MODULE -3

TOPICS TO BE COVERED
INVENTORY MANAGEMENT (IM)
• INTRODUCTION , MEANING AND DEFINITION OF
IM
• OBJECTIVES OF IM
• TYPES OF IM
• FUNCTIONS OF IM
• IMPORTANCES OF IM
• NEED FOR IM
• MOTIVES OF HOLDING IM
• TECHNIQUES OF IM
• RATIOS
 INTRODUCTION OF IM
• In any business or organization, all functions are interlinked and connected
to each other and are often overlapping. Some key aspects like supply
chain management, logistics and inventory form the backbone of the
business delivery function.
• Therefore these functions are extremely important to marketing managers
as well as finance controllers.
• Inventory management is a very important function that determines the
health of the supply chain as well as the impacts the financial health of
the balance sheet.
• Every organization constantly strives to maintain optimum inventory to be
able to meet its requirements and avoid over or under inventory that can
impact the financial figures.
• Inventory is always dynamic. Inventory management requires constant
and careful evaluation of external and internal factors and control through
planning and review.
• Most of the organizations have a separate department or job function
called inventory planners who continuously monitor, control and review
inventory and interface with production, procurement and finance
departments.
 What is Inventory Management?
It is important to manage inventory efficiently as it plays an
important role in various aspects of business. Thus inventory
management includes proper planning of buying, managing,
warehousing and accounting of inventory.

Businesses having proper inventory management systems are

able to know:
1. what to buy,
2. how much to buy,
3. where to buy,
4. at what time to buy
5. Where to store etc.
 Inventory Management Example
• Inventory Management is very important for a business to run
smoothly.
• Imagine a cake manufacturing shop if it keeps running out of flour
and sugar. Flour and sugar are like the main raw materials which
keep the business process running.
• The cake maker needs to plan the quantities of sugar and flour so
that he never runs out of them when he wants to make a cake. But
inventory management is just not about bulking up the supplies.
• If too much flour and sugar are stocked and there is not as much
demand for cake, the flour and sugar would go bad which would
cause financial losses to business.
Inventory Management advocated optimization of inventory.
The inventory management makes sure that the cake maker
has almost the exact amount of sugar and flour which are just
enough to make cakes which match with the demand of cake
eaters who order cake from his shop.
 MEANING AND DEFINITION OF IM
MEANING :Inventory management refers to the
process of ordering, storing, using, and selling a
company's inventory. This includes the management of
raw materials, components, and finished products, as
well as warehousing and processing of such items.

