04-Nov-15

What is inventory ?

Supply Chain Management

Topic : Inventory Management
Decisions

Idle stock of items stored to meet future demand

Stock of raw materials, in-process, finished,
packaging materials, tools, spares etc
Buffer stock between each stage of supply chain
Resources of economic value can be converted to
cash

Inventory- Introduction
Inventory refers to the stock of materials of any kind
stored for future use, mainly in the production
process.
Semi-finished goods, which are awaiting use in the
next process, or finished goods, which are waiting
for sale, are also included in this broad category.
But these are practically idle resources.
Thus inventories are materials / resources of any
kind having some economic value, either awaiting
conversion or use in future.

Introduction

Inventory management can be defined as the

sum total of those related activities essential for
the procurement, storage, sale, disposal or use
of material.

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04-Nov-15

Role of Inventory in Competitive Strategy

If a companys competitive strategy requires a very
high level of responsiveness, a company can use
inventory to achieve this responsiveness by locating
large amounts of inventory close to the customer.
A company can also use inventory to make it more
efficient by optimizing inventory through centralized
stocking.

Types of Inventory
Raw material
Purchased but not processed

Work
Work--in
in--process
Undergone some change but not completed
A function of cycle time for a product

Maintenance/repair/operating (MRO)
Necessary to keep machinery and processes
productive

Finished goods

Role of Inventory in Competitive Strategy

The latter strategy would support a competitive
strategy of being a low-cost producer.
The trade-off implied in the inventory driver is
between the responsiveness that results from more
inventories and the efficiency that results from fewer
inventories.

Functions of Inventory
Decoupling the manufacturing process
Storing resources
Managing irregular supply & demand
Taking advantage of quantity discounts
Avoiding stock out and shortages

Completed product awaiting shipment

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04-Nov-15

Inventory Cost

Procurement cost/ Ordering cost

Procurement cost is the total cost incurred during the ordering of
an item.
When an order is placed, the company has to incur certain costs at
the time of order.
These costs are not connected with the quantity ordered but
primarily with physical activities required to process the order

Costs of Inventories

Procurement
Cost

Inventory
Carrying Cost

Out-of-Stock
Cost

Incremental
Cost

These costs include :

- costs like handling and transportation costs,
- stationery costs,
- costs incurred for inviting quotations and tenders etc.
The more is the frequency of order , the more are these costs.

Carrying cost./ Holding Cost

The cost of carrying the inventory is the real out of
pocket cost associated with having inventory on hand,
such as :
- warehouse charges, insurance,taxes, lighting, losses
due to handling,cost of storage, spoilage, breakage etc,
and
- another important component of carrying cost is the
amount of interest lost due to the investment
If the production quantity is large, the inventory
carrying cost will be high as more inventory will have to
be carried over in the store.

Storage Costs.
Inventory holding costs may be divided into storage space costs
and material handling costs.
Inventory can be placed in four potential types of facilities:
company storages, public storages, rented storages, and
inventory in shipping areas.
Storage space costs include public, plant, rented, and company owned
warehouses

The costs for company-owned storages and the associated

material handling equipment are fixed and are not part of the
inventory carrying costs.

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04-Nov-15

Out of stock costs

Incurred when a customer places an order and the order cannot be
filled from the inventory to which it is normally assigned.

Cost are divided into :

Lost sales costs
- Cost of profit would have made if the sale had occured
- Higher substitute in market, higher is cost .Cost is intangible.

Back-order costs.
- Customer shall wait for his order to be filled so that sale is not lost but
only delayed.Cost is measurable and tangible.
- Eg: Non-availability of raw material.

Incremental cost
The final cost factor involved in making inventory decisions is incremental
cost

Incremental costs arise due to any change in the actual cost, actual
expenditure or profit that occurs as a result of an inventory management
decision.

For example, if the increase in total inventory unit volume causes increase
in the relevant costs from Rs.120,000 to Rs.150,000, then the incremental
cost of the decision to stock more units is Rs.30,000.
Paying for overtime, hiring and training cost for more employees,
temporary help and obtaining additional computer terminals due to an
increase in the order volume are included in the incremental costs.

Continue..

Need to hold Inventory

1. To keep down productions costs
Often it is costly to set up machines so production runs need to be
as long as possible to achieve low unit costs. It is essential,
however, to balance these costs with the costs of holding stock.

