6 Inventory Control

Industrial Pharmacy 165
PRODUCTION PLANNING AND

INVENTORY CONTROL
Learning Objectives
1. Discuss different categories of inventory in the
production process
2. Discuss the importance of inventory and the
strategies in inventory management
3. Calculate EOQ, safety stock, and reorder point
4. Perform ABC analysis as a tool for inventory
management
Inventory Control?
Inventory Control
Inventory
available balance
What is Inventory?
Inventory
list of items (what, how many)  currently existing
any stock of economic resource stored for future use
“stored capacity”
the resource can be held in stock with the intent of selling it or
converting the stock into a form that has greater value.
“selling it”  finished products

“converting the stock” raw material
What is Inventory?
Ordinary personnel • could just be items sitting around
the warehouse
Finance Department • could be an asset in the balance sheet

• could be cost/money tied up already
to goods or raw material
Sales and Marketing • could be items which are

opportunity to make profit
Department
What is Inventory?
Production planning
Inventory is can be treated as a symptom of how the
business is doing
the way the business is designed and managed can be

reflected by the presence and quantity of inventory
 Understand why inventory is there (or missing)

 How to manage it
Types of Inventory (Production)
Classification of Inventory
1. Source of Demand
2. Position of the Inventory in
the Process
3. Function or Use of Inventory
1. Source of Demand
a. Independent demand inventory
b. Dependent demand inventory
1. Source of Demand
Source of this demand inventory is outside the
company, external to any actions or decisions of
the firm
1. Source of Demand
Example: finished products
Driven by the customers’ orders
1. Source of Demand
Source of this demand inventory is directly
dependent on company’s internal decisions
1. Source of Demand
Example: Component parts of the final product
The company decides on the quantity (how
much to order) and the time to use or keep the
component parts as inventory
2. Position of the Inventory in the Process
a. Raw Materials
b. Work in Process
c. Finished Goods
d. Maintenance, repair and operations
a. Raw Materials
represent inventory that has been purchased for
use in the production process, but have no added
value yet
b. Work in Process
represent inventory that has had some value added,
but still has additional processing to be completed
before it can be used to meet customer demand
c. Finished Goods
represent inventory that has completed all the
processing. It is generally ready to be used to
meet the customer demand.
d. Maintenance, repair and operations
material used to support the company’s
business and production processes, but
typically will never be directly sold to a
customer.
a. Cycle inventory
b. Buffer inventory
c. Anticipation inventory
d. Decoupling inventory
e. Transit inventory
a. Cycle inventory
inventory that exists because for any time period,
the rate of replenishment exceeds the demand
often a situation caused by order costs, setup costs

and packaging considerations
a. Cycle inventory
Example:
• Average sales of ballpen per day is 10 pcs
• When you order replenishment stocks of ballpen from
the supplier, the MOQ is 500 pcs
a. Cycle inventory
Example:
• Assuming no old stock was left when the 500 pcs were
delivered, you have 500 pcs. Then the next day 490 pcs, then
the next day 480 pcs, and so on.
• The number of ballpens left from the shipment of 500 pens day
after day until it is consumed, is the cycle inventory
b. Buffer inventory
aka safety stock, exists “just in case”
Built up on purpose in anticipation of some
demand in excess of the usual production
output
Example: seasonal products
Ham for Christmas
- October  almost out of stock
- There is anticipated increase sales on December 
produce more during November until Christmas
d. Decoupling Inventory
Inventory that is purposely placed between
operations to allow them to operate
independently from one another
Example: filling machine (A)  labelling (B)
Process A Process B
90 units/hour 110 units/hour
Example: filling machine  labelling
Process A Process B
90 units/hour 110 units/hour
Inventory
(Process A)
e. Transit Inventory
Inventory in motion from one activity to