DEFINITION : Inventory management is an approach for

keeping track of the flow of inventory. It starts right from
the procurement of goods and its warehousing and
continues to the outflow of the raw material or stock to
reach the manufacturing units or to the market,
respectively. The process can be carried out manually or
by using an automated system .
FLOW OF INVENTORY
FLOW OF INVENTORY
OBJECTIVES OF IM
 OBJECTIVEOF IM (DIAGRAM)
• Preventing Dead Stock or Perishability: With an optimal inventory level,
the chances of wastage in the form of goods spoilage or dead stock.
• Optimizing Storage Cost: It reduces the chances of maintaining excessive
stock, even the requirements are pre-determined, which ultimately cuts
done the unnecessary warehousing costs.
• Maintaining Sufficient Stock: Now, the production department need not
worry about the shortage of raw material or goods because of its constant
supply.
• Enhancing Cash Flow: Inventory has a significant impact on the cash flow
of the company. With effective inventory management, the organization
can ensure sufficient liquid cash to enhance its operational efficiency.
• Reducing the Inventories’ Cost Value: When there is a constant purchase
of goods or stock, the organization can ask for discounts and other
benefits to decrease the purchase price.
 OBJECTIVEOF IM
1. Financial objectives
2. To create a buffer stock between the input and
output
3. To ensure against delay in deliveries
4. To allow for a possible increase in output if so
required
5. To ensure against scarcity of material in the
market
6. To make use of quantity discounts
7. To utiliz to advantages price fluctuations.
 TYPES OF IM
Inventory Management is a business process which is responsible for managing, storing,
moving, sorting, arranging, counting and maintaining the inventory i.e. goods,
components, parts etc.
Inventory management ensures that the right inventory is available as per the demand
at low costs. Inventory Management makes sure that the core processes of a business
keep running efficiently by optimizing the availability of inventory.
 TYPES OF IM
• Bar-code Inventory Management
The barcode system is its automated and simplified version. The
management can find out the stock remaining with just one click on a
computer device. The scanned barcodes enable the software to maintain a
track of all the purchases and the flow of inventory.
• Continuous Inventory Management
It links the barcode and radio frequency identification with the accounting
inventory system, inventory received, and point of sales systems along with
the production system, to trace the path of inventory movement. It is
mostly beneficial for accounting purpose. This is also termed as perpetual
inventory management.
• Periodic Inventory Management
It is a manual process, which is used for determining the closing inventory
value, for putting it up in the ledger at the end of a financial year.
Depending on the organizational need, it can also be analyzed quarterly.
However, it is a time-consuming way, since the inventory has to be
physically counted.
 Functions of IM
• Inventory serve as a cushions
• Inventory , a necessary evil for any enterprise
• Inventory provides production economies
• Maintenance of smooth and efficient
production flow
• Creation of motivational effect in decision
making
• Increase profitability
 Importance of Inventory
Management
• Increased overall efficiency
• Always know where your inventory is located
• Close every sale possible
• Always meet delivery dates
• Change vendor order frequency when needed
• Make re-ordering easier.
 NEEDS OF IM
1. Meet variation in production demand
2. Cater to cyclical and seasonal demand
3. Economies of scale in procurement
4. Take advantage of price increase and
quantity discounts
5. Reduce transit cost and transit times
6. Long lead and high demand items need to be
held in inventory
 Motives of holding Inventory
• Transaction motive
• Precaution motive
• Speculative motive

Benefits of Inventory Management

• Saves Money:
Understanding stock trends means you see how much of and where you
have something in stock so you’re better able to use the stock you have.
This also allows you to keep less stock at each location (store,
warehouse), as you’re able to pull from anywhere to fulfill orders — all
of this decreases costs tied up in inventory and decreases the amount of
stock that goes unsold before it’s obsolete.
• Improves Cash Flow:
With proper inventory management, you spend money on inventory
that sells, so cash is always moving through the business.
• Satisfies Customers:
One element of developing loyal customers is ensuring they receive the
items they want without waiting.
 Techniques of Inventory Management (Additional)
Inventory Management Techniques and Terms
Some inventory management techniques use formulas and
analysis to plan stock. Others rely on procedures. All methods
aim to improve accuracy. The techniques a company uses
depend on its needs and stock.
• ABC Analysis: This method works by identifying the most
and least popular types of stock.
• Batch Tracking: This method groups similar items to track
expiration dates and trace defective items.
• Bulk Shipments: This method considers unpacked materials
that suppliers load directly into ships or trucks. It involves
buying, storing and shipping inventory in bulk.
• Consignment: When practicing consignment inventory
management, your business won’t pay its supplier until a
given product is sold. That supplier also retains ownership of
the inventory until your company sells it.
 Continue….
• Cross-Docking: Using this method, you’ll unload items directly from
a supplier truck to the delivery truck. Warehousing is essentially
eliminated.
• Demand Forecasting: This form of predictive analytics helps predict
customer demand.
• Drop shipping: In this practice, the supplier ships items directly
from its warehouse to the customer.
• Economic Order Quantity (EOQ): This formula shows exactly how
much inventory a company should order to reduce holding and
other costs.
• FIFO and LIFO: First in, first out (FIFO) means you move the oldest
stock first. Last in, first out (LIFO) considers that prices always rise,
so the most recently-purchased inventory is the most expensive
and thus sold first.
• Just-In-Time Inventory (JIT): Companies use this method in an
effort to maintain the lowest stock levels possible before a refill.
• Lean Manufacturing: This methodology focuses on removing waste
or any item that does not provide value to the customer from the
manufacturing system.
 CONTINUE….(ADDITIONAL)
• Materials Requirements Planning (MRP): This system handles
planning, scheduling and inventory control for manufacturing.
• Minimum Order Quantity: A company that relies on minimum
order quantity will order minimum amounts of inventory from
wholesalers in each order to keep costs low.
• Reorder Point Formula: Businesses use this formula to find the
minimum amount of stock they should have before reordering,
then manage their inventory accordingly.
• Perpetual Inventory Management This technique entails recording
stock sales and usage in real-time. Read “The Definitive Guide to
Perpetual Inventory” to learn more about this practice.
• Safety Stock: An inventory management ethos that prioritizes
safety stock will ensure there’s always extra stock set aside in case
the company can’t replenish those items.
 Techniques of Inventory Management
1. ABC analysis is a technique of sorting of inventories into 3
categories. The categorization of the inventory under the ABC analysis is done
according to how well the inventory can sell and how much it will cost to
hold. Always Better Control technique (ABC) analysis classifies inventory into
three categories namely: A, B, and C.
• It is an integral part of material management. It is an inventory
categorization method, which classifies the inventory primarily into
three distinct categories based on the revenue generation.
• ABC inventory helps business entrepreneurs and stock owners
identify the essential products in the stock and prioritize their
management based on the value. The inventory analysis is based
on the Pareto Principle.
• It is a popular economic theory, discovered by renowned Italian
economist Vilfredo Pareto. ABC Analysis is based on the theory that
all inventory items cannot have similar or equal value.
 Continue… ABC Analysis
As a purchasing manager, understanding your sales over a certain
period will help you evaluate and segregate which product
belongs in which category i.e., A, B, or C. This will also assist the
purchase manager in analyzing what to buy, and in what quantity.

