*

INVENTORY MANAGEMENT &

CONTROL TECHNIQUES

Dr. Ashok Panigrahi

 * INTRODUCTION
• The term inventory means the value or amount of
materials or resource on hand. It includes raw material,
work-in-process, finished goods , stores & spares.

• Inventory Control is the process by which inventory is

measured and regulated according to predetermined
norms such as economic lot size for order or production,
safety stock, minimum level, maximum level, order level
etc.

• Inventory control pertains primarily to the

administration of established policies, systems &
procedures in order to reduce the inventory cost.
 * INVENTORY CONTROL
It costs money to hold stocks in terms of storage
space, personnel, insurance, security, deterioration
and obsolescence.

Higher inventory levels saddle a hospital with

avoidable costs. It may be more economical to
purchase an item on demand than to maintain an
inventory.

At the same time, a certain minimum amount of

each item must be held to minimize the chances of
total stock-out.
 * INVENTORY CONTROL…
Helps in maintaining an optimum level of all the
resources at least possible cost.

Determine appropriate levels of holding inventories, the

ordering sequence & the quantities, so that the total costs
incurred are minimized.
 * OBJECTIVES OF INVENTORY CONTROL
• To meet unforeseen future demand due to variation in
forecast figures and actual figures.

• To average out demand fluctuations due to seasonal or

cyclic variations.

• To meet the customer requirement timely, effectively,

efficiently, smoothly and satisfactorily.

• To smoothen the production process.

• To reduce loss due to changes in prices of inventory

items.
 * OBJECTIVES OF INVENTORY CONTROL..
• To meet the time lag for transportation of goods.

• To meet the technological constraints of

production/process.

• To balance various costs of inventory such as order cost

or set up cost and inventory carrying cost.

• To minimize losses due to deterioration, obsolescence,

damage, pilferage etc.

• To stabilize employment and improve labour relations

by inventory of human resources and machine efforts.
 * BENEFITS OF INVENTORY CONTROL

• Ensures an adequate supply of materials

• Minimizes inventory costs & facilitates purchasing economies
• Eliminates duplication in ordering
• Better utilization of available stocks
• Provides a check against the loss of materials
• Facilitates cost accounting activities
• Enables management in cost comparison
• Locates & disposes inactive & obsolete store items
• Consistent & reliable basis for financial statements
• A small number of items
represent a large % of the
cost value.

• Conversely, a large % of
the items represent only a
small portion of the cost
value. * ALWAYS BETTER
CONTROL (ABC)
• Procedure to determine
ANALYSIS PRINCIPLE
varying levels of control is
called the ABC analysis.
 * CONTD
…..of ABC analysis is PARETO’S 80 – 20 rule.
• The origin

• This rule says that 80 % of country’s economy is controlled by

20% of the people.

• If we apply this rule to verify its correctness, the results say

that it is correct.

Example:

• List out all the expenses we do over a period of time and

arrange them in the order from highest to lowest. Find the
total of expenses and workout percentage of each with respect
to the total. We see that only 20 % of items consume 80% of
our expenses.
 PROCEDURE FOR ABC ANALYSIS:
List all the materials used in the company
Work out their annual consumption value

Arrange items in the descending order

Add all & get the total annual inventory cost

Write cumulative consumption value in % of total
Draw a line at 70% and 90%

between 70% and between 90% and

under 70%
90% 100%

A B C
* ABC ANALYSIS- PROCEDURE…
Class % of Items % of value
(Annual
consumption )
A 10 70
B 20 20
C 70 10
 * ABC ANALYSIS- PROCEDURE…

• Class A : High level control, low safety stocks, frequent

physical verification, close schedule control and review.

• Class B : Controls not as tight as for “A’, but more than

for “C”.

• Class C : Inexpensive items, purchase in large

quantities, at lesser interval, minimize clerical effort to
control, large safety stock.
 * VED ANALYSIS
In addition to the intrinsic or market value of materials, which
is invested in the materials, there is sometimes a nuisance value
to the materials.

In ABC analysis, we have seen that annual consumption value;

quantity of materials consumed and unit cost plays a vital role.

This is to say that ABC analysis deals with the annual

consumption value of the item due to their presence and not
any other aspect such as the criticality of the material or the
nuisance value.
 * VED ANALYSIS
• Depending on their criticality, and thereby their value in
the operation of the hospital, most of the items of the
inventory of the hospitals can be classified, as Vital,
Essential, and Desirable .

• Those items the absence or shortage of which even for a

short period can seriously hamper the work of the hospital
are classified as vital items. E.g. Adrenaline injection,
steroid preparations.