another.
Production Planning Team
Inventory is a sign or a symptom

of how well (or how bad) the
business is doing.
Inventory Control
determines the optimum
amount of materials
needed in stock to
continuously supply the
needs of the products to
be manufactured.
Inventory Control
maintenance of accurate and
timely on- hand inventory of
items needed to support the
manufacture of goods or the
delivery of the required
services demanded by the
customer
Economic Order Quantity (EOQ)
Basic inventory lot sizing model Quantity with least cost =
EOQ
EOQ attempts to balance the

no
cost of having inventory inventory
against the costs of not (cost) with
inventory
having the inventory, with (cost)
the overall objective to
minimize total cost.
Additional costs of not having Additional cost of having
inventory inventory
• Stockouts • Storage
• Excessive setups • Insurance and taxes
• Backorder costs • Cost of capital
• Expediting costs • Obsolescence
• Spoilage
• Production rate problems • Cost of tracking inventory
• Poor facility utilization • Shrinkage
Ordering cost Holding cost

• The cost of making a • the cost incurred of the
purchase order from an material while it stays in
outside source the company
• Aka setup cost if the • Usually expressed as %
material is manufactured per year of the actual cost
by the firm of the item
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝑎𝑎 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 = 𝐷𝐷𝐷𝐷 + ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 + 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐
D = annual demand
C = cost per item
Least quantity with least cost
= EOQ
Cost (PhP) Total Cost
Holding cost
Ordering cost
Quantity (Q)
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 = 𝐷𝐷𝐷𝐷 + ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 + 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐
𝑄𝑄 𝐷𝐷
ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 𝐻𝐻 o𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 𝑆𝑆
2 𝑄𝑄
• D = annual demand
• C = cost per item
• Q = order quantity per order
• H = holding cost per year
• S = order cost
𝑄𝑄 𝐷𝐷
ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 𝐻𝐻 o𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 𝑆𝑆
2 𝑄𝑄
𝑄𝑄 𝐷𝐷
𝐻𝐻 = 𝑆𝑆
2 𝑄𝑄
2𝐷𝐷𝐷𝐷
𝐸𝐸𝐸𝐸𝐸𝐸 =
𝐻𝐻
Example:
Item A has an average annual demand of 2600 units,
with a standard deviation of 6 units per week. The
supplier quotes them a lead time of 3 weeks to replenish
the stock of item A with a unit price of 12 PhP. Order of
item A costs the company a total of 40 PhP every year.
The estimated annual cost of holding inventory is 20%
of the item cost. What is the EOQ of item A?
Assumptions of EOQ Model
• Demand is constant and uniform
• Inventory is depleted at a constant rate
• Lead time is constant
• Price per unit is constant
• Ordering and setup costs are constant
• No backorders are allowed
Safety stock
Safety stock = “just in case” inventory
you don’t want poor customer service
Safety stock =
(z score of the required customer service level)*
(SD of the demand)*( Lead time )
Safety stock
Safety stock =
(z score of the required customer service level)*
(SD of the demand)*( Lead time )
Required Customer Service Level

90%  z = 1.29
95%  z = 1.65
99%  z = 2.33
Example:
of the item cost. What should be the safety stock level
assuming 95% customer service?
Reorder Point and Replenishment Lead Time
MRP - planned order release is based on lead time and
safety stock
Reorder point – planned order release is based on

certain amount of inventory
Reorder point = (average demand)(lead time)

Example:
of the item cost. What is the reorder point of item A?
Inventory Control
 Quantity and holding time
• Location – ease of tracking

• Priority of control/checking
Inventory Control
 Location Approaches for Stockrooms and Warehouses
1. Homebase
2. Random
3. Zoned random
Inventory Control
1. Homebase
Each item has its own distinctive location, and that the
item is always stored in just that location.
The location is, therefore, dedicated to that specific
item, and must not be changed.
Inventory Control
2. Random
The item is placed in whatever location is available
(open space) anywhere in the storage area.
Inventory Control
3. Zoned random
Hybrid of homebase and random approach
Identify a ‘zone’ where items belonging to some defined
class of goods (often commodity-based) will all be
stored.
Inventory Control
 Quantity and holding time

