Q1.

CHAPTER
5
Inventory Management

CHAPTER STRUCTURE
5.1 Introduction
5.2 Concept of Inventory Management
5.3 Reorder Point
5.4 Safety Stock
5.5 Techniques of Inventory Management
5.6 Summary
5.7 Key Terms

CHAPTER OBJECTIVES
• Learn the concept of Inventory Management
• Explain the types and functions of inventory
• Discuss the Process of Inventory Management
• Learn the Inventory Control Techniques
• Elaborate on the Economic Order Quantity (EOQ)
Model
268 ■ 5

5.1 Introduction
Inventory refers to the total amount of materials or finished products maintained by an organization for production and
sales operations at a given point of time. Broadly speaking, inventory can be of three types, namely raw materials, work-
in-progress, and finished goods. Raw materials are the items that an organization uses to convert inputs into output.
Work-in-progress includes items that are currently in the process of production and are partly manufactured. Finished
goods are the items that have been produced but not yet sold. A manufacturing organization generally holds all the
three types of inventories, while a distribution organization holds mostly finished goods. All the three types of
inventories are highly valuable assets of an organization. Thus, it is important for an organization to manage its
inventory properly.
Inventory management is all about supervising the inflow and outflow of inventory in an organization. Effective
inventory management is integral to successful business operations. This is because excessive amount of inventory may
incur high cost for an organization, while inadequate inventory hampers the production process of the organization.
Effective inventory management helps an organization to maintain an optimum level of inventory and reduce material
handling costs, thereby enhancing the efficiency of the organization. To do so, an organization employs a number of
quantitative techniques, such as ABC analysis, VED analysis, and FSD analysis.
The chapter begins by explaining the concept of inventory management in detail. Next, it discusses the objectives of
inventory management. The chapter also explains different types of inventory at length. In addition, it details upon the
benefits of inventory and the process of inventory management. The chapter further sheds light on the concepts of
reorder point and safety stock. Toward the end, it explains different techniques of inventory management, such as stock
levels, VED analysis, FSD analysis, and ABC analysis.

5.2 Concept of Inventory Management

The term inventory refers to a physical stock of items kept by an organization for the future use. Gareth and Silver
(1973) defined inventory as “an idle resource of any kind that possesses economic value. It includes physical goods,
stock, pile of managerial and personal information, cash and production equipment. It is a list or schedule of articles,
human or material resources that are needed in the production process.” Inventory can be classified into raw materials,
work-in-progress, and finished products. Maintaining an adequate level of inventory incurs significant cost for an
organization. Therefore, it is necessary for an organization to manage and control its inventory properly.
Inventory management is all about supervising the activities involved in maintaining inventory at a level so that the
production and sales objectives of an organization can be met effectively. It protects an organization against adverse
situations, such as shortage or excess of materials or products. To manage its inventory effectively, an organization
needs to consider various factors, such as replenishment lead time, carrying costs of inventory, inventory
forecasting, price of products, physical inventory, quality management, scrap, and demand forecasting. The following
are some of the factors that affect the level of inventory to a large extent:
• Rate of Inventory Turnover: Refers to the rate at which inventory is consumed in the production cycle. When
the turnover rate is soaring, investment in inventory is likely to be reduced and vice versa.
• Characteristics of Products: Affect the inventory level to a large extent. For example, if the products are
durable in nature, the level of inventory would be high as the possibility of perishability and obsolescence would be
less. However, in case of perishable products, the level of inventory would be low.
• Structure of Market: Decides the level of inventory in an organization. If the market is imperfect and the
demand is indecisive, an organization needs to keep a large amount of inventory to exploit profitable opportunities.
• Economies of Production: Influence the cost and amount of inventory in an organization. Modern machinery
is very expensive and cost of in-operative machine time is substantial. Therefore, every organization prefers to
retain adequate stock of raw materials to maintain continuity in production.
 Inventory Management ■ 269
1.2.1 Objectives of Inventory Management
The prime objective of inventory management is to ensure effective production and sales operations in an organization.
This can be accomplished by maintaining a sufficient amount of inventory. For example, if an adequate amount of raw
materials is available, an organization can expand its production. On the other hand, if there is sufficient amount of
finished goods, an organization can meet sudden rise in demand at a very short notice. Therefore, efficient inventory
management helps in satisfying production and sales demand. The following are the main objectives of inventory
management:
• Meeting the anticipated demand
• Fulfilling production requirements
• Avoiding unnecessary delays in the supply of materials
• Maintaining an adequate amount of finished goods to carry out sales operations smoothly
• Enabling the organization to schedule its production operations effectively
• Reducing material handling costs
An organization maintains different types of inventory at a given point of time. Let us discuss the different types of
inventory in detail in the next section.
1.2.2 Different Types of Inventory
Different organizations maintain different types of inventory. For example, manufacturing organizations maintain
inventory of raw materials, spare parts, and other consumables required for production. On the other hand,
organizations involved in the distribution of products maintain inventory of finished products. Based on its function,
inventory is classified into three parts, which are as follows:
• Raw Materials: Include assemblies, sub-assemblies, and components required for producing finished products.
An organization generally purchases raw materials from suppliers.
• Work-in Progress: Refers to materials that have entered the production process but are yet not finished
products. In other words, work-in- progress are materials that are partly manufactured.
• Finished Products: Refer to inventory that is ready to be sold to customers.
1.2.3 Inventory Costs
As discussed earlier, an organization needs to incur significant cost for maintaining a desired level of inventory. This
type of cost is called inventory costs. The costs associated with inventory fall into various categories, which are shown in
Figure-1:

