Dr.

Suhas Rane
ranesuhas@hotmail.com

Acknowledgement :
1. APICS literature
2. Book authored by Simchi-Levi & Kaminsky
3. Operations Mgmt. by Gaither & Fraizer
 What Is Inventory?
APICS Dictionary : Those stocks or items used to
support production,…supporting activities,
…and customer service…”

Inventory is the blocked working capital of an

organization in the form of materials.
Since blocked – it should theoretically be zero,
although it is impossible to do so.
Inventory and the Flow of Materials
 Demand vs. Supply

INVENTORY CAPACITY DEMAND

 Inventory : CONFLICTING INTERESTS

OPERATIONS Viewpoint : STOCK MAINTAINED for

OPERATIONAL CONVENIENCE

Definition from FINANCE: MONEY LOCKED IN IDLE RESOURCES

AIM OF INV. Controller : TO PROVIDE OPERATIONAL

CONVENIENCE WITH MINIMUM POSSIBLE
INVESTMENT IN INVENTORY

HOW? : by EXERCISING A SELECTIVE INVENTORY CONTROL

METHODs and
APPLICATIONS OF INV. CONTROL TECHNIQUES
(ABC, VED )
 PUSH Approach to meet the demand
Sales Forecast

MRP Prod. Plan Actual Sale

R.M M/C 1 M/C 2 F.G

R.M Bin/ WIP F.G BIN/

Store BIN Warehouse

Traditional PUSH Approach

Why Do We Want to Hold Inventory ?

1. Unexpected changes in Customer demand

2. To improve customer service

3. Economy of scale (Production Lot Size , Transportation)

4. Lead times uncertainty

5. Hedging , Hoarding
 Why We Do Not Want to Hold Inventory ?

To reduce certain costs, such as

- Carrying costs

- Diluted return on investment

 Types of Inventory
• Raw material • Spares
• Wip • M.R.O.
• FF Goods • Tools/Tooling
• Distribution inventory • Capital equipment
• transit
 Why Average Inventory ?
400

Units in Stock
Q
200

1 2 3 4 5 6 7 8
Time (Weeks)

Weekly demand = 100 units; Order Qty. = 400 units/ month

Order quantity 400
Average inventory = = = 200 units
2 2

This means that:

Though your Actual Stock keeps varying,
from 400 (on 1st) to Zero (on 30th),
on an average – you are holding 200 Pcs any day
for the ICC calculation purpose
 Inventory Turns
A measure of how effectively inventory is being used

turns
Inventory Annual
cost
of goodssold
Average
inventory
inRs.
e.g.-
Annual cost of goods sold = Rs. 10 L
Average inventory = Rs. 1 L

turns
Inventory 1,000,000
10
100,000
 Inventory Analysis
2009-10 Inv. % Inv – days 2008-09 Inv. % Inv –
days
RM & Pkg 49.19 38.94
Inventory
WIP Inv. 14.65 12.91
F G Inv. 10.26 10

Stores & Spares 5.65 12.91

Inv.

Material 517 392

Consumed
Cost of Goods Mfr. 620 450
Net Sale 697 520
Stores & Spares 10.82 9.20
Consumed
 Inventory Analysis
2009-10 Inv. % Inv – days 2008-09 Inv. % Inv –
days
RM & Pkg 49.19 9.4 % 28 days stock 38.94 10 % 30 days
Inventory
WIP Inv. 14.65 2.3 % 7 days 12.91 2.9 % 8.6 days
F G Inv. 10.26 1.5 % 4.4 days 10 1.9 % 5.8 days
Sales
Stores & Spares 5.65 52 % 6 months 12.91 140 % 16 Mths
Inv.

Material 517 392

Consumed
Cost of Goods Mfr. 620 450
Net Sale 697 520
Stores & Spares 10.82 9.20
Consumed
 Inventory Related Costs

– Item (Material) costs

– Carrying costs

– Ordering costs

– Stock-out costs
 Inventory Related Costs

Item Cost - Direct material, direct labor, factory O/H,

Transportation, Customs duties,

Carrying costs –
1. Cost of Capital : Interest pd on tied up capital : 12-15 %
2. Storage costs : Space, personnel, and equipment 1–3%
3. Risk costs : Obsolescence, damage, pilferage 1 -3%
4. Insurance 2- 4%
ICC or Holding Cost : 20 -35 %
Ordering Costs - P O Paper-Work cost / Follow-up, Visits, Calls
Set-up costs, Inspection, Receiving, Sorting, Dispatch etc.
Portion of Sal & Wages, Exp. used for procurement process
Ordering Cost per PO = Total Cost incurred / Total POs released
Stock-out Costs : Back-order costs, Lost sales costs, Lost customer costs
 Economic Order Quantity

If you consume an item on regular basis,

- At what rate you should procure it
- How frequent? What periodicity ?
- What quantity ?