2. To accommodate variations in demand

The demand for a product is never wholly regular so it will vary in
the short term, by season, etc, To avoid stock-outs, therefore,some
level of safety stock must be held.

3. To take account of variable supply leads

Additional safety stock is held to cover any delivery delays from suppliers.

4. Buying costs
There is an administrative cost associated with raising an order, and to
minimize this cost it is necessary to hold additional inventory. It is
essential to balance these elements of administration and stock-holding,
and for this the economic order quantity (EOQ) is used.

3. To account for seasonal fluctuations

These may be for demand reasons whereby products are popular
at peak times only. To cater for this while maintaining an even level
of production, stocks need to be built up through the rest of the
year. Supply variations may also occur because goods are produced
only at a certain time of the year.

5. To take advantage of quantity discounts

Some products are offered at a cheaper unit cost if they are bought in
bulk.

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04-Nov-15

Continue..
7. To allow for price
fluctuations/speculations

The price of primary products can fluctuate for a variety of

reasons, so some companies buy in large quantities to cater for
this.

8. To help the production and distribution

operations run more smoothly
Here, stock is held to decouple the two different activities.

Continue..
10. To minimize production delays caused
by lack of spare parts
This is important not just for regular maintenance, but especially
for breakdown of expensive plant and machinery. Thus spares are
held to minimize plant shutdowns.

11. Work in progress

This facilities the production process by providing semi-finished
stocks between different processes.

9. To Provide Customers with immediate

service
It is essential in some highly competitive markets for companies to
provide goods as soon as they are required.

Types of Inventory
Inventory in Pipeline (in transit) - inventory in transit between
echelons of the supply channel.

Types of Inventory
Inventory for hedging against the variability and uncertainty in
demand - this extra measure of inventory or safety stock, is in addition
to the regular stock that is needed to met average demand and average
lead-time conditions.

Inventory due to speculation Raw materials such as copper, gold

and silver are purchased as much for price speculation as they are to meet
operating requirements.

Inventory of perishable in nature or of risk of obsoleteness where the products are of high value, perishable or easily stolen, special
precautions must be taken to minimize the amount of such stock

Regular or cyclical inventory- inventories necessary to meet the

average demand during the time between successive replenishments.

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04-Nov-15

Nature of Demand (Types of Demand Patterns)

Nature of Demand (Types of Demand Patterns)

The nature of demand over time plays a significant role in

determining how we treat the control of inventory levels.

Lumpy or erratic demand pattern demand may be perpetual but

there are periods of little or no demand followed by periods of high
demand.. Items in inventory are typically a mixture of lumpy and
perpetual demand items.(Eg: Construction equipments)

Perpetual Demand many products have a selling life that is

sufficiently long to be considered infinite for planning purposes. Even
though brands turnover at the rate of 20% per yr, a life cycle of 3 to 5 yrs
can be long enough to justify treating them as perpetual demand
pattern.(Eg: Canned drinks)

Terminating demand pattern- products whose demand terminates at

some predictable time in the future, which is usually longer than 1 yr.
Inventory planning here involves maintaining inventories to just meet
demand requirements, but some reordering within the limited time
horizon is allowed. (Eg: Pharmacy Products)

Seasonal Demand- inventories that are held to meet such a demand

pattern usually cannot be sold off without deep price discounting. (Eg:
Christmas trees )

Economic Order Quantity

How much quantity is to be ordered at any one
point of time?
Whether there are any costs associated with
the ordering quantity apart from the purchase
price?
Costs attached to the ordering quantity are of
two types : Ordering cost and Carrying cost.

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04-Nov-15

Impact on :

Economic Order Quantity (EOQ)

Condition

Materials
Ordered

Ordering
costs

Carrying costs

If No :of Orders
Frequent

Quantity per
order will
decrease

Goes
Increasing

will Decrease

If No: of orders
reduced

Quantity per
order will
increase

Will Decrease

will Increase

In this situation, the most desirable quantity to be ordered is that

quantity at which both, the ordering costs and carrying costs will
be minimum. this quantity is called as economic order quantity.

Economic Order Quantity is one of the important techniques

used to determine the optimum quantity or number of orders
to be placed from the suppliers.
The main objectives of economic order quantity is to
minimize the cost of ordering, cost of carrying materials and
total cost of production.
The quantity to be ordered should be such which minimises
the carrying and ordering costs.