Ordering Cost

Inventory
Carrying Cost
Inventory Costs
Under-stocking
Costs

Overstocking
Costs

Figure-1: Inventory Costs

270 ■ 5
The different types of inventory costs (as shown in Figure-1) are discussed as follows:
• Ordering Costs: Refer to costs that are associated with the acquisition of inventory. Organizations have to place
orders to suppliers to replenish the inventory of raw materials. Ordering costs include the following:
¢ Costs of calling quotations
¢ Costs of processing tenders
¢ Costs of placing purchase orders
¢ Costs of inspecting shipments
¢ Stationery charges
¢ Postage charges
¢ Telephone and telegram expenses
¢ Travelling expenses
¢ Entertainment and refreshment expenses
¢ Legal expenses in case of purchase disputes
Ordering costs can be determined by dividing the total costs mentioned above by the number of orders placed
during a given period.
• Inventory Carrying Costs: Refers to costs incurred by an organization at a certain point of time for holding
and storing its inventory. Carrying costs are referred as a percentage of inventory value. These costs include the
following:
¢ Interest on capital
¢ Insurance and tax charges
¢ Storage costs
¢ Allowance for deterioration or spoilage
¢ Salaries of stores staff
¢ Costs incurred in case of obsolescence of inventory
These costs can be controlled by using inventory policies. For instance, an organization has a shelf space of 1000 units
and it gets discount on purchasing more than 1000 units. In such a case, it has to increase its shelf space to get
discount. Apart from this, the organization can also use another alternative. One of the alternatives is vendor
releasing, where supplier agrees to deliver small amounts of a large order over a period of time.
• Under-stocking Costs: Refer to costs that are incurred when an item is out of stock. Under-stocking costs
include the following:
¢ Opportunity costs associated with production hold ups
¢ Payments made to idle workforce
¢ Administrations costs
¢ Unfavorable prices
• Overstocking Costs: Refer to costs incurred by an organization when there is surplus of inventory. Overstocking
costs include the following:
¢ High costs of storage and maintenance
¢ High insurance costs
It should be noted that only carrying costs and ordering costs are considered for calculating total inventory costs.
1.2.4 Benefits of Inventory
An adequate level of inventory helps in planning various organizational activities, such as purchasing, production, and
selling. All these three activities are interrelated; however, these activities can be carried out independently with the help
 Inventory Management ■ 271