• Essential items are those items, the shortage or absence

of which cannot be tolerated for more than a day or so or
which are likely to cause disruption of normal activity. E.g.
Life supporting items such as transfusion fluids.
 * VED ANALYSIS

• Desirable items which are definitely needed, but the

work can continue even without them for a substantial
period of time. E.g. Aspirin, other analgesics, vitamins,
enzymes.
 * FSN ANALYSIS
• FSN: Fast moving, slow moving & non moving.

• Classification is based on the pattern of issues from

stores & is useful in controlling obsolescence.

• Date of receipt or last date of issue, whichever is later, is

taken to determine the no. of months which have lapsed
since the last transaction.

• The items are usually grouped in periods of 12 months.

• It helps to avoid investments in non moving or slow

items. It is also useful in facilitating timely control.
* Contd
• For….analysis, the issues of items in past two or
three years are considered.

• If there are no issues of an item during the period,

it is “N” item.

• Then up to certain limit, say 10-15 issues in the

period, the item is “S” item

• The items exceeding such limit of no. of issues

during the period are “F” items.

• The period of consideration & the limiting number

of issues vary from organization to organization.
 * H-M-L Classification
• This method is similar to A-B-C classification. But in this case,
instead of the consumption value of items, their unit value is
considered for classification. As the name implies, the materials
are classified according to their unit value as:

▫ High,
▫ Medium
▫ Low.

• The cut-off point will depend on the individual user. The procedure
is to list out the items in descending order of unit value and invoke
management policy to fix the cut-off points. The management may
decide and delegate authority to various levels of officers
depending on the classification.
 * X-Y-Z Classification
• X-Y-Z has the value of inventory available on a particular date
in the stores as its basis. This study is taken up once in a year
during the annual stock-taking exercise.
▫ X items are those items whose stock value is high
▫ Y items fall between the two categories
▫ Z items are those whose stock values are low

• This classification helps in identifying the items which are

being extensively stocked. If the management is caught
napping, one can expect C items in the X category. Therefore,
controls should be developed for A-B-C items in conjunction
with X-Y-Z items.
 * G-O-L-F Classification
• In the G-O-L-F system, classification is based on the
availability and nature of suppliers. The nature of the
suppliers will determine the quantity and continuity of
supply, lead time payment terms and clerical processing cost
and time.

GOVERNMENT SUPPLIERS: Transactions with these

suppliers involve long clerical processing and the lead time
will also generally be long.

ORDINARY SUPPLIERS: Bulk of suppliers. The quality and

continuity of supply is good especially. Credit availability
from some of these sources may be available.
LOCAL SUPPLIERS: From whom cash purchases are
generally made. They are usually in the market areas of
cities.

FOREIGN SUPPLIERS: Foreign suppliers. Will involve

heavy clerical work—starting with government clearance,
e.g. obtaining an import license for customs clearance
before the foreign source of supply is contracted. After
orders have been placed, the shipping formalities must be
followed up and port clearance work done.
 * IMPORTANT TERMS
• Minimum Level – It is the minimum stock to be
maintained for smooth production.
• Maximum Level – It is the level of stock, beyond which a
firm should not maintain the stock.
• Reorder Level – The stock level at which an order should
be placed.
• Safety Stock – Stock for usage at normal rate during the
extension of lead time.
• Reserve Stock - Excess usage requirement during normal
lead time.
• Buffer Stock – Normal lead time consumption.
 * Order Point Problem
*The re-order point is that level of inventory when a fresh
order should be placed with suppliers. It is that inventory level
which is equal to the consumption during the lead time or
procurement time.
*Re-order level = (Daily usage × Lead time) + Safety stock.
*Minimum level = Re-order level – (Normal usage × Average
delivery time).
*Maximum level = Reorder level – (Minimum usage ×
Maximum delivery time) + Re-order quantity.
*Average stock level = Minimum level + (Re-order
quantity)/2.
*Danger level = (Average consumption per day × Lead time
in days for emergency purchases).
 * Problem 1:
* Normal usage: 100 units per day
* Maximum usage: 130 units per day
* Minimum usage: 70 units per day
* Economic Order Quantity:5000 units
* Re-order Period: 25 to 30 days
* From the above information you are required to calculate:
* (i) Re-order Level
* (ii) Minimum Level
* (iii) Maximum Level
* (i) Re-order Level = Maximum daily usage × Maximum Re-
order period
* Reorder Level = 130 × 30 = 3900 units
* (ii) Minimum Level = Re-order Level – Average usage for
average re-order period.
* Minimum Level = 3900 – (100 × 27.5)
* Minimum Level = 3900 – 2750 = 1150 units
* (iii) Maximum Level = Re-order Level – Minimum quantity
used in re-order period + Economic Order Quantity
* Maximum Level = 3900 – (70 × 25) + 5000
* Maximum Level = 3900 – 1750 + 5000 = 7150 units
* Solution:
 * Problem 2:
* Two types of materials A and B are used as follows:
* Minimum usage: 20 units per week each
* Normal usage: 40 units per week each
* Maximum usage: 60 units per week each
* Re-order Quantity (EOQ): A 400 units, B 600 units
* Reorder Period: A: 3 to 5 weeks, B: 2 to 4 weeks
* Calculate for two types of materials:
* (a) Ordering Point or Re-order Level
* (b) Minimum Level
* (c) Maximum Level
* (d) Average Stock Level
* (a) Ordering Point or Re-order Level = Maximum usage × Maximum re-
order period
* Ordering Point of Material A = 60 × 5 = 300 units
* Ordering Point of Material B = 60 × 4 = 240 units
* (b) Minimum Level = Ordering Point – (Normal usage × Normal re-order
period)
* Minimum Level of Material A = 300 – (40 × 4) = 140 units
* Minimum Level of Material B = 240 – (40 × 3) = 120 units
* (c) Maximum Level = Ordering Point – (Minimum usage × Minimum re-
order period) + EOQ
* Maximum Level of Material A = 300 – (20 × 3) + 400
* Maximum Level of Material A = 300 – 60 + 400 = 640 units
* Maximum Level of Material B = 240 – (20 × 2) + 600 = 800 units
* (d) Average Stock Level = ½(Minimum Level + Maximum Level)
* Average Stock Level of Material A = ½(140 + 640) = 390 units
* Average Stock Level of Material B = ½(120 + 800) = 460 units
 * Economic Order Quantity

