Inventory

Management

by
Joginder Grewal

10/8/2017 1
Inventory Definition
A stock of items held to meet future
demand
Inventory is a list for goods and
materials, or those goods and materials
themselves, held available in stock by a
business.

10/8/2017 2
 Introduction
The investment in inventory is very high in most of the
undertakings engaged manufacturing, whole-sale and
retail trade. The amount of investment is sometimes
more in inventory than in other assets. About 90
percent part of working capital invested in inventories.
It is necessary for every management to give proper
attention to inventory management. A proper planning
of purchasing , handling, storing and accounting
should from a part of inventory management. An
efficient system of inventory management will
determine (a) what to purchase (b) how much to
purchase (C ) from where to purchase (d) where to
store.
10/8/2017 3
 Types of Inventory

Work in
process

Vendors Raw Work in Finished Customer

Materials process goods
Work in
process

10/8/2017 4
 Nature of Inventories
Raw Materials Basic inputs that are converted into
finished product through the manufacturing process. The
purpose of holding raw material is to ensure
uninterrupted production in the event of delaying
delivery. The amount of raw materials to be kept by firm
depends on various factors such as speed with which
raw materials are to be ordered and procured and
uncertainty in supply of these materials.
Work-in-progress It includes partly finished goods
and materials held between manufacturing stages. It can
also be stated that those raw materials which are used
in production process but are not finally converted into
finished product are work-in-process.

10/8/2017 5
 Nature of Inventories
Finished Goods Completely manufactured
products ready for sale. It helps to reduce the
risk associated with stoppage in output on
account of strikes, breakdowns, shortage of
material, etc.
Supplies Office and plant cleaning materials
not directly enter production but are necessary
for production process and do not involve
significant investment.

10/8/2017 6
 Objective of Inventory Management
Availability of Materials: The first and foremost objective
of the inventory management to make all types of
materials available at all times whenever they are needed
by the production department so that the production may
not be held up for want of materials.
Minimizing the wastage: Inventory control is essential to
minimize the wastage at all levels i.e. during its storage in
the godowns or at work in the factory.
Better services to customers: In order to meet the
demand of the customers, it is responsibility of the concern
to produce sufficient stock of finished goods to execute the
orders received. It means, a flow of production should be
10/8/2017 7
maintained .
 Objective of Inventory Management
To maintain a optimum size of inventory for
efficient and smooth production and sales
operations
To maintain a minimum investment in inventories
to maximize the profitability
Effort should be made to place an order at the
right time with right source to acquire the right
quantity at the right price and right quality

10/8/2017 8
 An effective inventory management should
Ensure a continuous supply of raw materials to
facilitate uninterrupted production
Maintain sufficient stocks of raw materials in
periods of short supply and anticipate price
changes
Maintain sufficient finished goods inventory for
smooth sales operation, and efficient customer
service
Minimize the carrying cost and time
Control investment in inventories and keep it at an
optimum level
10/8/2017 9
 Costs Associated with Inventory
Ordering Cost: Ordering cost is incurred whenever
the inventory is replenished. It includes costs
associated with the processing and chasing of the
purchase order, transportation, inspection for quality
and so on. It is also known as the procurement cost.
Stock out cost: Stock out cost means the cost
associated with not serving customers. Stock out cost
imply shortage. If the stock out is internal (I.e., in the
production system) it would imply that some
production is lost, resulting in idle time for men and
machines, or that the work is delayed which might
attract some penalty. While if the stock out is external,
it10/8/2017
would result in loss of potential sales and/or loss 10of
customer goodwill.
 Costs Associated with Inventory
Carrying Cost: Also known as the holding cost or the
storage cost, carrying cost represents the cost that is
associated with storing an item in inventory. It is
proportional to the amount of inventory and the time
over which it is held. The elements of carrying cost
include the opportunity cost of capital invested in the
stock; the cost directly associated with storing goods
(like store men's salary, handling, insurance, lighting,
protective clothing etc.) deterioration costs and costs
incurred in preventing deteriorations; and fire and
general insurance etc.

