 Define inventory management

 List out components of inventory

 Highlight costs, and benefits of holding inventory

 Explain the techniques of inventory management

 Just in time inventory

 Stocks of manufactured products and the material
that make up the product.

 Components:
 Raw Materials
 Work-In-Process/ Semi Finished Goods
 Finished Goods
Consists of two counterbalancing parts:

● To minimise investment in inventory

● To meet the demand for products

That is, to have a trade off in terms of costs and

benefits
Two categories:

i. ORDERING/ ACQUISITION/ SET UP COSTS

Fixed costs of placing and receiving an inventory

order

It includes:

 Preparing purchase order

 Receiving, inspecting and recording of goods
received
ii. CARRYING COSTS

Variable cost per unit of holding an item in inventory

It includes:
 Cost due to storing of inventory such as
 Storage cost
 Insurance of inventory
 Deterioration of inventory
 Serving cost
 Opportunity cost of funds

iii. TOTAL COSTS

Sum of ordering cost and carrying cost of inventory

The major benefits are in the area of:

i. Purchasing
ii. Production and
iii. Sales

 Inventory acts as a buffer to decouple or uncouple the

various activities

 It enables firms in the short run to

 Produce at a rate greater than the purchasing of RM
 Sell at a rate greater than the production and vice
versa
Major problem areas are:

i. The classification problem-

ABC Analysis
ii. The order quantity problem-
Economic Order Quantity (EOQ)
iii. The order point problem-
Reorder Point
iv. Safety Stock
Classify inventory into three categories according to value/
money investment as
GROUP A
Investment in inventory largest
Inventory control Most rigorous and intensive
Control techniques Most Sophisticated

GROUP C
Investment in inventory Relatively small than A
Number of items Large
Attention required Minimum
 GROUP B
Stands midway between A and C categories
Deserves less attention than A but more than C

INVENTORY BREAKDOWN
Group No. of items (%) Inventory Value (%)
A 15 70
B 30 20
C 55 10
Total 100 100
EOQ Model: Technique
for determining the
optimum order quantity
that minimises the total of
its
 Ordering cost and
 Carrying costs

That is, it is the trade off

between the ordering and
carrying costs.
 ASSUMPTIONS FOR EOQ MODEL:
 Annual usage of inventory is known with certainty
 The rate of inventory usage is steady over time
 The orders placed are received at the time when
inventory reaches zero

Mathematically,

EOQ = √(2AB/C)

Where,
A = Annual usage of inventory (in units)
B = Buying cost per order/ ordering cost, and
C = Carrying cost per unit
Practice Problem 1

A firm’s inventory planning period is one year. Its inventory

requirement for this year is 1,600 units. Assume that its
acquisition costs are Rs. 50 per order. The carrying cost is
Rs. 1 per unit per year for an item. Determine the EOQ.

Solution

Annual usage, A = 1,600 units

Buying Cost, B = Rs. 50 per order
Carrying Cost, C = Rs. 1 per unit per year

EOQ = √(2AB/C) = √(2×1,600×50/1) = 400

EOQ = 400 units

“Level of inventory when fresh order should be placed”.

 Constant daily usage of inventory

 Fixed lead time

Lead Time: The time normally taken in receiving the

delivery after placing the order

Mathematically,
Reorder Point = Lead time in days × average daily
usage of inventory
Practice Problem 2

The average daily consumption of inventory of a firm is

5,000 units. The number of days required to receive the
delivery of inventory after placing the order is 15 days.
Determine the reorder point?

Solution

Reorder Point = Lead time in days × average daily usage

of inventory
= 15 × 5,000 = 75,000

Reorder Point = 75,000 units

That means the firm should place an order as soon as the
level of inventory reaches 75,000 units.
 “The minimum additional inventory to serve as a safety
margin/ buffer/ cushion to meet an unanticipated increase
in usage as a result of
 unusually high demand
 uncontrollable late receipt of incoming inventory”.

COSTS INVOLVED: two types

a. Stock Out
Associated with shortage (stock out) of inventory

b. Carrying Cost
Associated with the maintenance of inventory
DETERMINING THE SAFETY STOCK

By the trade off between stock out cost and carrying cost.

Total Cost
Cost

Carrying Cost

Stock Out Cost

● Safety Stock
“Acquiring materials and manufacturing goods only as
needed to fill customer orders”.

 It is also called lean production

 Is a demand pull manufacturing system

Practice Problem 3
A firm has 7 different items in its inventory. The average
number of each of these items held, along with their unit costs,
is listed below The firm wishes to introduce an ABC inventory
system. Suggest a breakdown of items into A, B and C
classifications.

Item No. Av. no. of units in Av. cost per unit (Rs.)
inventory
1 20,000 60.80
2 10,000 102.40
3 32,000 11.00
4 28,000 10.28
5 60,000 3.40
6 30,000 3.00
7 20,000 1.3
Answer

Category: A B C
Item: 1 and 2 3 and 4 5, 6 and 7