UNIT 2 INVENTORY CONTROL

Structure
2.0

Objectives

2.1

Introduction

2.2

Alms and Objectives of Inventory Control

2.3

Classification of Inventory

2.4

Functions of Inventory Control and Criteria of Inventory Control

2.4.1 NeedsINecessity of Inventory Control
2.4.2 Scope of Inventory Control
2.4.3 Factors Involved in Determination of Inventory Policy
2.4.4 How to Reduce Inventory

2.5

Tools and Techniques of Inventory Control

2.5.1 Techniques of lnventory Control
2.5.2 Types of Inventory Control System

2.6

Let Us Sum Up

2.7

Answers to Check Your Progress

2.0 OBJECTIVES

After going through this unit, you should be able to:

define Inventory Control;
describe aims and objectives of Inventory Control;
enumerate various classifications of Inventory;
discuss functions of Inventory and Criteria of Inventory Control;
describe tools and techni&tesoffnventory Cont~ol.
\

2!1 INTRODUCTION
In this unit you will learn, what is inventory control and how this is applied effectively in
various aspects of materids management particularly when you are dealing with the various
consumable items like, drugs, vaccines, gauge-cotton and other disposable items in your
daily use in a hospital. Also you shall learn how these consumable items can be
scientifically classified and wd can have a better control over these items and the drugs/
materials are available whenever required and wherever required.
In financial parlance, inventory is defined as the sum of the value of raw materials, fuels and
lubricants, spare parts, maintenance consumables, semi-processed materials and finished
goods stock at any given point of time. The operational definition of inventory would be:
the amount of raw materials, fuel and lubricants, spqe parts and semi-processed material to
be stocked for the smooth running bf the plant. Since these resources are idle when kept in
the stores, inventory is defined as an idle resource of any kind having an economic value.
Hence in simpler terms inventory may be defined as list or stock of items in store, which one
can count, measure or weigh.
by which an organisation is supplied with the
Inventory control is a s~ientific'~rocess
goods and services, that ~tneeds to achieve its objectives at optimum cost. Inventory
control can be viewed as the attainment bf a cost balance between shortage and excess of
stock. It is one of the modem management techniques of operations research.

p ~ q e Cr ~ f i ~Over
o \ the inventory, serious problems can precipitate, related to
manufac.ring, rnaIketlng, revenue generation m d customer satisfaction L*ew"e>
avadabll,q of life saving m g s

hospital supplies Can be C I - U C ~ ~ ~good

care and patlent satlshction.

--LA\

mpenc

F t o ~ gadequate
i
n*

,and- k u ~ dof stores

sdthat the
Tllis has to bZ40ne
--_x*;red

Essentials of Logistics and

Equipment Management

at m y optimum outlay offinancial and human resources. High inventory level lead to high
cost of inventories by - a) blocking the finances; b) large storage space; c) large handling
and adrninistrabon charges; d) obsolescence; and e) spoilage etc. On the contrary, low
inventories may led to frequent stock outs and high shortage costs. Balancing the cost of
carrying high inventories and the cost of shortage is done through a system of scienbfic
mventory control.
Materials management and Inventory problems are common to all organisations. The
importance of effecbve materials supplies was first recogmed by the profit making
industnal sector. Gradually, service orgamzations like educational mstitutions, hospitals,
etc., realized the value of managing their material supply system on scientific lmes.
Hospitals require a variety of materials and supplies, which are essential in providing good
pabent care. These supplies have to be obtained at most econormcal rates in nght quantity
and right quality at right bme. Effective management of these supplies is possible through
the scientific system of materials management.
The goal of a good hospital supply system is to ensure that there is adequate stock of
required items, so that an uninterrupted supply of all essential items is maintained taking
due care, we do not overstock the supplies which not only locks up the capital, but also
gives room to pilferage and obsolescence. We should also ensure that these items are
properly stored, controlled, made retrievable and distributed to the points of usage.
-

2.2 AIMS AND OBJECTIVES OF INVENTORY

CONTROL
Inventory Control deals with physical control of inventories. It is the process/techniques of
deciding as to when, what and how much of each item is to be kept in stock, minimizing the
ineffective stock and optimising the various costs associated with the inventories.
Objecbves of Inventory Control are to:
1) maintain availabilityof materials whenever and wherever required in optimal quantity.
2) minimize the ineffective stock.
3) optimize the various costs associated with inventories.