So that –
- you are incurring minimum
a. Ordering Cost
b. Inventory Carrying Cost.
 EOQ

What’s that ?

Why do we need it ?
 Ex.1 : Ordering Problem, EOQ
An item is consumed @ 10,000 pieces per year. (M)
The other details are - Unit Price: Re 1 (s)
ICC = 30% per year
Ordering Cost (Co) = Rs 60 per order.
1. Considering various possibilities of order quantities at a time
(e.g. 10000, 5000, 2000, 1000, 500),
work out - Ordering charges, Inv. Carrying Charges and Total Cost.
2. On a graph paper, plot graphs of Ordering charges, Inv. Carrying cost and Total
cost against each other.
3. Find out EOQ from the graph.
4. Find EOQ from formulae and tally with No. 3 above.
 Ordering Problem
Annual Demand = M = 10,000 pieces
Unit Rate = s = Re 1 ICC = 30% per year = 0.30
Ordering Cost (Co) = Rs 60 per order.

Order No of Orders Ordering Average Carrying Total Cost

Quantity per Yr. Charges Inventory Cost (ICC)
500
1000
2000
4000
5000
10000
 Ordering Problem
Annual Demand = M = 10,000 pieces
Unit Rate = s = Re 1 ICC = 30% per year = 0.30
Ordering Cost (Co) = Rs 60 per order.

Order No of Orders Ordering Average Carrying Total Cost

Quantity per Yr. Charges Inventory Cost (ICC)
500 20 1200 250 75 1275
1000 10 600 500 150 750
2000 5 300 1000 300 600
4000 2.5 150 2000 600 750
5000 2 120 2500 750 870
10000 1 60 5000 1500 1560
Ord. No of Ordrg Av. Carryi Total
Qty. POs per Charg Inv ng Cost
Yr. es Cost
(ICC)

A B= C=B X D= E= D F=C
10000/A 600 (A+0)/ X 0.3 +E
2
500 20 1200 250 75 1275
O
1000 10 600 500 150 750

2000 5 300 1000 300 600

4000 2.5 150 2000 600 750

O
5000 2 120 2500 750 870

10 K 1 60 5000 1500 1560

 Minimum Total Cost
The total cost curve reaches its minimum
where the carrying and ordering costs are
equal.
Q D
H = S
2 Q
Annual Annual
Total cost = carrying
cost
+ ordering
cost

Q H D
TC =
2 + Q
O

12-22
 EOQ Formula

EOQ= 2AS
iC
Where
A = Annual usage in units no.
S = Ordering cost in Rs. / order
i = Annual inventory carrying cost
as a decimal
C = Unit cost (Rs./ pc)

Or
 Cost of Not Operating Scientifically
Problem Solution
A Co. placed 6 orders/ yr. each of • Presently with 6 orders :
200 units. OC = 6 x 600 = 3600;
Given Ordg Cost = Rs 600 / ord. ICC = 200/2 X 40 X .4 = 1600
Unit Cost = Rs 40, Mat Cost = 1200 X 40 = 48000
Holding Cost = 40% of Unit cost . Thus, Total Cost = 53200

1. Find out loss to the Co. in not • Ideally  EOQ = 300 X 4 ord/ yr
operating scientific inventory Hence OC = 600 X 4 = 2400;
policy. ICC = 300/2 X 40 X .4 = 2400;
2. What is your recommendation Mat Cost = 48000 ;
for EOQ & No of orders / yr ? Thus Ideal Total Cost = 52800
3. How much would they save/yr ? • Loss = Rs 400
 Sensitivity of EOQ Curve

EOQ curve is flat at bottom

This means –
Even if you alter the EOQ slightly ( + or -- ),
the difference in the total charges
will not be very high
 EOQ Curve Sensitivity

E
Variation +100
-50% -20% -10% O +10% +20% +50%
in EOQ %
Q

Increase in 25 % 2.5% 0.5% 0 0.4 % 1.6 % 8.0 % 25 %

cost
 How Much to Order at One Time ?

Management wants to
– Minimize sum of all costs involved
– Maximize customer service

Methods of deciding how much to order at one time:

1. Lot-for-lot
2. Fixed order quantity
3. EOQ
 1. Lot-for-Lot

– Only required amount is ordered

– No unused lot-size inventory is created

– This is used -

• For dependent demand items

• For expensive components (A items)
• In a Just-in-Time (JIT) environment
 2. Fixed-Order Quantity

– Specific (pre-decided) Fixed Qty. is ordered each time

– Quick and simple

– On the basis of what seems reasonable

– Does not always produce the best results

 3. Economic Order Quantity

A = 1,000 units Demand per year

S = $ 20 per order Ordering Cost
i = 20% = 0.2 ICC
C = $5 per unit Unit Rate
Find EOQ = ???