• Category A is the smallest, always reserved for the biggest

moneymakers. It represents the highest quality, most valuable
products, and customers that you have. Such products will contribute
heavily to the overall profit without costing much when it comes to
the seller’s resources.
• Category B products are less critical than Category A products and
more critical than Category C products. So stay in the middle. This
category, in particular, holds the potential to either get moved into
category A if the sales are good, or can even slip down to category C.
• Category C items are marginally valuable. These products will help
you to continually run your business, with a fixed and steady income,
but don’t individually contribute much value to either the seller or to
the business.
 Just-in-time (JIT) Method

• Just-in-time is a Japanese technique of inventory management, in

this technique the company maintains only such quantity of
inventory as it requires during the manufacturing/production
process.
• It implies no excess inventory in hand and saves the cost of
warehousing, shipping, insurance and another allied cost. Further
inventory is ordered when the old stock is close enough to be
replenished.
• However, this is a slightly risky inventory management technique
because a little delay may result in loss of potential sales that can’t
be filled.
• Thus this technique requires proper planning, efficient supplier and
timely arrival of inventory so that new orders can be timely placed.
 Pros and Cons of Just-in-Time (JIT)
• JIT inventory systems have several ADVANTAGES over
traditional models. Production runs are short, which means
that manufacturers can quickly move from one product to
another. Also, this method reduces costs by minimizing
warehouse needs. Companies also spend less money
on raw materials because they buy just enough resources
to make the ordered products and no more.