Inventory Planning Models

Balancing Carrying Cost against Ordering Costs

Economic Order Quantity [EOQ]

Higher
Annual Cost

Total Annual
Stocking Costs
Annual
Carrying Costs
Annual
Ordering Costs

Lower

Assumptions
- Demand is known
- Demand is constant over a period of time
- No shortages allowed
- Lead time is constant
- Order quantity is received as a lot once.

Minimum
Total Annual
Stocking Costs

Smaller

EOQ

Larger

Order Quantity

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04-Nov-15

EOQ - Balancing costs

The sum of the two costs is the total stocking
cost (TSC)
When plotted against order quantity, the TSC
decreases to a minimum cost and then
increases
This cost behavior is the basis for answering
the first fundamental question: how much to
order
It is known as the economic order quantity

Determination of Reorder Point

(When to Order ?)
Suppose,
R=Reorder Point in Unit
D=Average Daily Demand
T=Average Replenishment Cycle Time
Hence, R=D X T
For Example,
D=5 units per day
T=10 days
Then, R = 5 x 10= 50 Units
That is, order should be placed for the next replenishment
when inventory is of 50 units.

Determination of Reorder Point

(When to Order ?)
The reorder point refers to the timing at which the re-supply
process should be initiated.
The reorder point is the determination of the most
appropriate timing for placing an order for the supply or
procurement of goods or products.
The basic reorder point formula can be derived under the
assumption that demand and replenishment cycle time are
known as well as predetermined and there is no buffer or
safety stock.

ABC Analysis basic method of stock-control

Any organization usually deals with lots of items.
It is very difficult to exercise control over all the items.
ABC analysis helps to classify the thousands or even
millions of individual items into three groups namely
items belonging to A group, B group, C group items
respectively.
ABC analysis is done based on the Paretos principle.
Consumption value is the basis for ABC classification.
Consumption value is the product of unit price and
consumption

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04-Nov-15

Paretos Law states that a few items of high usage having high
investment value should be paid more attention than items
having low usage value.
Popularly known as the "80/20" rule ABC concept is applied to
inventory management as a rule-of-thumb.
It says that about 80% of the Rupee value, consumption wise,
of an inventory remains in about 20% of the items.

For Example ;
A store has 2000 items of consumption and a
montly consumption of Rs.10,00,000.
According above report,

The ABC concept is derived from the Pareto's 80/20 rule curve.
It is also known as the 80-20 concept.
Here, Rupee / Dollar value of each individual inventory item is
calculated on annual consumption basis.

ABC Classification
Class A - High value items
10 - 20 % of units
70 - 80 % of value

Class B - Medium value items

20 - 30 % of units
10 - 20 % of value

Class C - Low value items

60 - 70 % of units
5 - 10 % of value

160 items will have consumption of Rs.7,50,000

500 items will have consumption of Rs.2,00,000
1340 items will consume material of Rs.50,000

ABC analysis is the widely used approach for classifying the inventories on
the basis of cost and use.
This is a type of pareto analysis and sometimes also referred to as Always
Better Control approach.
A-Type Inventory:
These are high value, low volume type of inventories.
This means that their annual consumption is very less but these are very
costly items.
Despite needed less in volume, their annual monetary value is quite high,
as these are very costly items.
ABC-analysis recommends careful control of A-Type inventory. More
periodic review is needed.
Involvement of higher level of management is recommended in the review
process.
A small reduction in the safety stock will cause substantial saving for the
organizations.

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04-Nov-15

Mechanism of doing ABC classification:

B-Type Inventory:
Items other than A and C type constitute 20-30% in terms of percentage of items
and 10 to 20% in terms of their annual consumption value.
These are termed as B-type inventories.
Their control and supervision are moderate as compared to A or C type
inventories.
Order for these items must be placed less frequently
C-Type Inventory:
Majority of the items (say 60-70%) constitute only a minor fraction of the total
annual monetary consumption (say 5 to 10%) in inventories. These items are CType items.
The control needed for these items may not be very stringent. Bulk-purchase
decisions may be useful as the item cost is less.
Therefore, lesser number of orders may be placed.
These items may be under the supervision of lower level of management and
only exceptional reports or monthly reports are needed by top management.