 Location – ease of tracking
• Priority of control/checking
Inventory  existing
Priority of control/checking
Inventory  existing
Item A
strictest
Cost = 1000 PhP/piece
inventory policy
Item B
Cost = 1 PhP/piece
Item C
Cost = 50 PhP/piece
INVENTORY CONTROL – ABC Analysis
Inventory Classification of Materials
Classification:
ABC Analysis
Value in terms of annual consumption
HML
Classification ABC – letter designation of items
VED A – high value
Classification C – low value
SDE
Classification
FSN Analysis
INVENTORY CONTROL - Techniques

ABC Analysis
HML Classification:
Classification Value in terms of unit price
VED
Classification H – high
SDE M – medium
Classification L – low
FSN Analysis

ABC Analysis
HML
Classification
VED Classification:
Classification Criticality in production/process
SDE
Classification V –vital
E –essential
FSN Analysis D –desirable

ABC Analysis
HML
Classification
VED
Classification
SDE Classification:
Classification Availability
FSN Analysis S – scarce, D – difficult, E – easy

ABC Analysis
HML
Classification
VED Classification:
Classification Pattern of usage/movement
SDE
Classification F – fast-moving
S – slow-moving
FSN Analysis
N – non-moving

Classification: Value in terms of annual
ABC Analysis
consumption/cost
HML ABC – letter designation of items
Classification A – highest value
VED C – lowest value
Classification Annual consumption value of items
SDE determines their priority level in the inventory
Classification control process
FSN Analysis based on the Pareto principle:
80/20 rule

ABC Analysis
List of materials Demand from
(Item code) Cost of material previous year
Item Unit Cost Annual Demand

X1 55 528000
X2 121 22000
X3 165 3300
X4 88 8800
X5 77 52800
X6 176 13200
X7 220 198000
X8 44 3300
X9 99 55000
X10 132 5500

ABC Analysis
(1) Annual Consumption Value = item unit cost x annual requirement
Annual Consumption
Item Unit Cost Annual Demand Value
X1 55 528000 29,040,000
X2 121 22000 2,662,000
X3 165 3300 544,500
X4 88 8800 774,400
X5 77 52800 4,065,600
X6 176 13200 2,323,200
X7 220 198000 43,560,000
X8 44 3300 145,200
X9 99 55000 5,445,000
X10 132 5500 726,000
Total: 89,285,900
ABC Analysis
List of materials Demand from
(Item code) Cost of material previous year
Item Unit Cost Annual Demand

X1 55 528000
X2 121 22000
X3 165 3300
X4 88 8800
X5 77 52800
X6 176 13200
X7 220 198000
X8 44 3300
X9 99 55000
X10 132 5500

ABC Analysis
(1) Annual Consumption Value = item unit cost x annual requirement
Annual Consumption
Item Unit Cost Annual Demand Value
X1 55 528000 29,040,000
X2 121 22000 2,662,000
X3 165 3300 544,500
X4 88 8800 774,400
X5 77 52800 4,065,600
X6 176 13200 2,323,200
X7 220 198000 43,560,000
X8 44 3300 145,200
X9 99 55000 5,445,000
X10 132 5500 726,000
Total: 89,285,900
(2) Compute for %Annual Consumption Value
Item Unit Cost Annual Demand Annual Consumption Value % Annual Consumption Value
X1 55 528000 29,040,000 32.52
X2 121 22000 2,662,000 2.98
X3 165 3300 544,500 0.61
X4 88 8800 774,400 0.87
X5 77 52800 4,065,600 4.55
X6 176 13200 2,323,200 2.60
X7 220 198000 43,560,000 48.79
X8 44 3300 145,200 0.16
X9 99 55000 5,445,000 6.10
X10 132 5500 726,000 0.81
Total: 89,285,900 100.00%

