inventory

management
CHAPTER 9
 Introduction
Inventory is material that the firm obtains in advance of need, holds until it is
needed, and then used, consumes, incorporates into a product, sells, or otherwise
disposes it of. A business inventory is temporary in nature.
Inventories are stock of any kind like fuel and lubricants, spare parts and semi-
processed materials to be stored for future use mainly in the process of
production or it can be known as the ideal resource of any kind having some
economic values.

Meaning

A stock of items held to meet future demand. Inventory is a list for goods and materials,
or those goods and materials themselves, held available in stock by a business.
 Objectives/Importance of Inventory
Management
1.To supply the required materials continuously:

There should be a continuous available of materials in the factory or finished goods for trade. The main
objective of inventory management in to maintain required inventory so that production and sales process run
smoothly.

2. To minimize the risk of under and over stocking of material: 

If a company keeps inventory without proper analysis, there will be a chance of overstocking, which will
increase the cost of carrying the inventory or under stocking of inventory that create problem in smooth
operation of a business. So one of the main objectives of the inventory management is to minimize the risk
caused due to under and over stocking of inventory.

3. To maintain systematic record of inventory: 

Management needs different information regarding inventory for planning and decision-making. A
systematic recodes of inventory helps provides such information to the management. It also assists to
evaluate the current inventory management policy.
4. To reduce losses, damages and misappropriation of materials:

 Inventory management aims to reduce or remove the losses and misappropriate of materials. This is done by maintaining the proper
stocks of materials with utmost care.

5. To minimize the cost associated with inventory: 

The proper maintenance of the information regarding inventory helps to make decisions like whether to take discounts or not, the size of
order to be placed, when to order etc. the total cost associated with inventory may be minimized by analyzing the lot size to be acquired,
the offer of discount on variable lot size and the timing of order. Such analysis helps to reduce the unnecessary inventory in inventories.

6. To make stability in price: 

An effective inventory management system minimizes the effects of regular price fluctuation. This is turn helps to gain the stability is
selling price.

7. Other Objectives
Protection against fluctuating demand.

Protection against fluctuations in output.

Minimization of risk and uncertainty.

Risk of obsolescence.

Minimization of material cost

 Types/ Nature of Inventory

Work in
process

Vendors Raw Work in Finished Customer

Materials process goods
Work in
process

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Raw Materials – Basic inputs that are converted into
finished product through the manufacturing process
Work-in-progress – Semi-manufactured products need
some more works before they become finished goods for
sale
Finished Goods – Completely manufactured products
ready for sale
Supplies – Office and plant cleaning materials not
directly enter production but are necessary for
production process and do not involve significant
investment.
 Reasons or motives of holding inventory
The main reason or motives of holding inventory is to supply the required of inventory to different
department as needed so that production/ sales process does not get hampered. The motives or
reason of holding inventory are:

1.Transaction motive: The manufacturing concerns need inventories of raw material and work in
progress so as to maintain regular production activities. Similarly, the trading organization need the
inventories of finish goods for supplying the goods and services to the customers regularly, in this
way, holding of inventories helps to have regular transactions.

2. Precautionary motive: due to different reasons, like shortage of inventory with the suppliers,
week relation with the supplier, disturbance in transaction, delay in inventory supply etc. might
take place. It is also importance objective of holding the inventory to take precaution from take the
above.

3. Speculative motive: generally the price of inventories rise, so the companies may keep
additional amount of inventory to get benefit by selling the surplus inventory at higher price than
purchase price. It crates risk when the price of inventory falls.
 Inventory Functionality
1) Geographical Specialization :