10/8/2017 11
 An optimum inventory level involves three
types of costs
Ordering costs:- Carrying costs:-
Quotation or tendering Warehousing or storage

Requisitioning Handling

Order placing Clerical and staff

Transportation Insurance

Receiving, inspecting and Interest

storing Deterioration,shrinkage,
Quality control evaporation and
Clerical and staff obsolescence
Stock-out cost Taxes

Loss of sale Cost of capital

Failure to meet delivery

commitments
10/8/2017 12
Dangers of Over investment
Unnecessary tie-up of firms fund and loss of
profit involves opportunity cost
Excessive carrying cost
Risk of liquidity- difficult to convert into cash
Physical deterioration of inventories while in
storage due to mishandling and improper
storage facilities

10/8/2017 13
Reasons To Hold Inventory
Meet variations in customer demand:
Meet unexpected demand
Smooth seasonal or cyclical demand
Pricing related:
Temporary price discounts
Hedge against price increases
Take advantage of quantity discounts
Process & supply surprises
Internal upsets in parts of or our own processes
External delays in incoming goods

10/8/2017 14
 Factors Affecting Inventory Management
1.Characteristics of the Management System: The natures of the
production process, the product design, and production planning and
plant layout have significant affect on inventory policy.
i) Degree of Specialization and Differentiation of the products at
Various Stages: The degree of changes in the nature of the product
from raw material to final product at various stages of transformation
viz. Final assembly, assembly and packaging determines the nature
of inventory control operation, for example, if nature of product
remains more or less same at various stages of production then
economics can be achieved by keeping the right balance of stock of
semi finished product.
ii) Process Capability and Flexibility: Process capability is
characterized by processing time of various operations, e.g., the
replenishment lead time (length of delay in execution after issuance
of a replenishment order) directly influence the size of inventory.
10/8/2017 15
 Factors Affecting Inventory Management
Similarly how rapidly and economically a system can adjust its
production rate, shift production facilities from one operation to
another and change equipment from one product to another,
determines the magnitude of flexibility. Inventory policy should
aim towards balancing the production flexibility, capability,
inventory levels and customer service needs.
iii) Production Capacity and Storage Facility: The capacity of
production system as well as the nature of storage facilities
considerably affects the inventory policy of an organization
,e.g., capacity for heating oil production in an oil refinery is
governed in part by its distribution system. Similarly if for any
product the cost of facility is high it sets a limit on the storage
capacity.
10/8/2017 16
 Factors Affecting Inventory Management
iv)Quality Requirements: Quality is the performance of the product as
per the commitment made by producer to the customer . It is the
degree of excellence at an acceptable price and the control of
variability at an acceptable cost. The qualities required for various
factors are quality of material, manpower, machine and management.
The quality requirements of material directly affect the inventory
decision.
V) Nature of the Production System: It is characterized by the number
of manufacturing stages and the inter relationship between various
production operations, e.g., in product-line system inventory control is
simpler than in Job-type system. Similarly when there are many
operational stages then the inventory control system must provide
smooth adjustment of early operating stages and inventories to
fluctuations in finished stock.
10/8/2017 17
 Factors Affecting Inventory Management

2) Amount of Protection against Storages: There is always

variation in demand and supply of product. The protection
against such unpredictable variations can be done by means of
buffer stocks.
i) Changes in Size and Frequency of Orders: The amount of
product sold in large number of orders of small size can be
operated with fewer inventories.
Unpredictability of Sales: If there too many fluctuations in
demand of product then these cab be held only by flexible and
large capacity of inventory operations.

10/8/2017 18
 Factors Affecting Inventory Management

iii) Physical and Economic Structure of Distribution Pattern: Longer

the channel of distribution the more is the inventory requirement.
Field inventories basically improve service to retailers by removing
some of the burden of keeping stocks.
iv) Costs Associated with Failure to Meet Demands: When there is
heavy penalty on any delay in fulfillment of any order then inventory
should be large.
V) Accuracy, Frequency and Detail of Demand Forecasts:
Fluctuations in stock exist when forecasts are not exact. The
responsibility of forecast errors for inventory needs should be clearly
recognized.
vi) Breakdown: Protection against breakdown or other interruptions in
production.
10/8/2017 19
 Factors Affecting Inventory Management

3) Organizational Factors: There are certain factors, which are

related to the policies, traditions and environment of any enterprise.
i) Labour relation policies of the organization.
ii) Amount of capital available for stock.
iii) Rate of return on capital available if invested elsewhere.
4) Other Factors: These are related to the overall business
environment of the region, viz.:
i) Inflation.
ii) Strike situation in communication facilities.
iii) Wars or some other natural calamities like famines, floods etc.
iv) Difference between input and output.