The basic principle of inventory control is also to contain costs. There are four types of
costs involved in the management of material supplies as described earlier. The purchase
cost is the duect cost of the material, whch is inclusive of taxes and freight. We can reduce
this cost without compromising with the quality of the supplies. The techniques followed
are bulk buying, rate contract, and combined buying, negobatmg purchase prices by
assuring long-term busmess. The carrying cost whch consists of costs incurred on money
invested storage space, additional manpower, obsolescence, deterioration, breakage and
pilferage is difficult to calculate.
It can be generally about 30% of the actual cost of inventory. To contro! this cost we have
to strike a balance between purchase cost and carrying cost by procuring the items m
optimum quanbty, known as the economc order quantity which IS discussed later in this
unit The shortage cost covers the loss of hospital revenue due to the non-availability of
cr~ticalitems other than the extra cost, which has to be pald to procure this Item from an
alternate source. To contam this cost it IS advisable to have two to three suppliers of good
reputation for all the cribcal and vital items. The ordering costs both duect and indirect will
go up with more frequent orders. The techmque to control this cost is agam by effecting
economy in materials management:
1)

Purchase Costs

n) Canylng Costs
IN)

Shortage Cost

iv) Ordering Cost

Economics
h v e n t o IS
~ an important aspecr
-ofM
Inventory goes "D t h ~
,-Q-.:--

,f+hfi I-..-

the other hand, if we have a smaller inventory, turnover is greater requiring less carrying
charge but more of ordering costs, as orders have to be repeated more often. We have
to strike a baiance between these two costs. By inventory control we can find out
optmpm quantity to be stocked so that these costs are kept at the minimum. It is
necessary to understand the apparent costs and the hidden costs in the management of
the supplies.

Purchase Cost
It is the actual cost of the materials whether it is drugs, chemicals, linen or other stores. It is
an apparent type of cost, which is easily understood by all. The aim is to reduce this cost
without compromising with the quality of suplies, say drugs. The effort should be to reduce
this as much as possible by following the simple techniques like 'bulk-buying', buying
under generic names and Not Trade Names and at negotiated rates by assuring .future
business over a reasonable period. While having discussions with a General Manager of a
large Indian Drugs Public Sector Undertaking, the author was told that the GM shall be very
happy to give substantial discount [up to 25 per cent] over and above the hospital, rates if
purchased in bulk quantities. But there are some inherent problems, which are associated
with bulk purchasing i.e. it may lead to huge stockslinventory, which in turn increases the
'carrying cost'.

Carrying Costs
This is hidden cost and not amenable to easy calculation. The cost of carrying an inventory
can be large if one is not conscious of its implications. ~ a r r y i ~ ~ c oare
s t composed
s
of the
following elements:
a) Cost of using or borrowing money
b) Cost of storage space
c)

Cost of additional manpower

d) Cost of obsolescence
e)

Cost of deterioration

f)

Cost of pilferage, breakage

Taxes and insurance premiums may add to the above list. Most of these costs can be
described as invisible costs. Invisible because they may not reflect in the drugs store
budget but add on to the overall budget of the hospital.
Let us discuss in brief about the aforesaid elements of the carrying cost:
a)

Cost of money: When we purchase the drugs in bulk, we pay also lkge proportion of
the drug budget at one time. Imagine if you were to borrow this money from a financier
how much interest would accrue to the hospital. You can look at it in a different way
also. An efficient stores manager instead of purchasing in bulk would divide it into
small portions and stagger the supply at a quarterlylmonthly interval and release the
payment only for that small portion received.

b) Cost of space: If the annual requirements of drugs were purchased in bulk, additional
spacelstore rooms with fittings and furniture would be required. This would mean
additional expenditure.
c)

Cost of additional manpower: More the material more hands to deal with it. Thls means
more st~rekee~ersl~harmacists,
clerks, orderlies etc. Their salarieslwages would add up
to the cost.

d) Cost of obsolescence: Drugs also go out of fashion. If a drug's annual requirement in

k@ is purchased in bulk and right at the beginning of the year, there is every likelihood
that a betterlnewer alternative arrives in the market. As and when it happens the
'
demand or prescriptions for the old drug purchased in bulk will either cease or reduce
considerably. It happens more often than not. Such dead stocks of medicines are a net
loss to the hospital.
e) Cost of deierioration: Drugs are sensitive and thermolabile items. When purchased in
bulk they are llkely to be stored for a very long period and get exposed to hot, humid
and hostile weather and storage conditions. Thls may lead to disintegration, colour
changes, growth o f fungus in glucose-saline bottles etc. That is, we are not getting the
right value for our investment.

Inventory

Essentials' of Logistics an
Equipment Management

f)

Cost of pilferage: Pilferage is directly related to the level of stocWinventory of a drug.

A large stock of a drug (following bulk purchase) will result into more pilferage and vice
versa.

Conservative estimates are that the carrying cost may be 25 per cent to 35 per cent of the
actual inventory cost. As managers we have to be acutely aware of the carrying cost.
To reduce this cost one should buy in small quantity. But this may increase the purchase
cost. The purchase cost and the carrying cost oppose each other. But there is a point/
quantity at which both are minimum/optirnum. This quantity is known as economic order
quantity (EOQ).

