CHAPTER IV

INVENTORY CONTROL (MANAGEMENT)

4.1. INTRODUCTION
Inventories are materials and supplies that a business or institution carries either for sale or to
provide inputs or supplies to the production process. All businesses and institutions require
inventories. Often they are a substantial part of total assets. Financially, inventories are very
important to manufacturing companies. On the balance sheet, they usually represent from 20% to
60% of total assets. As inventories are used, their value is converted into cash, which improves
cash flow and return on investment. There is a cost for carrying inventories, which increases
operating costs and decreases profits. Good inventory management is essential.
Inventory management is responsible for planning and controlling inventory from the raw
material stage to the customer. Since inventory either results from production or supports it, the
two cannot be managed separately and, therefore, must be coordinated.
4.2. MEANING OF INVENTORY
Inventories are stock of materials of any kind stored for future use. They are materials or
resources of any kind having some economic values, either awaiting conversion or use in the
futures. They include semi-finished goods awaiting release for sale, many indirect materials such
as maintenance materials, fuels and lubricants, etc. Here the responsibility of materials
management is to maintain sufficient inventories to meet demand for goods and at the same time
incurring the lowest inventory handling costs.
4.3. TYPES AND FUNCTION OF INVENTORIES
There are many types of inventories, such as raw materials and production inventories,
components and service parts, as well as work in process and finished goods inventories. They
may also be functionally classified as movement inventories, lot-size inventories, anticipation
inventories, fluctuation inventories, etc.
When we consider inventories in the context of manufacturing and distribution, there is a natural
classification scheme suggested by the value added from manufacturing or processing. Based on
this concept there are five types of Inventories. They are;
1. Raw Materials; These are the resources required in the production or processing
activity of the firm.
2. Components; Components correspond to items that have not yet reached completion in
the production process. Components are sometimes referred as Sub-assemblies.
3. Work –in-process; Work-in-process (WIP) is inventory either waiting in the system for
processing or being processing. Work-in-process inventories include component
inventories and may include some raw materials inventories as well. The level of work-
in-process inventory is often used as a measure of the efficiency of a production
scheduling system.