10/8/2017 20
 Inventory Control

Inventory control is the means by which materials of the correct

quality and in correct quantity are made available as and when
required with due regard to economy in storage and ordering
costs, purchase prices and working capitals. In other words it is the
technique of maintaining the size of the inventory at some desired
level keeping in mind the best economic interests of production
system. The desired level can neither be much higher nor much low
because high level of inventory will lead to increase in carrying cost
while low level of inventory will lead to increase in ordering cost.
L.V. Fine defines Inventory control as the planning and scheduling
of materials used in the manufacturing process. It is possible to
exercise control over the three types of inventories recognized by
the accountant as raw-material, work-in-process and finished
goods.
10/8/2017 21
 Scope of Inventory Control

Determination of Inventory Policies

Determining Various Stock Levels
Determining Economic Order Size
Safety or Buffer Stock
Determining Lead Time
Examining the Work of Inventory Policy

10/8/2017 22
 Objectives of Inventory Control

To ensure smooth flow of stock.

To provide for required quality of materials.
To control investment in stock.
Protection against fluctuating demand.
Protection against fluctuations in outputs.
Minimization of risk and uncertainty.
Risk of obsolescence.
Minimization of material cost.

10/8/2017 23
 Functions of Inventory Control

To ensure timely availability of material.

Better use of financial resources.
Protecting the inventory from losses.
Provides protection against the uncertainties of demand and
supply.
Preparation of accurate material report.
Determination of results.
To minimize wastages and rate of deterioration.

10/8/2017 24
 Advantages of Inventory Management & Control
1. Inventory control ensured and adequate supply of materials
and stores minimizes stock-outs and shortages and avoids
costly interruptions in operations.
2. It keeps down investment in inventories, inventory carrying
costs and obsolescence losses to the minimum.
3. It facilitates purchasing economies through the measurement
of requirements on the basis of recorded experience.
4. It eliminates duplication in ordering or in replenishing stocks by
centralizing the source from which purchase requisitions
emanate.
5. It permits a better utilization of available stocks by facilitating
inter department transfers within a company.
10/8/2017 25
 Advantages of Inventory Management & Control
6. It provides a check against the loss of materials through
carelessness or pilferage.
7. It facilitates cost accounting activities by providing a means
for allocating material costs to products, departments for
other operating accounts.
8. It enables the management to make cost and consumption
comparisons between operations and periods.
9. It serves as a means for the location and disposition of
inactive and obsolete items of stores.
10. Perpetual inventory values provide a consistent and reliable
basis for operating financial statements.

10/8/2017 26
Functions of Inventory Management

-Track inventory
How much to order
When to order

10/8/2017 27
Inventory Control System
The inventory Control system have been classified as:
1)Periodic Inventory System: Periodic inventory system is a method of
ascertaining inventory by taking an actual physical count (or measure
or weight) of all the inventory items on hand at a particular date on
which information about inventory is required. The cost of goods sold
is calculated as a residual figure (which includes lost goods also) as
under:
1) Cost of Goods Sold = Opening Inventory + Purchasing-Closing Stock
In other words, periodic inventory system defined as the method of
recording inventory at the end of the accounting year after making
a physical verification of the quantity in hand. Under this system,
inventory is ascertained by the physically counting the stock at
the end of the year. All the items of inventory are weighted,
measured or counted, then listed and priced so as to get the
valuation of inventory on that date, Thus, inventory is valued by
means of annual stock taking.
10/8/2017 28
Inventory Control System
2) Perpetual Inventory System: Perpetual inventory system
is a method of recording the store balance after every
receipt and issue, to facilitate a regular checking and to
prevent the closing down for stocktaking. After every
receipt or issue, the entry is made in the bin card and
the balance is adjusted. Thus, the bin card becomes a
perpetual inventory record and the store balance is
recorded continuously after every receipt and issue. All
errors detected are adjusted both in the in card as well
as in the stores ledger under proper authority.