Ordering Costs

It is the cost of placing an order like cost involved in stationery, postage, telephone, fax,
manpower etc. This apparently is simple but can assume higher proportions because of the
costs on manpower.
Shortage Cost
It deals with the cost of not having a particular material. The direct cost is the higher price
we pay for procuring a substitute from an alternate source. The indirect costs in this
element are related to the business that we loose, an! public criticism etc. For example, you
are suddenly told that oxygen is out of stock in the hospital. The functioning of the
operation theatre and other sensitive areas of the hospital will be seriously disrupted. The
patients will suffer and there will be a public criticism. Arrangements will habe to be made to
procure oxygen or for that matter another such vital drug, at a premium from market thereby,
increasing the cost. 0n.the other hand if tablets B complex, antacid or cough syrup is out of
stock hardly anything will happen. Therefore, the shortage cost would vary according to
the nature of an item.
Check Ysur Progress 1
1)

Describe the objectives of Inventory Control?

'#hat are the various costs involved in Inventory Management? How they oppose
each other?

3)

IVhat arc the Inventory Carrying Cost?

.........................................................................................................................................................

2.3 CLASSIFICATION OF INVENTORY

For the better management of inventory one must classify the inventory so that the control
.of the inventory becomes much more easier and effective. The basic principle of the
classificatidn of inventory is based on Paretos Law. Pareto a German Economist while
studying the income pattern of a given city, found out that 20% of the people have got 80%
of the total money and rest of the 80% of the people were having 20% of the money. This
finding of Mr. Pareto is equally applicable to so many other spheres of life as well as in the
classification of ihventory management.
The types of selective inventory control are as follows:
1)

ABc

Based on cost criteria i.e. annual consumption cost of the items

Does not depend on unit price of the item

Hence it is also know as always better control

V~tal,Essential, Desirable

Based on importance, criticality and shortage cost of the item in

terms of availability, function, specifications, source of supply,
production process, storage etc.

Commonly used for management of consumable items.

High, Medium, Low

Based on unit price

Does not depend on consumption

Scarce, Difficult, Easy to obtain

Based on purchasing terms with respect to availability

Government Ordinary, Local and Foreign

6) Fm'

Fast moving, Slow moving and Non moving

Based on issues from stores

7) xYz
8) SOS

Based on the value of Inventory stored

Seasonal, Of seasonal

Based on seasonal requirements

SDE

4)
'

5) GOLF

Based on source of supply from which material is procured

Check Your Regress 2

En-te

the various ways by which inventories can be chified,

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2.4 FUNCTIONS OF INVENTORY CONTROL AND

CRITERIA OF INVENTORY CONTROL

The main functions of the Inventory Control are to have the optimal quantity of the items at
any time and every time in all the service outlets. Inventory Control will ensure that there
will be no stock outs whereas on the same time there should not be any overstocking.
The functions of the inventory control are mamly:
a) stocking of adequate amount, number and range of stores (or k h d of stocks of
materials) at all service outlet points;
b) provide maximum supply service consistent with maxfm~~efficiency
and optimum
~

investment

c) provide a c u s w between the forecasted and actual demand for a material; and
d) gives optimal outlay of financial and human resources.

2.4.1 NeedsiNecessity of Inventory Control

A good Invkntory Control Aintains availability of materials and also controls stock-out
and under-stocking. Also by this we can ensure no idling of service prov~dersand dissatisfaction among the patients. The cost of not having the items sometimes is costller than
cost of having. This in long run improves the image of the Health Centre/Hospital.

On the same time good Inventory Management also controls over-stocking vis-a-vis
minimize the ineffective stock. May be that is the reason that the business world saysInventories are yard of business or the necessary evils as they drain out the company's
profit.
A good Inventory Control will'have a duect impact on the service provided by the Hospital/
Health Centres, as a result it will enhance the patients' satisfaction and better service
conditionc

Inventory Control

Essentials oY Logistics and

Equipment M a n a g e m e n t

Inventory Control is also a necessary measure to control the various costs, which are
discussed earlier. Larger is the Inventory greater are the problem with respect to
investment, planning, procurement, handling, receiving, inspection, storage, distribution,
accounting, deterioration, obsolescence, pilferage, damage, shelf life, theft etc. Other than
those it also controls the costs arised due to changes in technology i.e. advent of newer
drugs and antibiotics, changes in market situation, changes in line of treatments and
changes in govenunent policies for various health programmes time to time.

2.4.2 Scope of Inventory Control

An efficient Inventory Control system can:
a)

Reduce costs

b) Improve service delivery

c)

Increase return on investment

d) Improve liquidity
e) Improve service conditions
Increase efficiency of man and machine

f)

g) And hence improve patients, satisfaction and goodwill of the Hospital in the
Community.

