MANAGING INVENTORY

INVENTORY
1. It includes
Raw Materials
WIP
Finished Goods

2. It is the second largest category of assets in most

of the business especially in manufacturing
concerns
Purpose of maintaining
Inventory

It allows each stage of the production like

purchasing, manufacturing and sales to
operate economically
It also maintains equilibrium in all three
aforementioned phases.
DILEMMA
Holding inventory has a cost especially an
opportunity cost

Zero inventory has also a cost in form of lost

sales and factory shut downs ( Stock out cost)

This dilemma is required to be settled at minimum possible ‘Stock

costs’ which include ‘Ordering costs’ and ‘Holding costs’ of
inventory
ECONOMIC ORDER
QUANTITY MODEL ( EOQ )
This model, by determining the Stock
Order Level, creates a balance between
two extremes of holding inventory and
zero inventory
When to re-order
1. Economic Order Quantity Model
2. Two bin System
3. Periodic Review System
4. Perpetual Stock taking
5. Just in Time Scheduling ( KANBAN )
Formula for EOQ model

Q = 2 x O x D
H
O = Ordering Cost and are those which are involved in placing,
processing and receiving orders
H = Holding costs are costs of storing, handling, insuring and
financing inventory
D = Total demand for period
Q = Optimal order
Assumptions in EOQ Model
1. Order quantity would arrive in
business premises instantaneously so
there is no problem even if stock level
touches zero level at any point of time.
2. Demand could be ascertained
accurately not only in number but also
along its spread in a given time period.
Facts of the real world
There is always time intervening between the
placement of order and the delivery of stock
which is known as LEAD TIME or DELIVERY
LAG.
Therefore if we order at zero level stock we can
lose sales during the lead time.Alternatively we
should maintain stock to the extent of the
demand in lead time ( BUFFER STOCK ).
Suppose Garden Ltd needs 2 days to place and
receive an order and the demand per day is 25
units then we must place an order when the
stock level drops to 50
Demand Uncertainty
When there is a demand uncertainty the firm
must trade off the cost of carrying more
inventory against the profit on lost sales or
the cost of shutting down the plant.
This implies carrying SAFETY STOCK Whose
level could only be determined through
complex exercises requiring an estimate of
stock out costs and probability of distribution
of demand
Purpose of managing
inventory
It is to achieve an equilibrium in
Opportunity costs and Stock Out Costs
at minimum possible level of Total
Costs of inventory.
Total Costs = Holding Costs + Ordering Cost
Holding Costs = O/2 x Holding cost per unit
Ordering cost = Ordering cost per unit x No of orders
QUIZ
Garden Ltd sells garden lights. Sales are expected to be
25 units per day. Purchase price of garden light is RS
300 and annual holding cost is estimated at 15% of
purchase price.

It costs RS 15 to place an order with the supplier. The

supplier currently charges RS 2 per garden light
supplied and RS 40 per order.

The Supplier has offered an alternative scheme of

charges. The purchase price would come down by
10% , the charge per order would rise by 10% , while
the charge per garden light would rise by 5%.

Should Garden Ltd accept the new arrangement ?