10/8/2017 29
Classification of inventory

ABC Classification
EOQ Classification
FIFO Classification
VED Classification
LIFO Classification
ABC Classification

In most of the cases 10 to 20 % of the

inventory account for 70 to 80% of the annual
activity.
A typical manufacturing operation shows that
the top 15% of the line items, in terms of
A
annual rupees usage, represent 80% of total
annual rupees usage.

rupees B
Next 15% of items reflect 15% of annual

Next 70% accounts only for 5% usage

C
Assumption of EOQ
This model is based on the following assumption:
1) The demand for the item in certain, continuous and
constant over time.
2) The lead-time, that is, the time between placing on order
and its delivery, is known and fixed. Thus when the lead-
time is zero, the delivery of item is instantaneous.
3) Within in the range of the quantities to be ordered, the
per-unit holding cost and the ordering cost (per order)
are constant and thus independent of the quantity
ordered.
4) The purchase price of the item is constant, that is, to
say, no discount is available on purchase on purchase of
large lots.
10/8/2017 32
Weakness of EOQ
1) Erratic Usage: The formulae we have used assume that
the usage of materials is both predictable and evenly
distributed. When this is not the case, the formulae are
useless. Different and far more complex formulae can be
developed for wide swings in usage, so long as these
swings can be predicted. But if usage varies
unpredictably, as it often does, no formula will work well.
2) Faulty Basic Information: EOQ calculations are only as
accurate as the order cost and carrying cost information
in which they are based. It is no easy job to calculate
order cost . In practice, order cost varies from
commodity to commodity. Carrying cost can very with
the companys opportunity cost of capital.
10/8/2017 33
Weakness of EOQ
3) Costly Calculations: It is not easy job to estimate the cost of
acquisition and cost of possession accurately. This requires hours
of work by skilled cost accountants. Actual calculation of EOQ can
be time-consuming even when the simple formulae for steady
usage are used.
4) No Formula Substitute for Commonsense: It is therefore, desirable
to include a number of modifiers. The formula may suggest that, we
order six years supply, based on the assumption that we will
continue to require the Item at the same rate for the next six years.
The modifier is a maximum , limit, not more than one years supply
or two years supply perhaps.
5) 5) EOQ Ordering must be Tempered with Judgment: Certain
corporate operating goals must be followed in managing an
inventory. Sometimes, the guidelines provide a conflicts with an
operating goals, order strategy restrictions should be developed to
permit honouring the goal.
10/8/2017 34
10/8/2017 35
10/8/2017 36
10/8/2017 37
VED Classification

Mainly for spare parts because their

consumption pattern is different from raw
materials.
Therefore V items has to be stocked more
Raw materials on market demand
and D Items has to be less stocked
Spare parts on performance of plant and
machinery.
V Vital, E Essential, D Desirable
Basic EOQ Model

Assumption
Seasonal fluctuation in demand are ruled out

Zero lead time Time lapsed between purchase

order and inventory usage
Cost of placing an order and receiving are same
and independent of the units ordered
Annual cost of carrying the inventory is constant

Total inventory cost = Ordering cost + carrying

cost
EOQ Three Approaches

Trial
and Error method
Order-formula approach

Graphical approach

10/8/2017 40
EOQ & Re-order point

EOQ gives answer to

question How much to Order
Re-order point gives answer
to question when to order

10/8/2017 41
 Trial & Error Method
Assumptions:-
Annual requirement (C)=1200 units
Carrying cost (I) = Rs.1
Ordering cost (O) =Rs.37.5

Order size Q 1200 600 400 300 240 200 150 120 100

Average inventory Q/2 600 300 200 150 120 100 75 60 50

No. of orders C/Q 1 2 3 4 5 6 8 10 12

Annual carrying cost 600 300 200 150 120 100 75 60 50

I* Q/2
Annual ordering cost 37.5 75 112.5 150 187.5 225 300 375 450
O*C/Q
Total annual cost 637.5 375 312.5 300 307.5 325 375 435 500

10/8/2017 42
 Order- Formula approach
1/2
EOQ =(2CO/I)
C = Annual demand
O = Ordering cost per order
I = Carrying cost per unit
1/2
EOQ =(2*1200*37.5/1) = 300 units

10/8/2017 43
Graphical method to find EOQ
Cost in RS.

0 EOQ
Order quantity
THANK YOU