of inventories. For example, if the organization has a sufficient pool of raw material then it can produce finished goods
without any constraint. In such a case, the organization would not depend entirely on the sales of goods and services to
buy raw material for further production. This is a benefit of holding inventory in the long run. However, the benefit of
holding inventory in the short run is to meet unexpected rise in demand of customers. Other benefits of maintaining
inventory are as follows:
• Benefits in Purchasing: Refer to the benefits, which arise by purchasing goods in larger quantities. If an
organization purchases raw material or goods in huge quantity then it may avail discounts. This would lower the
ordering and carrying cost.
• Benefits in Production: Imply that the adequate level of inventory facilities the smooth flow of production. If
the organization has sufficient amount of inventory then it can increase or decrease the level of production to
match with the sales. This would be a special advantage to the organizations with seasonal sales pattern. Suppose the
sales volume of a cooler manufacturing organization is higher in summer season and lower in winter season. In such
a situation, it would be better for the organization to maintain a sufficient level of inventory to avoid the situation
of scarce or excess production.
• Benefits in Sales: Refers to the fact that the maintenance of inventory helps an organization to enhance its sales
efforts. If there is no inventory of finished goods, the level of sales would depend upon the level of current
production. In such a situation, the organization would not be able to meet higher demand instantly. There would
be a time lag depending upon the production process. If the organization has inventory, the actual sales would not have
to depend on lengthy manufacturing processes.
1.2.5 Process of Inventory Management
From the discussion so far, it can be said that inventory management is all about ensuring the availability of inventory
as and when required. Inventory management is a systematic process that involves four steps, which are shown in
Figure-2:

Planning and
Determining Planning
Determining designing the
an optimum Inventory
the degree of inventory
inventory control
control control
level Organization
system

Figure-2: Process of Inventory Management

The steps involved in inventory management process (as shown in Figure-2) are explained as follows:
1. Determining an optimum inventory level: Involves defining the exact level of inventory that an organization
can hold. Defining an optimum inventory level is of utmost importance for an organization. This is because excess
of inventory may incur huge cost for the organization, whereas shortage of inventory would hamper the production
process of the organization.
2. Determining the degree of control: Involves deciding the extent of control required for realizing the
objectives of inventory management. This is done by using a technical Always Better Control (ABC) classification.
A detailed explanation of ABC classification is given later in the chapter.
3. Planning and designing the inventory control system: Involves developing a system to record the inflow
and outflow of inventory. By doing so, an organization can maintain an adequate level of inventory. There are two types
of systems commonly used by organizations, which are as follows:
¢ Fixed Order Period System (P System): Reviews the position of stock on a regular basis. In case there is
a requirement for materials, a new order is placed. The following are the main advantages of the P system:
272 ■ 5
• Requires low ordering and inventory costs
• Works well for materials that are used irregularly
¢ However, the P system has certain limitations, which are as follows:
• Makes system inefficient as it demands periodic review
• Piles up the purchasing work during review days
• Involves a limited number of ordering cycles, which leads to variation in the actual ordered quantity and the
optimum quantity
• Fixed Order Quantity System (Q System): Refers to a system in which fixed order quantity is ordered
whenever the stock in hand reaches the reorder point. The fixed quantity of materials that is ordered each time is
called Economic Order Quantity (EOQ). The Q system helps an organization to obtain the following advantages:
¢ Procuring the most economical quantity of materials
¢ Fulfilling the requirements of materials as and when required
¢ Maintaining an optimum level of inventory
However, the Q system has certain limitations, which are as follows:
• May place purchase orders at a point of time that is not convenient for suppliers
• Fails to group different items, which may make the stock-taking process time consuming
• Requires time and efforts of an organization to fix the new order quantity and a new order point on a regular basis
Table-1 distinguishes between the P system and Q system:
Table-1 Differences between P System and Q System of Inventory
Point of Difference P System Q System
Order initiation Order is placed on the basis of review Order is placed when stock in
period hand reaches the reorder point
Period of order Order is placed only after the pre- Order is placed anytime when the
determined period stock reaches the reorder point
Order quantity Quantity varies at different points of Quantity remains constant
time
Size of inventory More than Q system Less than P system