Inventory allows geographical specialization for individual operating units. The need
for geographical specialization arises because various factors of production like
power, materials, water, labour etc. are located at a considerable distance from the
major markets. Hence, for economical gains, manufacturing operations are usually
located close to the sources of these factors ofproduction.Such geographical
separations will require internal inventory transfer to completely integrate
components into a final product. Thus, the manufactured goods from various
locations are collected at a single warehouse to assemble into final product. For
example, Procter & Gamble uses distribution centres to combine products from its
laundry, food and health care divisions to offer the customer a single integrated
shipment. When geographical specialisation is utilised, inventory in the form of
materials, semi-finished goods, components and finished goods is introduced to the
logistical system. Economies gained through geographical specialisation will
invariably offset increased inventory and transportation cost.
2) Decoupling:
The economic lot size of manufacturing (or transportation) may be different from the
market requirements. Decoupling process permit each product to be manufactured &
distributed in economic lot sizes that are greater than market demands. For example, let us
consider a tyre manufacturing unit. This unit, once the production operations begin, will
continue top roduce a certain type of tyre till an economic lot size is produced. There may
not be market demand for the entire lot of production. But the production of the lot was
carried out keeping in mind the future demand as well as the economies of production. This
is sent to the market in large shipments with full load capacity to achieve economies of
transportation. This results in the need to hold excess inventory.

3) Balancing Demand and Supply :

There is a time gap between the demand and supply for the products. Some products
areproduced throughout the year but are sold only during a short market period. e.g.
Woollen clothes. Similarly, some products are produced only during a short period butare
consumed throughout the year. e.g. Agricultural products. In both cases, holding inventory
is very important.
4) Buffer uncertainties :
Safety stock is also known as Buffer uncertainties .The purpose of
safety stock is to facilitate continuity in operations. Holding
inventory as safety stock protect against two types of uncertainties:
a. Demand in excess of forecast during the performance cycle. For
example: customer request for more or less units than planned.
b. Delays in the performance cycle length itself. for example:
Delay in order receipt, order processing or transportation.
 Classification of inventory
(Selective Inventory Control Techniques/Traditional
Technique)

1. ABC Classification

2. HML Classification

3. XYZ Classification

4. VED Classification

5. FSN Classification

6. SDF Classification

7. GOLF Classification/GNGLF Analysis

8. SOS Classification

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ABC Classification
•In most of the cases 10 to 20 % of the inventory account for 70 to
80% of the annual activity.
•A typical manufacturing operation shows that the top 15% of the
line items, in terms of annual rupees usage, represent 80% of total
annual rupees usage.
A
•Next 15% of items reflect 15% of annual rupees
•Next 70% accounts only for 5% usage
B
C
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A-B-C analysis states that when a large number of items are involved, relatively a few item account for
a major part of activity, based on annual value of consumption of items.

According to A-B-C analysis, inventories are reported in percent averages and classified as follows :-

A-items :- 15% of the items are of the highest value and their inventory accounts for 70% of the
total.

B-Items :- 20% of the items are of the intermediate value and their inventory accounts for 20% of the
total

C-Items :-65% of the items are of the lowest value and their inventory accounts for the relatively
small balance i.e., 10%
XYZ Classification
On the basis of value of inventory stored
Whereas ABC was on the basis of value of consumption to value.
X – High Value
Y – Medium value
Z – Least value
Aimed to identify items which are extensively stocked.

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HML Classification
On the basis of unit value of item

There is 1000 unit of Q @ Rs. 10 and 10,000 units of W @ Rs. 5.

Aimed to control the purchase of raw materials.

H – High, M- Medium, L - Low

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VED Classification
•Mainly for spare parts because their consumption pattern is different from raw materials.
•Raw materials on market demand
•Spare parts on performance of plant and machinery.
•V – Vital, E – Essential, D – Desirable

Therefore V items has to be stocked more

and D Items has to be less stocked

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FSN Classification
According to the consumption pattern

To combat obsolete items

F – Fast moving

S – Slow moving

N – Non Moving

SDE Classification
 Based on source of procurement
 S – Scarce, D- Difficult, E- Easy 20
 GOLF Classification

G – Government, O – Ordinary, L – Local, F – Foreign.

Also known as GNGLF analysis.

