Inventory Management and Control

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Working Capital Management

Cash

Debtors

Creditors

Inventory

Raw Materials

Unfinished Goods
(WIP)

Inventory
Stores & Spares
(Supplies)

Finished Goods

Why Inventory Management?

Conflicting views w.r.t. appropriate inventory
level:

Finance: less costs

Production: higher stock of raw materials
Marketing: higher stock of finished products
Purchasing/Stores: minimum no. of orders

Our job: to reconcile them

Effective cash management
Minimum costs high inventory turnover optimal level of
stock no effect on production and sales demand

Twin Objectives
To minimize investment in inventory, and
To meet demand for the product(s)
Efficient organization of production and sales
operations

How: CBA
Costs-Benefits Analysis: Trade-off
Smaller the inventory, lower the costs;
Higher the inventory, smoother the operations.

Costs
Ordering/acquisition costs
Carrying costs
Arising due to inventory
storage
Opportunity costs of
funds

Benefits
Uninterrupted and
independent operation:
Purchasing
Production
Selling

Long-term vs. Short-term

Long-term goal:
Purchase and production processes should depend on sales.

Short-term goal:
The processes should be independent, almost!

Examples:
Seasonal production vs. level production issue in Toy
World, Inc.
Oswal Knitwears: Production and sales of woolen clothes;
highly seasonal.

Issues in Inventory Managements

Determination of control required
Classification problem: ABC System

The order quantity problem

Economic Order Quantity (EOQ),

The order point problem

Re-order level,

Safety stocks

Inventory Control: ABC System

Inventory divided into three categories
Based on rupee investment in each
Caution: An inexpensive item may be critical for production process.

A
The costliest items
Slowest turning
Highest control
Most sophisticated
techniques
Least wastage

Moderate
investments
Manageable control
Little wastage
affordable

The least expensive

items
Large no. of items
Minimum attention

ABC System

Illustrative Example 1: ABC Analysis

Mooca Furniture has 7 different items in its inventory
as follows (average number of each items with their
respective unit costs). The firm wishes to implement
ABC system of inventory management.
Item

Avg. No. of Units

Avg. Cost/Unit (Rs.)

20,000

60.80

10,000

102.40

32,000

11.00

28,000

10.28

60,000

3.40

30,000

3.00

20,000

1.30

ABC Analysis
Item

Units

% of total

Unit cost

Total cost (Rs.)

% of total

(1)

(2)

(3)

(4)

(2) X (4) = (5)

(6)

20,000

10

60.80

12,16,000

38.00

10,000

102.40

10,24,000

32.00

32,000

16

11.00

3,52,000

11.00

28,000

14

10.28

2,88,000

9.00

60,000

30

3.40

2,04,000

6.38

30,000

15

3.00

90,000

2.80

20,000

10

1.30

26,000

0.82

Total

2,00,000

100

32,00,000

100.00

1
5
30

55

70
20

10

EOQ: How Much to Order?

The optimal order quantity for a particular item of
inventory, given its forecast usage, ordering cost, and
carrying cost.
Ordering costs: requisitioning, order placing, transportation,
receiving, inspecting and storing, administration (constant).
Carrying costs: warehousing, handling, clerical and staff,
insurance, depreciation and obsolescence (varying).

Ordering can mean either the purchase of the item or its

production.

EOQ
EOQ =

2( )( )

Where,
O: ordering costs per order,
S: total usage (in units) of an item of inventory
C: carrying costs per unit

EOQ: Derivation
If usage of an inventory item is at a steady rate over a
period of time and there is no safety stock, average
inventory (in units) can be expressed as:
Average inventory = Q/2

Total inventory costs are the sum of the total carrying

costs plus total ordering costs:
Total inventory cost (T ) = C(Q/2) + O(S/Q)

Taking the first derivative of above equation with respect

to Q and setting the result equal to zero, we obtain:
dT/dQ = (C/2) O(S/Q2) = 0

Now, solving for Q, we get

O(S/Q2) = C/2
Q = 2(O)(S)/C = Q*

EOQ: Assumptions
Annual consumption of an item known with certainty,
The rate of usage of an inventory steady over time,
The order placed to replenish the stocks received at
exactly that point in time when inventory = 0.
Ordering and carrying costs constant.

EOQ

Illustrative Example 2: EOQ

The usage of an inventory item is 2,000 during a 100day planning period, ordering costs are $100 per
order, and carrying costs are $10 per unit per 100
days.
The EOQ amount, then, is: ??

EOQ =

2($100)(2,000)
$10

EOQ = 200 units

With an order quantity of 200 units, the firm would
order (2,000/200) = 10 times during the period under
consideration or, in other words, every 10 days.