4. Planning inventory control organization: Involves updating inventory on a periodical basis. It is necessary for
an organization to update the inventory control system from time to time as per changing market conditions.

5.3 Reorder Point

The reorder point is stated in terms of the level of inventory at which an order should be placed to replenish the current
stock of inventory. In simple words, reorder point may be defined as the level of inventory when fresh order should be
placed with the suppliers for procuring additional inventory. The reorder point is based on the following assumptions:
• The usage inventory is constant on a daily basis.
• The lead-time to procure inventory is fixed.
The formula to calculate reorder point is as follows:
Reorder point = Lead time in days * Average daily usage of inventory
The lead time refers to the time normally taken in receiving the delivery after placing orders to suppliers. It covers the
time-span from the point when a decision to place the order for the procurement of inventory is taken to the actual
receipt of inventory by the organization. The lead time may also be called as the procurement time of inventory.
Therefore, it can be said that the reorder point is the point where inventory level of an organization is equal to the
 Inventory Management ■ 273

consumption during the lead time. For example, the average inventory consumption of an organization is 500 units per day.
The number of days required to receive the delivery of inventory after placing order is 15 days. The reorder point
= 500 units * 15 days = 7500 units. The implication is that the organization should place an order for replenishing the stock
of inventory as soon as the inventory level reaches 7500 units. The size of reorder would be equal to the EOQ.

5.4 Safety Stock

The safety stock can be defined as the minimum additional inventory to serve as a safety margin or buffer to meet an
unanticipated increase in demand. Therefore, it is also called minimum inventory, buffer stock, or reserve stock. The
formula to calculate the level of safety stock is as follows:
Safety stock= (Maximum usage rate – Average usage rate) * Lead time Or
Safety stock = Reorder Point – (Lead time (in days) * average usage)
Where,
Usage rate is the rate at which the inventory is used in the organization. For example, if an organization uses 300 units of
inventory every day then the usage rate would be 300 units.
The safety stock is maintained to avoid the situations of shortage of stock, which is also known as stock out. If the lead-
time and usage rate change frequently, the organization may face a situation of stock out. In such a situation, complete
protection against stock-out is required by maintaining a large safety stock. An organization also maintains the safety stocks
to deal with the situations of unexpected delays in delivery. Thus, in the situation of uncertainties when the safety stock is
maintained, the reorder point can be determined as follows:
Reorder point = (Lead time * Average usage) + Safety stock
One another method of making a provision for safety stock is a simple formula in which the safety stock varies directly
as the square root of lead time. Consumption varies and is adjusted according to the degree of safety desired. The
formula for safety stock level is:
S= K √D
Where
S= Safety stock
K= Value of constant that varies from 1 to 4 depending on the degree of safety desired
D= Average consumption during lead time

5.5 Techniques of Inventory Management

Inventory management is mainly concerned with striking a balance between anticipated costs and benefits of holding
inventories. Moreover, it aims at maintaining an adequate level of inventory to meet production and sales objectives of
an organization. To do so, an organization needs to apply a number of inventory management techniques ranging from
simple graphical techniques to more sophisticated and complex techniques. Let us discuss some of the important
inventory management techniques in detail in the next sections.