2.4.3 Factors Involved in Determination of Inventory Policy

The basic questions asked in determination in Inventory Policy are what to order, when to
order and how much toorder.
1) Requirement

Quantity in stocWin transit

Quantity to be procured keeping in view the

consumption pattern, fluctuatioii in demand and
utilization

Seasolla1and peak requirements

2)

LeadTirne

Internal and External Lead-time

3)

Cost Factors

Ordering cost

inventory carrying cost

Underlover stock cost

Savlng in transportation/quantity discounts

This will decide capacity to buy and capacity

to hold inventory

Change in design of Final Indent

Change in design of Quantity of the item

Advent.of newer drugs and antibiotics

Imported/channelised items

Change in import dutylcustom duty specially before the

budget.

4)

LiquidityRinancial
Pbsition

5) Availability of Credit
6) Obsolescence

7)

Government Policies

8)

Storage

Shelf life, inflammable, evaporation,deterioration, bulky

items, air-conditioned environment to store etc.

9)

Patient Service
Provider Relations

Smooth deliveries result in lower inventories

Increaseldecrease in quantity in peaWslump
season or due to change in indent/consumption rate

10) Marketing C ~ d i t i o n s-

Items easy to get yesterday may be difficult to get

tomorrow and vlce-versa

11) Other factors such as single source, mult~plesources, proprietary Items, location of
source of supply, Import substitution, make or buy decision etc.

8 .

?.

Inventory Control

2.4.4 Bow to Reduce Inventory

1) Fixing up maximum limit of inventory in terms of value.
2) Fixing up responsibility of controlling the inventories with one person preferably at
Senior level reporting to top Management.
3) Meticulous materials planning and forecast.
4) A well designed and defined Inventory Control system.

5) Fixing up realistic Inventory levels i.e. maximum, minimum,reorder levels and safety
stock Inventory levels should be fixed itemwisellocationwise.
6) By reducing lead-time.
7) Adjustment in Inventory levels. Wherever called for Inventory levels should be
adjusted as per changes in requirement/consumption,changes in market conditions etc.

8)

Strict control on obsolete, slow moving and non-moving items.

9) Reducing the number of stock points.

10) Standardization and variety reduction.
11) Maintaining close co-ordination wth other user Deptts., Store, Quality Assurance, etc.
and creating an awareness and positive attitude at all levels in all the Deptts. to reduce
the Inventories. Push the idea that Inventories are cash.
12) Computerized the Inventory control system.
13) By improving the buyer seller relationship, selecting the right source of supply in terms
of location, quantitylquality etc.
Check Your Progress 3
1) What are the hnctions of ~ n v a t o r yControl?

2) What are the various factors which determine Inventory Policy?

2.5 TOOLS AND TECHNIQUES OF INVENTORY

CONTROL
Inventory control is basically a scientific system which indicates as to what to order, when
to order, how much to order, how often to order so that the purchasing costs and storing
costs are kept as low as possible. The two basic techniques of inventory control are ABC
analysis and VED analysis.
\

2.5.1 Techniques of Inventory Control

ABC Analysis
It is based on cost criteria governed by Pareto's Law where a small number of items
consume a big chunk of resources and vice-versa. The ABC principle which is generally
applicable to any type of store states that:
-

Around 10 per cent of the drugslstore material would cost 70% of the resources. (Group

Essentials o f Logistics
Equipment Manageme

20% of the drugststore material generally consume 20% of resources (Group B).

Remaining 70% of the drugststore material would consume just about 10% of the
resources (Group C).

The calculations will not be so exact and the range may vary by about 5 per cent.
Methodology for ABC analysis

Work out the annual consumption cost of each itemldrug.

ii) The list of drugs or items should be arranged in descending value of their cost. The
most expensive item is at the top followed by the next less expensive and the cheapest
item which has consumed least amount will be at the bottom.
iii) The cumulative cost of the items is worked out on this list. The cumulative cost of the
first item will represent its annual cost, whereas, the cumulative cost of the second item
will be its annual cost plus the cumulative cost of the item above it. Similarly, that of the
third item will be its own annual cost and the cumulative cost of first and second item.
The cumulative cost of the last item will be the total annual expenditure on medical
store. Refer Table 2.1 for further guidelines.
iv) The list is now ready for undertaking ABC analysis. Mark the figure close to 70% of the
total expenditure. All items up to this figure will be A category items. This will be
equivalent to only 10-15% of the total number of drugs. The interpretation - about 10%
of the items cost as much as 70% of total budgetary expenditure.
v) The next figure to mark will be close to 90% of the total annual expenditure. The items
between the two figures i.e., after the A category items and up to the figure close to
90% will be B category. These will be generally around 20% of all the items. The
interpretation - about 20% of the items consume 20% of the total expenditure. '
vi) The remaining items will be c categox$, which constitutes around 65-70% of the items.
The interpretation - about 70% of the store items cost as little as 10% of the total
expenditure.
Following is a convenient example to understand the exercise better in undertaking ABC
analysis.
Let us imagine the medical store of a small hospital has 100 items on its inventory and the
total annual expenditure is Rs. 10,00,000. The items can be arranged in the descending value
of their annual cost in the following manner:
Table 2.1
S. No.

