Inventory - Definition

• Inventory generally refers to the materials in stock or all movable goods that are used in
production..

• It is also called the idle resource of an enterprise.

• Also refers to physical stock of goods held by manufacturing or business units

• Inventories represent those items which are either stocked for sale or they are in the process of
manufacturing or they are in the form of materials which are yet to be utilised.

• It is the physical stock of items a business or production organization kept in hand for the efficient
running of business or its production.

• It is classified as a current asset on a company's balance sheet.

 Inventory - Need
1] To stabilise production: The demand for an item fluctuates because of the number of factors,
e.g., seasonality, production schedule etc. The inventories (raw materials and components) should
be made available to the production as per the demand failing which results in stock out and the
production stoppage takes place for want of materials. Hence, the inventory is kept to take care of
this fluctuation so that the production is smooth.

2] To meet the demand during the replenishment period: The lead time for procurement of
materials depends upon many factors like location of the source, demand supply condition, etc. So
inventory is maintained to meet the demand during the procurement (replenishment) period.

3] To prevent loss of orders (sales): In this competitive scenario, one has to meet the delivery
schedules at 100 per cent service level, means they cannot afford to miss the delivery schedule
which may result in loss of sides. To avoid this the organisations have to maintain inventory.

4] To keep pace with changing market conditions: The organisations have to anticipate the
changing market, sentiments and they have to stock materials in anticipation of non-availability of
materials or sudden increase in prices.
 Inventory - Need
5] Meet Customer Demand: Having the right amount of inventory ensures that you can meet customer demand
promptly. Stockouts can lead to lost sales and dissatisfied customers, while excess inventory ties up capital and
incurs holding costs.

6] Optimize Working Capital: Maintaining an optimal level of inventory helps in using working capital
efficiently. Excessive inventory ties up funds, while insufficient inventory can lead to missed sales opportunities.

7] Minimize Holding Costs: Holding inventory comes with costs such as storage, insurance, depreciation, and
obsolescence. Effective inventory management aims to minimize these holding costs while ensuring product
availability.

8] Prevent Stockouts: Out-of-stock situations can result in lost sales, backorders, or delays in fulfilling customer
orders. Inventory management helps in preventing stockouts and ensuring a smooth flow of products.

9] Avoid Overstocking: Excess inventory ties up funds and warehouse space. It can lead to product obsolescence,
increased holding costs, and potential markdowns to clear out outdated stock.
 Inventory - Need
10] Improve Cash Flow: Effective inventory management ensures that capital is not tied up in excessive stock,
allowing for better cash flow and the ability to invest in other areas of the business.

11] Forecasting and Planning: Inventory data helps in making accurate forecasts and informed decisions
regarding purchasing, production, and marketing strategies. It enables better planning for seasonal demands,
promotions, and new product launches.

12] Enhance Supplier Relationships: Efficient inventory management helps in building strong relationships with
suppliers by providing clear and timely information about inventory needs, leading to better negotiations and
discounts.

13] Mitigate Risks: Proper inventory management allows businesses to mitigate risks associated with
overstocking, market changes, supplier issues, and economic fluctuations.

14] Compliance and Reporting: Many industries have specific regulations and compliance requirements related
to inventory management. Effective inventory tracking and reporting ensure compliance with these standards.
In summary, effective inventory management is crucial for maintaining a balance between meeting customer
demand and minimizing holding costs, ultimately leading to improved profitability and sustainability for the
business.
 Inventory - Types
• There are various fundamental types of inventory when it comes to the products a
business might sell.
1) Raw materials: Raw materials are any items used to manufacture finished products, or
the individual components that go into them. These can be produced or sourced by a
business itself or purchased from a supplier.
For example: A business that makes its own bespoke furniture may purchase materials from
a supplier. While a small business supplying specialty herbs may actually grow these itself.
Either way, raw materials are still considered a type of inventory. And so must be managed,
stored and accounted for accordingly

2) Work-in-progress (WIP): inventory Work-in-progress (WIP) inventory again refers to

retailers that manufacture their own products. These are unfinished items or components
currently in-production, but not yet ready for sale. For our furniture business, this may be
products that have been put together without yet being painted or packaged.
 Inventory - Types
3) Finished goods: Finished goods are products that are complete and ready for sale. These may
have been manufactured by the business itself, or purchased as a whole, finished product from a
supplier. Most retailers will either purchase whole, finished products from a supplier, or have
custom products manufactured for them by a third-party

4) Maintenance, repair & operations (MRO): goods MRO goods are items used within the
manufacture of products, but without directly making up any part of a finished product. This can
include items such as: ● Production & repair tools. ● Uniforms & safety equipment. ● Cleaning
supplies. ● Machinery. ● Batteries. ● Computer systems

5) Packing materials: Packing materials are anything you use for packing and protecting goods
- either while in storage, or during shipping to customers. This is therefore particularly important
for online retailers. And may include things like: ● Bubble wrap. ● Padding. ● Packing chips. ●
A variety of boxes
 Inventory - Types

6] Cycle Inventory: Cycle inventory represents the regular fluctuations in inventory levels due
to ordering and production cycles. It is managed to balance production and customer demand.

