Inventory Management

Prepared By:
Dr. Nitya Khurana
 Inventory Management
• Inventory management involves forecasting and
product replenishment. Inventory management
determines when to order products, in what quantities
and from which supplier. This ensures that your
business will always have the right quantity of the right
item in the right location at the right time.
• In managing your inventory, you’re aiming to get
inventory at the right place at the right time. This
involves quickly reordering stock, having resources in
the right place and having an efficient process in place
to receive and store inventory stock.
 Inventory
• Inventory is the stock of raw materials, semi processed
material, finished products and any other item held by
the organization for further processing or for sale.
• Inventory is the stock of those goods which are procured
and stored for smooth functioning of the organization.
• Even though an inventory is a must for any organization,
yet higher inventory blocks the capital employed of the
organization and creates an additional burden in the
form of opportunity cost of interest on money blocked.
 Types of Inventories
• Raw Material Inventory
• Inventory of semi Finished Goods
• Finished Goods Inventory
• Spare Parts Inventory
• MRO (Maintenance, Repair and Operating)
Inventory
 Inventory Costs
Procurement cost or Ordering cost or Acquisition Cost:
• These are the costs of getting an item into the firm’s
inventory. They are incurred each time when order is
placed or the machine is set up for production. They are
expressed as cost per order in rupees.
• Procurement cost include cost of administration such as
salaries of persons engaged in purchasing department,
stationary, telephone expenditure, computer costs,
transportation of item ordered, expediting and follow up,
receiving and inspection of goods, processing payments
and preparing a purchase order etc.
 Inventory Costs
Carrying and Holding costs:
• These are the costs incurred because a firm owns or maintains inventory. It
includes:
• Interest on money investment in inventory
• Obsolescence
• Storage space rent
• Wages of the persons working in the stores
• Insurance
• Deterioration: fresh seafood, meats and poultry products, backed products are
subject to rapid deterioration and spoilage. Dairy products, medicines, batteries
and film have limited shelf life.
• Taxes
• Safety measures: some items are easily concealed (e.g. pocket camera,
calculators, mobiles etc.) or fairly expensive (cars, TVs etc) are prone to theft.
 Inventory Costs
Shortage and stock out costs:
• It is the costs that arise due to not fulfilling the
demand. It may include the cost of lost sales,
cost of the lost goodwill, cost of idle
equipments and penalty of missing delivery
etc.
 Advantages of Inventory
• To maintain independence of operations
• To meet variations in product demand
• To allow flexibility in production scheduling
• To provide safe guard for variation in raw
material delivery time
• To take advantage of economic purchase order
size
 Inventory Control
• Inventory control is a scientific system which
indicates as to what to order, when to order,
and how much to order, and how much to
stock so that purchasing costs and storing
costs are kept as low as possible.
• Inventory control is the technique of
maintaining the size of inventory at some
desire level keeping in view the best economic
interest of an organization.
 Objectives of Inventory Control
• To supply the materials in time.
• To give maximum clients service by meeting
their requirement timely, effectively, smoothly
and satisfactorily
• To reduce or minimize idle time by avoiding
stock out and shortages
• To avoid shortage of stock
• To meet unforeseen future demand
• To average out demand fluctuations
 Functions of Inventory Control
• To carry adequate stock to avoid stock-outs
• To order sufficient quantity per order to reduce order cost
• To stock just sufficient quantity to minimize inventory carrying
cost
• To make judicial selection of limiting the quantity of perishable
items and costly materials
• To take advantage of seasonal cyclic variation on availability of
materials to order the right quantity at the right time.
• To provide safety stock to take care of fluctuation in demand/
consumption during lead time.
• To ensure optimum level of inventory holding to minimize the
total inventory cost.
 Principles of Inventory Control
• Determination of order quantity
• Determination of Re-order point of Re-order
level
 Important Terminology used in Inventory
Control
• Lead time: It is the average number of days between placing an indent and
receiving the material. Lead time is composed of two elements:
– Administrative or buyer‘s lead time (i.e. Time required for raising purchase
requisitions, obtaining quotations, raising purchase order, order to reach supplier
etc.)
– Delivery or supplier‘s leading time (i.e. Time required for manufacture, packing and
forwarding, shipment, delays in transit
• Minimum/safety/ buffer stock: This is the amount of stock that should be
kept in reserve to avoid a stock-out in case consumption increases
unexpectedly or in case the lead time turns out to be longer than normal. It
is also the level at which fresh supply should normally arrive, failing which
action should be taken on an emergency basis to expedite supply and
replenish the stock.
Safety stock = maximum daily consumption- average daily consumption x
total lead time
 Important Terminology used in Inventory
Control
• Maximum order level: This is the maximum
quantity of the materials to be stocked, beyond
which the item must not be in the inventory.
• Re-order level: This is the value which is very
important from the point of view of the
inventory control. This is the point at which we
have to place an order for procurement for
replenishing the stock. It is derived by the
formula (minimum order level + buffer stock )
 Essentials of Good Inventory Control
System
• Classification and Identification of Inventories
• Standardization and Simplification of Inventories
• Setting Maximum and Minimum limits for each part of
inventory
• Economic Order Quantity
• Adequate Storage Facilities
• Adequate Records and Reports
• Intelligent and Experienced Personnel
• Co-ordination
• Budgeting
• Internal Check
Factors Affecting Inventory Control System

