UNIT - III

OPERATIONS
MANAGEMENT

INVENTORY
MANAGEMENT

 WHAT IS INVENTORY ?
WHAT ARE THE TYPES OF
MANUFACTURING INVENTORY ?
WHAT IS THE PURPOSE OF
INVENTORY ANALYSIS ?

UNIT III : INVENTORY MANAGEMENT

Inventory Is the stock of any item or raw

materials used in an organization. An inventory
system is the set of policies and controls that
monitor levels of inventory and determine what
levels should be maintained, when stock should be
replenished.
Types of manufacturing inventory
Manufacturing inventory generally refers to items
that contribute to a firms product output.
Manufacturing inventory is classified into Raw
Materials, Component parts, Work-in-process, and
Finished Products.
The basic purpose of inventory analysis in
manufacturing is to satisfy : (1) when items should
be ordered and (2) how large the order should be

UNIT III : INVENTORY MANAGEMENT

Purpose or objective of inventory

1. To ensure uninterrupted production
2. To meet variations in product demand
3. To provide a safeguard in case of late delivery
of raw material by supplier
4. To take advantage of economic purchase
order size
5. To reduce undesired accumulation of
inventory thereby to reduce blocking of
capital

 TYPES OF INVENTORY :
1. CYCLE INVENTORY (Variation with Lot size)
2. ANTICIPATION INVENTORY
3. PIPELINE INVENTORY
4. SPECULATIVE INVENTORY
5. SURPLUS INVENTORY or SAFETY STOCK

UNIT III : INVENTORY MANAGEMENT

Types of inventory
Cycle inventory - The portion of total inventory
that varies directly with lot size. Determining
how frequently to order and what quantity to be
ordered is lot sizing.
Safety stock - This is surplus inventory that
protects against uncertainty in demand
Anticipation inventory Inventory used to absorb
uneven rates of demand or supply
Pipeline inventory - Inventory moving from
point to point in the materials flow system.
Materials move from supplier to plant and from
one operation to other operation.
Speculative inventory - Inventory that protects
against some future event, e.g. labor strike

UNIT III : INVENTORY MANAGEMENT

Two
common measures to evaluate supply chain
efficiency are :
Inventory turnover and Weeks of supply
Inventory turnover =
Cost of goods sold is the annual cost incurred by
company to produce the goods or services provided
to customer; it is sometimes reffered to as cost of
revenue. This does not include selling and
administrative expenses of the company.
Average aggregate inventory value is the total
value of all items held in inventory for the firm valued
at cost. It includes the raw material, work-in-process,
finished goods, and distribution inventory considered
owned by the company.
Weeks of supply is a measure of how many weeks
worth of inventory is available in the system at a

UNIT III : INVENTORY MANAGEMENT

Q1.Dell computer reported following information in

its 2010 annual report(all amounts are expressed in
millions) :
1.Net revenue (fiscal year 2010) : $18,243
2.Cost of revenue (fiscal year 2010)
: $14,137
3.Cost of production materials(fiscal year 2010) :
$6423
4.Production materials on hand(25Jan.2010) :$234
5.Work-in-process & finished goods on hand : $39
(25 Jan.2010)
6.Production materials days of supply : 6 days
(a)What is the inventory turnover?
(b)What is weeks of supply?

UNIT III : INVENTORY MANAGEMENT

SOLUTION

Inventory turnover =
= = 51.78 Turns/year
Weeks of supply = ( ) x 52 weeks
x 52
= 1 week

 INVENTORY COST :1. HOLDING COST

2. SETUP COST
3. ORDERING COST
4. SHORTAGE COST

UNIT III : INVENTORY MANAGEMENT

INVENTORY COSTS :
1.Holding (or carrying) costs - Includes
cost of storage facilities, handling, insurance,
breakage, depreciation, taxes, and opportunity
cost of capital.
2.Set up cost To make each different
product, it is required to obtain necessary
materials, arrange specific equipment set up,
and to move out the previous stock of
materials. The cost involved in completing
these exercises is called set up cost.
3.Ordering cost
These costs refer to the
managerial and clerical costs to prepare and place the
purchase order. Ordering costs include preparing bill of

UNIT III : INVENTORY MANAGEMENT

4.Shortage costs - When the stock of an item

falls short, an order for that item either waits until
the stock is replenished or it is cancelled. There is
a trade-off between carrying stock to satisfy
demand and the costs resulting from the stock out.
This balance is difficult to obtain, because it may
not be possible to estimate lost profits, the effects
of lost customers, or lateness penalties. The
assumed shortage cost is little more than a guess.
Establishing the correct quantity to order on
vendors involves a search for the minimum total
cost resulting from the combined effects of four
individual costs : holding costs, setup costs,
ordering costs and shortage costs.

UNIT III : INVENTORY MANAGEMENT

INVENTORY MODELS
1.Fixed-order Quantity Models (also called
Economic Order Quantity or EOQ Model, and QModel).
2.Fixed Time Period Models (referred to as
Periodic system, Periodic Review System, Fixed
Order Interval System, and P-Model)

UNIT III : INVENTORY MANAGEMENT

Difference between Q-Model & P-Model

Feature

Q-Model (Fixed
order quantity
model)
Order Quantity Same amount
ordered each time
When to place
order
Record
keeping
Size of
inventory

When inventory
level drops to
reorder level
Each time a
withdrawal or
addition is made
Less than fixed-time
period model

P-Model (FixedTime period

model)
Quantity varies
each time order
is placed
When review
period arrives
Counted only at
review period
Larger than
fixed-order