• The DISADVANTAGES of JIT inventory systems involve

potential disruptions in the supply chain. If a raw-
materials supplier has a breakdown and cannot deliver the
goods in a timely manner, this could conceivably stall the
entire production line. A sudden unexpected order for
goods may delay the delivery of finished products to end
clients.
 Safety Stock Inventory
• This technique emphasis on maintaining a small stock of inventory in hand to
protect against any unexpected market demands and the timing difference
between the initiation and completion of a production process (lead time). This
inventory management technique plays an important part in the smooth
operations of the supply chain in various ways. Such as:

• Guard against unanticipated market demand

• Prevention of stock outs
• Provide compensation in case of inaccurate market forecasts
• And a buffer for longer-than-expected lead times
• Without safety stock inventory an organization could experience:
• Lost customers
• Loss of revenue
• Loss of market share

Safety stock is an additional quantity of an item held in the inventory to reduce the risk that
the item will be out of stock. It acts as a buffer stock in case sales are greater than planned
and/or the supplier is unable to deliver the additional units at the expected time.
 Dropshipping
• It is a business model, it allows to sell and ship commodities without owning and
stocking them. This technique of inventory management eliminates the cost of
inventory holding all together. The Dropshipping process is very simple.
• Following are the benefit of dropshipping:
a. Low startup costs
b. Low inventory cost
c. Low cost of fulfillment of orders
d. Sell and test more products with less risk
 TWO BIN SYSTEM
• A two bin system is a simple, visually-based method for stocking and replacing
items that is used. It is common on assembly and moving production lines where
elements units are added to the merchandise. One bin is the working bin, where
items for manufacture and sale are taken from. When the first container gets
empty, it means time to refill. But when it is refilling, the second container with
elements is used in work.
 CONTINUE… (two bin system)
• Advantages of Two Bin System
• Prevents running out of stock
• Triggered for replenishment
• Managed in lead time
• Meet the demand of customers
• Pooled risk
• Spreads inventory throughout the plant
• Manage the disaster span
• Disadvantages of Two Bin System
• Inventory level is high
• More investment
• Increase costing due to high-level demand
• Spend more to get insured
• Other expenses to manage extra stock
 VENDOR MANAGED INVENTORY
• The idea of vendor managed inventories was first adopted by consumer goods manufacturers. Since then,
it’s spread to a variety of different industries, including the aviation industry.
• Although it’s widely used today in many industries, the earliest instances of VMI involved consumer goods
manufacturers assuming replenishment planning responsibilities for their large retail customers
• The vendor managed inventory definition is a supply chain agreement where vendors or
suppliers manage, maintain, and optimize their inventory while it’s in the possession of a
buyer.
 Vendor Managed Inventory Benefits for Vendors and Suppliers

• More control over in-store product display, organization, and branding.

• Able to leverage the sales expertise of in-store staff, which ultimately boosts sales and brand
loyalty.
• Decreases the magnitude of the bullwhip effect. Which is a phenomenon that sees material
orders increase in contrast to demand swings the further up the supply chain you go.
• Accurate demand forecasting for products. With visibility into sales patterns, stock level, and
demand forecasting, vendors can anticipate inventory needs and customer orders.
• Reduces carrying costs. With more accurate understanding of your products’ demands, you’ll
know how much of your manufacturing inventory (be it work in process inventory, raw
materials inventory, or finished goods inventory) is in your warehouse at a given time. Then
you can decrease the amount of in transit inventory in the pipeline and safety stock on hand.
 ADVANTAGES OF VMI to the Buyer
• Reduced risk because buyers don’t have to invest (or invest as much) in inventory they may
not be able to sell.
• No more cash flow restrictions. Money isn’t tied up in sitting inventory because inventory
isn’t paid for until it’s sold. And/or vendors bring their entire analytical ability to bear on
replenishment, making sure inventory is optimized.
• Lower inventory levels. With suppliers accepting the risk of inventory not selling, you can be
sure they’re cognizant of overstock and potentially obsolete or expired inventory. That means
they’ll err on the side of caution and opt for lower inventory levels and more frequent
shipments.
• Lower carrying costs. Lower inventory levels means lower carrying costs because you reduce
all your excess stock and eliminate the cost of storing and maintaining it.
• Less or no safety stock. Safety stock, buffer stock, and safety stock tie up lots of money and
effort. They also carry risk. When your supplier takes control of inventory management
process, they’ll be able to combine your data with their familiarity with their lead time to
eliminate the need for extra stock.
• Reduce inventory shrinkage. Shrinkage is an unavoidable part of carrying inventory. The less
inventory you keep on hand, the less shrinkage you’ll experience.
• Less or no stockouts. It’s in a vendor’s best interest to keep buyers happy or they’ll find
another vendor. By establishing fluid, consistent replenishment with a vendor managed
inventory system, you’ll eliminate the uncertainty around random and periodic ordering. Your
vendor will always know exactly how to juggle lead time with demand, because they’re used
to doing it.
• Planning, ordering, and inventory management costs decrease because they’re all shifted to
 DIADVANTAGES OF VMI
• Loss of control. Giving over access to your data to a third party can be
uncomfortable for some businesses. You might not want your inventory to
be controlled by an outsider, especially if you’re unsure of that vendor’s
ability to handle your unique needs. Plus, you may have reservations
about handing over your data because of security concerns.
• Limited options. Once you go with a VMI partner, it may cause a big
disruption to that supply chain should you become unsatisfied with their
service. Perhaps you may find other suppliers that are more cost-effective
or have better products – but being in a VMI relationship might dissuade
you from making a change.
• Less agile market responsiveness. If you feel that your expertise regarding
your business’ demand fluctuations is your strong suit, going the VMI
route might not be the best option for you. A VMI supplier will work with
your data insights, but those might not accurately reflect your sales
forecast or your anticipated, sometimes unpredictable, market shifts.
 ENTERPRISE RESOURCE PLANNING (ERP)

