UNIT3:INVENTORY MANAGEMENT

Meaning of Inventory: It consists of usable but

idle resources (not to be used immediately) such
as men, materials or money etc.

When the resource involved is a material, the

inventory is also called "STOCK".

The stock may be raw material, finished product,

(or) in process material (semi finished goods).
 Classification of Inventory
1.Direct inventories: Integral part of the
finished good Ex: Raw materials

2.Indirect inventories: Do not become

the part of the finished good.
Ex: Accessories, cutting tools etc.
Types of Inventory
 Why Inventory is maintained?
It helps the business to be run in a smooth and
efficient manner.
Service to the customer can be provided properly at a
short notice.
As the customer is satisfied, it promotes good will.
It is not practical to purchase material when required,
because going in for such purchase will be costly.
By purchasing material in bulk quantity, the advantage
of price discount given by the supplier can be made
use of.
 Why Inventory is maintained?
It tends to reduce the cost of the product as
there is no idle time of production facilities
due to non availability of material/resources.

In many cases, it acts as a safety stock when

the material ordered is received late.
 Inventory functions
To ensure against delays in
deliveries
To allow for possible increase in
output
Maintain smooth & efficient
production flow
To keep better customer relations
To take advantage of quantity
discounts
 Inventory functions
To ensure against scarcity of materials in the
market.

To have a better utilization of men and

machinery
 Inventory Control
It is defined as the scientific method of
providing the right type of material at right
time in the right quantities & at the right
price to sustain production schedules.
It is essentially concerned with 2 aspects:
1.Minimizing investments on the materials
2.Maximizing the service levels to the
customers & its own operating departments.
 Objectives of Inventory Control
To ensure adequate supply of products to
customer and avoid shortages as far as possible.
To make sure that the financial investment in
inventories is minimum
Efficient purchasing, storing, consumption and
accounting for materials is an important
objective.
To ensure timely action for replenishment.
To provide a reserve stock for variations in lead
times of delivery of materials.
 Objectives of Inventory Control
To provide a scientific base for both
short-term and long-term planning of
materials.

To maintain timely record of

inventories of all the items and to
maintain the stock within the desired
limits
 Disadvantages of inventory
It is expensive. Keeping inventory means the
company has to fund the gap between paying
for the stock to be produced and getting
revenue in by selling it. This is known as
working capital. There is also the cost of
keeping the stock in warehouses.
Items can deteriorate while they are being kept.
Products can become obsolescent while they
are being stored. Fashion may change.
Economic order quantity(EOQ)
It is the quantity of material that
can be ordered at one time to
minimize the cost of ordering and
carrying the goods in stock.

It refers to the size of the order that

keeps the total cost at low value.
 INVENTORY COSTS
1.Inventory carrying cost/storage cost/
holding cost.

2. Setup cost/ordering cost/replenishment

cost.

3. Shortage cost
 Carrying costs
These are the expenses incurred to the
organization due to the volume of inventory
carried.
▪ a) Interest amount, Handling charges
▪ b) salaries of staff ,Transport charges
▪ c) depreciation, Obsolescence costs
▪ d) Taxes, Insurance charges
▪ e) Storage costs
 Ordering costs
These are the fixed costs incurred in placing
of a purchase order to buy materials from
vendors.
▪ a) Calling Quotations
▪ b) Processing Quotations
▪ C) Placing of purchase orders
▪ d) Follow up costs
▪ e) Stationery etc. charges
 Shortage costs

These are the penalty costs

that are incurred as a result
of running out of stock .
▪ Sales may be lost, Good will may
be loss
 Purchase/Simple EOQ/Wilson Harris
Formula
Assumptions:
▪ Annual Demand is uniform, known and
is constant
▪ Supply of material is instantaneous
▪ Lead time is zero
▪ Ordering cost is same in every order
▪ Quantity discounts are not allowed
▪ Shortages are not allowed
EOQ Derivation
 Lead Time & Safety stock
representation
• Q • Usage • Profile of Inventory
• Qu Level Over Time
• rate
ant
ity
•• on
Reo
han
rde
dr
• P • Re • T
• poi• Re • P • Re
i
cei •l Lead cei l cei
nt m
ve a time ve a ve
e
 Symbols used
• D=Annual Demand
• C=Cost/unit(Rs.)
• I=Carrying cost(%)
• Cc =Carrying cost(Rs/unit/year)=C.I
• CO =Ordering cost(Rs./order)
• Q=Economic Order quantity
 METHODS

1.Graphical method

2.Calculus method
Graph
EOQ Derivation
EOQ formula
SAFETY STOCK REPRESENTATION
 Reorder Level(ROL)
Re Order Level = (Demand during the
lead time) + (safety stock)
▪ Demand during the lead time (DLT) =
(Demand/day)X(lead time in days)