UNIT III : INVENTORY MANAGEMENT

FIXED-ORDER QUANTITY MODEL

Fixed-order quantity model attempts to determine
the specific point, R at which an order will be placed,
and the size of that order, Q.
Inventory position is defined as :
Inventory position = Inventory on hand +
Inventory on order Backordered quantity
Assumptions for developing Q-Model
Demand for the product is constant and uniform
throughout the period
Lead Time (Time from ordering to receive) is constant
Price per unit of product is constant
Ordering cost or setup costs are constant
Inventory holding cost is based on average inventory

UNIT III : INVENTORY MANAGEMENT

All demands for the product will be satisfied (No

backorders are allowed).
Total
=
Annual
+
Annual
+
Annual
Annual cost
purchasing cost ordering cost
holding cost
TC
=
DC
+
+
H
TC = Total annual cost,
S=Setup cost/Ordering cost
D = Annual demand
R=Reorder point
C=Cost/Unit
L=Lead Time
Q= Quantity to be
H=Annual holding or storage
cost
ordered, EOQ
per unit of average
inventory

UNIT III : INVENTORY MANAGEMENT

The
second step in model development is to find
out the optimum order quantity, QOPT at which
the total cost is minimal.
Using calculus, we take the derivative of total
cost with respect to Q and set this equal to zero.
TC = DC + S + H
=0+()+ = 0
QOPT = )
TC = (D/QOPT ).S + (QOPT /2).H
Reorder point, R = D.L
D = Average daily demand (constant)
L = Lead Time in days (constant)

UNIT III : INVENTORY MANAGEMENT

Q1.Synergy Incorporation requires 1000 Units of

product-A per annum. The firm purchases each unit of
A for Rs.100 and spends Rs.500 on each order. The
inventory carrying cost of item is 25% of the unit price.
Determine the EOQ and total annual cost associated
with the item A. [I.P.University]
Q2.A two wheeler manufacturing company uses large
quantities of a component made of steel. Although
these are production items, the demand is continuous.
The annual demand for the component is 2500 boxes.
The company procures the item from a supplier at the
rate of Rs.750 per box.The company estimates the cost
of carrying inventory to be 18% per unit per annum
and the cost of ordering as Rs.1080 per order. The
company works for 250 days in a year. How should the
company design an inventory control system for this
item? What is the overall cost of the plan?

Solution
#1. QOPT = )

Given, D = 1000 Units
C = Rs.100 / Unit
S = Rs. 500 / order
H = 25% of Rs.100 = Rs.25
Therefore, QOPT = ) = 200 Units
TC = S + H
= x 500 + x 25 = Rs.5000/-

Solution #2.
Given : D = 2500 Boxes/year
d= No. of working days =
250
Unit cost of item, C = Rs.750
Inventory carrying cost, H = 18% of Rs.750 =
Rs.135/unit/year
Ordering cost, S = Rs.1080 /order
The average daily demand = 2500/250 = 10 Boxes
Economic order quantity, QOPT = )
= ) = 200 boxes
Number of orders to be placed = D/ QOPT = 2500/200=12.5
=13(Say)
Time between orders = QOPT /D = 200/2500 = 0.08 year
= 0.08 x 250 =
20 days
Total cost of plan = TC = S + H = (2500/200)x1080 + (200/2)x135
= Rs.27,000/-

#3.Alpha industry estimates that it will sell

12000 units of its product for the forthcoming
year. The purchase price per unit is Rs.50. The
ordering cost is Rs.100 per order and the
inventory carrying cost per unit per year is 20%
of purchase price per unit. Find :
(a)The Economic order quantity
(b)Number of orders per year
(c)Time between successive order

Solution :
Given :
D = 12000 units/year
S = Rs.100 per order
H = 20% of Rs.50 = Rs.10/Unit/Year
C = Rs.50 per Unit
(a) Qopt = [(2DS)/H] = [(2 x12000 x 100)/10] = 490
unit approx.
(b)No. of orders / year = D /QOPT = 12000/490 = 24.49
(c) Time between successive orders = Q opt /D =
490/12000
=
0.04 year
=
0.48 Month

 SELECTIVE CONTROL OF INVENTORY

1. ABC ANALYSIS
. ABC CLASSIFICATION OF INVENTORIES IS
BASED ON COST (OR VALUE ) OF THE ITEMS
CONSUMED.
. VERY HIGH VALUE ITEMS ARE A-CLASS
ITEMS WHICH REQUIRES TIGHTER CONTROL
. MEDIUM VALUE ITEMS ARE CATEGORISED AS
B-CLASS ITEMS
. LOW VALUE ITEMS ARE CATEGORISED AS CCLASS ITEMS

2. XYZ ANALYSIS
XYZ ANALYSIS IS DONE ON THE BASIS OF UNIT
COST OF ITEM
HIGH UNIT COST ITEMS ARE CONSIDERED AS XCOST ITEM
MEDIUM UNIT COST ITEMS ARE CONSIDERED AS
Y-COST
ITEMS
LOW UNIT COST ITEMS ARE CONSIDERED AS ZCOST ITEMS

3. FSN CLASSIFICATION
FSN CLASSIFICATION IS DONE ON THE BASIS
OF MOVEMENT OF INVENTORY
FAST-MOVING INVENTORY
SLOW-MOVING INVENTORY
NON-MOVING INVENTORY

4.VED CLASSIFICATION
VED CLASSIFICATION IS DONE TO DETERMINE
THE CRITICALITY OF THE ITEM. THIS
CLASSIFICATION IS DONE IN CASE OF
MAINTENANCE ITEMS
CLASSIFIED IN FOLLOWING THREE WAYS : VITAL ITEMS
ESSENTIAL ITEMS
DESIRABLE