5.5.1 Stock Levels

Carrying too much or too little inventory is unfavorable for any organization. If the inventory is too little, the
organization would face regular stock-outs involving high ordering cost. On the other hand, if the inventory level is too high,
the situation of overstocking arises. Therefore, it is important for an organization to keep an optimum level of
inventory. The various stock levels maintained by an organization are discussed as follows:
274 ■ 5
• Minimum Stock Level: Represents the rate of inventory that must be maintained by an organization at any
point of time. Minimum level gives an element of safety in production as materials can always be kept in reserve for
emergencies. This is why sometimes the stock at minimum level is known as emergency reserve stock. The level in any
case is not allowed to touch the zero level. This is because if the inventory is less than the minimum level, the
production process of the organization would hamper due to the shortage of materials. The formula to calculate
minimum stock level is as follows:
Minimum Stock Level = Reordering level – (Normal consumption * Normal reorder period)
Or
Minimum Stock level = Reorder level – (Average Rate of Consumption Lead time)
• Reordering Level: Refers to the rate of inventory at which an organization places the reorder of materials. In
other words, when the amount of inventory reduces to a certain level, then a new order is forwarded to get
materials again. The order is forwarded before the amount of raw material depletes to a minimum stock level.
Reordering level or ordering level is fixed between minimum level and maximum level of inventory. The formula
to calculate the reordering level is as follows:
Reordering level = Maximum consumption * Maximum reorder point
Or
Reordering level = Lead time (in days) * Average daily usage
• Maximum Stock Level: Refers to the maximum amount of inventory that an organization should keep with
itself. The organization should not go beyond the maximum stock level because it would unnecessarily increase
inventory holding cost. The formula to calculate the maximum stock level is as follows:
Maximum stock level = (Reordering level + Reordering quantity) – (Minimum consumption * Minimum
reordering period)
The maximum stock level depends on the following factors:
¢ Rate of consumption of the materials
¢ Time required to receive deliveries
¢ Amount of capital available
¢ Storage space available
¢ Possibility of loss due to evaporation and deterioration
¢ Current market conditions
¢ Economic ordering quantity
¢ Government restrictions as in the case of explosive materials
¢ Staff and other facilities available for the maintenance of stores
¢ Total maintenance cost
¢ Need of buffer stock (safety stock) in relation to active stock
• Danger Level: Refers to the level beyond which inventory should not fall in any case. If the danger level arises,
then the immediate steps should be taken to replenish the stocks, even if more cost incurs in arranging the
materials. Danger level is determined by the following formula:
Danger level = Average consumption * Maximum reordering point for emergency purchases
 Inventory Management ■ 275

However, in an organization, stock levels are influenced by various factors, which are shown in Figure-3:

Operational
Needs

Factors
Availability of
Delivery Time Affecting the
Capital
Stock Levels

Cost of
Storage

Figure-3: Factors Affecting Stock Levels

The factors affecting stock levels (as shown in Figure-3) are explained as follows:
• Operational Needs: Imply that the stock level of an organization depends on its level of production. For
example, an organization having a high level of production needs to maintain maximum stock level. On the other
hand, an organization that produces only after receiving orders from customers needs to maintain minimum stock
level.
• Delivery Time: Refers to time when the ordered materials are dispatched. Sometimes organizations face delay in
the delivery of materials due to various reasons. These situations generally take place in festive seasons, poor
climatic conditions, wars, and technology failure. In such cases, an organization needs to maintain a sufficient stock
level to meet production and sales requirements.
• Availability of Capital: Refers to one of the major factor that affects stock levels. An organization needs to
maintain a level of inventory according to the capital available. This is because if the organization goes beyond the total
capital available, it would adversely affect the overall budget of the organization.
• Cost of Storage: Indicates another crucial factor that influences the stock level maintained by an organization.
Higher the level of stock maintained by an organization, the higher would be the storage cost.

