Inventory Control

Inventory: Inventory is a detailed list of those

movable goods/items which are necessary for
manufacturing a product and to maintain the
equipment and machineries in a good working
conditions.
Inventory is actually “money” kept in a store-
room in the shape of mild steel rod, milling
cutters, welding electrode etc.
 Types of Inventory
1. Raw Inventory: raw materials and semi finished products
supplied by another firm which are raw materials for the
present inventory. Ex. Round bars, angles, channels,etc.
2. In process or (Work in Progress) Inventory: These are semi
finished good at various stages of manufacturing cycle.
3. Finished inventory: Ready for dispatch.
4. Indirect inventory: Include those inventories which are
needed for repair , maintenance and operation during
manufacturing e.g. lubricating oil, machine spares, grease, etc.
5. Tool Inventory: Include both standard and special tools.
6. Miscellaneous Inventories: Office stationeries and other
consumable items.
Inventory Control: Inventory Control means ensuring the
availability of desired items of required quality and quantity to various
department when needed.
Too much inventory creates :
--a problem of their storage ,
---high investment of money and maintenance of the
stored items from deterioration , pilferage( Theft) and damage etc.
Low inventory leads to:
--- chances of stoppage of production ,
-----increase in overheads and
----disruption in production schedules.
Therefore ,the optimum amount of inventory should be maintained in
stores.
Inventory Control is defined as :scientific method of finding how much
stock should be maintained in order to meet the production demands
and to provide the right materials of right quality and right quantity at
right time at right prices.
 Objective of Inventory Control
1. To ensure adequate supply of products to customers and to avoid
shortage of products as possible.
2. To ensure minimum investment in inventory.
3. To maintain timely record of inventories of all items and to
maintain the stock within limits.
4. To ensure formally action for replenishment.
5. To provide reserve stock for variation in lead time of delivery of
materials.
6. To provide scientific base for long term and short term planning of
materials.
7. To ensure smooth and uninterrupted production and no stock out.
8. To minimize loss due to deterioration , obsolescence, damage.
9. To eliminate the possibility of duplicate ordering.
 Costs associated with inventories
The inventory cost plays an important role in the study of
inventory. These costs are classified as:
1. Purchase cost
2. Capital cost
3. Ordering cost
4. Inventory carrying cost(Holding cost)
5. Shortage cost
Total Inventory cost is given by:
Total Inventory Cost(TIC)= Purchase cost + Total variable cost of
managing the inventory(TVC)
i.e., TIC = Purchase cost + Inventory Carrying cost + Ordering cost
+ Shortage cost
1. Purchase cost: The cost of purchasing of an item is called as
Purchase cost. It is given by:
Purchase cost = Price per unit X Demand per unit time
= 𝐶𝑝 X D
where , 𝐶𝑝 = unit cost and D= annual demand.
2. Ordering cost: Cost of placing an order from a vendor. It includes
all cost from calling for quotations to the point at which the item
is taken into stock. It consists of:
a. Receiving Quotations
b. Processing purchase requisition
c. Receiving materials and then inspecting it.
d. Follow up and expediting purchase order.
e. Processing sellers invoice
If 𝐶0 is the cost of placing order and Q the order quantity , then
unit cost of placing an order = 𝐶0 /Q .
Unit cost of placing an order decreases with increase of order
quantity Q.
The bigger the amount purchased in one lot, lower the unit
ordering cost.
If D= Annual requirement(Annual Demand) then
𝐶0
Annual cost of ordering= x D.
𝑄
3. Carrying cost(Holding Cost): these are cost incurred in
maintaining the stores in the firm. Carrying cost includes:
a. Storage Cost , it includes
i. Rent of stores
ii. Salaries of personal and related storage
expenses(upkeep of material, record keeping)
 b. Cost of obsolescence of items of stores
c. Cost of deterioration and spoilage etc.
d. Cost of insurance
e. Cost of capital
f. Special tax paid for storing certain items.
g. Cost of pilferage(theft) and security person

