individual postings Small group postings Group postings
Central purchasing & storage Combination purchasing Decentralized purchasing
Maximum efforts to reduce Moderate Minimum clerical efforts
lead time
Must be handled by senior Can be handled by middle Can be fully delegated
officers management

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 ABC Analysis: Example
a) Determine annual usage of each item
Item ₹ / unit Quantity Usage ₹
A1 100 90 9,000
B2 50 23 1150
C3 110 100 11,000
D4 25 50 1250
E5 20 70 1400
F6 45 30 1350
G7 70 1000 70,000
H8 125 12 1500
# of items I9 10 175 1750
J10 64 25 1600
Total 100,000

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 ABC Analysis: Example
b) Rank the items according to their annual usage (descending order)
Item Usage ₹ Cumulative Usage ₹ % of Total Usage Class
G7 70,000 70,000 70.00% A
C3 11,000 81,000 81.00% B
A1 9,000 90,000 90.00% B
I9 1750 91,750 91.75% C
J10 1600 93,350 93.35% C
H8 1500 94,850 94.85% C
E5 1400 96,250 96.25% C
F6 1350 97,600 97.60% C
D4 1250 98,850 98.85% C
B2 1150 100,000 100.00% C

** ** ** **

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