Inventory Management

In production management and in any type of operation management, the term inventory refers to the material
in stock. The inventory is maintained by the organization to avoid the stock out of an item. A stock out is
undesirable for manufacturing because it halts the production process. It is as a detail list of moveable goods
such as raw material, material in process, finished product. Inventory is the stock of any item or resources used
in an organization. The term inventory is a stock of goods and resources that are stored for further production or
for meeting further demand. The term inventory includes raw material work in process, finished products and
store and sports. Inventory management involves administration policies and procedures to reduce in inventory
cost.

Objective / Need of inventory

 The transaction motives which facilitates continuous production

 The precautionary motives which necessities the holding of inventories for meeting the unpredictable
changes in demand and supply of materials.
 The speculating motives which induces to keep inventories for taking advantage of price fluctuation,
saving in quantity discount.
 The primary objective of inventory management is to ensure continuous supply of raw materials and
facilities uninterrupted production.
 Ensure an adequate supply of materials and minimize inventory costs.

Classification of inventory

 ABC analysis (consumption value) – ABC inventory control technique divides inventory into three
categories A, B and C based on their annual consumption value. The annual consumption can be
calculated by multiply by price into quantity.
 HML classification(unit price) – The High, Medium and Low classification follow the same procedure
as in adopted in ABC classification, only difference between is that in HML classification unit value is
the criteria and not the annual consumption value.
 VED classification (importance) – classify the inventory on the basis of Vital, Essential and Desirable.
 SDE classification (availability) – divides units based on availability scarce, difficulty and easy to get.
 FSN classification (movement) – classification based on the pattern of issue from stores as fast moving,
slow moving and none moving.
 SOS classification (season) – classify the inventory as seasonal items and off – seasonal items.
 GOLE classification (sources) – this stand for government, open market, local or foreign source of
supply.
Inventory cost

(i) Ordering cost – cost of placing an order with a vendor of material is known as ordering cost like salary,
stationary, telephone, transportation, and time, energy, receiving and inspecting the material, processing
payments. It is directly proportional to the number of order. Higher the number of order, higher the ordering
cost.

(ii)Carrying cost – the cost that is incurred by holding of stock is termed as the inventory carrying cost like rent,
insurance, salary, storage, pilferage, breakage, obsolescence, depreciation, taxes and the opportunity cost of
capital. The purpose of holding inventories is to maintain the supply of inventories to the production process. It
is also known as holding cost or set up cost. It is directly proportional to the amount of inventory holds.

(iii)Shortage cost – There are the cost incurred not holding the inventory when needed like opportunity.

(iv)Purchase cost- The cost of purchasing after due negotiation per unit is called the purchase cost.

Factors affecting inventory

 Type of product (high unit low limit value)

 Type of manufacture
 Volume of production
 Lead time
 Procurement cost and Transportation cost
 Discounts
 Nature of demand

Economic order quantity (EOQ)

Inventory model fundamentally deals with the two basic issues (i) when to order and (ii) how much to order.
The problem of when to order is decided by prescribing the reorder level of each of the inventory item. The
other incidental issue is how much to order i.e., what should be size of each order. The issue of how much to
order is decided on the basis of Economic Order Quantity (EOQ).It prescribe the size of the order at which the
ordering cost and carrying cost will be equal and total cost is minimum.EOQ is the level of inventory order of
which inventory cost is minimum.

Assumption for calculating EOQ

 Demand for the product is constant and uniform.

 Lead time is constant and known
  Price per unit of product is constant
 No shortage of item occur
 Quantity discount are not calculated
 Receipt of the order occurs in a single instant
 Ordering cost or setup costs are constant.

Derivation of EOQ model

EOQ is the quantity at which total ordering cost is equal is equal to total carrying cost

Total ordering cost = total carrying cost

DQ/ S = Q/2 H

Q = square root of 2DS/H

Type of inventory models

(a)Fixed order quantity system or Q system

Fixed quantity of material ordered whenever stock reaches the reorder point.

Holding Cost = HQ/2

Advantage of Q system

 Each material can be procured in the most economical quantity.

 Purchasing and inventory control personnel automatically devote attention to the items that are needed
only when required.
 Positive control can easily be exerted to maintain total inventory investment at the desired level simply
by manipulating the planned maximum and minimum values.