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 4. Finished goods; These are also known as end items; these are the final products of the
production process. During production, value is added to the inventory at each level of
the manufacturing operation, culminating with finished goods.
5. Supplies; These are items that facilitate the production and administrative functions.
They are not part of the final item. (eg. Tools, office supplies, lubricants, stationary items
etc…). The appropriate level to place on inventory depends upon the context. For
example, components for some operations might be the end products for others.
Functions of inventories:
o Inventories smooth production requirements. They provide balance in production (smooth
running of production system)
o Inventories help to meet anticipated customer demand.
o Inventory protect against stock out situations: delay shipments and unexpected increase in
demand may results in shortage of materials. This may occur due to bad weather or the
shipped materials may be inferior in quality. Thus, inventories would be used to minimize
the risk. Such inventories are called safety stock. Safety stocks are inventories that are in
excess of normal requirement that would put the organization in the safest point.
o Inventories provide a means of hedging (protecting) against future price increase and
delivery uncertainties in case there is strike, boycott, inflation, etc. However, it is not
possible to meet all these objectives at the same time due to different interest in the other
organization ‘s department, for instance:
 Production department tends to have over stocking. This is because shortage of
materials will lead to disruption which will increase cost of production and may
finally lead to shots down.
 Purchasing department tends to buy large quantity purchase due to benefit it may
get like quantity discount and ordering cost, etc.
 Marketing department tends to have high stock of finished goods to ensure a rapid
customer service and timely delivery.
 Finance department argues in fever of low inventory level to free up the tied-up
capital and use it for another purpose.
Thus, the materials management manager must be able to trade off these conflicting interests
among departments. This would be solved by determining the optimum level of inventory using
economic order quantity- is a quantity at which total inventory cost become minimum and at the
same time meet organizational needs.
4.4. NATURE OF DEMAND IN INVENTORIES
In order to establish an efficient inventory planning and control, we have to identify whether the
demand is dependent or independent for the products. The demand for inventory may be
dependent or independent.
1. Dependent Demand Items: - are those items where their demand is related to the demand
for another item. This demand is also known as Derived Demand. Example, if a motor
cycle requires two tires and if you decide to produce ten motor cycles, then the demand
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 for the tire is 20. This is because the demand for the tire is dependent up on the demand of
motor cycle. For determining the right quantity for dependent demand materials, we use
materials requirement planning.
2. Independent Demand Items: -are those items that are not influenced by production
operation but by the market forces. For stoking decisions of independent demand item
forecasting and EOQ model is required.
4.5. MOTIVATION FOR HOLDING INVENTORY
Organizations may hold inventories with the various motives as stated below……
1. Economies of Scale; economies of scale are the cost advantages that enterprises obtain
due to their scale of operation, and are typically measured by the amount of output
produced. A decrease in cost per unit of output enables an increase in scale. This means
that it could be economical to produce a relatively large number of items in each
production run and store them for future use. This allows the firm amortizes fixed set up
costs over a large number of units.
2. Uncertainties; it is potential and unpredictable events, which requires a response to re-
establish the balance. An event can be an unexpected order, late delivery from a supplier
or a breakdown of critical production equipment. Uncertainties often plays major role in
motivating firm to store inventories. Uncertainty of external demand is the most
common. Inventory provides a buffer against the uncertainty of demand. Other
uncertainties provide a motivation for holding inventories as well. One is the
uncertainty of the lead-time. Lead-time is defined as the amount of time that elapses
from the point that an order is placed until it arrives. In the production-planning context,
interpreter the lead-time as the time required to produce the item.
3. Speculation; Speculative inventory is another term for “anticipation inventory.” This is
stock businesses hold to meet an expected increase in demand. Anticipation
inventory may also help businesses protect against forecast increases in the cost of
supplies. If the value of an item or natural resource is expected to increase, it may be
more economical to purchase large quantities at current price and store the items for
future use than to pay the higher price at a future date. For example, silver is required
for the production of photographic film. So, by correctly anticipating a major price
increase in silver, a major producer of photographic film, such as Kodak, could purchase
store, large quantities of silver in advance of the increase and realize substantial savings.
4. Transportation; In-transit or pipeline inventories exist because transportation times are
positive. When transportation times are long, as is the case when transporting oil from
the Middle East to the United States, the investment in pipelines inventories can be
substantial.
5. Logistics; Certain constraints can arise in the purchasing, production, distribution of
items that force the system to maintain inventory. One such case is an item that must be
purchased in minimum quantities. Another is the logistic of manufacture; it is virtually
impossible to reduce all inventories to zero and expect any continuity in a manufacturing
process.
4.6. INVENTORY COSTS
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Because we are interested in optimizing the inventory system, we must determine an appropriate
optimization or performance criterion. Virtually all inventory models used cost minimization as
the optimization criterion. An alternative performance criterion might be profit maximization.
However, cost minimizations and profit maximizations are essentially equivalent criteria for
most inventory control problems. Although different systems have different characteristics,
virtually all inventory costs can be placed in to one of the three categories; holding cost, order
cost, or penalty cost. Each will be discussed as follows:
1. Holding Costs
The holding cost, also known as the carrying cost or the inventory cost, is the sum of all costs
that are proportional to the amount of inventory physically on hand at any point in time. The
components of the holding cost include a variety of seemingly unrelated items. Some of these
are:
i. Cost of providing the physical space to store the items
ii. Taxes and insurances
iii. Breakage, spoilage, deterioration, and obsolescence
iv. Opportunity cost of alternative investments
v. The salaries and wages of storing, receiving and issue of material personnel.
vi. Stationary and other consumables use by the stores.
The opportunity cost of alternative investment turns out to be the most significant in computing
holding costs for most applications. Inventory and cash are in some sense equivalent capital
must be invested to either purchase or produce inventory, and decreasing inventory levels results
increased financial capital. This capital could be invested by the company either internally, in its
own operation, or externally.
In general, however, most companies must earn higher rates of return on their investment in
order to remain profitable. The value of the interest rate that corresponds to the opportunity cost
of alternative investment is related to a number of standard accounting measures, including the
internal rate of return, the return on assets, and the hurdle rate (the minimum rate that would
make an investment attractive to the firm).
For example, we may use the term cost of capital to refer to this component of the holding cost.
Therefore, we may think of the holding cost, as an aggregated interest rate comprised of the four
components listed above.
For example;
20% = cost of capital
2% = Taxes & Insurance
6% = Cost of Storage
2% = Breakage & Spoilage
30% = Total interest charge
This would be interpreted as follows: We would assess a charge of 30 cents for every birr that
we have invested in inventory during a one-year period.