SOS Classification
 Raw materials especially for agriculture units
 S – Seasonal
 OS – Off seasonal

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Modern Inventory Control Techniques

JIT I

JIT II

Vendor Managed Inventory/ Continuous Replenish Strategies/ CR

Quick Response

Automatic/ Profile Replenishment/ AR

 JIT(JUST-IN-TIME)
W H AT I S J U S T- I N - T I M E M A N U FA C T U R I N G ?
J I T I S P H I L O S O P H Y O F M A N U F A C T U R I N G B A S E D O N P L A N N E D E L I M I N AT I O N O F A L L WA S T E A N D
C O N T I N U O U S I M P R O V E M E N T O F P R O D U C T I V I T Y I T E N C O M PA S S E S T H E S U C C E S S F U L E X E C U T I O N O F
A L L M A N U FA C T U R I N G A C T I V I T I E S R E Q U I R E D T O P R O D U C E A F I N A L P R O D U C T F R O M D E S I G N
E N G I N E E R I N G T O D E L I V E R Y A N D I N C L U D I N G A L L T H E S TAT E S O F C O N V E R S I O N F R O M R A W M AT E R I A L
O N WA R D .
Founder of JIT
Founded by Taiichi Ohno

A vice president of Toyota

Basically implemented in Toyota plant 1950,

well established after 1970

Well known as Toyota Production System

Emergence of JIT
Evolved in Japan after World War II, as a result of their diminishing market
share in the auto industry.

Toyota Motor Company- first to implement fully functioning and successful

JIT system, in 1970’s.

Japanese Manufacturers looked for a way to

gain the most efficient use of limited resources. They worked on "optimal
cost/quality relationship.
 JIT FUNCTIONS

JIT • ZERO INVENTORY

(JUST-IN- • ZERO LEAD TIME
• ZERO FAILURE
TIME)
 Functioning of JIT
 Involves keeping stock
levels to a minimum
 Stock arrives just in time
to be used in production
 Works best where there
is a close relationship
between manufacturer and
suppliers
 Goods not produced unless
firm has an order from a
customer
 Aims to get highest
volume of output at the
lowest unit cost.
Functioning of JIT
 A method of production
control.
 No demand - no production!
 Anticipated/planned consumer
demand triggers production
 Finished goods assembled just
in time to be sold to customer
 Component parts assembled
just in time to become finished
goods
 Materials purchased just in
time to make component parts.
Companies adopted JIT
Advantages of JIT
 Capital not tied up in stocks
 Less space required for stock
 Closer relationships with suppliers
 Reduction in stockholding costs
 Transportation, warehousing, Material handling cost gets
reduced
 Processing time get reduced
Disadvantages of JIT
 Danger of disrupted production due to non-arrival of
supplies
 High dependence on suppliers
 Less time for quality control on arrival of materials
 May lose bulk-buying discounts
 JUST IN TIME II

•JIT II is a customer-supplier partnership concept pioneered at the Bose

Corporation & now practiced by many companies & their suppliers.
•Designed to create harmony and efficiencies for both sides.
•It relies heavily on trust.
•It is a customer-supplier relationship where suppliers have been given
authority in customer’s operations.
•The employee of the supplier works in-house with the customer.
•The employee of the supplier takes all the responsibilities of inventory
management.
•Though he works full time in the customer’s firm, he is being paid by the
supplier.
Benefits of JIT 2
Inventory level of firm gets reduced.
Inventory level of suppliers also gets reduced.
Improved relationship with the suppliers.
JIT II reduces administrative costs for both the customer &
supplier.

35
 Vendor Managed Inventory/ Continuous
Replenish Strategies/ CR
Traditionally the customer has to place order before the supplier for the goods.
But in this revised model, the customer no longer places order but instead
shares information with the vendors.
This information relates to the actual usage of their products, current stock on
hand & anticipated demand.
On the basis of this information, the supplier takes responsibility for
replenishment of customer’s inventory.
No order is received but an indication is given by the customer on maximum
& minimum limits of stocks that they wish to keep in stock.
It is the responsibility of the supplier to maintain customer’s inventory within
the stipulated stock level. 36
 Quick Response

When a retailer places an order for replenishment, the supplier with the
help of EDI (Electronic Data Interchange) finalizes the delivery details &
communicates them to the customer in advance.
It helps to increase turnover & improved availability.
It is a technology driven cooperative efforts from suppliers & retailers to
increase the inventory velocity.

37
 Automatic/ Profile Replenishment/ AR

AR enables the supplier to anticipate the customer’s requirement in

advance to make replenishment.
The responsibility for inventory management is placed directly on the
supplier.
There should be information flow between customer & supplier that
makes inventory available visible.