• Financial factors
• Suppliers
• Lead Time
• Product Type
• Management
• External Factor
Methods/Techniques of Inventory Control

• ABC analysis
• VED analysis
• SDE analysis
• HML analysis
• FSN analysis
 ABC Analysis
• In this analysis, the classification of existing inventory is
based on annual consumption and the annual value of
the items.
• Hence we obtain the quantity of inventory item
consumed during the year and multiply it by unit cost to
obtain annual usage cost.
• The items are then arranged in the descending order of
such annual usage cost.
• The analysis is carried out by drawing a graph based on
the cumulative number of items and cumulative usage of
consumption cost.
ABC Analysis
 ABC Analysis
• Once ABC classification has been achieved, the policy
control can be formulated as follows:
• A-Item: Very tight control, the items being of high value.
The control need be exercised at higher level of
authority.
• B-Item: Moderate control, the items being of moderate
value. The control need be exercised at middle level of
authority.
• C-Item: The items being of low value, the control can be
exercised at grass root level of authority, i.e., by
respective user department managers.
 Procedure of ABC Analysis
• Find the usage value of each item by multiplying the number of units of
that items by its per unit price.
• Arrange the usage value obtained in (1) in descending order.
• Find cumulative usage value, categorize the items on the basis of annual
usage value and calculate the total number of items in each class.
• Represent the cumulative usage value and total number of items into
percentages.
• Plot the two percentages on graph paper by taking percentage of items
on X axis and corresponding percentage usage value on Y axis.
• Mark the points in the curve where the curve sharply changes its shape.
This will give three segments which classify items as A class, B Class and
C class items, depending upon the percentages for A, B and C items fixed
by the management.
 Example
• Example: Ten items in inventory by school of management studies at state
university are listed below. Which item should be classified as ‘A’ class, B
class and ‘C’ class items. What percentage of items is in each class?

Items Annual Usage Value per unit (Rs)

1 200 40
2 100 360
3 2000 0.20
4 400 20.00
5 6000 .04
6 1200 .80
7 120 100.00
8 2000 .70
9 1000 1.00
10 80 400
Step 1: Find out the Usage value for each item by multiplying
the per unit value with the annual usage and rank each item
according to their annual usage value:
Sr. No Annual Usage in Unit price in Rs. Annual usage Ranking
units value
1 200 40 8000 IV
2 100 360 36000 I
3 2000 .20 400 IX
4 400 20 8000 V
5 6000 .04 240 X
6 1200 .80 960 VIII
7 120 100 12000 III
8 2000 .70 1400 VI
9 1000 1.00 1000 VII
10 80 400 32000 II
Step 2,3 & 4: Arrange items based on their annual
usage value in descending order.
Item no Rank Annual Cumulative Cumm% of No of % of Items
Usage Usage usage value Items