EOQ= 2 x1,000unitsx$20=200units
0.2x$5
What to control in Inventory Costs ?

EOQ= 2AS
iC

A = Annual usage in Units / Nos.

S = Ordering Costs (Rs/ order)
i = Inventory Carrying Cost
C = Unit Cost (Rs/ Unit)
 EOQ Assumptions -
Assumes that –
– Demand is relatively constant and known

– Order preparation costs and inventory carrying costs are

constant ( all through period) and known

– Replacement occurs all at once (instantaneous)

Whereas the market functions independently.

Hence EOQ is hardly workable in practice.

More practical in use is MRP systems
 When to Place an Order ?

 Late PO  possibility of a stock-out

 Early PO  extra inventory and cost

 The system is needed to trigger

 when to order
 The Inventory Cycle

Profile of Inventory Level Over Time

Q Usage
rate

Quantity
on hand

Reorder
Level.

Reorder Reorder Time

Receive Time Receive Receive
Time
order order order
Re-Order Lead time
Point
 Re-Order Point (with Safety Stock)System

ROP
Quantity

SS Level
LT Time Scale
Re-Order point = demand during lead time + safety stock
ROP = DDLT + SS
 Safety Stock
Quantity

Maximum probable demand

during lead time

Expected demand
during lead time

ROL

Safety stock reduces risk of Safety stock

stockout during lead time LT Time
12-36
 Safety Stock

– Purpose of SS  to prevent a stock-out during L

– SS Qty. depends on
• Demand Variability during the lead time
• Frequency of ordering
• Desired service level
• Length of the lead time

SS = Z x STD x L
= (Safety factor ) x Std Devn. x Sq Rt. (Lead Time)

At 90 % Service Level, Z (90%) = 1.285,

Z (92%) = 1.41, Z ( 95%) =1.65, Z ( 99%) = 2.33
 Re-Order Point System (with SS)

Quantity

ROQ
SS

LT

Re-Order Level = demand during lead time + safety stock

ROL = DDLT + SS
 Inventory Classifications
and
Selective Inventory Control
 Selective Inventory Control Methods
SI. Type of Control No. Criteria Main use

1. A. B. C. Value of consumption. To control R Ms,

(Always better control (It has nothing to do with Comp. & WIPs
or Pareto’s Law) unit rate of the items)

2. H. M. L. Unit price of the materials To control Purchase Rates,

(High, Medium, Low) Pilferage in Storage
(This is opposite of ABC and does not take consumption into
account Critically of the item)

3. V. E. D. / VEIN Criticality Criteria To determine the stocking

(Vital, Essential levels of Parts, from
& Desirable. Production criticality view.
Imp & Normal)

4. S. D. E. (Scarce, Purchasing problems in Lead time Analysis

Difficult and regard to availability and Review.
Easy to obtain)
 Selective Inventory Control Methods
SI. Type of Control No. Criteria Main use

5. G. O. L. F. Source of supply of to determine

(Government, Open Materials SS Levels
market, Local and
Foreign Source)

6. F. S. N. (Fast Moving, Consumption pattern of To design Stores

Slow Moving, Non Moving) the component. Layout, To control
(Movement Analysis) obsolescence.

7. S. O. S. (Seasonal Nature of supplies, Procurement and

and Off-Seasonal) and seasonality. Holding Strategies
for seasonal items
like Agro. Products.

8. X. Y. Z. Inventory value of To review High Value

items in store, inventories and their
as on 31 March uses at scheduled
intervals.
 ABC Analysis:

Nos. Of Items Annual Category

Consumption
Value
High 40 10% 470 Cr 70% A
Consumption
Items
Medium 80 20% 134 Cr 20% B
Consumption
Items
Low 280 70% 68 Cr 10% C
Consumption
Items
Total Items 400 100% 672 Cr 100%
Actions to be taken
A items B items C items

1. High consumption Moderate value Low value

2. Very strict control Medium control Loose control

3. Nil Safety Stock Low safety stocks High safety st.

4. Daily Deliveries Weekly/ Monthly Bulk/ Quarterly

5. Multi-sources Few sources Max.- 2 sources

6. Accurate forecasts Estimates Guestimmates

7. Central storage/ Storage in each plant Site storage

8. Max. Cost control Minimum efforts No efforts for.

 VED Analysis
This method can be better suited for stocking critical item from production or
maintenance view
V – Items of vital importance,
E – Items of essential importance,
D – Items of desirable importance.