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 2. Order Costs
The holding cost includes all of those costs that are proportional to the amount of inventory on
hand, whereas, the order cost depends on the amount of inventory that is ordered or produced.
Placement of purchase order for a material is associated with certain obvious cost due to
advertising, consumption of stationery and postage, telephone charges etc… In fact, all the
annual expenditure of the purchasing department of a company can be considered to be on the
purchase order it places during the year.
The cost associated with ordering would, therefore, consists of;
o Salaries of the staffs in the purchasing department
o Negotiating purchases, placing orders and follow up.
o Rent for the space used by the purchasing department.
o The postage, telegram, telephone bills, and Traveling expense.
o Entertainment charges for vendors, inspecting shipment & moving goods to storage.
o Lawyers and court fees due to any legal matters arising out of purchase.
When more order placed in a period, the more would be the stationery and postage consumed,
more staff and officers will be required for handling the work, the more will be the space
required for accommodating them and soon. Thus, the total expenditure on purchasing or
ordering would depend on the number of orders placed. It is assumed that the expenditure on
ordering of material is directly proportional to the number of orders placed. The ordering cost is
expressed as cost/order.
3. Penalty Costs
The penalty cost, also known as the shortage cost or the stock-out cost, is the cost of not having
sufficient stock on hand to satisfy demand when it occurs. This cost has a different interpretation
depending on whether excess demand is back-ordered (orders that cannot be filled immediately
are held on the books until the next shipment arrives) or lost (known as lost sales). In the book-
order case, the penalty cost includes whatever bookkeeping and /or delay costs might be
involved. In the lost-sales case, it includes the lost profit that would have been made from sales.
In either case, it would also include the “lost good-will” cost, which is a measure of customer
satisfaction. Estimating the loss of goodwill component of the penalty cost can be very difficult
in practice.
4. Purchase Cost:
The purchase cost is the price paid to supplier for purchasing materials. The nature of purchasing
cost is that it is constant i.e. purchase price per unit is constant unless otherwise discount are
offered.
The relevant costs for the purpose of determining the optimum quantity are ordering cost and
carrying cost. They are called incremental cost because they increase or decrease is relation to
decrease or increase of quantity.
4.7. THE ECONOMIC ORDER QUANTITY(EOQ) MODEL

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The EOQ (Economic Order Quantity) model is one method of determining the adequate
(optimum) inventory level for independent demand materials. This model is one of the
mathematical models and it results in an inventory level which is not too large or too small. i.e.
It is the economical level of inventory.
Here very large order size may result in few numbers of orders there by low ordering cost.
However, the annual carrying cost may be high for large size of inventory. On the other hand,
small order size involves many orders which decreases the annual carrying cost and increases the
annual ordering cost of the item.
Therefore, the annual total inventory/increment at cost will be large due to both inadequate and
more than adequate inventory level. At the point of EOQ, the total inventory cost will be kept at
minimum level.

Basic Assumptions of EOQ:

1. Annual demand is known - through forecast or actual order placed.
2. Items will be withdrawn from inventory at a uniform rate. i.e. usage is spread evenly
throughout the year.
3. Lead Time does not vary.
4. Each order is received in a single delivery. i.e. orders are received the movement
inventory is deleted. We receive inventory immediately when our inventory level is
reduced to zero.
Economic Order Quantity Determination

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 ECONOMIC ORDER OF
QUANTITY(EOQ)

