Inventory control Management

12-1

ABC Classification System

Figure 12.1

Classifying inventory according to some

measure of importance and allocating
control efforts accordingly.

A - very important
B - mod. important
C - least important

High
Annual
$ value
of items

A
B
C

Low
Low

High

Percentage of Items
12-2

ABC ANALYSIS
(ABC = Always Better Control)
This is based on cost criteria.
It helps to exercise selective control when confronted with large number
of items it rationalizes the number of orders, number of items & reduce
the inventory.
About 10 % of materials consume 70 % of resources
About 20 % of materials consume 20 % of resources
About 70 % of materials consume 10 % of resources

A ITEMS

Small in number, but consume large amount

of resources
Must have:
Tight control
Rigid estimate of requirements
Strict & closer watch
Low safety stocks
Managed by top management

B ITEM
Intermediate
Must have:
Moderate control
Purchase based on rigid requirements
Reasonably strict watch & control
Moderate safety stocks
Managed by middle level management

C ITEMS
Larger in number, but consume lesser amount of resources
Must have:
Ordinary control measures
Purchase based on usage estimates
High safety stocks
ABC analysis does not stress on items those are less costly but
may be vital

VED ANALYSIS

Based on critical value & shortage cost of an item

It is a subjective analysis.
Items are classified into:
Vital:
Shortage cannot be tolerated.
Essential:
Shortage can be tolerated for a short period.
Desirable:
Shortage will not adversely affect, but may be using more
resources. These must be strictly Scrutinized
V

ITEM

COST

AV

AE

AD

CATEGORY 1

10

70%

BV

BE

BD

CATEGORY 2

20

20%

CV

CE

CD

CATEGORY 3

70

10%

CATEGORY 1 - NEEDS CLOSE MONITORING & CONTROL

CATEGORY 2
- MODERATE CONTROL.
CATEGORY 3
- NO NEED FOR CONTROL

Cycle Counting
A physical count of items in inventory
Cycle counting management
How much accuracy is needed?
When should cycle counting be performed?
Who should do it?

12-9

Economic Order Quantity Models

Economic order quantity (EOQ) model
The order size that minimizes total annual
cost

Economic production model

Quantity discount model

12-10

 Economic Order Quantity (EOQ)

Economic order quantity (EOQ) is the order
quantity of inventory that minimizes the total
cost of inventory management.

12-11

EOQ
Ordering costs are costs that are incurred on
obtaining additional inventories. They include
costs incurred on communicating the order,
transportation cost, etc.
Carrying costs represent the costs incurred
on holding inventory in hand. They include
the opportunity cost of money held up in
inventories, storage costs, spoilage costs,
etc.
12-12

 Ordering costs and carrying costs are quite

opposite to each other. If we need to minimize
carrying costs we have to place small order
which increases the ordering costs. If we want
minimize our ordering costs we have to place
few orders in a year and this requires placing
large orders which in turn increases the total
carrying costs for the period.
We need to minimize the total inventory costs
and EOQ model helps us just do that.
12-13

 Total inventory costs = Ordering costs +

Holding costs
EOQ = SQRT(2 Quantity Cost Per
Order / Carrying Cost Per Order)

12-14

 Example
ABC Ltd. is engaged in sale of footballs. Its
cost per order is $400 and its carrying cost
unit is $10 per unit per annum. The company
has a demand for 20,000 units per year.
Calculate the order size, total orders required
during a year, total carrying cost and total
ordering cost for the year.

12-15

 Solution
EOQ = SQRT(2 20,000 400/10) = 1,265 units
Annual demand is 20,000 units so the company will
have to place 16 orders (= annual demand of
20,000 divided by order size of 1,265). Total
ordering cost is hence $64,000 ($400 multiplied by
16).
Average inventory held is 632.5 ((0+1,265)/2) which
means total carrying costs of $6,325 (i.e. 632.5
$10).
12-16

Assumptions of EOQ Model

Only one product is involved
Annual demand requirements known
Demand is even throughout the year
Lead time does not vary
Each order is received in a single delivery
There are no quantity discounts
12-17

Figure 12.2
Q
Quantity
on hand

The Inventory Cycle

Profile of Inventory Level Over Time

Usage
rate

Reorder
point

Receive
order

Place Receive
order order

Place Receive
order order

Time

Lead time
12-18

When to Reorder with EOQ

Ordering
Reorder Point - When the quantity on
hand of an item drops to this amount,
the item is reordered
Safety Stock - Stock that is held in
excess of expected demand due to
variable demand rate and/or lead time.
Service Level - Probability that demand
will not exceed supply during lead time.
12-19

Determinants of the Reorder

Point
The rate of demand
Demand and/or lead time variability
Stockout risk (safety stock)

12-20

Quantity

Figure 12.12

Safety Stock

Maximum probable demand

during lead time
Expected demand
during lead time

ROP
Safety stock reduces risk of
stockout during lead time

Safety stock
LT

Time
12-21

Reorder Point
Figure 12.13
The ROP based on a normal
Distribution of lead time demand
Service level

Risk of
a stockout

Probability of
no stockout
Expected
demand
0

ROP

Quantity

Safety
stock
z

z-scale

12-22

Fixed-Order-Interval Model
Orders are placed at fixed time intervals
Order quantity for next interval?
Suppliers might encourage fixed intervals
May require only periodic checks of
inventory levels
Risk of stockout
Fill rate the percentage of demand filled
by the stock on hand

12-23

Fixed-Interval Benefits
Tight control of inventory items
Items from same supplier may yield
savings in:
Ordering
Packing
Shipping costs

May be practical when inventories

cannot be closely monitored

12-24

Fixed-Interval Disadvantages
Requires a larger safety stock
Increases carrying cost
Costs of periodic reviews

12-25

Floating/ process stock

Float inventory is inventory that is still "in
process." It is the inventory that companies
are shipping from one stocking location to
another. It is not counted as inventory on
hand because technically it is not in any of
the company's facilities, but inventory
managers still have to track it so the
company knows how much total inventory
the company owns.
12-26

 Thank you

12-27