ERP systems are designed to offer multiple modules to handle many of your business processes in one centralized
location. Just a few of the most popular applications are:
• Accounting: Features modules such as accounts payable, accounts receivable, a general ledger, and payroll
• Budgeting and forecasting: Features departmentalized budgeting, budget approvals, rolling budgets, predictive
budgeting, and workforce planning
• Customer relationship management (CRM): Features contact management, conversation history, lead tracking,
order histories, quote/invoice creation, and call center integration
• Human resources: Features application processing onboarding, time and attendance tracking, and benefits
management.
• Inventory management: Features inventory costings, location tracking, and various methods of stock count tracking
• Supply chain management: Features requisition and approvals, purchase orders, vendor/supplier management,
demand planning, sales forecasting, and warehouse management
With so many applications, ERP can speed up internal processes across every department. HR can inform
management of new hires while accountants can simultaneously send spending reports. By providing a common
software interface, the entire company database is managed in a singular manner, allowing much more efficient
processes.
 ADVANTAGES OF ERP
• The advantages presented by the ERP are:
• Optimization of business processes.
• Accurate and timely access to reliable information.
• The ability to share information between all components of the organization.
• Elimination of unnecessary operations and data.
• Reduction of time and costs of litigation
• Then, as each module of the ERP system enters the same real-time database, another
advantage is that no duplicate records or playback operations, ie, redundancy is avoided.
• The performance of all work units that make up their business because better use time is
increased. If you previously had to make reports and take them from one place to another,
now the time is spent on other activities.
• To improve performance and save time, optimize the control and analysis of management
decisions there in the long term, reduced costs for the company.
• Another obvious advantage is in terms of customer service, because the response time is
reduced attention to them.
• When a company has an ERP system is more competitive in the environment in which it
operates.
 DISADVANTAGES OF ERP
• The installation of the ERP system is costly. ERP consultants are very expensive take approximately
60% of the budget.
• The success depends on the skills and experience of the workforce, including education and how to
make the system work properly.
• Resistance in sharing internal information between departments can reduce the efficiency of the
software.
• The systems can be difficult to use.
• Change of staff, companies can employ administrators who are not trained to manage the ERP
system of the employing company, proposing changes in business practices that are not
synchronized with the system.
• Having an ERP system has many advantages, but does not guarantee the total success of the
company. Organizational culture, know how to involve staff and anticipate changes that will suffer
the organization using this system of administration, are important elements for the completion of
the implementation.
• The effectiveness of the ERP system may decrease if there is resistance to share information
between business units or departments. Due to strong changes that implementation of the ERP
system brings in the culture of work, there may be poorly trained or disinterested in making use of
the same staff...
• The benefits of having an ERP system are not presented immediately with the implementation of
the software, they will be evident long after the system is running.
• The culmination of the implementation depends on the ability and skill of the workforce, also
involves education and training, to make the system is correctly applied.
 MATERIAL REQUIREMENT PLANNING (MRP)
MRP Systems: Background
• Material requirements planning was the earliest of the integrated information
technology (IT) systems that aimed to improve productivity for businesses by using
computers and software technology.
• The first MRP systems of inventory management evolved in the 1940s and 1950s.
They used mainframe computers to extrapolate information from a bill of
materials for a specific finished product into a production and purchasing plan.
Soon, MRP systems expanded to include information feedback loops so that
production managers could change and update the system inputs as needed.
• The next generation of MRP, manufacturing resources planning (MRP II), also
incorporated marketing, finance, accounting, engineering, and human resources
aspects into the planning process. A related concept that expands on MRP
is enterprise resources planning (ERP), which uses computer technology to link the
various functional areas across an entire business enterprise. As data analysis and
technology became more sophisticated, more comprehensive systems were
developed to integrate MRP with other aspects of the manufacturing process.