PURCHASING CARRYING
Order Cost
COST COST

EOQ is an order size that balances the annual carrying cost & annual ordering cost. At EOQ the
annual carrying cost is equivalent to the annual ordering cost. Now in order to calculate the
annual carrying cost (ACC) let us look at the concept of average inventory. The concept of
average e inventory is based on the following assumption;
o Purchase is made at the beginning.
o Usage rate is constant and
o The last item is used on the last date
The ACC = Q/2 x CC  Where CC = unit carrying cost per year
Q= Order quantity in unit
The annual ordering cost (AOC) is also calculated as follows;
AOC = D/Q x OC  Where D = Annual Demand
OC = Ordering Cost per order
Annual ordering cost is simply the product of number of orders & the ordering cost per order.
At EOQ  ACC = AOC

Q/2 x CC = D/Q x OC
If we multiply both sides by Q, the result will be

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 2
Q QD∗OC
 2
∗CC=
Q
2
Q D∗OC
 2
=
CC
2∗D∗OC
 2
Q=
CC

 Q=
√ 2×D×OC
CC

Where  Q = economic order quantity

D = Annual demand
OC = Ordering Cost/order
CC = Carrying Cost per unit per year.
The above analysis can be summarized as follow.
 Minimum Inventory Cost = ACC = AOC
 Minimum total Annual Cost = ACC + AOC + Purchase cost
Example
A local distributor for Addis Tire Company expects to approximately 9,600 steel belted tires of
certain size next year. The annual carrying cost is 16.00 Birr per tier per year and the ordering
cost are 75.00 Birr per order. The distributor operates 288 days a year.
Required:
1. Determine EOQ.
2. What is the Ordering Cost per year and annual carrying cost at EOQ?
3. What is the total incremental or total inventory cost at EOQ?
4. If purchase price per tire is 80.00 Birr. What is the total cost at EOQ?
5. How many times per year the store does reorders?
6. Determine the length of an order cycle.
7. Compute Ordering, Carrying, Total Inventory costs & overall total costs. If order
quantities are 100, 150, 200, 250, 300, 350 and 400 units. What do you infer from this
exercise?
Solution:
Given: D = 9,600
CC = 16.00 Birr
OC = 75.00 Birr
Working days per year 288

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 1. Q0 =
√ 2×D×OC
CC
Where Q0 is optimum Quantity.

=
√ 2×9600×75
16

= 300 tires per order.

2. ACC = Q/2 x CC AOC = D/Q x OC
= 300/2 x 16 = 9,600/300 x75
= 2,400 Birr = 2,400 Birr
3. Minimum Inventory Cost = 2,400 +2,400
= 4,800 Birr

4. Total Cost = AOC + ACC + Pc Pc = is purchase cost

= 2,400 +2,400 +80(9600)
= 772,800 Birr
5) Number of Order per year = Annual Demand
Order Size
= 9,600
300
= 32 Order
6) Length of Order Cycle = Annual Working Days x Q0
D
= Annual Working Days
No. of orders per year
= 288 = 9 Working Days
32
It means the optimum quantity will be used within nine working days’ interval
7)
Order ACC=(Q/2*H) AOC=(D/Q*O) Total Total Cost
Quantity Inventory Cost
100 800 7200 8000 Birr 776,000
150 1200 4800 6000 774,000
200 1600 3600 5200 773,200
250 2000 2880 4880 772,880

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 300 2400 2400 4800 772,800
350 2800 2057 4857 772,857
400 3200 1800 5000 773,000
450 3600 1600 5200 773,200
From this we can infer that at EOQ, total inventory or overall total cost will be minimum. When
the order size is large, the ACC will be high & for small order sizes the AOC will be high.
EOQ with Quantity Discounts & Price Breaks
The optimum quantity when there is quantity discount is the one that makes the savings from the
purchase cost greater than the total inventory cost.
EOQ model is not the best method to determine the optimum level when there is quantity
discount.
Example:
A factory required 1,500 units of an item per month, each costing 27.00 Birr. The cost per order
is 150.00 Birr & inventory carrying charge is 20% of price.
Required:
1. Find the EOQ & the total material cost.
2. Would you accept a 2% discount on a minimum supply of quantity of 1,200 units?
Solution:
Given - Monthly demand = 1,500 unit so the annual demand will be 1,500x12 = 18000
Price = 27.00 Birr
CC = 0.2(P)  0.2(27) = 5.4 Birr /year /unit
OC = 150/Order