I)
2)
3)
4)
5)
6)
7)
8)
9)
10)
11)

Name of the
Items
Inj. Ampicillin
lnj. Ciprofloxacin
Inj. Dextrose 5% 540ml
Inj. Normal salrne 540ml
Inj. Cefatoxim 1Gm
Inj. Streptokinase
Tab. Ciproflaxacin
Inj. Haemaccel iv
Fluothane
Inj. Dexamethasone2ml
-

0) Acr~flavine

Annual
Consumption
in Rs.
9 1,000
89,000
83,000
81,000
7 1,000
. 65,000
63,000
59,000
5 1,000
47,000
-

300

Cumulative
Total
in Rs.
9 1,000
1,80,000
2,63,000
3,44,000
4,15,000
4,80,000
5,43,000
6,02,000
6,53,000
7,00,000

Cumulative Category
Percentage
9.1
18
26.3
34.4
41.5
48
54.3
60.2
65.3
70
-

9,00,000
10,00,000

90
100

A (70%)

B (20%)
C(IO%)

Another method of doing ABC analysis is to pick up approximately first 10% of the items
from the list arranged in descending order, which generally consume 70% of the
expenditure. This is category A. The next 20% of the items in the list account for 20% of the
total expenditure. This is category B. The remaining items (category C) constitute about
70% of the items which consume only 10% of the total expenditure. As mentioned earlier,
the percentages will not be exactly identical and the variation may be up to 5%.

Application far ABC Analysis

Inventery CentroI

~ollowi&are the applied benefits of the practice of ABC analysis:

Table 2.2

S. No.
I)
2)
3)
4)
5)
6)
7)

Activity

Frequent of Purchase
Turnover/Consumption
Level of Control
Estimates of Requirement
Safety Stock
Management Level
Monitoring

Group A

Group B

Croup C

More Fnqumt
Tight

Less Frequent
Medium
Moderate

VqRigid

Ri@

Least Frequent
Low
Routine
Moderate

Low
TOP
Very Strict

Moderate
Middle
Strict

Lower
Moderate

High

High

VED Analysis
The limitation of ABC analysis is that it is based only on monetary value and the rate of
consumption of the items. Sometimes, particularly in a hospital, and item of low monetary
.value and consumphon (e.g. Injection Adrenaline, Anti-Snake Venom etc.,) may be very
vital or even life saving. Their importance cannot be overlooked simply because they do not
appear in A category of inventory. Therefore, another parameter of tde materials is their
"criticality' '. This could be in terms of the therapeutic value of a drug or intrinsic value of
/he material in achieving the objectives of hospital system. VED analysis is based on critical
values and shortage cosfs of the Item. Ba;ed on the; criticality, the i k could be classified
into three categories: Vital, Essential and Desirable.
1)

Vital Items: There are several vital items in the inventory of a hospital, which could
make difference between life and death. There can be serious functional dislocation of
patient care when such items are not available even for short period adversely effecting
the image of the hospital. Such items should always be stocked in sufficient quantity to
ensure their constant availability. Top management should control this group of items. -

2) Essential Items: The shortage of such items can be tolerated for a short period. If these
items are not available for a few days or a week, functioning of the hospital can be
adversely affected (drugs like Antibiotics etc.). Toplmiddle level management should
preferably control these items.
3)

Desirable Items: The shortage of these items will not adversely affect the patient care
or hospital functioning even if the shortage is prolonged (items like Vitamins). Middle1
lower level management should control desirable items.

As against the cost criteria in ABC analysis the VED analysis 'is based on subjective
analysis by a group of physicians. Such an analysis enables the admirustrator to give more
attention to vital and essential items. A combination of ABC and VED analysis can be
gainfully employed to evolve a meaningful control over the material supplies particularly in
a hospital system.
V

A
Category 1
\

B
Category 2

C
Category 3

ABC and VED Analysis

Category I includes all vital and expensive items. These requite close monitoring and strict
control.
Category I1 covers item of essential category and they are less expensive.

Essentials of Logistics and

Equipment Management

Category I11 comprises the desirable and cheaper group of items.

SDE Analysis

This is based on the availability of items in the market. S items are scarce, D items are
difficult to procure and E items are easily available in the market. Such an analysis may be
handy when there is a lot of uncertainty or vagaries in the availability/procurementof the
items.
Other types of analysis which are not of much significance to a materials manager are: HML
analysis (based only on cost i.e., High, Medium, Low cost items) and FMS analysis based
only on rate of movement~consumption(Fast, Medium and Slow moving items).