7] Seasonal Inventory: Inventory held in anticipation of seasonal demand fluctuations. This is

common in industries where demand varies significantly throughout the year.

8] Buffer Inventory (Safety Stock): Buffer inventory is held to account for uncertainty in
demand, lead times, and supply. It helps prevent stockouts and ensures a smooth flow of
production and distribution.

9] Anticipation Inventory: Inventory that is built up in anticipation of future demand,

especially when there is an expected increase in demand or a potential supply disruption.

10] Pipeline Inventory: Inventory that is in transit between different locations, such as goods
being transported from suppliers to the company or from the company to retailers.
 Inventory - Types

11] Speculative Inventory: Inventory acquired based on speculation about future price
changes or shortages. This inventory type is considered a form of investment.

12] Dead Stock or Obsolete Inventory: Inventory that has not been sold or used for a long
time and is unlikely to be used or sold in the future. It may be outdated, damaged, or no
longer in demand.

13] Consignation Inventory: Inventory held by a seller at a customer's location until the
customer actually uses or sells the items. The seller still owns the inventory until it is
consumed or sold.
 Inventory – Associated cost

Whenever you entered in shopping mall and you see there is huge stock of multiple items.

Did you think that the only cost associated with inventory or stock is purchase cost? No, you
are wrong.

There are some other costs like carrying or handling cost or stock out costs.
 Inventory – Associated cost

Inventory cost is defined as the cost incurred over procurement, storage and management of
inventory.

Huge cost is associated with inventory procurement or purchasing, inventory handling or

storage and inventory management.

Inventory costs is divided into three categories:

1. Ordering cost
2. Carrying cost
3. Shortage or stock out cost
 Inventory – Associated cost – Ordering costs
• Ordering cost is also named as setup cost
• Ordering cost is the cost incurred while procuring inventory.
• Ordering cost includes:
1. cost of inventory purchase (Ordering and reordering).
2. Cost of administering procurement ( HR + Paper work)
3. Cost of finding suppliers and placing supply orders
4. Accounting: The cost of checking supply against each order, making payments and
maintaining records of purchases.
5. Cost of inbound logistics (transportation)
6. Receiving cost ( unloading and inspection)
7. Cost of electronic interchange.
 Inventory – Associated cost – Ordering costs

• Ordering cost is depends on two factors:

• Cost of ordering excess and cost of ordering less

• Ordering excess will increase carrying cost while ordering less will increase replenishment
cost

• Total stocking cost (TSC) = cost of ordering excess + cost of ordering less

• There is a need to balance between ordering excess and ordering less.

 Inventory – Associated cost – Carrying costs

• Carrying cost is also named as holding cost.

• Carrying cost is the cost incurred over inventory storage and management

• Storage could be neither in the organization's own warehouse or the third party warehouse.
 Inventory – Associated cost – Carrying costs

• Administrative cost over inventory record keeping

• Opportunity cost of the money invested in the inventory
• Storage space cost (building rent, ventilation, lighting etc.)
• Handling cost (equipment required for movement of inventory, labour etc.)
• Depreciation cost (inventory may damage while handling, chemical changes etc.)
• Inventory risk cost (loss of inventory. Theft, fraud etc.)
• Obsolescence cost ( inventory may obsolete)
• Insurance cost (to secure inventory from loss and theft or flood etc)
• Taxes
 Inventory – Associated cost – Shortage costs

• Shortage cost is also named as stock out cost

• Shortage cost or stock out cost and cost of replenishment is incurred when businesses
becomes out of stock due to unusual circumstances.

• Shortage cost include:

1. Disrupted production cost (fixed cost increased due to no working of human resource)
2. Emergency shipment cost (paying extra for shipment in less time or on time)
3. Customer loyalty and reputation cost
 Inventory – Selective control of inventory

• It means stocking adequate number and kind of stores, so that the materials are available
whenever required and wherever required. Scientific inventory control results in optimal
balance
• To provide maximum supply service, consistent with maximum efficiency & optimum
investment.
• To provide cushion between forecasted & actual demand for a material
• Selective control of inventory involves implementing strategies and tactics to efficiently
manage and optimize the levels of inventory for different products or categories within a
business.
• The goal is to strike a balance between having enough inventory to meet customer demand
and minimize carrying costs, holding costs, and the risk of obsolescence.
 Inventory – Selective control of inventory

There are many criteria used for this purpose. They are:
• Based on the cost of the product/item
• Lead time
• Usage rate
• Procurement difficulties, criticality, frequency of usage
Inventory – Selective control of inventory
Inventory – Selective control of inventory

A) ABC Analysis

• This is based on cost criteria.