1. EOQ =
√ 2×1 ,800×150
5. 4
= 1000 units
The total cost without discount is
TOC = D/Q x OC
= 18000/1000 x 150 = 2,700 Birr
TCC = Q/2 x CC
= 1000/2 x 5.4 = 2,700 Birr
Total Purchasing Cost = 27 x 18000 =  486,000 Birr
Total Material Cost = 491,400 birr
2. The minimum supply is 1,200 units.
The unit cost will be decreased by 2%. i.e.
= 27 – (0.02(27)) = 26.46Birr

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 The total material cost with quantity discount of 2% can be obtained as follows
(N.B. – Q is 1,200 unit)
TOC = 18000/1200 x 150 = 2,250 Birr
TCC = 1,200/2 x (26.46 x 0.2) = 3,175.20 Birr
(CC is 20% of Price)
TPC = 18000 x 26.46 = 476,280 Birr
 Total material cost is 481,705.20 Birr with a discount of 2% for an
order size of 1,200 units is need to be accepted.
Illustration on Price Breaks
Determine the order quantity that will minimize total annual inventory cost for the price schedule
below. Annual demand is 1200 units, ordering cost is 41 br., and holding cost is birr 2 per unit
per year.
Quantity in Unit Unit price (birr)
1 to 199 27
200 to 299 26
300 to 399 25
400 or more 24
Solution:
The first step is to calculate EOQ, then to identity the price break that it falls.

EOQ =
√ 2×D×OC
CC

EOQ =
√ 2×1 ,200×41
2
= 222 units
The EOQ is in the range of 200 to 299 which is not optimal because of the price breaks.
The second step is to calculate the total cost at EOQ and the price breaks of 300 to 399 and 400
or more. The calculation is as follow:
TC = ACC + AOC + Purchase Cost
TC222 = 222/2 x (br.2) + 1200/222(br.41) + 1200(br.26) = Birr 31,644
TC300 = 300/2 x (br.2) + 1200/300(br.41) + 1200(br.25) = Birr 30,464
TC400 = 400/2 x (br.2) + 1200/400(br.41) + 1200(br.24) = Birr 29,323
Therefore, the fourth range’s value is optimal because it has the lowest total cost.
EOQ with Gradual supply of orders from external supplier

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This one is the case where the supply of orders is not instances. i.e. there is no immediate supply
of items from the suppliers’. In order to grasp the idea of gradual supply let’s look at the
concepts of lead-time and safety stock.
A. Lead-Time
From the time the requisition for an item is raised, it may take several Weeks or months before
the supplies are received, inspected and taken in to the stock. This time is called Lead-Time and
involves the time for the completion of all or some of the following activities:
a. Raising purchase requisition.
b. Inquiries, quotations and approval, (import license procedure for imported items).
c. Placement of an order on supplier(s).
d. Suppliers time to make the goods ready.
e. Transportation or clearing.
f. Receipt of goods at the company.
g. Inspection of received items.
h. Taking the items in to the store.
Obviously, in order to receive supplies before the stock reaches zero level, it is necessary to
order the materials much in advance.
Suppose an item has lead time of 15 days and the monthly consumption (assuming 30 days per
month) of the item is 600 units, then the reorder must be placed when the stock available is
sufficient to last 15 days is 300 units.

ROL = Stock sufficient to last during the lead time is 300 units.
Here the Re-order point is lead- time multiplied by daily demand.
B. Safety Stock (Buffer or Reserve) ROL = 300

It is well known that neither the consumption rate of a material is constant through neither the
year nor the lead-time. Hence in the earlier example though reorder is place at a stock level of
300 units. The consumption rate may rise subsequently and the stocks may well be exhausted in
7 days instead of 15 days or it may be that the supplier fails to supply after 15 days as expected.
In either case a stock out would be experienced resulting into hampering of production to guard
mainly against these uncertainties in consumption rate and lead time, an extra stock is
maintained all along this is called as buffer stock or safety stock.