Level of Inventory at which

Total Cost* of Inventory is

MINIMUM
*(Ordering and Carrying
Cost)
 EOQ MODEL
2UP
Q = S
Q = Economic Order Quantity
U = Annual usage/demand
P = Cost of Placing an order
S = Storage cost per unit per order
* Where Storage cost is given in % , it is always calculated by
multiplying the % with the purchase price of raw material per unit, i.e
Storage cost = % X Purchase price of raw material
These costs placing an order or ordering cost comprise of:

1. salaries and wages of involved personnel,

2. postal, telephone, telex and other similar bills,
3. advertisements,
4. stationary,
5. entertaining the vendors, suppliers, and
6. travel of stores personnel.
 * INVENTORY CARRYING COST

* Costs incurred for holding the volume of inventory and

measured as a percentage of unit cost of an item.

* It includes-
* Capital cost
* Obsolescence cost
* Deterioration cost
* Taxes on inventory
* Insurance cost
* Storage & handling cost
 * ECONOMIC ORDER QUANTITY...
• The EOQ Formula
• If stock-outs are not permitted, the total inventory cost
per year is depicted by the following formula:
Total annual cost = (purchase cost) + (order cost) +
(holding cost)

TC=RP +RC/Q +QH/2

R = annual demand in units
P = purchase cost of an item
C = ordering cost per order
H = holding cost per unit per year
Q = lot size or order quantity in units.
Q =√2CR/H
 * INVENTORY CARRYING COST
• Costs incurred for holding the volume of inventory and
measured as a percentage of unit cost of an item.

• It includes-
▫ Capital cost
▫ Obsolescence cost
▫ Deterioration cost
▫ Taxes on inventory
▫ Insurance cost
▫ Storage & handling cost
 * ECONOMIC ORDER QUANTITY...
• Example ABC Hospital purchases 1,600 pairs (units) of
surgical gloves each year at a unit cost of Rs. 15.00. The
order cost is Rs. 100.00 per order, and the holding cost
per unit per year is computed at Rs. 8.00. The EOQ will
be:

• Q=√2CR/H=√2x100x1600/8
=200 units

• TC=RP +RC/Q +QH/2= 1600 x 15 +(1600 x100)/200+

(200 x 8)/2= Rs. 25,600/

• Number of orders to place in one year=1600/200=8

No. at Order * Averag carrying Annual Total cost
orders size e Annual 50% ordering
per year inventory order Qty cost
cost

1 1,600 800 64,00 100 6500

2 800 400 32,00 200 3400
3 540 270 2160 300 3460
4 400 200 1600 400 2000
5 320 160 1280 500 1780
6 270 135 1080 600 1680
7 230 115 920 700 1620
8 200 100 800 800 1600
9 180 90 720 900 1620
10 160 80 640 1000 1640
11 146 73 584 1100 1684
12 132 66 528 1200 1728
* Relationship between cost and quantity.

50
Cost per period

40

30
Min
20 cost

10
EOQ Procuring costs

100 200 300 400 500

Order quantity