Classify products into categories based on their importance or value (e.g., revenue generated, profit margins).
• Category A: High-value, critical items (often a smaller portion of the inventory but higher value).
• Category B: Moderate-value items (moderate portion of the inventory and value).
• Category C: Low-value, less critical items (larger portion of the inventory but lower value).
• About 10 % of materials consume 70 % of resources

• About 20 % of materials consume 20 % of resources

• About 70 % of materials consume 10 % of resources

 ANNUAL COST CUMMULATIVE
ITEM % ITEM
[Rs.] COST [Rs.]
COST %
ABC
1 90000 90000
10 % 70 %
A 2 50000 140000
3 20000 160000
N 4 7500 167500
20 % 20 %
A 5 7500 175000
6 5000 180000
L
7 4500 184500
Y 8 4000 188500
9 2750 191250
S
10 1750 193000
I 11 1500 194500

S 12 1500 196000
13 500 196500 10 %
70 %
14 500 197000
15 500 197500
WORK 16 500 198000
SHEET 17 500 198500
18 500 199000
19 500 199500
20 500 200000
 Inventory – Selective control of inventory

B] VED Analysis

• This is based on importance of inventory in industry.

• VED stands for Vital Essential and Desirable
• This analysis is mainly carried out to identify critical items.
1] Vital items are those items the unavailability of which will stop the production.
2] Essential items are those items whose stock out costs are very high.
3] Desirable items will not cause any immediate production stoppages and their stock out
costs are nominal.
 Inventory – Selective control of inventory

C] SDE Analysis:-
• The criterion for this analysis is the availability of the materials in the market.
• S stands for scares: In industrial situations where certain materials are scarce (especially in
a developing country like India) this analysis is very useful and gives proper guideline for
deciding the inventory policies. Scarce, classification includes items which are in short
supply, imported items. Such items are procured once in a year because of effort and
expenditure involved in its import.
• D stands for difficult items, items which are not readily available in local markets and
have to be procured from faraway places, or items for which there are a limited number of
suppliers; or items for which quality suppliers are difficult to get.
• E refers to items which are easily available in the local markets
 Inventory – Selective control of inventory

D] HML Analysis:-

• This analysis is similar to ABC analysis but here the criteria is 'price' instead of usage
value
• The items in this analysis are classified into three groups, i.e., high, low and medium.
• HML Analysis classifies inventory based on how much a product costs/its unit price.
High Cost (H) – Item with a high unit value.
Medium Cost (M) – Item with a medium unit value.
Low Cost (L) – Item with a low unit value.
 Inventory – Selective control of inventory

E] FSN (FAST, SLOW & NON-MOVING )Analysis:-

• This method of inventory control is very useful for controlling obsolescence.

• All the items of inventory are not used in the same order; some are required frequently,
while some are not required at all.
• So this method classifies inventory into three categories, fast-moving inventory, slow-
moving inventory and non-moving inventory.
• The order for new inventory is placed based on the utilization of inventory
 Inventory – Selective control of inventory

F] SOS analysis:
• This classification is based on the seasonality of the items as seasonal and off seasonal.
Seasonal items are available only for a limited period and, hence, they are procured to
meet the demand till the next season.

G] GOLF analysis:
• GOLF Classification:- The letter stands for Government, Ordinary, Local and Foreign.
 Inventory – Selective control of inventory

H] XYZ analysis:

• XYZ analysis is one of the basic supply chain techniques, often used to determine the inventory
valuation inside the stores.
• It's also strategic as it intends to enable the Inventory manager in exercising maximum control
over the highest stocked item, in terms of stock value.
• The XYZ analysis is a way to classify inventory items according to variability of their demand.
X class items which are critically important and require close monitoring and tight control –
while this may account for large value these will typically comprise a small percentage of the overall
inventory count.
Y class are of lower criticality requiring standard controls and periodic reviews of usage.
Z class require the least controls, are sometimes issues as “free stock” or forward holding.
 Inventory – Models

An inventory system can be modelled quantitatively based on demand patterns. They are

• Deterministic inventory models in which demand rate of an item is assumed to be constant.

• Probabilistic inventory models where the demand for an item fluctuates and is specified in
probabilistic terms.
 Inventory – Models
Economic Order Quantity (EOQ)
• There are two major costs associated with inventory. Procurement cost (ordering cost) and inventory carrying cost.