2 I 36000 36000 36%

10 II 32000 68000 68% 2 20%
7 III 12000 80000 80%
1 IV 8000 88000 88% 30%
3
4 V 8000 96000 96%
8 VI 1400 97400 97.4%
9 VII 1000 98400 98.4% 5 50%
6 VIII 960 99360 99.36%
3 IX 400 99760 99.76%
5 X 240 1,00000 100%
Step 5 & 6: Plot the two percentages and join the
points to make the curve
 ABC Analysis
Sr. No A Item (high usage B Item (Moderate usage C Items (Low usage
value) value) value)
1 Very strict control Moderate control Low control
2 No safety stock Low safety stock High safety stock
3 Frequent ordering Once in 3 months Bulk ordering once in 6
months
4 Weekly control Monthly control reports Quarterly control reports
statement
5 As many source as Two or more reliable source Two reliable source for
possible for each item each item
6 Accurate forecasting and Estimate based on past data Rough estimate for plg.
material planning and present plans
7 Maximum efforts to Moderate effort Minimum Clerical effort
reduce lead time
8 Minimization of waste, Quarterly control over surplus Annual Review over
obsolete and surplus & obsolete items surplus & obsolete
materials
 HML Analysis
• It follows the same procedure as adopted by ABC
classification. Only difference is that in HML classification,
unit value is the criteria and not the annual consumption
value. In this analysis, the classification of existing
inventory is based on unit price of the items. They are
classified as High price, Medium price and Low cost items.
• The items of inventory should be listed in the descending
order of unit value and it is upto the management to fix
limits for three categories.
• For example a jeweller may assign the inventory of
diamonds and precious stones in H class, silver jewellery in
M class and artificial jewellery in L class.
 VED Analysis
• In this analysis, the classification of existing
inventory is based on criticality of the items.
They are classified as Vital, Essential and
Desirable items. It is mainly used in spare
parts inventory.
 FSN Analysis
• FSN stands for fast moving, slow moving and
non-moving items. Here classification is based
on the pattern of issues from the store and is
useful in controlling obsolescence.
• To carry out an FSN Analysis, the date of receipt
or last date of issue, whichever is later is taken
to determine the number of months, which
have lapsed since the last transaction. The items
are usually grouped on basis of consumption.
 SDE Analysis
• The SDE classification is based upon the availability of items and
is very useful in the context of scarcity of supply. In this analysis
‘S’ refers to ‘scarce’ items, generally imported, and those which
are in short supply. ‘
• D’ refers to difficult items which are available indigenously but
are difficult to procure. Items which have to come from distant
place or for which reliable suppliers are difficult to come by, fall
into D category.
• ‘E’ refers to items which are easy to acquire and which are
available in the local markets.
• The SDE classification, based on problems in procurement, is vital
to the lead time analysis and in deciding on purchasing strategies.
 GOLF Analysis
• In this analysis, the classification of existing
inventory is based sources of the items. They
are classified as Government supply,
Ordinarily available, Local availability and
Foreign source of supply items.
 SOS Analysis
• In this analysis, the classification of existing
inventory is based nature of supply of items.
They are classified as Seasonal and Off-
Seasonal items.
 Models of Inventory Control