Vital - Indicating that production stops without ‘V’ Item.

Essential - Production (or Maintenance) can be saved, but by compromising
some parameters as such efficiency, noise reduction etc.
Desirable- Production can be managed without them
Or M/c can run but factor of safety, industrial formalities
can’t be satisfied (e.g. - wearing ear protection aid)

Factors to be reckoned for giving weightage during VED classification -

1. Effect on Production : can it stop the work ?
2. Lead Time of Supply
3. Availability : Standard ready item or Customized design ?
4. Source of Supply : Local, Outstation, or Import
 HML Analysis

• Only Price or Item Rate is the criteria

Very simple method of classification (unlike ABC )
(High > Rs 1000/ pc., Medium = 100-999, Low < Rs.100/pc.)

• Good for making Storage & Security arrangement (to avoid

pilferage etc)

• Helps delegation of purchasing authority ( H items purchased

by Senior Managers)

• Frequent stock verification for H items

 Practical Inventory Management
(Production Items)

Step 1 : Guidelines are given by the top management such as - -

Max. permissible inventory (for the entire dept./ section) in
terms of …… Cr. Rs value and ……. Inv./Turnover ratio

Step 2 : Inventory levels (for each individual item) are fixed

based on –
– Consumption Pattern
– Procurement Lead Time (covering : Order Processing,
Mfg. Lead Time For Supplier, Delivery Time
– Shelf Life
– Criticality Nature of the items (VED)
 Inventory Sheets for a Fan Mfg. Company

DAILY PRODUCTION – 100 Fans Per Day

INVENTORY NORMS - A 4 – 6 Days
B 10 - 15 Days
C 20 - 30 Days

How would you design your

Inventory Management Sheet ?
 Inventory Review Sheet
ITE DESC B Std. Min. Max. Actual Stock +VE -VE Rema
M O RATE Inv. Inv. Stock Value Var. Var. rks
Cd. M Rs/Pc. Days Days QTY Rs. Qty. Qty.
(Qty.) (Qty.) (Rs). (Rs).
M101 MOTOR 1 100 4D 6D -
(A) (400) (600) 500 50000

B143 BLADE 3 10 20 D 30 D - 2000 Trptn

(C) (6000) (9000) 4000 40000 20000 Pro
O432 OUTER 1 50 1000 1500 200 -
BODY (10) (15) 1700 85000 10000
(B)
C673 CAPS 2 5 4000 6000 - -
(C) (20) (30) 4100 20500

R950 ROD (C) 1 10 2000 3000 100 -

(20) (30) 3100 31000 1000
2.265
1.90 L 2.85 L + 11 K -20 K
L
 Ex. 5 : Purchasing at diff. Rate & Diff. Pack size
Ram Trading is a firm dealing in an item, whose annual
requirement is fairly uniform @ 1800 pieces. They have a choice
to buy from any one manufacturers : Laxman or Bharat who are
equally reputed for quality and delivery.

Their rates are : Laxman - Rs 5 / pc, whereas Bharat Rs. 7/-. both
have offered instant deliveries, but the pack-size order
quantities stipulated are 1300 and 1000 pcs. resp. The ordering
cost is Rs 600/- per order. The inventory carrying cost is 30
percent per year.

To whom would you give the annual order and why?

 Ex. 6 - Buying with Discount
A toy shop buys from a toy manufacturer, and sells annually 5000
pcs. of a toy-car model. For a new model, the manufacturer has
offered a bulk purchase discount scheme as given below.
Order Quantity Price per toy car-
1-999 5.00

1000-1999 4.80
2000 and above 4.60

The ordering cost is Rs. 49 per order. The inventory carrying

cost per year is estimated to be 20%.

Suggest – what is the best order quantity to be selected by the

shop-keeper, based on his over-all cost for the year.
 Work-sheet
Price Ideal Nearest Ordering Cost Inv. Carrying Material Total Cost
Rs. EOQ Possible Cost Cost for the
EOQ whole
year

Rs 5 700 700 (5000 / 700 x 0.5 x 5 5000 x 5 25700

each 700) x 49 x 2 % = 350 = 25000
= 350

Rs 4.80 715 1000 (5000 / 1000 x 0.5 x 5000 x

each 1000) x 49 4.80 x 0.2 4.8 =
= 245 = ….. ……. …….

Rs 4.60 730 2000 (5000 / 2000 x .5 x 5000 x

each 2000) x 49 4.6 x 0.2 4.6
= 122.50 = …….. =23000 ---------