Illustrative Example 3: EOQ

A firms inventory planning period is one year. Its
inventory requirement for the period is 1,600 units.
Assume that its acquisition costs are Rs. 50 per order.
The carrying costs are expected to be Re. 1 per unit per
year for an item.
The firm can produce inventories in various lots as
follows:

1,600 units
800 units
400 units
200 units
100 units

Which of these order quantities is the EOQ?

(1)
Size of
order (units)

(2)

(3)

(4)

(5)

(6)

1,600

800

400

200

100

16

Cost per
order (Rs.)

50

50

50

50

50

Total
ordering
costs (Rs.)

50

100

200

400

800

Carrying
cost per
unit (Rs.)

Avg.
inventory
(Units)

800

400

200

100

50

Total
carrying
costs (Rs.)

800

400

200

100

50

Total costs

850

500

400

500

850

No. of
orders

Illustrative Example 4: EOQ

Vostick Filter Company is a distributor of air filters to retail stores.

It buys its filters from several manufacturers. Filters are ordered in
lot sizes of 1,000, and each order costs $40 to place. Demand from
retail stores is 20,000 filters per month, and carrying cost is $0.10 a
filter per month.
1.

What is the optimal order quantity with respect to so many lot sizes
(that is, what multiple of 1,000 units should be ordered)?

2.

What would be the optimal order quantity if the carrying cost were
cut in half to $0.05 a filter per month?

3.

What would be the optimal order quantity if ordering costs were

reduced to $10 per order?

Inference: Illus. Ex. 4

The lower the carrying costs, the more important
ordering costs become relatively, the larger the optimal
order size;
The lower the ordering size, the more important carrying
costs become relatively, the smaller the optimal order
size.

Illustrative Example 5: EOQ

A college bookstore is attempting to determine the optimal order

quantity for a popular book on psychology. The store sells 5,000
copies of this book a year at a retail price of $12.50, and the cost to
the store is 20 percent less, which represents the discount from the
publisher. The store figures that it costs $1 per year to carry a book
in inventory and $100 to prepare an order for new books.
Determine the total inventory costs associated with ordering 1, 2, 5, 10,
and 20 times a year.
Determine the economic order quantity.

Illustrative Example 6: EOQ

The Hedge Corporation manufactures only one product: planks. The

single raw material used in making planks is the dint. For each
plank manufactured, 12 dints are required. Assume that the
company manufactures 150,000 planks per year, that demand for
planks is perfectly steady throughout the year, that it costs $200
each time dints are ordered, and that carrying costs are $8 per dint
per year.
Determine the economic order quantity of dints.
What are total inventory costs for Hedge (total carrying costs plus total ordering
costs)?
How many times per year would inventory be ordered?

Order Point: When to Order?

In addition to knowing how much to order, the
firm also needs to know when to order.
The quantity to which inventory must fall in order to
signal a reorder of the EOQ amount

Earlier assumed that inventory can be ordered

and received without delay.
Time lapse between placement of a purchase order
and receipt of the inventory, or in the time it takes to
manufacture an item after an order is placed.
This lead time must be considered.

Re-order Point: Certainty

Order point (OP) = Lead time Daily usage

 EOQ: 200 units

Order frequency: 10 days
Lead time: 0 day (assumed)
Daily usage: 20 units
Now, revise the assumption that 5 day lead period is
required before it runs out of stock:
The Order Point = 5 days x 20 units = 100 units

Order Point
Units
200

EOQ
100

10
Lead time

20

Days

Re-order Point: Uncertainty

Reorder point = (Lead time x average usage) + safety stock

Other Inventory Control System

Just-in-Time (JIT) Systems
Out-sourcing
IT/ITeS firms providing inventory management services

Computerized Inventory Control System

Sophisticated software, e.g. PosMaid, inFlow, BS1
Help run lean operations
Strengthen vendor relationship
Forecast with confidence
Timely information and insights

Inventory Management: Analysis

Estimation of incremental operating profit
Estimation of incremental investment in inventory
Estimation of the incremental rate of return (IRR)
Comparison of the incremental rate of return with the
required rate of return (RRR)
Optimum inventory:
IRR = RRR

Inventory Management: Process

Explicitly state the inventory policy
Create an inventory monitoring cell
Management group for controlling purchases
Periodic meetings between purchase, materials planning
and production executives
Monthly reviews of total inventory at plant/corporate
level
Dovetail inventory control to the total budgeting system
Identify critical inventory items for closer scrutiny

This is it!
Thank you very much!