Single Period Inventory Model

Multi Period Inventory Model

• Fixed Order Quantity Model

• Fixed Time Period Model
 Single Period Inventory Model
• In this model the unfulfilled demand cannot be back-
ordered to the next period because the demand ceases to
exist after the period for which planning is done. In other
cases, even though demand exists in the future, what is
ordered for a period could not be used for future periods
due to the perishable nature of the item.
Applications:
• Fashion items, Seasonal items, High tech goods, Holiday
items e.g. Christmas trees, toys, flowers on valentine’s
day, perishable products e.g. meals in cafeteria, Dairy
food, newspapers etc.
 Single Period Inventory Model
• Let Cos = cost of over stocking per unit
• Cus = cost of under stocking per unit
• Q = optimal number of units to be stocked
• d = single period demand
• If d>Q then the cost of under stocking is incurred. On
the other hand if d < Q then we incur the cost of over
stocking.
• At very low values of Q we tend to experience costs
arising out of under stocking and as we increase Q
incrementally we will approach optimal Q. At very high
values of Q, we will incur cost of over stocking.
 Single Period Inventory Model
• Overbooking of airline flights. It is common for customers to cancel flight
reservations for a variety of reasons. Here the cost of underestimating the
number of cancellations is the revenue lost due to an empty seat on a flight.
The cost of overestimating cancellations is the awards, such as free flight s
or cash payments, that are given to customers unable to board the flight.
• Ordering of fashion items. A problem for a retailer selling fashion items is
that often only a single order can be placed for the entire season. This is
often caused by long lead times and limited life of the merchandise. The
cost of underestimating demand is the lost profit due to sales not made. The
cost of overestimating demand is the cost that results when it is discounted.
• Any type of one-time order. For example, ordering T-shirts for a sporting
event or printing maps that become obsolete after a certain period of time.
 Fixed – Time Period model (P-Model)
• In a fixed–time period system, inventory is counted only at
particular times, such as every week or every month. Counting
inventory and placing orders periodically are desirable in situations
such as when vendors make routine visits to customers and take
orders for their complete line of products, or when buyers want to
combine orders to save transportation costs.
• the stock position of each item is regularly reviewed. When the
stock level of a given item is not sufficient to sustain production
operation until the next review, an order is placed to replenish the
supply. The frequency of review varies from firm to firm. It also
varies among materials within the same firm, depending upon the
importance of the material, specific production schedules, market
conditions and so forth. Order quantities vary for different materials.
 Fixed – Time Period model (P-Model)
• Suppose we fix review period for an item as two months and the lead time is 15
days. Then the order would be placed every two months i. e. ordinates of R1, R2
and R3 etc. the supplies would be received at ordinates S1, S2 and S3 etc. (15 days
after R1, R2 and R3).

Y1 Y2 Y3

R1 S1 R2 S2 R3 S3

• At R1, let us assume that the stock available be Y1, then the stock together with
the quantity ordered at R1 (supplies received at S1) should be sufficient to last till
the next supplies are received at S2 i.e. to last a total period of two and half
months. (Review + lead time)
 Fixed – Time Period model (P-Model)
Advantages
• Items can be grouped and ordered, so ordering cost is considerable
reduced.
• The suppliers also offer attractive discounts as sales are guaranteed.

Limitations
• It compels a periodic review of all items that in itself makes the system
inefficient. Because of difference in usage rates supplies may not have
to be ordered until the succeeding review.
• The usage of some items during the period may have increased to the
point where they should have been ordered before the current review
date, but the manager may not notice it, since review period has not
been arrived.
 Fixed – Order Quantity model
• It is known as Q-model [ basic EOQ model and EOQ with safety stock]
• In this a fixed quantity of material is ordered whenever the stock on hand
reaches the re-order point. The fixed quantity is nothing but the economic
order quantity.
 Fixed – Order Quantity model
Basic EOQ model is based on the following assumptions:

• Demand for the product is constant and uniform

throughout the period.
• Lead time (time from ordering to receipt) is constant.
• Price per unit of product is constant.
• Inventory holding cost is based on average inventory.
• Ordering or setup costs are constant.
• All demands for the product will be satisfied. (No
backorders are allowed.)
Fixed – Order Quantity model
 Fixed – Order Quantity model
• The Exhibit shows that when the inventory position drops to point R, a reorder is placed. This
order is received at the end of time period T1, which does not vary in this model.
• Total annual cost = Annual purchase cost + Annual ordering cost + Annual holding cost

