INVENTORY

MANAGEMENT

MODULE 3
INVENTORY

 Inventory is the stock of any item or

resource used in an organization and can
include: raw materials, finished products,
component parts, spares, and work-in-
process.
 It can be used to refer to the stock on hand at
a particular time of raw materials, goods-in-
progress of manufacture, finished products,
merchandise purchased for resale, and the like,
tangible assets which can be seen,
measured and counted…
The Term Inventory Includes The
Following Categories Of Items:

 Production Inventories:
 Raw material, parts and components which
enter the firm’s product in the production
process. These may consist of
(i) special items manufactured to company
specifications,
(ii) standard industrial items purchased off the shelf
 MRO Inventories:
Maintenance, repair and
operating supplies which are
consumed in the production process,
but which do not become part of the
product.
 E.g., oil, nut/bolt, machine repair parts
 In-process
Inventories:
Semi-finished
products found
at various stages
in the
production
operation.
 Finished Goods Inventories:
completed products ready for shipment.
PURPOSES OF INVENTORY

TO MEET TO ALLOW FLEXIBILITY TO TAKE ADVANTAGE

IN PRODUCTION OF ECONOMIC
VARIATION IN SCHEDULING
TO PROVIDE A
PURCHASE-ORDER
PRODUCT SAFEGUARD FOR
VARIATION IN RAW SIZE/QUANTITY
DEMAND MATERIAL DELIVERY DISCOUNTS
TIME
INVENTORY COSTS

 Holding (or carrying) costs

 Costs for storage, handling, insurance,
obsolescence, depreciation, opportunity cost of
capital,etc
 Holding costs tend to favor low inventory levels
and frequent replenishment(restoration of a stock
or supply to a former level or condition.)
 It includes costs of storage facilities, depreciation,
taxes.
 INVENTORY COSTS

 Holding (or carrying) costs

Fixed costs Variable costs

Capital costs of warehouse or store Cost of capital in inventory

Cost of operating the warehouse or Insurance on inventory value

store
Personnel costs Losses due to obsolescence, theft,
storage
Cost of renting warehouse or storage
space
INVENTORY COSTS

 Setup (or production change) costs

 Costs for arranging specific equipment
setups, etc
 Set up costs reflect the costs involved in obtaining
the necessary materials, arranging specific,
equipment setups, filling out the required parts
appropriately charging time and materials, and
moving out the previous stock of materials, in
making each different product.
INVENTORY COSTS

 Ordering costs
 Costs involved in replenishing inventory,
e.g., staffing, order placing, vendor
development, receiving and inspection, etc., are
called inventory ordering costs
INVENTORY COSTS

 Stock out costs / Shortage costs

 The costs that are incurred as result of
running out of stock are known as stock
out or shortage costs.
INDEPENDENT VS. DEPENDENT DEMAND
Independent Demand (Demand for the final end-product or
demand not related to other items)
Finished
product

Dependent
Demand
E(1 (Derived demand
) items for
component parts,
subassemblies,
raw materials, etc)
Component parts
THE ROLE OF INVENTORY IN SUPPLY
CHAIN MANAGEMENT
 Since demand is usually not known with
certainty, it is not possible to produce exactly
the amount demanded
 So an additional amount of inventory, called safety or
buffer is kept on hand to meet variations in product
demand
 The bullwhip effect: The bullwhip effect is a
phenomenon that represents the instabilities and
fluctuations in product and supplier orders throughout
various stages of the supply chain
 INVENTORY AND QUALITY MANAGEMENT

 Level of customer service: The ability to meet

effectively internal or external customer demand in a
timely and efficient manner
 Customer for finished goods perceive quality
service as availability of goods they want at the
time when they want them
 To provide this level of quality customer service, the
tendency is to maintain large stocks of all types of
items
 CONTI..

 As the level of inventory increases to provide better

customer service, inventory costs increase, whereas
quality-related customer service costs, such as lost sales
and loss of customers decrease
 The conventional approach to inventory management is to
maintain a level of inventory that reflects a compromise
between inventory costs and customer service
INVENTORY CONTROL SYSTEM
 An inventory system is the set of policies and
controls that monitor levels of inventory and
determines what levels should be maintained, when
stock should be replenished, and how large orders
should be
 There are two basic inventory systems:
 Continuous system
 Periodic system
CONTINUOUS INVENTORY SYSTEMS

 In a continuous inventory system, a continual

record of the inventory level for every item is
maintained
 It is also referred to as a “perpetual system” or a
“fixed-order-quantity system”
 Whenever the inventory at hand decreases to a
predetermined level, referred to as the
“reorder point”, a new order is placed to
replenish the stock of inventory
CONTINUOUS INVENTORY SYSTEMS