(3) Arrange (2) from highest to lowest
(4) Get the Cumulative % Annual Consumption Value
Annual
Consumption Cumulative of
Item Unit Cost Annual Demand Value (ACV) % ACV %ACV
X7 220 198000 43560000 48.78 48.78
X1 55 528000 29040000 32.52 81.31
X9 99 55000 5445000 6.09 87.41
X5 77 52800 4065600 4.55 91.96
X2 121 22000 2662000 2.98 94.94
X6 176 13200 2323200 2.60 97.54
X4 88 8800 774400 0.86 98.41
X10 132 5500 726000 0.81 99.22
X3 165 3300 544500 0.60 99.83
X8 44 3300 145200 0.16 100
Total: 89,285,900
based on the Pareto principle: 80/20 rule
Annual Consumption Value

Annual
Annual Consumption Cumulative of
Item Unit Cost Demand Value (ACV) % ACV %ACV
X7 220 198000 43560000 48.78 48.78
X1 55 528000 29040000 32.52 81.31
X9 99 55000 5445000 6.09 87.41
X5 77 52800 4065600 4.55 91.96
X2 121 22000 2662000 2.98 94.94
X6 176 13200 2323200 2.60 97.54
X4 88 8800 774400 0.86 98.41
X10 132 5500 726000 0.81 99.22
X3 165 3300 544500 0.60 99.83
X8 44 3300 145200 0.16 100
Total: 89,285,900
based on the Pareto principle: 80/20 rule
% no of items responsible for the 80%

Annual Consumption Value
Annual
Cumulative of Consumption Cumulative of
Item % of items %items Value (ACV) % ACV %ACV
X7 10 10 43560000 48.78 48.78
X1 10 20 29040000 32.52 81.31
X9 10 30 5445000 6.09 87.41
X5 10 40 4065600 4.55 91.96
X2 10 50 2662000 2.98 94.94
X6 10 60 2323200 2.60 97.54
X4 10 70 774400 0.86 98.41
X10 10 80 726000 0.81 99.22
X3 10 90 544500 0.60 99.83
X8 10 100 145200 0.16 100
Total: 89,285,900
Cumulative Cumulative
Item %items %ACV Class % Items %value
X7 10 48.78 A 20 X7, X1 81.31%
X1 20 81.31
X9 30 87.41
B 30 X9, X5, 13.63%
X5 40 91.96 X2
X2 50 94.94 C 50 X6 5.06%
X6 60 97.54 X4,X10,
X4 70 98.41
X3,X8
X10 80 99.22
X3 90 99.83
Class % items %value
X8 100 100
A 5-20% 70-80%
B 10-25% 10-20%
C 50-70% 10-20%
110
100
90
Cumulative % Value
80
70
60
50 A B C
40
30
20
10
0
0 10 20 30 40 50 60 70 80 90 100 110
Cumulative % Items

6 Inventory Control

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Industrial Pharmacy 165

PRODUCTION PLANNING AND

“selling it”  finished products

Finance Department • could be an asset in the balance sheet

Sales and Marketing • could be items which are

the way the business is designed and managed can be

 Understand why inventory is there (or missing)

often a situation caused by order costs, setup costs

Inventory in motion from one activity to

Inventory is a sign or a symptom

EOQ attempts to balance the

Ordering cost Holding cost

Required Customer Service Level

Reorder point – planned order release is based on

Reorder point = (average demand)(lead time)

 Quantity and holding time

• Location – ease of tracking

 Quantity and holding time

INVENTORY CONTROL - Techniques

INVENTORY CONTROL - Techniques

INVENTORY CONTROL - Techniques

INVENTORY CONTROL - Techniques

INVENTORY CONTROL - Techniques

INVENTORY CONTROL – ABC Analysis

Item Unit Cost Annual Demand

INVENTORY CONTROL – ABC Analysis

Item Unit Cost Annual Demand

INVENTORY CONTROL – ABC Analysis

INVENTORY CONTROL – ABC Analysis

Annual Consumption Value

% no of items responsible for the 80%

INVENTORY CONTROL – ABC Analysis

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