Disadvantage of Q system

 The orders are raised at irregular intervals which may not be convenient to the suppliers.
 The items cannot be grouped and ordered at a time at a time since the reorder points occur irregularly.
 Further, system assumes stable uses and defines lead time. When these changes significantly, a new
order quantity and a new order point should be fixed, which is quite cumbersome.
 Order qty, Q
(b) Fixed order period system or P system

In this inventory is ordered based on fixed period.

Advantage of P system

 The ordering and inventorying cost are low. The ordering cost is considerably reduced through follow
up work for each delivery may be necessary.
 The supplier will also offer attractive discounts as sales are guaranteed.
 The system works well for material which exhibit an irregular or seasonal uses and whose purchases
must be planned in advance on the basis of sales estimates.

Disadvantage of P system

 It compel a periodic review of all items, this in itself makes the system somewhat inefficient.
 The periodic review system tends to peak the purchasing work around the review dates.

The Fixed Time Period

Model

Difference between Q system and P system

Point of Q system P system

difference
 1.Initiate or order 1. Stock on hand reaches to reorder point. 1. Based on fixed review
2.Period of order 2. Any time when stock level reaches to period and not stock level.
3.Record keeping reorder point. 2. Only after the
4.Order quantity 3. Continiusly each time a withdrawal or predetermined period.
5.Size of addition is made. 3.Only at the review period
inventory 4. Constant the same quantity ordered each 4. Quantity of order varies
6.Time of time. each time order is placed.
maintain 5.Less than the P system 5.Larger than the Q system
6.Higher due to perpetual record keeping 6. Less time due to only at the
review.

Numerical on Inventory

1. (Basic model) for a given item, the annual demand is 6000 units. The price of the item is Rs 60 per unit. The
price of the item is Rs 60 per units. The ordering cost is Rs 150 and inventory carrying cost is 20%. Find (i)
Economic order quantity (ii) Total cost (iii) Number of order (iv) Time between order (v) Re-order if lead
time is 2 days. (vi) Maximum inventory if safety stock is 200 units.

2. (Price bracket) Calculate the EOQ from the given information

No of units bought at time Price per units (Rs)

Less than 1000 10.00

1000 to 2999 9.85

3000 and above 9.70

The order cost is Rs 60 per order and carrying cost is 20% of the price and annual demand is 6000.

3. (ABC analysis).From the following data draw an ABC analysis graph after classifying A,B,C class items.

Item Unit price Annual consumption (units)

1 200 3000
2 2 60000
3 5000 20
4 12 200
5 9 350
6 25 6000
 7 1000 40
8 70 300

4. An auto industry purchases speaks plug at the rate of Rs 25 per piece. The annual consumption of spark plug
is 18000 numbers. If the ordering cost is Rs 250 per order and carrying cost is 25% per annum, what would be
the EOQ? If the supplier of spark plug offers a discount of 5% for order quantity of 3000 number per order, do
you accept the discount offer?

5. If demand = 14400, ordering cost = 50, carrying cost = 6% and price = 2 per unit. Find EOQ. If the company
gets 5% discount if it place single order. Should they accept the discount offer?

6. for one of the A class item, the following data are available

Annual demand = 1000, ordering cost = Rs 400, holding cost = 40% and the cost per unit =Rs 20. The
following three strategies are available for the procurement.

(i) Place four order of equal size every year.

(ii) Place the order for 500 units at a time and avail a discount of 10% on the cost of time.
(iii) Follows EOQ policy

Which of the above strategy do you recommended? Justify your answer.

7. A company uses 1200 units per month of electronic components each costing Rs 2, placing each order cost
Rs 50 and carrying cost is 6 % per year of the average inventory. Find (i) EOQ (ii) If the company gets 5%
discount if it placed single order, Should they accept the discount offer.

8. XYZ Company buys in lots of 500 boxes which is a 3 month supply. The cost per box is Rs. 125 and the
ordering cost is Rs. 150. The inventory cost is estimated at 20% of unit value.

(i) What is the total annual cost of the existing inventory policy?
(ii) How much money could be saved by employing the economic order quantity?
9 .A shop keeper has uniform demand of an item @ 50 items per month. He buys from a supplier at a cost of Rs
6/- per item and cost of ordering is Rs.10/- each time. If stock holding cost is 20% per items of stock value, how
frequently should he replenish his stock? Suppose the supplier of a 5% discount on order between 200 & 999
items and 20% discount on order exceeding 1000, can shop keeper reduce his cost by taking advantage of either
of these discounts.