MRP is designed to answer three questions:

• What is needed?
• How much is needed?
• When is it needed?
 Steps of Material Requirements
Planning (MRP)
• Estimating demand and the materials required to meet it. The initial step
of the MRP process is determining customer demand and the
requirements to meet it. Utilizing the bill of materials—which is simply a
list of raw materials, assemblies, and components needed to manufacture
an end product—MRP breaks down demand into specific raw materials
and components.
• Check demand against inventory and allocate resources. This step
involves checking demand against what you already have in inventory. The
MRP then distributes resources accordingly. In other words, the MRP
allocates inventory into the exact areas it is needed.
• Production scheduling. The next step in the process is simply to calculate
the amount of time and labor required to complete manufacturing. A
deadline is also provided.
• Monitor the process. The final step of the process is simply to monitor it
for any issues. The MRP can automatically alert managers for any delays
and even suggest contingency plans in order to meet build deadlines.
 Advantages and Disadvantages of Material
Requirements Planning (MRP)
ADVANTAGES TO THE MRP PROCESS:
• Assurance that materials and components will be available when needed
• Minimized inventory levels and costs associated
• Optimized inventory management
• Reduced customer lead times
• Increased manufacturing efficiency
• Increased labor productivity
• Increased overall customer satisfaction
DISADVANTAGES TO THE MRP PROCESS:
• Heavy reliance on input data accuracy (garbage in, garbage out)
• MRP systems can often be difficult and expensive to implement
• Lack of flexibility when it comes to the production schedule
• Introduces the temptation to hold more inventory than needed
 MATERIAL RESOURCE PLANNING (MRP-II)

• MRP II is an extension of the original materials requirements planning (MRP I)

system. Materials requirements planning (MRP) is one of the first software-based
integrated information systems designed to improve productivity for businesses.
• MRP II is a computer-based system that can create detailed production schedules
using real-time data to coordinate the arrival of component materials with
machine and labor availability.
• A materials requirements planning information system is a sales forecast-based
system used to schedule raw material deliveries and quantities, given assumptions
of machine and labor units required to fulfill a sales forecast.
• By the 1980s, manufacturers realized they needed software that could also tie into
their accounting systems and forecast inventory requirements. MRP II was
provided as a solution, which included this functionality in addition to all the
capabilities offered by MRP I.
• Real-World Examples of MRP II Software
• The following are a small sampling of some popular MRP II software providers, as
of early 2020:
• IQMS, Fishbowl, FactoryEdge, Prodsmart, abas, Oracle Netsuite Manufacturing
Edition, Epicor, S2K Enterprise
 MRP I vs. MRP II
MRP I included the following three major
functionalities:
• master production scheduling
• bill of materials
• inventory tracking
MRP II includes those three, plus the following:
• machine capacity scheduling
• demand forecasting
• quality assurance
• general accounting
 DISTRIBUTION RESOURCE PLANNING (DRP)

• Distribution Resource Planning (DRP-II) is an extended version of Distribution

Requirement Planning (DRP-I). Distribution Requirement Planning is a process
which is used to determine which goods or materials will be required at which
location and at what time to meet the anticipated demand.