Steps involved:
1. Collect previous year consumption and unit price for each item
2. Multiply the consumption and unit price for each item to get
the consumption value
3. Rank the items corresponding to the consumption value
4. Calculate cumulative consumption value against each item
5. Find the percentage of cumulative consumption value.
6. Find the % of high,medium and low valued items in terms of
total value of items.
7. A graph can be plotted between % of items on X axis and % of
total value of item on Y axis.

ABC Classification: Example

ITEMS
1
2
3
4
5
6
7
8
9
10

UNIT COST
Rs. 60
350
30
80
30
20
10
320
510
20

ABC Classification: Example (cont.)

ANNUAL USAGE
90
40
130
60
100
180
170
50
60
120

ITEMS

TOTAL
PART
VALUE

% OF TOTAL % OF TOTAL
UNIT
ANNUAL
USAGE
VALUECOSTQUANTITY
% CUMMULATIVE

9 Rs.30,600
35.9
6.0
6.0
1
$ 60
90
8
16,000
18.7
5.0
11.0
2
350
40
A
2
14,000
16.4
4.0
15.0
3
30
130
1
5,400
6.3
9.0
24.0
4
80
60
4
4,800
5.6
6.0
30.0
B
5
30
100
3
3,900
4.6
10.0 % OF TOTAL
40.0
% OF TOTAL
6
3,600
4.2
18.0
58.0
20
180
CLASS 6 ITEMS
VALUE
QUANTITY
5
3,000
3.5
13.0
71.0
7
10
170
C15.0 83.0
10 A 2,4009, 8, 2
2.8 71.0 12.0
8
320
50
25.0 100.0
7 B 1,7001, 4, 3
2.0 16.5 17.0
9 6, 5, 10, 7 510 12.5
60
C
60.0
Rs.85,400

10

20

120

Example 10.1

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04-Nov-15

VED Analysis
VED analysis represents classification of items based on
criticality.
The analysis classifies the items into 3 groups:
Vital, Essential and Desirable
Vital category encompasses those items which, if not made
available, being the production to a halt, causing heavy losses.
Spares stock out costs cause major disruptions to many work
stations.

VED Analysis

Illustration of VED analysis

Essential group includes items whose stock out cost is very

high because it reduces production.

Desirable group comprises items which do not cause

noticeable loss of production or their stock-out entails
nominal expenditure and causes minor disruptions

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Steps of VED Analysis

SDE Classification
S D E analysis is employed by the purchase department:
The SDE analysis is based upon the availability of items and is very
useful in the context of scarcity of supply.
In this analysis, S refers to scarce items, generally imported,
and those which are in short supply.
D refers to difficult items which are available indigenously but
are difficult items to procure.
Items which have to come from distant places or for which
reliable suppliers are difficult to come by fall into D category.
E refers to items which are easy to acquire and which are
available in the local markets.

1. To decide on the method of buying.

E.g. Forward buying method may be followed for some of the
items in the Scarce group; scheduled buying and contract
buying for Easy group.
2. To fix responsibility of buyers.
E.g. senior buyers may be given the responsibility of S and
D groups while items in E group may be handled by junior
buyers or even directly by the storekeeper.

The SDE classification, based on problems faced in procurement,

is vital to the lead time analysis and in deciding on purchasing
strategies.

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F-S-N Analysis:
Criterion employed: Rate of consumption of items in
terms of rate of their issue from stores.
In F-S-N analysis, items are classified according to
their rate of consumption.
The items are classified broadly into three groups:
F means Fast moving, S means Slow moving,
N means Non-moving.

F-S-N Analysis:
FSN analysis helps a company in identification of the
following:
a) The items to be considered to be active may
be reviewed regularly on more frequent basis.
b) Items whose stocks at hand are higher as
compared to their rates of consumption.
c) Non-moving items whose consumption is nil
or almost in significant.

F-S-N Analysis:
The FSN analysis is conducted generally on the
following basis:
The last date of receipt of the items or the last date
of the issue of items, whichever is later, is taken into
account.
The time period is usually calculated in terms of
months or number of days and it pertains to the time
elapsed seems the last movement was recorded.