Hence, ROL= (DLT)+SS

 Limitations of EOQ formula
▪ In actual practice Annual Demand may not
uniform, unknown
▪ Supply of material is not instantaneous
▪ Lead time may not be zero
▪ Ordering cost is varying in every order in real
▪ Quantity discounts are allowed
Manufacturing model(EBQ)
 Symbols used
• D=Annual Demand
• p=Production rate
• d=consumption rate
• C=Cost/unit(Rs.)
• I=Carrying cost(%)
• Cc =Carrying cost(Rs/unit/year)=C.I
• CS =Set up cost(Rs./order)
• Q=Economic Batch Quantity
 EBQ(Economic Batch Quantity)
• TP = Production time
• TD = Depletion time.
• During the period TP, inventory builds up at
the rate of (p — d) units per unit time. After
time TP, inventory depletes at the rate d
• TP = Q/p
• Maximum on-hand inventory= TP(p—d)= Q/
p (p—d)
• Average Inventory level = Q/2 ( 1 - d/p)
EBQ(Economic Batch Quantity)
(TC) = Total ordering cost + Total carrying cost
=( D/Q ) Cs + Q/2 ( 1 - d/p) Cc
Differentiating (TC) with respect to Q and
equating it to zero, we get:

d (TC)/dQ = - D/Q2 Cs + 1/2 ( 1 - d/p) CC = 0

Q* = √2DCs/(1 - d/P)Cc
EBQ Formula
 Formulas to be remembered
1.Optimal number of production runs per
year N =D/Q

2. Length of production run, TP =Q/P

3. Total inventory cost,

(TC) =(D/Q) CO + Q/2 (1 - d/p) Cc
Quantity discounts(or) Price breaks

Single price break

Multi price break

Selective Inventory Control
techniques
 ABC analysis
It is one of the selective inventory
control technique
ABC means Always Better Control
It is based on “Pareto’s principle” (i.e.
Vital few & Trivial many)
All the items of inventory are classified
into 3 categories (i.e. A,B and C)
 ABC analysis
A items are the costly . Hence these items
need to be stocked in smaller quantities and
should be procured frequently.
C items are the low cost items . Hence these
items need to be stocked in larger quantities
and should be procured at a time.
B items are the moderate cost items. But
these stock levels are more than A items
 ABC analysis
In this technique all the items are
arranged in descending order of their
annual usage value.

Annual consumption value is calculated

with the following formula
=(Annual usage) x (cost per unit)
 ABC analysis
Category Percentage Desired
Percentage
of items value of degree of
of
annual control
items(Units)
usage(Rs)
Strict
Class A 10% 70% control

Moderate
Class B 20% 20%
control

Low
Class C 70% 10%
control
 Procedure for conducting ABC
Analysis

• Prepare a list of items and estimate their

annual consumption (units).
• Determine unit price of each item .
• Multiply annual consumption with unit price
to get the annual consumption value in
rupees
• Arrange the items in descending order of
their annual usage value starting with the
highest and ending with the lowest .
 Procedure for conducting ABC
Analysis
• Calculate cumulative usage value and express
the same as cumulative usage value as
percentage. Also express the no of items into
cumulative item percentage
• Plot a graph of cumulative usage value
percentage vs cumulative items percentage
and segregate into three categories as A, B and
C items.
• Decide the policies for control of these three
categories .
ABC Analysis graph
 VED Analysis
It is applied to the classification of
maintenance spare parts.
This analysis is based on the criticality
(importance) of the items.
The spares are split into three categories of
importance from the view of functional utility.
V-stands for vital items, E-stands for Essential
items & D-stands for Desirable items.
 Vital items
These items irrespective of their costs
that are highly important without
which you cannot run the production
(or) assembly are vital. If these items go
out of stock (or) are not readily
available there will be loss of
production.
 Essential items
E-stands for Essential items, without
which the performance or efficiency of
the equipment will be reduced. The
absence of essential items may not stop
the production chain but suffers
production chain considerably.
 Desirable items
The desirable items are usually required to
make the product good looking or aesthetic
and their absence hardly has not any impact
on production chain.
Example: For a scooter, Engine is a vital part,
brakes are essential and seat cover is
desirable. Note that a low value of the tyre is
also vital though cheaply available.
 Introduction to Supply chain
management
Supply chain management is the
management of the network of businesses
involved in the supply of goods or services.
It begins with the supply of raw materials
and ends with the consumption of the good
or services and includes all organizations,
employees,resources,technology and
information involved in the process.
 Introduction to Supply chain
management
It is the oversight of materials, information,
and finances as they move in a process from
supplier to manufacturer to wholesaler to
retailer to consumer.
It involves coordinating and integrating
these flows both within and among
companies. It is said that the ultimate goal of
any effective supply chain management
system is to reduce inventory
 Introduction to Supply chain
management
Supply chain management flows
can be divided into three main
flows:
• The product flow
• The information flow
• The finances flow
 Introduction to Supply chain
management
The product flow includes the movement of
goods from a supplier to a customer, as well
as any customer returns or service needs.
The information flow involves transmitting
orders and updating the status of delivery.
The financial flow consists of credit terms,
payment schedules, and consignment and
title ownership arrangements.