These stocks also come in use when:

1) Any excess in process rejections.
2) Rejections at the time of receipt or goods due to damages or subsequent quality.
Since safety stock is part of inventory, it should be maintained just sufficient to guard against the
uncertainties and not –too –excessive (especially for ‘A’ items).

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In order to decide on the level of the safety stock, we should analyze the following aspects:
1. Is the variation in consumption more predominant in lead-time?
2. If the variation in consumption more predominant, can it be forecasted in Advance?
3. If the variation in lead-time is more predominant, is it restricted to a particular period (say
a season) or spread all over the year?
In most cases it is found that the variations in consumptions can be predicted fairly in advance
accurately by good production and maintenance planning and does not present much a problem.
However, the lead-time variation is more erratic and unpredictable.
Determining Safety Stock
One simple method of determining safety stock in such cases is to approximately estimate the
maximum lead-time and the normal lead time for an item in consultation with the purchasing
personnel and from the past records. The safety stock then be sufficient to last the periodic
difference between maximum and minimum lead-time period.
Suppose for an item monthly consumption is 100 units, the normal lead-time is 15 days and
maximum lead-time is estimated as one month. The safety stock will be;
Safety stock= (Maximum lead-time  Normal lead-time) x Monthly consumption
(1-1/2) x 100
= 50 or say 50 to be on safe side.
It should be well understood that safety stock is meant only to provide for above normal lead-
time and above normal consumption rate. The normal lead-time and consumption rate is already
taken care of in setting Re-Order Level (ROL). If normal lead-time consumption is 300 units
and safety stock is 50 units, the reorder level is set at 350 units.
4.8. ECONOMIC PRODUCTION QUANTITY (EPQ)
We have seen the application of the EOQ model in determining the optimum order quantity of
items purchased/ordered from external suppliers. But when the company is the producer and
user of its items, the run size is the economic production quantity (EPQ). In other words, the
company is the supplier for itself.
In the determination of the EPQ the carrying cost remains the same but the ordering cost is
replaced by set-up-cost which is the cost of preparing for production.
Let us now derive the formula of EPQ;
Let d = Daily demand rate for the products.
P = Daily production rate for the product
t= Number of days for a production run (In order to produce the Specified quantity).
When p > d;
 Daily rate of inventory build-up = p-d
 Level of inventory by the end of t day = (p-d) x t  Maximum inventory.
Run size  Q = pt
Run time =Q  Stated as days.
p
The maximum inventory is given above as = (p-d) x t

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Since t is = Q/p it can also be stated as = (p-d) x Q/p
= (1 –d/p) x Q
And the average inventory will be = Maximum inventory
2
= Q/2 (1-d/p)
Consequently, the annual carrying cost is = Q/2 (1-d/p) x CC
The annual set-up cost (ASC) can be obtained as follows:
ASC = (No. of production run / year) x (set–up cost /year)
= (D/Qo) x Sc Where:
Q0 = run Size  EPQ
Sc = Set-up cost/year.

 The Total Annual inventory cost =

Q
2 ( )
d
1− ×CC +
p
D
Q0
×Sc
( )
The Optimum production size will also be determined as follows;

EPQ  Q0 = √ 2×D×Sc
(1−d / p )×cc
Where D = Annual demand
Sc = Set-up cost /run
CC = Annual carrying cost/unit
d/p = Part of production that is not inventoried
1 - d/p = Part of production that is carried in inventory
Example
A toy manufacturer uses 48,000 rubber wheels per year for its popular dump- truck series. The
firm makes its own wheel, which it can produce at a rate of 800 per day. The toy trucks are
assembled uniformly over the entire year. carrying cost is Br 1.00 per wheel a year. Set up cost
for a production and change over from the previous production is Br. 45.00. The firm operates
240 days per year. Determine each of the following.
A) The optimum Size (EPQ)
B) The minimum total inventory cost.
C) The cycle time for the optimal size.
D) The run time.
E) The number of production runs in a year.
F) Maximum level of inventory.
Solution:
Given: D = 48,000
P = 800/day
CC = Br. 1/unit /year
Sc = Br. 45/production
Run
Working Days = 240 days
Daily demand = 48000 = 200/day