38
 Material Requirement Planning
(MRP)
&
Distribution Requirement Planning
(DRP)
 Material Requirement Planning (MRP-1)

Introduction of MRP in 1960’s by

Dr Joseph Orlicky.

Definition :
MRP is a software based production, planning and inventory control
system used to manage the manufacturing process.
It is a computer based system in which the given Master Schedule is
exploded with Bills Of Material, into the required amount of raw
material, parts and subassemblies needed top produce the final products
in each tome period of say a week or month (called as “Buckets”)
MRP

MRP stands for Material requirement planning.

Basic definition:
It is a planning technique which converts master production schedule of end products into
detailed schedule for raw materials and parts used in those end products.

MRP is a means for determining the number of parts, components, and materials needed to
produce a product
 MRP 1 - Functions
Forecasting
Order, Planning and Control
Priority Planning and Control
Planning Capacity Requirement and Development of
Broad Business Plans
 Objectives
Ensure The Availability of Material Components and Products For
Planned Production and Customer Delivery.
Maintain The Lowest Possible Inventory Level.
Plan Manufacturing Activities, Delivery Schedules and Purchasing
Activities.
Inputs to MRP system
Master Production Schedule (MPS):-
MPS is a series of time phased quantities for each item that a company manufactures. It gives the details of
the products to be manufactured over the given space of time.

Bills Of Material (BOM):-

BOM is the document generated at design stage. It gives the details of the structure of the product by
dividing the final assembly into major assemblies and sub-assemblies. BOM provides details such as part
name, part no., description, quantity required material, etc.
Inventory Status File (ISF):-
ISF reports the inventory on hand. It allows the company to subtract existing inventory from gross
requirements, so net requirements can be ordered. The ISF also reports on safety stock needs and lead times
for each item.
Outputs And Reports:-
The MRP 1 package generates many reports such as action notices, priority reports, inventory status
information.
 Material Requirements Planning MRP1

Master
Customer orders Production Demand forecast
Schedule

Inventory records
Bill of materials MRP
Material
requirement
planning
Works orders
Purchase orders
Material plans
Benefits
Keep inventory levels to a minimum.

Keeps track of inventory that is used.

Tracks the amount of material that is required.

Set safety stock levels for emergencies.

Set up production times among the separate manufacturing stages.

Plan for future needs of raw materials or components.

Drawbacks

Inaccurate information can result in mis-planning , overstock, under-

stock, or lack of appropriate resources.

The inaccurate master schedule will provide wrong lengths of time for
production . Hence affecting planning.

MRP systems can be costly and time-consuming to set up

 Manufacturing resource
planning (MRP- II)

In the 1980,MRP technology was expanded to create a new approach called

manufacturing resources planning MRP II .

It expanded included financial ,marketing and logistic elements .

Manufacturing resource planning (MRPII) is defined as a method for the effective

planning of all resources of a manufacturing company.

MRP II serves as an extension of MRP(closed loop manufacturing

resource planning, also abbreviated as CLMRP).
 Benefits
More efficient use of resources
Reduced inventories

Less idle time

Fewer bottlenecks ( a stage in a process that causes the entire process to slow down or stop)

Better priority planning

Quicker production starts

Schedule flexibility

Improved customer service

Meet delivery dates

Improved quality

Lower price possibility

Improved employee moral

Better management information

 Drawbacks
Error Due To Poor OR incorrect Information

Can be used only manufacturing operations of firm.

 Distribution Requirements Planning (DRP I)

DRP is the application of MRP principles to the distribution environment. It

integrates the, special needs of distribution. It is a dynamic model which looks at a
time-phased plan of events that affect inventory.
DRP provides the basis for integrating supply chain inventory information and
physical distribution activities with the Manufacturing Planning and Control system.
Managing the flow of materials between firms, warehouses, distribution centers.
DRP helps manage these material flows. Just like MRP did in Manufacturing.
Links firms in the supply chain by providing planning records that carry demand
information from receiving points to supply points and vice versa.
Marketing Benefits
Increases service level and decrease customer complaints.

Improve inventory coordination.

Enhances ability to offer customer a coordinated inventory management service.

Logistical Benefits
Reduces freight costs.