2.5.2 Types of Inventory Control System

There are two basic types of inventory control systems. Several modifications and
improvements are based on these systems.
1) The cyclical ordering system
Rased on the previous year's consumptionpatterns, the requirement is worked out for all
the items. A fured time base is worked out for ordering the supplies (once in a month, two
months, or three months) and orders are repeated in the cyclical fashion. Although the
system appears to be simple, some of the disadvantages are that it does not provide for
unforeseen variations in the demand/consumption and the ordering quantities may not be
economical with risk of overstocking or even going out of stock.

2) Fixed order size system

Also known as perpetual inventory system. Fixed number of units are ordered every time.
The demand rate is constant but the time between the orders varies according to the
fluctuations in use. When the stock reaches a predetermined level, fixed quanbty of items is
ordered. This system permits ordering the optimum quantity of each item required. Based on
price, rate of usage, time taken to replace the stock, the maximum and minimum stock levels
are worked out to establish the Reorder level. The ordering point is so fixed that by the time
the supplies against the new order are received the stock level will fall to the minimum and
when the fresh supplies are received, the stock wlll rise to the maximum level. This is also
known as 'Min-Max' approach.
A d~scussionof the right quantity to purchase would not be complete without a brief

summary of the "min/max" (minimum/maximum levels) approach to the ''quality factor" as

an alternative and comparison to the EOQ approach to quantity determination. Basically the
' ' d m a x " approach relies on the combination of two factors: (1) the order point, and (2) the
total quantity to be ordered. Thus the order point is the minimum level and the combination
of the order point and the total order quantity is the maximum level. The figures can be
expressed in days, weeks, and months. A simple illustration of the formula is:

Minimum level
Maximum level
Supplier lead time
Order quantity

2 weeks
6 weeks
1week
4 weeks

Therefore, in order to maintain amaxirnum level of six weeks supply, the order must be
placed when the level on brand is at 3 weeks (one week supplier lead tune plus 2 weeks
minimum level); but the order must not exceed a four-week supply so that the maximum level
will not be exceeded.
When recommendations for improvement are considered, it is impossible that they will
exceed the resources available. In this situation, it is wise to develop a inin-max strategy that'identifies the rmnirnum changes needed to environmentally improve the materials
management system and the maximum changes needed to substantially improve
performance.
The advantage of the system is that each item can be procured in the most economc
quantity. The constraiqts\inthis system are that it will funchon smoothly only when the
lead-time (Procurement Time) and the consumpbon rate are constant. When these two
factors are varying fresb reordering levels have to be calculated. Therefore, may be more
cumbersome than the cyclical o r d e w system.

Inventory Control

Stock Available

Demand occurs
(un~tswithdrawn)

. Determine stock position

(on hand + on order - back orders)

Is stock position <

Reorder point

I I

Issue replenishment

Fixed Order Size System

3) Double bin or double shelf system

This inventory control system is a modification of fixed quantity ordering system. Here, no
perpetual inventory records are maintained. The stock of each item is kept in two bins or
two shelves, one containing quantity equal to the reorder point and the other bin containing
quantity equal to the difference between the reorder point and the maximum level. When the
stock m the latter bin is used up, the storekeeper places fresh order before cbnsuming the
stock of first bin.

E l

"Z ;

Balance of the Supplies

Requirement for Lead

Time +Buffer Stock

Bin A

B
i
nA

Double Bin System

To understand h s system on simpler terms let us take a look at the system practiced by a
housewife in the management of cooking gas. She acquires two cooking gas cylinders but
uses only one at a given time. When one cylinder is exhausted she wastes no tinie in
ordering a refill while connecting the second cylinder to the stove which sees her through
till the fresh cylinder is delivered. There is no stock out nor any overstock.
None of the above systems are exclusive or foolproof, particularly when we cannot control
the procurement time and the market availability of the items. The hospital requires a large
number of material supplies constantly. It may be better to adopt Flow Control System for
items required often in large quantities. The long-term contract is entered into with a reputed
rnanufacturerJsupplier for supplying a definite quantity of each item scheduled in intervals.
/

Other Useful Terminology

To grasp the inventory control system fully we have to understand the following
terminology and formulae:

,Essentials o f Logistic8 and

~qui~men
Management
t

It is the length of time in days between the decision to replenish an item, and its actual
addition to the stock. The lead time consists of internal element (time elapsing between
decision making and communication of the order) and external element (time elapsing
between the receipt of order by the supplier and actual receipt'of the material). We can
control internal lead time to an appreciable extent but will have no control over the external
lead time.