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 240
A) The optimum Size

= EPQ = √ 2×D×Sc
(1−d / p )×cc

√
2×48 , 000×45
= (1−200 /800 )×1 = 2400 Wheels

Here one run will last for 3 days = 2400 and form this quantity level 600
800
wheels will be consumed (3 x 200) and the remaining 1,800 units will be kept in the sore.
B) The minimum Total inventory cost is = ASC + ACC

 The Total Annual =

( )
D
Q0
Q
2
d
×Sc+ 1− ×CC
p ( )
(= 2400
48 , 000
)×45+ 2 , 400
2 ( 1−
800 )
200
×1

= 900 + 900
= Birr 1,800
C. The cycle time for the optimal run size:
Optimum Quantity = 2,400 =12 Working days
Daily Demand 200
The optimal run size covers 12 working days.
i.e. 3 days for production & usage time & 9 days will be idle time.
D. The Run time:
t = Q0 = 2,400 = 3 days
p 800
E. The number of production runs in a year:
= Annual demand = 48,000 = 20 runs.
Optimal Quantity 2,400
The 20 runs cover 60 production days. i.e. 20 x 3 = 60 days and in this period there is
production and consumption simultaneously. The remaining 180 days are idle time between
runs & during these periods there is only consumption.
F. Maximum inventory level:
= Q0 x (1 – d/p)
= 2,400(1- 200/800) = 1800
4.9. Materials Requirements Planning (MRP)
The MRP concept provides a very basic and different way of looking at the management of
production inventories. Fundamentally, in its present sense, MRP challenges the traditional
concept that any significant level of production inventory need be carried prior to the time
materials are actually required by production operation.

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The techniques of an MRP system are designed for use in certain specialized operating situations
the system can be used more advantageously under the following conditions.
1. When usage or demand of the material is discontinuous or highly unstable during a
firm ‘s normal operating cycle.
2. When demand for the material is directly dependent on the production of other specific
inventory items or finished products
MRP Logic and Format
MRP acts as an information processing system that seeks to develop and maintain a set of orders
that support the production plan, while simultaneously maintaining inventory within the
production system at reasonably low level. Orders within an MRP system fall into two
categories:
1. Open orders which have been released but have not yet arrived and
2. Planed orders which are developed in anticipation of future release
The use of MRP requires three basic information inputs.
1. Master production schedule (MPS), which specifies the anticipated production of
finished products week by week in to the future. In order to effective MPS should cover a
time span that exceeds the cumulative lead time of the finished product.
2. Bills of materials (BOM), which specifies the materials required to produce each item in
the inventory system. Generally, the BOM covers multistage type of products. A multistage
product requires a serious of purchasing or production stages or steps to transform the raw
materials into a finished product. Each stage presents a stocking point for inventory.
Therefore, the production of a single finished product involves a series of related inventory
decisions.
3. Inventory record file (IRF), which contains the current status of an inventory item. This
status includes the current inventory balance, the timing and sizing of all open orders for the
item, the lead time, and any other information used for planning. IRF links the MRP system to
past decision which must be considered in developing the new plan.
4.10 Just in Time (JIT) management
Just in time is a U.S term coined to describe the Toyota production system widely recognized
today as one of the most efficient manufacturing operations in the world. In its simplest, JIT
requires only necessary units be provided in necessary quantities at necessary time. Producing
one unit extra is as bad as being finishing one day late. Items are supplied only when needed.
Stock exists because items have been bought before they are required. It is normally uncertainty
or over caution that causes stock. The principle of just in time (JIT) is simple that we have items
when they are needed and none when they are not needed. The idea may be simple but the
application of just in time has given the opportunity to decimate stock holding without affecting
customers.
Companies which are considering how JIT can work in their business, or avoiding it, should
realize that JIT is an outcome of other techniques, not a technique of its own. It is a logical aim
of tight inventory control, effective progress planning and plant design, work force motivation,

