Chapter 29

INVENTORY MANAGEMENT

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 OUTLINE

• Need for inventories

• Order quantity – EOQ model

• Order point

• Pricing of raw materials and valuation of stocks

• Monitoring and control of inventories

• Criteria for judging the inventory system

• Inventory management in practice

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 NEED FOR INVENTORIES

• ‘Process or movement’ inventories are required because

it takes time to complete a process/operation and to

move products from one stage to another.

• Organisation inventories are maintained to widen the

latitude in planning and scheduling successive

operations.

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 ORDER QUANTITY – EOQ MODEL
2FU
Q=
PC

Q = economic order quantity

F = cost per order
U = annual usage/demand
F = cost per order
C = percent carrying cost
P = price per unit
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BEHAVIOUR OF INVENTORY
RELATED COSTS

Costs
Total costs

Carrying costs

Ordering costs
Quantity ordered

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 ORDER POINT

• If the usage rate of materials and the lead time for

procurement are known with certainty, then the
ordering level would simply be:

Lead time in days

x Average daily usage
for procurement

• When the usage rate and lead time are likely to vary, the
reorder level should be:

Normal consumption + Safety stock

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 PRICING OF RAW MATERIALS

The important methods of pricing inventories used in

production are:

FIFO (First in First Out) Method The material which is

issued first is priced on the basis of the cost of material
received earliest, so on and so forth.

Weighted Average Cost Method Material issued are

priced at the weighted average cost of materials in stocks

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 TREATMENT OF FIXED
MANUFACTURING COSTS

Direct Costing Fixed manufacturing overhead costs are

treated as period costs and not product costs. Hence, they
are not reflected in inventory valuation.

Absorption Costing Fixed manufacturing costs are treated

as product (or inventoriable) costs.

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GRAPH OF CUMULATIVE PERCENTAGE OF ITEMS
AND CUMULATIVE PERCENTAGE OF USAGE
Cumulative usage of
items (percentage)

100

80

60

40

20
A B C
Cumulative
25 40 60 80 100 percentage of items

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 JUST-IN-TIME (JIT) INVENTORY CONTROL

• The JIT control system implies that the firm should

maintain a minimal level of inventory and rely on
suppliers to provide parts and components ‘just-in-time’
to meet its assembly requirements.

• This may be contrasted with the traditional inventory

management system which calls for maintaining a
healthy level of safety stock to provide a reasonable
protection against uncertainties of consumption and
supply – the traditional system may be referred to as a
“just-in-case” system.

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PROGRAMME OF INVENTORY
MONITORING AND CONTROL
• Exercise of vigilance against imbalances of raw materials and
work-in-process which tends to limit the utility of stocks.
• Vigorous efforts to expedite completion of unfinished production
jobs to get them into saleable condition.
• Active disposal of goods that are surplus, obsolete, or unusable.
• Shortening of the production cycle.
• Change in design to maximise the use of standard parts and
components which are available off-the-shelf.
• Strict adherence to production schedules.
• Special pricing to dispose of unusually slow-moving items.
• Evening out of seasonal sales fluctuations to the extent possible.
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 INVENTORY MANAGEMENT IN INDIA

• The most commonly used tools of inventory management

in India are ABC analysis, FSN (fast moving, slow
moving, and nonmoving analysis), and inventory
turnover analysis.

• Inventory management in India can be improved by

effective computerisation, review of classifications,
improved coordination, development of long-term
relationships, and disposal of obsolete/surplus
inventories, and adoption of challenging norms.

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 SUMMING UP
• Inventories represent a very significant proportion of total assets.
• A distinction may be drawn between ‘process or movement’
inventories and ‘organisation’ inventories.
• According to EOQ model, the optimal order quantity is:
2 FU
Q=
PC
• The reorder point may be determined by the following formula:
Reorder Point = S (L) +  S R(L)
• FIFO method and weighted average cost method are commonly used
for pricing inventories.
• ABC analysis advocates a selective approach to inventory control.
• The most commonly used tools of inventory management in India
are: ABC analysis, FSN analysis and inventory turnover analysis.
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