• DRP-II includes maintaining the provision for major non-inventory items and
resources such as labour, material handling systems, and storage space. It may
include other resources such as finances, trucks, freight cars, etc. This
information is then entered into an MRP-II ( Manufacturing Resource Planning)
as gross requirements for estimating and calculating input flows and preparing
the schedules of production activities.

• The main goal of DRP-II is to eliminate or at least minimize the shortages and at
the same time, reduce the costs incurred during ordering, transporting and
storing or holding goods. It is also called as Distribution Replenishment Planning.
It is a time based approach which estimates when inventory is expected to be
depleted and accordingly replenishes the same on time.
 Benefits of DRP
• Reduce distribution center
• Improved coordination of inventory
• Decrease warehouse space
• Improve service levels
• Reduce freight cost
• Enhanced budgeting capability
• Improved and more efficient promotional
DISTRIBUTION RESOURCE PLANNING
(DRP)
 Economic Order Quantity (EOQ) Model

• In this inventory management technique, a company focuses on the decision

regarding how much quantity of inventory should be ordered and when the
order should be placed. In this technique, the stock of inventory is re-ordered
when it reaches the minimum ordering level. This inventory management
technique saves the carrying and ordering cost incurred while placing the order.
• The economic order quantity (EOQ) model is a fairly popular means of calculating
inventory reorder quantities and working out how many orders to place per
annum.
• The objective of the economic order quantity (EOQ) model is to minimize the
total costs associated with the carrying and ordering costs as the mount ordered
gets larger, average inventory increases and so do carrying costs.
• Importance : The concept of Economic order quantity helps companies to
minimize blocking excess money in inventory. At the same time, it indicates when
to reorder to avoid any shortage and disruptions in the production or other
processes.

• EXAMPLES : Economic order quantity (EOQ) is the the order size which
minimizes the sum of carrying costs and ordering costs of a company's
inventories. These include opportunity cost of money held-up in inventories,
storage costs such as warehouse rent, insurance, spoilage costs, etc.
 CONTINUE…
• Ordering costs are the expenses incurred to create and process
an order to a supplier. These costs are included in the
determination of the economic order quantity for an inventory
item. Examples of ordering costs are: Cost to prepare a purchase
requisition. Cost to prepare a purchase order.
• CARRYING Cost : Holding inventory, too, has costs of its own. It can
be in the form of godown space or rentals for the storage area,
electricity bills, and repairs and maintenance. Then there would be
the cost of human resources to look after the stock. Also, if the
company had not invested in the product under consideration, the
same could have been put to an alternative use. It is the
opportunity cost of holding a particular product. Similarly, there
may be interest cost, too, that is associated with the inventory if the
money was invested elsewhere. The holding costs also include the
costs incurred due to perishability, leakage, or theft of goods and
inventory insurance.
 LIMITATION OF EOQ MODEL
• Forecast of Accurate Demand not Possible :The biggest disadvantage of
economic order quantity is that it is based on the assumption that demand
for company’s products can be forecasted accurately which in real life is not
possible because demand for company’s product never remain static rather
it keeps changing and if demand for good produced by the company rises or
decreases substantially than having EOQ system in company is of no use.
• Immediate Availability of Products with Suppliers :Another problem with
EOQ is that it may be possible that supplier does not have raw materials and
if the company needs immediate raw material for meeting unexpected
demand than it can lead to problems as EOQ system is based on the premise
that demand will be constant which can be predicted accurately. In simple
words, if the company has good relationships with multiple suppliers than it
is not much of a problem.
• Requires Continuous Monitoring :Companies in case of economic order
quantity have to constantly monitor reorder levels as moment level of raw
materials reaches reorder level company has to order goods from suppliers
and this is where the company will need to employ staff so as to monitor
stock levels which again is a time consuming as well as an expensive process.
REORDER LEVEL / REORDER POINT
• Reorder Point (ROP) system is a process where the inventory is
restored as soon as the existing stock hits a specific bottom.
• This will help in ensuring that there is no interruption in the
production and also saves on extra costs.
• Given the fact that every item has its own importance and a usage
rate in the production process, the reorder point differs for every
item.
• It also is dependent on several other factors such as discounts, the
delivery time of the item, safety stock, and so on.
• With the evolution of ERP, this process is automated and hence very
simple to perform. All the crucial is tracked in the system and is
taken care of.
• Early ordering also helps in cutting down high costs put forth by
vendors and administers good negotiation.
REORDER LEVEL / REORDER POINT
• Advantages • Disadvantages
1. It allow smooth 1. Overloading the
inventory flow with no reordering system
halts. 2. Sometime EOQ
2. Unnecessary calculation is not
expenditure is accurate.
reduced. 3. Ramdom fashion – no
3. Helps to make set sequence.
appropriate decisions
 Continue….
• Reorder Point = (Average lead Time in days X
Average daily usage )+ Safety Stock
• Lead time is the time difference between a
purchase order issued and product delivery.
• Safety stock is the number of days – incase of
unexpected emergencies.
• Basic stock – generally maintained
 ‘Q’ MODEL & ‘P’MODEL
There are two models of inventory system:- The fixed order quantity system (Q)
The fixed order periodic system (P)

