Inventory management

UNIT 2 LECTURE 1
 Inventory?

⚫ Inventory means all the materials (may be raw or

finished parts/components in process or finished
products, castings and consumable tools,
⚫ recorded on the ledgers/books of the
organization and kept in its stocks (in the store or
warehouses) for some period of time.
⚫ Inventory is defined as a descriptive list or items/goods
which gives quantity and money value of each item.
Inventory includes raw materials, semi-finished
products or work in process inventories,
finished parts/components and finished final
products etc. held in storage awaiting use or
marketing.
⚫ Even though inventory of materials is an idle resource in
the sense it is not meant for immediate use but for
smooth functioning of the organization or
enterprise, maintenance of some inventory is essential.
⚫ So inventory is an essential part of an organization.
Every enterprise/business or manufacturer concern
however big or small has to maintain some
inventory.
 MOTIVES BEHIND CARRYING INVENTORY :

Transaction Motive

Precautionary motive:
HT: (Checkeffect of pandemic on SCM in any
particular industry)?

Speculative motive
REASONS FOR HOLDING INVENTORIES

To facilitate and stabilize production

To eliminate disruption
To meet customer demand whenever arises
To carry safety stocks in order to prevent stock-outs
To deal with variations in supply and demand
To hedge against the price escalations
To take advantage of price discounts
 Terms associated with inventory

⚫ Order point: point where the action to be taken to

replenish the stock.
⚫ Lot size: how much amount of items to be ordered
each time economically
 INVENTORY COST AND ITS RELEVANCE FOR
DECISION MAKING

⚫ The costs associated with the inventory are:

⚫ 1. Item costs or materials costs – Direct cost for
getting an item
⚫ 2. Holding costs or carrying costs – costs associated
with carrying materials in inventory
⚫ 3. Ordering costs – Fixed costs associated with
placing an order
⚫ 4. Shortage costs or stock-out costs – cost associated
with not having enough materials to meet demand
 ask

⚫ What is lead time and cycle time?

 Inventory cost reduction(discussion)

⚫ Inventory cost reduction is the important cost decision in

any business
⚫ Time and lean manufacturing principles can be used
to manage inventory levels more efficiently.
⚫ Technology plays an important role in cost reduction.
⚫ Many experts were finding ways and means of
reducing the size of holding the inventory

❑ Dell
❑ Barcode
 CARRYING COST

Two important costs associated with the inventory

holding are carrying cost and purchasing/
ordering cost
Both are opposite in nature. If one increases, then
another decreases
Right order quantity is the balance between both
the ordering cost and carrying cost
The cost incurred over the period of time for
holding the inventory – “Carrying cost”
⚫ Cost of carrying or holding inventory may be:
⚫ 1. Opportunity cost
⚫ 2. Physical space occupied by the inventory such as
rent, insurance etc.,
⚫ 3. Cost of materials handling and cost of wastage and
obsolescence.
⚫ 5. Spoilage and shelf life of various input materials.
 Economic Order Quantity (EOQ)

⚫ Economic order quantity (EOQ) is the the order size

which minimizes the sum of carrying costs and
ordering costs of a company’s inventories.
⚫ The two most significant inventory management costs
are ordering costs and carrying costs.
⚫ Ordering costs are costs incurred on placing and
receiving a new shipment of inventories.
⚪ These include communication costs, transportation costs, transit
insurance costs, inspection costs, accounting costs, etc.
⚫ Carrying costs represent costs incurred on holding
inventory in hand.
⚪ These include opportunity cost of money held-up in inventories,
storage costs such as warehouse rent, insurance, spoilage costs, etc.
⚫ Ordering costs and carrying costs are opposite in nature.
To minimize its inventory carrying costs, a company
must place small orders.
⚫ But small order size means that the company must place
more orders which increases its total ordering
costs.
⚫ Similarly, if a company wants to cut its ordering costs, it
must reduce the number of orders placed which is
possible only when order size is large. But increase in
order size means that average inventory balance on hand
will be high which increases total carrying costs for the
period.
 EOQ

⚫ Instead of focusing on ordering costs or carrying

costs individually, a company should attempt to
reduce the sum of these costs.
⚫ The economic order quantity (EOQ) model does just
that.
 EOQ

⚫ EOQ= √2AO/C
⚫ Annual consumption
⚫ Carrying cost
⚫ Ordering cost
⚫ A= 10000 units
⚫ Cost per Unit = 10/ unit
⚫ A= 100000
⚫ OC= 1000/ order
quarterly Bi annually

⚫ 10000 units ⚫ 10000 units

⚫ Orders= 4 ⚫ Orders= 2
⚫ OC= 4* 1000= 4000
⚫ OC= 2* 1000= 2000
⚫ No of units ordered=
2500 ⚫ No of units ordered=
5000
⚫ More units ordered result
in more cc and less oc
A= 1600
O= 100/ order
CC= 8/ unit
PRICE =50 / unit

NO OF NO OR AVG QTY AVG PURCHA-S TOTAL

UNITS 1 ORDE OC 4 STORAG E COST
COST (OC+CC)
RS 2 3 E COST
(Annual
5 Cost)
(CC)
{4*Rs.8 /
unit]

1600 1 100 800 6400 80000 6500

800 2 200 400 3200 80000 3400
400 4 400 200 1600 80000 2000
200 8 800 100 800 80000 1600
100 16 1600 50 400 80000 2000
80 20 2000 40 320 80000 2320
50 32 3200 25 200 80000 3400
 NO OF NO OR OC AVG QTY AVG PURCHA-S TOTAL
UNITS ORDERS STORAG E COST
COST (OC+CC)
E COST
CC
1600 1 100 800 6400 80000 6500
800 2 200 400 3200 3400
400 4 400 200 1600 2000
200 8 800 100 800 1600
100 16 1600 50 400 2000
80 20 2000 40 320 2320
50 32 3200 25 200 3400
⚫ EOQ= √2AO/C
⚫ Annual consumption
⚫ Carrying cost
⚫ Ordering cost

⚫ √2*1600*100/8= 200
⚫ No of orders= AC/EOQ=8
 Inventory control technique

⚫ ABC (Total value)

⚫ FSN (frequency of usage)
⚫ HML (cost per unit)
⚫ VED (crticality of an item)
⚫ GOLF
End