2) Buffer Stock
Also known as Safety stock or Reserve stock. It is the minimum quantity of supplies set
apart as an insurance against variations in supply and demand. This is greatly influenced
by lead-time. This can be calculated by multiplying the average demand for maximum delay
or the probable delay. The probable delay (D) is estimated from the past experience and
graded as Dl (Least delay), D2 (mean delay), and D3 (maximum delay). If the lead-time
requirement<sR, the buffer stock (BS) can be calculated by using a formula: BS=D x R. If
the item is very critical, value of D3 is taken into consideration to ensure almost 100%
availability.The rule of thumb is to calculate the difference betweenmaximum lead-time and
average lead-time in days and multiply it by average daily consumption.
There is another method of calculating the Buffer Stock. As we know the buffer stock is the
quantity of storeslcushion set apart as an insurance against stock outs. This quantity is
kept as an emergency supply. It can be calculated by the following formula:

Buffer Stock

K
D

=
=

KxD

A constant and has three values i.e. K1,K2 and K3.

Average estimated consumption during the lead-time. Value of K will change
according to the shortage cost or criticality of an item or how vital an item is.

The average estimated consumption during lead-time (D) can be multiplied by K 1, K2 or K3.
A buffer stock of:

K1 x D will ensure that the drug is available 67 per cent of times when indented from stores.
K2 x D will ensure that the drug is available 95 per cent of times.
K3 x D will ensure that the drug will be almost always (99 per cent) available in stores
whenever indented.
The average estimated consumption during lead-time (D) can be multiplied by K1,K2 or K3.
A buffer stock of:

K1 x D will ensure that the drug is available 67 per cent of times when indented from stores.
K2 x D will ensure that the drug is available 95 per cent of times
K3 x D will ensuri: that the drug will be almost always (99 per cent) available in stores
whenever indented.

INVENTORY

Key:

Q = lot size; 412 = average inventory

B = reprder point;
ac = ce = interval between orders;

ab = cd = ef = lead time
Fig. 2.1: Inventory Model

The ideal lnventory model 1s shown In Fig. 2.1. The stock on hand consists of two
components, the worklng stock and the safety stock. Working Stock varies from zero to the
order quantity ( 0 ) and represents the stock, which is used to satisfy demand between
deliveries. Safety Stock (S), also called reserve stock, buffer stock or fluctuation stock,
exists to protect against stockouts which would otherwise occur when deliveries are
delayed for any reason or the working stock is consumed at an unexpectedly high rate.
In the Ideal model, drugs are &sued m response to demand and the stock on hand steadily
decllnes untll the pomt at which an order must be placed. Followmg the lead tlme period,
during which all the actlvlt~esof the procurement cycle are performed, the quantity ordered
s
maximum point (Q+S).
(Q) 1s received and the Inventory level 1s back to ~ t starting
From Fig. 2.1, it is apparent that the average working stock is one-half of the order quantity.
Average working stock = %Q.
To reduce the average inventory and, thereby, reduce the inventory holding costs, either
the working stock, the safety stock, or both should be lowered.
When drugs are used at a constant rate, the line in Fig. 2.1 representing stock on hand
decl~neswith a constant slope. The working stock can be reduced only by placing smaller
order (reduce the size of Q) more frequently.
3) Reorder ~ e v e l
This denotes the stock level at which a fresh order has to be placed. This is equal to
average consumption per day multiplied by lead time plus the buffer stock. We can avoid
stockouts by working out the reorder level of all important material so that immediate action
can be taken as soon as the-stocks drop to reorder level. In fact, the author advocates
simple practice of material mailagement by calculating the reorder level of all stored items to
ensure we do not overstock or understock the material. This practice can simplify the store
management partlcularly when we do not want to indulge in complicated mathematical
calculations.
4) Economic Order Quantity (EOQ)

This is the most economical quantity of the material to be purchased. As mentioned earlier,
the ordering costs and the inventory carrying costs are antagonistic to each other, if we
keep the ordering costs low (by placing fewer orders) the inventory carrying costs go up as
we have to purchase huge quantities which locks up our capital and storage space. The
reverse is also true, when we keep the carrying cost low (by ordering smaller quantities).
The ordering costs will tend to rise as we have to place more frequent orders. To confront
this situation, we have to strike a balance between these two costs. EOQ is a tool for the
same
The formula is EOQ
A
Oc
PC
Ic

=
=
=

2A x Oc
=

PC x Ic

annual demand of ltems in units

ordering cost
purchase cost of item per unit.
inventry carrying cost in percentage.

E x ~ ~ m p l If
e :annual demand (A) of 1nj. Ampicillin 1 ~m k 20,000 units, the cost ofplacing
order (Oc) is Rs. 100, the purchase cost (PC)is Rs. 20 per unit and the inventory carrying
cost is 20% of the purchase cost, the calculation will be:

EOQ

2 x 2000 x 100
=

20 x 0.2

1000units

While the industrial sector can precisely calculate these costs the EOQ formula will be very
handy 'f9r them to buy the most economical quantity. The hospitals may find it difficult to
calculate these costs partlcularly the indirect or hidden costs.
Check Your Progress 4
1)

How to do ABC Analysis?

Inventory Control

11s of Logistics and

c o t Management

2)

How to do VED Analysis?

.........................................................................................................................................................
3) What is Buffer Stock?