Just In Time (JIT)

Just In Time (JIT) is a production and inventory control
system in which materials are purchased and units are
produced only as needed to meet actual customer demand.
Basics of the concept are that the company produces only what
is needed, when it is needed and in the quantity that is needed.
The company produces only what the customer requests, to
actual orders, not to forecast.
Taiichi Ohno of Toyota Motor Co.-Japan, coined JIT concept in
1950s (widely known as father of JIT concept)

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Features of Just In Time System

Inventories are reduced to the minimum and in some

cases are zero.

JIT focuses on minimizing the holding costs of stock

Stocks are brought into the production process at the
time they are needed-Vendor Managed Inventory
System (VMI).

Requirements for JIT Systems

1. Flexibility
Suppliers and internal workforce need to be able to expand and contract
output at short notice
Need to be able to deliver supplies quickly and reliably

2. High quality
Raw materials must be of guaranteed quality
Whole production process must focus on quality
There are no/minimal buffer stocks should a batch of raw materials from a
particular supplier prove faulty, or if they are damaged during the
production process.

3. Close working relationship with suppliers

With JIT systems, production and purchasing are closely
linked to sales demand on a week to week basis.

Often geographically close

Joint approach to ensuring quality
Systems need to be able to share information (e.g. sales data, purchasing
requirements, delivery times)

Advantages of Just in time

1. Lower levels of cash tied up in stocks (i.e. lower Working
capital)
2. Reduction in stock holding costs
3. Reduced manufacturing lead times
4. Improved labour productivity
5. Eliminate waste by prohibiting overproduction, waiting, undue
warehousing and handling facilities, and defective production.
6. Improve customer service and commitments, bringing
competitive advantage

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04-Nov-15

Inventory Control Ratios

Inventory Control Ratios

Formula:
Inventory turnover ratio (ITR) is an activity ratio
that evaluates the liquidity of the inventories of a
company.
It measures how many times the company has sold
and replaced its inventory during a certain period.

Two components of the formula of inventory turnover ratio

are cost of goods sold and average inventory at cost.
Cost of goods sold is equal to cost of goods manufactured
(purchases for trading company) plus opening inventory less
closing inventory.
Average inventory is equal to opening balance of inventory
plus closing balance of inventory divided by two.

This ratio is computed by dividing the cost of

goods sold by average inventory at cost.

Two Bin System:

Inventory turnover ratio (ITR)

If cost of goods sold is unknown, the net sales figure
can be used as numerator and if the opening balance
of inventory is unknown, closing balance can be used
as denominator.
If both numerator and denominator are unknown,
the formula would be written as follows:
Inventory turnover ratio = Sales / Inventory

Under this system , all inventory items are stored in two

separate bins.
In the first bins , a sufficient supply is kept to meet the
current requirements over a designated period of time, in the
second bin , a safety stock is maintained for use during lead
time.
When the stock of first bin is used , an order for further stock
is immediately placed , the material in second bin is then
consumed to meet stock need until the new product is
received .
On receipt of new order , second bin is restored and the
balance is put in the first bin.

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04-Nov-15

Perpetual Inventory System

Under this system, a complete and continuous record
of movement of each inventory item is maintained.
Perpetual records are useful in preparing monthly quarterly
or other financial statement.
Record used is normally a "store ledger card" specifying
quantity wise receipt, issue and
balance together with values in chronological sequence

Perpetual Inventory System

1.It protects materials from theft or loss.
2. It helps in reducing wastages and spoilages.
3. Inventory levels can be fixed and observed.
4. It serves as a moral check.
5. It helps in highlighting slow moving and obsolete inventory.
6. It helps in frequent physical counting

Periodic Inventory System

Periodic Inventory System

Benefits :

Under this system, the value of inventory is determined

at the end of the year through a physical count of inventory
in store/warehouse.
It does not maintain a continuous record of movement of
each inventory item

1. It is very simple.
2. It is very cheap.
3. No calculations required.
4. No technical knowledge required

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Store Or Material Or Inventory Records:

Two important records of material received & issued
are generally kept.

BINCARD

STORES
LEDGER

Bincard:
Bin means a place, rack or that place where materials are
stored.
A bincard is usually kept in bin. It provides quantitative record
of reciepts, issues & balances of stock.
It is maintained by store keeper.
Stores ledger:
This ledger is kept in costing dept.
This ledger provides the information for pricing if materials
issued and the money value at any time of each item of
stores.

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