Reduces inventory level.

Decreases warehousing space.

Reduces customer freight cost.

Enhances budgeting capitability.

Constraints of DRP
Inventory planning systems require accurate and coordinated forecasts for each distribution center.
Integrated planning is subject to system nervousness and frequent rescheduling, because of production
breakdowns and delivery delays.
DRP is not the universal solution for inventory management.
 Distribution Resource planning II
Distribution resource planning [DRP II] is an extension of DRP
I.Distribution resource planning applies the time phased logic of DRP
I to replenish inventories in multi echelon warehousing
systems.Distribution resources planning extends DRP I to include the
planning of key resources in a distribution system – warehouse space,
equipments, labors, transport capacity [e.g trucks,rail cars] and
financial flows
Objectives Of DRP II
The objective of Distribution Resource Planning are,
To improve customer service levels by anticipating customer demand at
distribution centers and providing finished products at the correct
location when customer needs arise.
To provide an accurate requirements plan for manufacturing.
To optimize the distribution of available stock in the distribution network
using the deployment function.
 Difference between DRP and MRP
  MRP DRP

Scope Inbound logistics Outbound logistics

Guiding factor Guided by production Guided by customer demand

schedules

Control of the firm Under control of the firm Not under control of the firm

Demand situation Operates in dependant demand Operates in independent

situation demand situation

Area of operation & Coordinates scheduling & Coordinates demand between

coordination integration of materials into outlets & supply sources
finished goods

Stage of functioning Controls inventory until Controls inventory after

manufacturing & assembly is manufacturing & assembly of
complete finished goods

Planning availability of stock Market[retailers] &

at? Raw materials store, warehouses
conversion process &
finished goods store
 EOQ & Re-order point

EOQ – gives answer to question

“How much to Order”

Re-order point – gives answer to

question “when to order”
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If demand is known exactly, place an order when
inventory equals demand during lead time.

Order Q: When shall we order?

Quantity A: When inventory = ROP
Q Q: How much shall we order?
A: Q = EOQ
Inventory

Reorder
Point
(ROP)
ROP = LxD

Lead Time
Time
D: demand per period
Place Receive
L: Lead time in periods
order order
Economic Order Quantity
It is also known as standard order quantity , optimum quantity or economic lot size.

By definition economic order quantity that size of order for which the total cost is
minimum.

65
Economic Order Quantity (EOQ)
EOQ or Fixed Order Quantity system is the technique of ordering materials whenever stock reaches
the reorder point.

Economic order quality deals when the cost of procurement and handling of inventory are at optimum
level and total cost is minimum.

In this technique, the order quantity is larger than a single period’s ne requirement so that ordering
costs & holding costs balance out.

66
Basic EOQ Model
Assumption
•Seasonal fluctuation in demand are ruled out
•Zero lead time – Time lapsed between purchase order and inventory usage
•Cost of placing an order and receiving are same and independent of the units ordered
•Annual cost of carrying the inventory is constant
•Total inventory cost = Ordering cost + carrying cost

67
Assumptions of EOQ
Demand for the product is constant

Lead time is constant

Price per unit is constant

Inventory carrying cost is based on average inventory

Ordering costs are constant per order

All demands for the product will be satisfied (no back orders)

68
Weaknesses of EOQ formula
Erratic usages

Faulty basic information

Costly calculations

No formula is substitute for commonsense

EOQ ordering must be tempered with judgment

69
 Computation of EOQ
The widely used formula is

EOQ =√{2*AD* OC}

CPU * ICC

AD= Annual demand

OC= Ordering cost per order

ICC = Inventory Carrying cost

CPU= Cost per unit

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 Re-Order Level
It is the level of stock at which to storekeeper initiates the purchase requisition for fresh
supplies of material. The fresh order must be made before the actual touches the
minimum level. This level should be fixed by taking into account as abnormal usages
of material; unexpected delay in procuring the material etc. the following factors should
be taken into consideration while fixing re-ordering level.

a. Minimum quantity of the item to be maintained.

b. Rate of consumption

c. Lead time
The re-order point, order quantity and procurement time may be show by diagram as given above.
Re ordering level can be computed by using one of the following formula's based on information
available.