• FIXED ORDER PERIOD SYSTEM (P SYSTEM) :In this system, the stock position of
each material of a product is checked at regular intervals of time period. When the
stock level of a given product is not sufficient to sustain the operation of
production until the next scheduled tested, an order is placed destroying the
supply. The frequency of reviews varies from organization to organization. It also
varies among products within the same organization, depending upon the
importance of the product, predetermined production schedules, market
conditions and so forth. The order quantities vary for different materials.

• FIXED ORDER QUANTITY SYSTEM (Q SYSTEM) : The fixed order quantity system is
also known as the Q system. In this system, whenever the stock on hand reaches
the reorder point, a fixed quantity of materials is ordered. The fixed quantity of
material ordered each time is actually the economic order quantity. Whenever a
new consignment arrives, the total stock is maintained within the maximum and
the minimum limits. The fixed order quantity method is a method that facilitates
for a predetermined amount of a given material to be ordered at a particular
period of time.
 RATIOS
• Asset management ratio also called for efficiency or activity
ratio indicates the return generated from a particular type
of asset using the sales, cost and asset data.
• This ratio helps the business to identify effective utilization
of the assets and thereby facilitates efficient management.
• Inventory turnover ratio is one of the most important asset
management ratios for an entity selling physical goods.
• Ratios related to inventory are given below:
a) Inventory turnover
b) Inventory Outstanding
c) Operating cycle
 What Is Inventory Turnover?
• Inventory turnover is a financial ratio showing how many
times a company has sold and replaced inventory during a
given period. A company can then divide the days in the
period by the inventory turnover formula to calculate the days
it takes to sell the inventory on hand.
• Calculating inventory turnover can help businesses make
better decisions on pricing, manufacturing, marketing, and
purchasing new inventory.
 Inventory Outstanding Days

• Inventory Outstanding Days : It represent the

average number of days it takes for an entity to sell
the inventory. It is the number of days the inventory
stored in the warehouse before it is sold to the
customer.
 Operating cycle

• Operating cycle is the number of days it takes for an entity to

sell the inventory and collect cash from the customers. This is
termed as operating cycle because it is the process of
purchasing inventories, selling them, recovering cash from
customers, using that cash to purchase inventories and so on
is repeated as a cycle
THANK YOU