• Annual procurement cost varies with the number of orders.

• This implies that the procurement cost will be high, if the item is procured frequently in small lots. The
procurement cost is expressed as Rs./Order

• The annual inventory carrying cost (Product of average inventory x Carrying cost) is directly proportional to the
quantity in stock.

• The inventory carrying cost decreases, if the quantity ordered per order is small.
• The two costs are diametrically opposite to each other.
• The right quantity to be ordered is one that strikes a balance between the two opposing costs.
• This quantity is referred to as "Economic order quantity" (EOQ).
 Inventory – Models
Economic Order Quantity (EOQ)
 Inventory – Models
Assumptions of the Economic Order Quantity (EOQ)
The basic EOQ model is based on the following assumptions:

• The usage/demand of material for a given period, usually one year, is known.

• The consumption of raw material is distributed evenly throughout the period.

• Inventory orders can be replenished immediately (There is no delay in placing and receiving orders).

• There are two distinguishable costs associated with inventories: costs of ordering and costs of carrying'.

• The cost per order is constant regardless of the size of order.

• The cost of carrying is a fixed percentage of the average value of inventory

 Inventory – Models
Economic Order Quantity (EOQ)
For determining the EOQ formula we shall use the following symbols:

• A = annual usage/demand
• Q = quantity ordered
• B = cost per order
• C = carrying cost per unit
• P = price per unit
• TC = total costs of ordering and carrying
 Inventory – Models
Economic Order Quantity (EOQ)
Ordering cost Carrying cost

A

Q
B  Q
2 C

A Q
Total cos t  B C
Q 2
 Inventory – Models
Economic Order Quantity (EOQ)

• The order level at which the total cost of managing inventory is minimum is known as
EOQ.

• This can be derived by applying minima rule of differentiation.

• If you take first differential and make it equal to zero, you

2AB
EOQ 
C
 Inventory – Models

Inventory models for obtaining economic order quantity:

i) EOQ Model with Uniform Demand

ii) EOQ Model with Different Rates of Demand in Different Cycles

iii) EOQ Model when Shortages are Allowed

iv) EOQ Model with Uniform Replenishment

v) EOQ Model with Price (or Quantity) Discounts

 Inventory – Models

Inventory models for obtaining economic order quantity:

i) EOQ Model with Uniform Demand
Assumptions:-
• Demand rate (D) is constant and known;
• Replenishment rate (rp) is instantaneous;
• Lead time is constant and zero;
• Purchase price is constant, i.e., discounts are not allowed;
• Carrying cost and ordering cost are known and constant; and
• Shortages are not allowed.
 Inventory – Models

Inventory models for obtaining economic order quantity:

ii) EOQ Model with Different Rates of Demand in Different Cycles
• In this EOQ model, the same quantity is ordered each time when the stock vanishes with
the assumption that the replenishment is instantaneous.
• The demand is not uniform and the stock vanishes in different periods of time.
 Inventory – Models

Inventory models for obtaining economic order quantity:

iii) EOQ Model with Uniform Replenishment OR Economic order quantity when stock
replenishment is non-instantaneous (production model)
This model is applicable when inventory continuously builds up over a period of time after
placing an order or when the units are manufactured and used (or sold) at a constant rate.
Because this model is especially suitable for the manufacturing environment where there is a
simultaneous production and consumption, it is called "Production Model."
 Inventory – Models
Inventory models for obtaining economic order quantity:
iv) Economic order quantity with instantaneous stock replenishment (basic inventory model)
Assumptions
1. Demand is deterministic, constant and it is known.
2. Stock replenishment is instantaneous (lead time is zero)
3. Price of the materials is fixed (quantity discounts are not allowed)
4. Ordering cost does not vary with order quantity.
 Inventory – Models

Inventory models for obtaining economic order quantity:

v) EOQ Model when Shortages are Allowed
In many practical situations, shortages or stock outs are not permitted. So, it is must that
stock out situations are to be avoided. There are occasions where stock out are economically
justifiable. This situation is observed normally when cost per unit is very high.
 Inventory – Models

Inventory models for obtaining economic order quantity:

vi) EOQ Model with Price (or Quantity) Discounts

• If the items are purchased in bulk, some discount in price is usually offered by the
supplier.
• The discount is called all units discount if it is applicable for all the units purchased.
• It is said to be incremental discount if discounts are offered only for the items which are
in excess of the specified amount.
 Inventory

Q.1) Define Inventory and explain its various types.

Q.2) Explain need of inventory in manufacturing processes.
Q.3) Explain different Costs associated with inventory.
Q.4) Explain in detail Economic order quantity.
Q.5) Explain Models of Inventory Control.
Q.6) Explain Selective control of Inventories.