Re-order level = maximum consumption x maximum Re-ordering period

Re-order level = safety stock + daily consumption x lead time

Re-order level = safety stock + normal consumption x normal re-ordering period

If no information has been given, the minimum stock level should be assumed to be the safety
stock lead time. Delivery period and re-order period refer to the total time taken to receive the
material after the order has been placed. Consumption, usage and need refer to the need of
material for a certain period of time, say per day, week month etc.
 Maximum Level:
It is a peak level of the material in stock. It is also called as 'maximum limit' or maximum stock'. It represents the maximum
quantity of an item of material, which may be held in stock. The stock should not exceed his quantity. The purpose of fixing
this quantity is to avoid overstocking. Overstocking unnecessarily blocks working capital, which can be utilized in some
profitable activities. Similarly, overstocking also increase the cost due to the requirement of more space in go down. There
may be more chances of having obsolescent and deterioration of quality when the actual stock exceeds the maximum stock
level.

The following points are to be considered while determining the maximum stock level.

a. Working capital: sufficient amount of working capital should be kept for maintaining the maximum level of
stock.
b. Go down space: for putting the material safely, there is a need to have sufficient space in go down
requirement may arise at any time.
c. Maximum requirement: there is a need to keep maximum stock of material since maximum requirement
may arise at any time.
d. Time lag: the lead-time should be determined.
e. Rate of consumption: while fixing maximum level of material, the rate of consumption of
material during the lead-time should be determined.
f. Cost of managing the store: it is another importance factor, which should be kept in mind while
fixing maximum level of material.
g. Loss of managing the store: the maximum quantity of material will be fixed at a lower level in as of
store, which deteriorates in quantity if they are stored over a lag period.
h. Seasonal nature of material: Some materials are available only during specific season in a year. Such
materials should be stored beyond the maximum level during the season.
i. Change is fashion and habit: possibility of change in fashion and habit, which may
necessitate changes in the requirement of materials, should also be considered.
j. Fluctuation in price: the fluctuation in the price of material may have effect on the fixation of
maximum stock level. For instance, if it is anticipated that the price of the material will increase
in future, a possible of decreasing the price of the material on the near future, maximum stock
level may be fixed at a comparatively lower level.
 Minimum Level
It is also known as 'buffer stock', ' safety stock', minimum limit' or ' minimum stock', this represents the minimum
quantity of the material which must be kept in hand at all the times. Such level of material is fixed so that production
may not be held up due to shortage of material. The following points should be considered to determine the minimum
stock level:

a. Lead time: it is a time lag between the points of placing an order and receiving the material.

b. Consumption rate: the consumption rate of material during the lead time should also be considered.

c. Re-order level: the level at which initiation to purchase requisition for new purchase of materials is taken by the
store in-charge is the re-order level. It should also be considered.

d. Disruption of supply: the possibility of any disruptions in supply of material in near future should be taken into
mind.

e. Nature of material: it is another factor, which should be considered while fixing minimum level. Minimum level is
not need in the case of the material that is required against customer's specific order.
 Average stock level

Average stock level refers the normal or moderate stock level. It is calculated as under.

Average stock level= minimum stock level + Average of recorder quantity (EOQ)

Average Stock Level = Minimum Level + Maximum level/2

 Danger level

This is the level of material at which issue of material is temporarily stopped. From this level material are
issued for some abnormal situations only. The issue of material can be made against the special order from
the level. Since it is a danger level, some serious actions should be taken to acquire materials.

Danger level = normal consumption x maximum re-order period for emergency purchase
 Formulas:
1) a)Re-order level = Maximum consumption x Maximum Re-order period

b) Re-order level = Safety stock + Daily consumption x Lead time

c)Re-order level = Safety stock + Normal consumption x Normal Re-order period

2) Maximum Level = Re-Order Level + Re-Order Qty – (Minimum Rate of Consumption X Minimum Re-Order
Period)

3) Minimum Level= Re-Order level – (Normal Rate of Consumption X Normal Re-Order Period)

4) a)Average stock level= Minimum level + EOQ or Re-order Qty /2

b) Average Stock Level = Minimum Level + Maximum level

2
Thank you