5.5.2 VED Analysis

The VED analysis segregates inventories into three categories in the decreasing order of their criticality. In the VED
analysis, V stands for vital items whose shortage may hamper the production process. Therefore, V items should be
stored sufficiently to maintain smooth business operations. E denotes essential items that are regarded indispensable for
efficient business operations. Therefore, the organization must ensure the adequate availability of E items. D stands for
desirable items that do not influence production instantly but accessibility of such items would lead to more
effectiveness. The VED analysis can be very valuable to capital-intensive industries.
276 ■ 5
5.5.3 FSD Analysis
The FSD analysis segregates the items into three categories in the decreasing order of their usage rate. In the FSD
analysis, F stands for fast moving items and such items are exhausted within a short period of time. S signifies slow
moving items whose usage rate is low; therefore, the existing stock of S items lasts for two years or more. D stands for dead
stock whose usage rate is negligible because the organization does not foresee any additional demand of such
products. Stocks of fast-moving items must be taken care of constantly and replenishment orders must be forwarded in
time to prevent stock-outs. Slow moving stocks must be evaluated very cautiously before any replenishment orders are
placed. The amount of reorder of such items must be decided after taking into consideration the future demand. Dead stock
of inventory signifies the amount of money spent that cannot be realized. Therefore, once such items are
recognized, efforts must be made to find all substitutes used for it, or else, it must be disposed of.

5.5.4 Just in Time (JIT) Inventory Management

As the name suggests, JIT inventory management means ordering and receiving inventory for sales and production
purposes only when it is needed and not before. This implies that an organization does not hold safety stock and
operates with minimum inventory level. The JIT approach helps an organization in reducing its ordering and carrying costs.
The successful operation of JIT inventory management has the following requirements:
• The organization must have limited suppliers.
• The suppliers must be bound under long-term agreements and prepared to make repeated deliveries in small lots.
• The organization must develop a system of total quality control.
• Poor quality of raw materials or parts cannot be accepted.
• Workers must be multi-skilled in the JIT environment.
In JIT inventory control, the inventories are obtained and introduced in production process at the right time. This
involves proficient purchasing, dependable suppliers, and a well-organized inventory-handling system. One thing that has
made possible JIT inventory control is the introduction of the Internet.

5.5.5 Always Better Control (ABC) Analysis

ABC analysis is a technique that is based on an assumption that an organization should not exercise the same degree of
control on all items of inventory. An organization should keep a more rigorous control on items that are costly while
less-expensive items should be given less control effort.
On the basis of cost, various inventory items are categorized into three classes, such as A, B, and C. The items included
in group A require a large amount of investment. Therefore, inventory control should be made stringent by adopting
advanced techniques. The group C consists of items that involve comparatively small investments. The items of group
C require minimum level of control. The investment incurred in the items of group B is moderate, thus, it deserves less
attention than A but more attention than C.
ABC analysis divides the total inventory into three classes using their percentage value. The class A constitutes 15%,
class B includes 35%, and class C contains 50% of the total inventory. However, the actual break-up of inventory may vary
from situation to situation. The preceding categorization is represented in Table-2:
Table-2: ABC Analysis of Inventory Items
Category Percentage of Items Percentage of Value
A 15 80
B 35 15
C 50 5
Total 100 100
 Inventory Management ■ 277

Class A is made up of items that are either very expensive or used in massive quantities. Thus, these items, though few
in number, contribute a high proportion of the value of inventories (80%).
Class B items are neither too few nor too many in number. These items are neither very expensive nor very cheap and
constitute only 15% of the total value of inventory.
Class C contains relatively a large number of items used in very small quantities. Therefore, such items do not
constitute more than a negligible fraction of the total value of inventories.
To rank materials in A, B, and C classes, the following procedure is recommended:
i. First, the quality of each material expected to be used in a given period should be estimated.
ii. Secondly, the money value of the items of materials selected should be calculated by multiplying the quantity of
each item with its price.
iii. Thirdly, the items should be re-arranged in the descending order of their values irrespective of their quantities.
iv. Fourthly, a running total of all the values and items would then be taken and then the figure so obtained should be
converted into percentage of the gross total.
v. Fifthly and lastly, it would be found that a small number of a first few items may amount to a large percentage of
the total value of the items. After that, items are classified into A, B and C categories on the basis of investment
made in them.
Let us understand ABC analysis with the help of an example.
Example-1: Table-3 shows the inventory records of an organization:
Table-3: Inventory Records of an Organization
Item Annual Usage (in units) Per Unit Annual Usage (in `) Ranking
Cost
10501 30,000 0.10 3,000 6
10502 280,000 0.15 42,000 1
10503 3,000 0.10 300 9
10504 110,000 0.05 5,000 4
10505 4,000 0.50 200 10
10506 220,000 0.10 22,000 2
10507 15,000 0.05 750 8
10508 80,000 0.05 4,000 5
10509 60,000 0.15 9,000 3
10510 8,000 0.10 8,000 7