Carrying cost ∝ order quantity

4. Shortage cost or stock out cost : When an item cannot be
supplied on customer’s demand, the penalty cost for running out
of stock is called shortage cost or stock out cost.
 Economic Order Quantity
A problem always remains that how much material may be
ordered at a time. EOQ is the point where ordering cost and
inventory carrying cost is equal and where the total cost is
minimum. Fig. shows the different quantity standard:
In the figure, A is the point where the inventory is maximum
(OA is the maximum inventory) . The inventory consumes
gradually in quantity from A along AD at a uniform rate. It takes L
number of days between initiating order for new inventory and
receiving the require inventory. When the quantity reaches the
point B purchase requisition is initiated which takes from B to C
i.e., time R(B’C’) from point C to D is the inventory procurement
time i.e.,(C’D’). At the point D when the only reserve stock(RS) is
left.
The ordered material is supposed to reach and again the total
quantity shoots (reaches) to its maximum value i.e., point A’
(A’=A). OE is the minimum which must be kept in the stores at
any time.
The purpose to hold enough and not excessive stock of materials i.e.
stock holding.
1. Avoids running out of stock.
2. Helps creating a buffer stock which may be utilized if the materials
falls below the minimum level E.
3. Provides quick availability of materials.
4. Helps in reducing the variety of items to be handled.
Standard Order(A’D): The difference between maximum quantity and
reserve stock.
Recorder Point (B): It is the high time to initiate a purchase order.
Lead Time (L): It includes –(L= R +P)
i. Requisition Time, R: Time to prepare purchase requisition and placing
the order.
ii. Time taken to deliver purchase order to seller.
iii. Time for seller to get or prepare inventory.
iv. Time for inventory to dispatch from the vendors end and to reach
the customers.
Procurement Time(P)= ii + iii + iv
Economic Order Quantity depends on two types of cost:-
1. Inventory Procurement Cost(Ordering Cost)
2. Carrying Cost
The total cost is calculated by adding procurement cost and
carrying cost. The total cost is minimum at point A and thus A’
represents the Economic Order Quantity or Economic lot size(at
X axis).
Model-1. Economic Order Quantity with Instantaneous Stock
Replenishment (basic Deterministic Inventory Model)
Assumptions:
• In this model stock replenishment is instantaneous i.e. Lead
time, L is Zero.
• Price of the material is fixed.
• Ordering cost doesn’t vary with order quantity.
A
Consumption Rate
Quantity

Average Inventory
Q

B Q/2
Recorder Point

D
Time
𝑄2 =2𝐷𝐶0 /𝐶ℎ
Optimum Number of Production runs,
∗ 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑 𝐷
𝑁 = = ∗
𝐸𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝐵𝑎𝑡𝑐ℎ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑄
𝑇𝑐𝑚 =2 * Ordering Cost =360 Rs./min
Ordering cost = Inventory carrying cost
Ordering cost = optimum number of order X ordering cost / piece
= 5X 36 = 180
𝑇𝑐𝑚 =2 * Ordering Cost = 2X180 = 360 Rs./annum

Note: At EOQ, order cost equals carrying cost

Given, Cost per unit = Rs. 40
I = 40/100= 0.4
𝐶ℎ =𝐶𝑝 I

h
 ABC ANALYSIS
ABC Analysis : It is also known as always better control.
• It is a part of Inventory Control.
• It divides Inventory into three groups (A,B,C groups) in terms
of number of items and percentage of total value(cost).
A group items- High value items are grouped in A which are less
in percentage of total items.
C group items- While trivial i.e.(low usage value items).
B group items- the remaining middle level items are grouped in
B items.
This analysis is based on the principle of Management by
Exceptions i.e. rigorous control on A items, moderate control
on B items and loose control on C items.
The items are classified by virtue of their usage.

Category Weightage Percentage of Percentage

items (approx. in of value
quantity)
A High value items 10 70
B Medium value items 20 20
C Low value items 70 10

A items: Need accurate, careful record , handling and storage

under tight control such items should be thought of in advance
in purchase well in time. Such items are purchased in small
quantity as they are costly.
B items: These are middle level items which don’t require as
detail and close control like A items but they do need for
attention and control than C items. These items only represent
20 percent of total quantity of the items (in approx.) and
represent 15 percent to 20 percent of the total expenditure on
the items. This requires moderate control.
C items: These are low value items therefore, safety stock of
such items should be liberal . These items only require routine
check.
STEPS IN ABC ANALYSIS
• Identify all items.
• List all the items as per their value.
• Count the number of high valued, medium valued , and low
valued items.
• Count the percentage of low valued, high valued, and medium
valued items in terms of cost.
High valued items generally contribute 70 percent of the total
Inventory Cost , medium valued 20 percent and low valued 10
percent respectively.
A graph is plotted between percentage of items and percentage
of total Inventory Cost
 BREAK EVEN ANALYSIS
Break Even Analysis is the study of cost-volume of production
profit (CVP) relationship.
Profit mainly depends upon three factors-
• Cost of production
• Amount of input
• Sales revenue
Cost of production is of two costs: variable cost and fixed cost.
Fixed cost are assumed to be constant at all levels of output. E.g.
Expenditure on permanent labours and overheads
(Administrative cost).
Variable cost increases with the increase of output of
production i.e. (material cost , inventory cost etc.)
One of the technique to study the total cost , total revenue and
output relationship is known as Break Even Analysis.
Hence, Break Even Analysis is the study of cost, volume of
production and profit relationship.
It is analysis to study the point where neither profit nor loss is
occurred. This pint is known as Break Even Point. This break Even
Analysis can be done in two ways:
1. Algebraic method
2. Graphical method
But, usually a Break Even Analysis is done graphically.