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cost reduction, logistics and even material requirement planning (MRP). The optimization of
these together inevitably leads to the JIT approach. The elements of JIT are the techniques to be
developed, for example:
 Supply what is required and Supply the quality required
 Reduce lead times and Organize effectiveness
 Use all the expertise available (i.e. people who do the jobs plus technical backup)
JIT Implementation
The firms that have been most success full in implementing JIT understood the breadth and inter
relatedness of the concepts and adopted them to their own particular environment. This makes
sense when you consider the essence of JIT- eliminate waste, speed up change over, work
closely with suppliers, stream line the flow of works, use flexible resources, pay attention to
quality, expose problems, and use worker teams to solve problem.
Many firms may call JIT version in different terms like stock less production, (Hewlett-Packard),
material as needed (Harvey-Davidson), continuous flow manufacturing (IBM), zero inventory
production system (o mark industries).
We should note that JIT is not appropriate for every type of operation. For high volume
repetitive items mass production is still the best process to use. Similarly, JIT is in appropriate
for very low volume items or unique orders. For JIT to be successful there must be some stability
of demand. A true make to order shop would find it difficult to operate under JIT. Even make to
order businesses however there are usually some parts or processes that are common or repetitive
and can benefit from JIT concept.
Benefits of JIT
A study of the average benefit accrued to us manufacturers over a five-year period from
implementing JIT is impressive: 90%reduction in manufacturing cycle time, 70%reduction in
inventory, 50% reduction in labor cost, and 80% reduction in space requirements. While not
every company can achieve results at this level, JIT does provide a wide range of benefits
including;
 reduced inventory  increase productivity
 improved quality  greater flexibility
 lower costs  better relations with suppliers
 reduced space requirements  simplified scheduling and control
activity
 shorter lead time
 increased capacity

Other Tools/ Techniques of Inventory Management

1. The ABC Classification

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 ABC = Always Better Control; This is based on cost criteria. It helps to exercise selective control
when confronted with large number of items. It rationalizes the number of orders, number of items
and reduces the inventory. In general
 An item (5-15 % of all inventory items that account for 70-80% of annual inventory value)
 B items (30% of total inventory items that account for 15% of annual inventory value)
 C items (50-60 % of total inventory items that account for 5-10 % of annual inventory value
% of inventory value)
This classification will not be exact but they have been found to be close to the actual
occurrences in firms with remarkable frequency.
Table 11. Descriptions of ABC classification.
Characteristics Policy Method
A items Tight control Frequent monitoring
Few items Rigid estimate of requirements Accurate records
Most significant Strict and closer to watch Sophisticated forecasting
inventory value Low safety stock Service level policy
Managed by top management
B items Moderate control Rely on sophisticated system
Important Items Purchased based on rigid requirements Calculated safety stock
Significant Reasonably strict watch and control Limit order value
inventory value Moderate safety stock level Computerize management
Managed by middle level management and exception reporting

C items Ordinary control measures Simple system

Many items Purchased based on usage estimates Avoid stock outs and excess,
Low inventory high safety stock policy infrequent ordering
value Automatic system

2. FSN Analysis
This classification is made on the bases of utilization.
F - Stands for fast moving.
S - Stands for slow moving.
N - Stands for non-moving materials. Non-moving items must be periodically reviewed to prevent
expiry and obsolescence.
3. VED Analysis
VED analysis is an inventory management technique that classifies inventory based on its
functional importance. It categorizes stock under three heads based on its importance and
necessity for production or any of its other activities. It is based on critical value and shortage
cost of an item. It is a subjective analysis.
V – Class items: are vital items without them production will immediately stop. Shortages cannot
be tolerated.
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E – Class items: are essential items where the non-availability of them would affect only
performance or efficiency in the system. Shortages can be tolerated for a short period.
D – Class items: are desirable items in the absence of them production will not be affected.
Shortages will not adversely affect, but may be using more resources. These must be strictly
scrutinized.
4. HML Analysis
It is based on cost per unit Highest, Medium and Low. This is used to keep control over
consumption at departmental level for deciding the frequency of physical verification.
5. SED Analysis; Based on availability
Scarce items or imported materials: Those are always in a short supply. They are managed by
top level management. Maintain big safety stock.
Easy to obtain items are items that are easily available in the market. Maintain minimum safety
stock.
Difficult to obtain items are already available in the market but difficult to obtain them.
Maintain sufficient safety stock.

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