Table-4 shows the ABC ranking of all the items given in Table-3:
Table-4: ABC Ranking
ABC Ranking
Item Annual Usage (in `) Cumulative Annual Percent Ranking
usage (in `)
10502 42,000 42,000 48.00 A
10506 22,000 64,000 73.1 A
10509 9,000 73,000 83.4 B
10504 5,000 78,000 89.6 B
 Table-4: ABC Ranking
ABC Ranking
Item Annual Usage (in `) Cumulative Annual Percent Ranking
usage (in `)
10508 4,000 82,000 94.1 B
10501 3,000 85,000 97.6 C
10507 750 87,050 99.4 C
10503 300 87,350 99.6 C
10505 200 87,550 100.00 C

Table-5 shows ABC analysis:

Table-5: ABC analysis
ABC analysis
Class Item % Item `/group %
A 10502, 10506 20 64,000 73.1
B 10509, 10504, 10508 30 18,500 21.1
C All other 50 5,050 5.8

5.5.6 Economic Order Quantity (EOQ) Model

The Economic Order Quantity (EOQ) model provides answers to the two basic questions related to inventory
management. These questions are as follows:
• What should be the size of the order?
• At what level should the order be placed?
When an organization orders huge inventory with an intention to reduce total ordering cost; the carrying cost increases. In
view of such a relationship, if the organization wishes to minimize the overall cost of inventory, it needs to consider both
the ordering cost and carrying cost. After determining the acceptable cost of inventory, the organization compares the cost
with the benefits of the inventory. The optimal level of inventory is the one that minimizes the cost and maximizes
the benefits of the inventory. The optimal level of inventory is popularly referred as EOQ. Therefore, EOQ may be
defined as the level of inventory order, which reduces the total cost related with inventory management. The EOQ
model is based on the following assumptions:
• The forecasted consumption for the inventory, usually for one year, is known.
• The consumption is even throughout the year.
• The orders placed to replenish inventory stocks are received at exactly that point of time when the level of
inventory becomes zero.
• The costs associated with the inventory, such as ordering cost and carrying cost, can be distinguished.
• The cost per order is constant regardless of the size of order.
• The carrying cost is a fixed percentage of the average value of inventory.

5.7 Summary
In this chapter, you have learned the concept of inventory management and its importance. After that, the chapter has
explained different types of inventory, such as raw materials, work-in progress, and finished products. It has also
discussed various types of inventory costs, such as ordering costs, inventory carrying costs, under-stocking costs, and
overstocking costs. Next, the chapter has detailed upon the steps involved in the process of inventory management. It
has also shed light on two main concepts of inventory management, namely reorder point and safety stock. The chapter has
discussed various techniques of inventory management. These techniques include stock levels, VED analysis, FSD analysis,
 Inventory Management ■ 279
JIT inventory management, ABC analysis, and EOQ model. In the end, several solved illustrations are given to grasp
the practical implementation of the concepts studied in the chapter.

5.8 Key Terms

• Inventory: Refers to the physical stock of items kept for production or sales operations
• Ordering Costs: Refer to costs that are incurred during the process of procurement
• Inventory Management: Implies the process of developing policies for inventory