...........................................................................................................................................................
4)

What is Reorder Level?

2.6 LET US SUM UP

An inventory can be identified as those goods, which are procured, stored and used for the
daily requirement of the organisation. They are sort of lubrication for the supplyproduction-distribution system that protects it from excessive friction. Inventories isolate
one part of the system from the next to permit each to work independently, absorb the stock
of forecast errors and permit the effective utilization of resources when demand fluctuations
are experienced.
Thus inventory management is the process of deciding what and how much of various
items are to be kept in stock at optimum overall costs to the health care system. It is the
science and art of weighing the costs of carrying the stock against the losses that may
accrue if the material is not available when needed. No one can predict with complete
certainty what the demand will be or what the subsequent loss will amount to if the material
is not available. Nor is it easy to estimate the costs of following various alternative-stocking
policies. However, it must be mentioned here that all systems and organlsatidns must be
primarily designed to suppfy drugs, medicines and other supplies in time in order to provide
meaningful and effective service.
When an organisation has material inventory, costs are inevitably incurred. Money that
could otherwise be profitably employe'd elsewhere is tied up, physical storage costs are
incurred and there may be losses due to spoilage or p i l f e r a ~All
. these costs added
together comprise what is called the cost of possession. Purchase quantity is usually the
biggest determinant of hventory investment, and consequently, of average carrying cost.
As long as usage is reasonably regular, inventory tends to be increased by an average
amount equal to one half the purchase quantity. There is usually an inverse relationship.

2.7 ANSWERS TO CHECK YOUR PROGRESS

Check Your Progress 1

1)

Objectives of inventory control: ,

i) To maintain availability af materials whenever and wherever required.

ii) To minimize the ineffective stock

iii) To optimize the various costs associated with inventories.
2)

Various costs involved in Inventory Management are:

1) Purchase cost
ii) Inventory carrying cost
iii) Shortage cost

iv) Ordering cost

If the ~urchasecost is lowered by buying in bulk the carrying cost will go up, and viceversa. Also if the carrying cost is to be rninlmized the ordering cost will go up as
frequent ordering will be required.

3) Various inventory cairying costs are:

3 Cost of using or borrowing money
ii) Cost of manpower

iii) Cost of storage space

iv) Cost of obsolescence
v) Cost of deterioration
vi) Cost of pilferage.

Check Your Progress 2

Various ways of classifying inventories:
i)

ABC

Based on Annual consumption cost of items.

ii)

Based on criticality or shortage cost of items.

iii) HML

Based on rate of consumption.

iv) SDE

Based on the availability of the items in market.

v) FSN

Based on issues from stores.

vi) XYZ

Based on the value of Inventory Stored.

vii) GOLF -

Based on source of supply.

viii) SOS

Based on seasonal requirements.

Check Your Progress 3

1)

Functions of inventory control are:

Stocking of adequate amount, number and range of stores at all service outlets.

ii) Provide minimum supply service consistent with maximum efficiency and optimum
investment.

iii) Provide a cushlon between the forecasted and actual demand for a material.
iv) Gives optimal outlay of financial and human resources.
2)

Factors determining inventory policies should be based on what to order, when to order
and how much to order:
i)

Requirement

ii) Lead tissue

iii) Cost factors
iv) Financial politicslliquidity
v) Availability of credits
vi) Obsolescence
vii) Government policies
viii) Storage.factors
k) Patient service provider relations

X)

Marketing conditions.

Check Your Progress 4

1)

In the ABC analysis the items in stock are classified in A, B and C categories based on
the Annual Consumption cost of each item. Usually 'A' items are 10% of all items
consuming 70% of total budget. 'B' items are 20% of all items consuming 20% of total
budget. 'C' items are 70% of all items consuming 10% of total budget. Hence 'A' items
to be under stnct control of top management. Rest of the 'B' and 'C' categories can be
dealt by middle and lower level management respectively.

Inventory Control

Essentials o f Logistics
Equipment Mnnngeme

In this analysis the items are classified into Vital (V), Essential (E) and Desirable [D) as
per the criticality or shortage cost of the store items. 'V' .Items are those, the absence of
which cannot be tolerated even for single moment. 'E' items are those, where the nonavailability for some time may be tolerated but not for long time. 'D' items are those, the
absence even for longer duration will not seriously hamper the nonnaVgenera1
hnctioning of the hospital.
VED classification of items will vary from Hospital to Hospital and it will purely depend
on the objective of the Hospital.
Buffer stock or safety stock is the minimum quantity of supplies set apart as an
insurance against variation in supply and demand. Hence it acts as cushion to deal
with the unforeseen exigencies or emergencies.
This denotes the stock level at which a fresh order has to be placed. This is equal to
average consumption per day multiplied by lead time plus the buffer stock. Bjl this it
will help the store manager to ensure that there will be no overstocking or
understocking of materials.