TC = DC + D/Q *S + Q/2 * H

where
• TC = Total annual cost
• D = Demand (annual)
• C = Cost per unit
• Q = Quantity to be ordered (the optimal amount is termed the economic order quantity —EOQ
—or Q opt )
• S = cost of placing an order
• R = Reorder point
• L = Lead time
• H = Annual holding and storage cost per unit of average inventory (often holding cost is taken as
a percentage of the cost of the item, such as H = iC , where i is the percent carrying cost)
Fixed – Order Quantity model
 Fixed – Order Quantity model
• The second step in model development is to find that order quantity Q
opt at which total cost is a minimum.
T C = DC + D/Q S + Q/2 H
• d_T_C /dQ = 0 + ( −DS/Q2 ) + H/2 = 0
Qoptimum = √2DS/H

• Because this simple model assumes constant demand and lead time,
neither safety stock nor stock-out cost is necessary, and the reorder
point, R, is simply
R=dL
Where:
d = Average daily demand (constant)
L = Lead time in days (constant)
 Fixed – Order Quantity model
Suppose
• Annual Usage Quantity = 1600
• Order Placement Cost = Rs. 100
• Holding Cost = Rs. 8 /unit
• Price = Rs. 50/unit
No. of No. of Order Avg Qty = Avg Holding Purchase Total Cost
Units Orders Cost Order Cost Price
Qty/2 (1600*50)
1600 1 Rs. 100 800 Rs. 6400 Rs. 80000 Rs. 6500
800 2 Rs. 200 400 Rs. 3200 Rs. 80000 Rs. 3400
400 4 Rs. 400 200 Rs. 1600 Rs. 80000 Rs. 2000
200 8 Rs. 800 100 Rs. 800 Rs. 80000 Rs. 1600*
100 16 Rs. 1600 50 Rs. 400 Rs. 80000 Rs. 2000
80 20 Rs. 2000 40 Rs. 320 Rs. 80000 Rs. 2320
50 32 Rs. 3200 25 Rs. 200 Rs. 80000 Rs. 3400
 Difference Between Fixed-order quantity (Q
system) and fixed time period system (p-system)

Features Q model P model

Order Quantity Q-constant (the same amount q-variable (varies each time
ordered each time) order is placed)
When to place order R- when inventory position drops T – when the review period
to reorder level arrives ‘time triggered’
‘event triggered’

Record keeping Each time a withdrawl or addition Counted only at review

is made period
Size of inventory Less than P model Larger than Q model
Time to maintain Higher due to perpetual record
keeping
Types of items Higher priced, critical or important
items
 Questions
• A company uses annually 12,000 units of raw
material costing Rs. 1.25 per unit. Placing each
order cost Rs. 15 and the carrying cost are
15% per year per unit of the average
inventory. Find out EOQ.
• Annual usage = Rs. 2,00,000, cost of placing
and receiving one order = Rs. 80. Annual
carrying cost = 10% of inventory value. Find
EOQ
 Questions
• An auto industry purchases spark plugs at the rate of Rs. 25
per piece. The annual consumption of sparkplug is 18000
units. If the ordering cost is Rs. 250 per order and carrying cost
is 25% p.a, what would be the EOQ? If the supplier of spark
plug offers a discount of 5% for order quantity of 3000 units
per order, would you accept the discount offer?
 Just in Time
• JIT is a philosophy that focuses attention on eliminating waste by
purchasing or manufacturing just enough of the right items just in time.
It is a Japanese production management philosophy since 1970s, which
involves having the right items of the right quality and quantity, in the
right place and at the right time. This is hand to mouth approach to
production. The primary goal of JIT is to achieve zero inventories within
the organization as well as throughout the entire supply chain. The
concept of JIT is extended to the whole system of production –
• To produce and deliver finished goods just in time to be sold.
• Sub-assemblies just in time to be assembled into finished goods.
• Fabricate parts just in time to go into sub assemblies and
• Purchase material just in time to be transformed into fabricated parts.
 Objectives of JIT
• To eliminate Disruptions
• To make system flexible
• To eliminate waste
 Components/Tools of JIT
• Factory Layout Revision
• Set up time Reduction (Change – over time)
• PULL system of production
• Better co-ordination with suppliers
• Flexible workforce
• Automated production
• Preventive maintenance
• Standardized components and work methods