 The order that is placed is for a fixed amount

that minimizes the total inventory costs
 This amount of order placed is called the
“economic order quantity”
 Continuous inventory systems often incorporate
information technology tools to improve the speed
and accuracy of data entry. E.g. Barcodes
 PERIODIC INVENTORY SYSTEMS
 It is also referred to as “fixed-time-period system” or
“periodic review system”
 In a periodic inventory system, the inventory on hand is
counted at specific time intervals-every week or at
the end of each month
 After the inventory in stock is determined, an order
is placed for an amount that will bring inventory
back up to a desired level
 Since inventory level is not monitored at all during the
time interval between orders, little or no record keeping
is required
PERIODIC INVENTORY SYSTEMS

 Disadvantage is less direct control

 Results in larger inventory levels to guard against
unexpected stock outs early in the fixed
period
 Also requires that a new order quantity be
determined each time a periodic order is
made
 Used in college library, small retail stores, drug stores,
grocery stores, and offices
THE BASIC EOQ MODEL
 In a continuous system, when inventory reaches a
specific level, referred to as the reorder point, a
fixed amount is ordered
 The most widely used and traditional means of
determining how much to order in a continuous
system is the “Economic Order Quantity (EOQ)
Model”
 The function of EOQ Model is to determine
the optimal order size that minimizes total
inventory costs
THE BASIC EOQ MODEL - ASSUMPTIONS

1. Demand is known with certainty and is

constant over time
2. No shortages are allowed
3. Lead time for the receipt of orders is
constant
4. The order quantity is received all at once
THE ABC CLASSIFICATION SYSTEM

 The ABC system is a method for classifying inventory

according to several criteria including its monetary value
to the firm
 About 5 % - 15% of all inventory item account for 70%
to 80% of the total value of inventory. These are
classified as class A items
 B items represent approximately 30% of total inventory
units but only about 15% of the total inventory value
 C items account for 50% - 60% of all inventory units
but represent only 5% - 10% of total value
THE ABC CLASSIFICATION SYSTEM

 A items require a continuous control system,

while for B and C items periodic review system
with less monitoring
 Items kept in inventory are not of equal importance in
terms of:
 Profit potential
 Sales or usage volume
 Stock-out penalties
 Items A Items B Items C
Very strict control Moderate control Loose control
No safety stocks (or Low safety stock High safety stock
very low)
Frequent ordering or Ordering once in 3 Bulk ordering, once in
weekly deliveries months 6 months
Weekly control Monthly control Quarterly reports
statements statements
Maximum follow-up Periodic follow-up Follow-up in
and expediting exceptional cases
Rigorous value analysis Moderate value Minimum value
analysis analysis
As many sources as Two or more reliable Two sources for each
possible for each item sources item
 Items A Items B Items C
Accurate forecasts in Estimates based on Rough estimate
materials planning past data
Minimization of waste, Quarterly review Annual review
obsolete, and surplus
(review every 15 days)
Individual postings Small group postings Group postings

Central purchasing and Combination purchases Decentralized

storage purchasing
Maximum efforts to Moderate efforts Minimum efforts
reduce lead time
To be handled by To be handled by Can be fully delegated
senior officers middle management
HML CLASSIFICATIONS

 The high , medium and low (HML) classification follows the same
procedure as is adopted in ABC classification. Only difference is
that in HML, the classification unit value is the criterion
and not the annual consumption value.
 The items of inventory should be listed in the descending
order of unit value and it is up to the management to fix
limits for three categories.
 For example, the management may decide that all units with unit
value of Rs 2000 and above will be H items, Rs 1000 to 2000 M
items and less than Rs 1000, L items.
VED CLASSIFICATION
 It is done to determine the criticality of an item
and its effect on production and other
services. It is specially used for classification of
spare parts.
 If a part is vital, it is given ‘V’ classification, if it is
essential, then it is given ‘E’ classification and if it is
not so essential, the part is given ‘D’ classification.
 For ‘V’ items, a large stock of inventory is generally
maintained, while for ‘D’ items, minimum stock is
enough
SDE CLASSIFICATION
 It is based on the availability of items and is very useful in
the context of scarcity of supply.
 ‘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.
FSN ANALYSIS
 FSN stands for fast moving, slow moving and non-
moving. Here, classification is based on the pattern of
issues from stores and is useful in controlling obsolescence.
 For FSN analysis, the date of receipt or the last date of issue,
whichever is later, is taken to determine the number of
months, which have lapsed since the last transaction. The
items are usually grouped in periods of 12 months.
 FSN analysis is helpful in identifying active items which need
to be reviewed regularly and surplus items which have to be
examined further. Non moving items may be examined
further and their disposal can be considered.