Unit2

Inventory management

Dr. O.P. Mishra

 Syllabus
• Warehouse management systems Inventory
Control Definition: Types, Functions, Role,
Importance of inventory.
• Reasons for carrying inventories, Inventory
levels, Need for inventory control Stores,
Ledgers, Masters Stock List and Methods of
Pricing.
• Inventory carrying cost, Inventory holding cost,
Profitability, Modern trends in Inventory.
 What are Inventories?
Material Inbound Production Outbound Finished goods Customers
sources transportation transportation warehousing

Receiving
Production
materials

Inventories
in-process

Shipping
Finished goods

Inventory
locations
 Why inventories ?
• To ensure smooth production
• To provide quick customer service
• To facilitate production during lead time
• To facilitate a reasonable utilisation of labour
and equipment
• To enjoy the economies of large scale buying
• To enable efficient and economic operations
 Inventory levels
• Inventory level and sales rate of product will
be used by typical Invt. manager to determine
– the optimal time for producing more– for
manufacturer
– And order more if the product is being stored as
stock at retail store– for managing Warehouses.
 COST CONCEPTS of Inventory

• It is accounting of both the estimated and

actual cost of the product.
• These numbers are used for inventory
valuation and selling price considerations.
• Important method are
– ACTIVITY-BASED COSTING (ABC analysis)
– Cost management
 ABC
• ABC traces activities performed on the
products and reclassifies the costs by types of
work (activities), rather than by accounting
categories..
• An ABC system would collect the overhead
activities such as engineering, quality control,
production control, and supervision, and
charge their costs to the products rather than
to a department.
 Inventory
Inventory: a stock or store of goods Independent Demand

A Dependent Demand

B(4) C(2)

D(2) E(1) D(3) F(2)

Independent demand is uncertain.

Dependent demand is certain.
12-8
 Inventory Models
• Independent demand – finished goods, items
that are ready to be sold
– E.g. a computer
• Dependent demand – components of finished
products
– E.g. parts that make up the computer

12-9
 Types of Inventories

• Raw materials & purchased parts

• Partially completed goods called work in
progress
• Finished-goods inventories
– (manufacturing firms) or merchandise (retail stores)

• Replacement parts, tools, & supplies

• Goods-in-transit to warehouses or customers

12-10
 Functions of Inventory
• To meet anticipated demand
• To smooth production requirements
• To decouple operations
• To protect against stock-outs

• To take advantage of order cycles

• To help hedge against price increases
• To permit operations
• To take advantage of quantity discounts
12-11
 Objective of Inventory Control
• To achieve satisfactory levels of customer
service while keeping inventory costs
within reasonable bounds
– Level of customer service
– Costs of ordering and carrying inventory

Inventory turnover is the ratio of

average cost of goods sold to
average inventory investment.
12-12
 Effective Inventory Management
• A system to keep track of inventory
• A reliable forecast of demand
• Knowledge of lead times
• Reasonable estimates of
– Holding costs
– Ordering costs
– Shortage costs
• A classification system
12-13
 Inventory Counting Systems
• Periodic System
Physical count of items made at periodic intervals
• Perpetual Inventory System
System that keeps track
of removals from inventory
continuously, thus
monitoring
current levels of
each item

12-14
 Inventory Counting Systems (Cont’d)
• Two-Bin System - Two containers of
inventory; reorder when the first is empty
• Universal Bar Code - Bar code
printed on a label that has
information about the item
to which it is attached
0

214800 232087768

12-15
 Key Inventory Terms
• Lead time: time interval between ordering
and receiving the order
• Holding (carrying) costs: cost to carry an
item in inventory for a length of time,
usually a year
• Ordering costs: costs of ordering and
receiving inventory
• Shortage costs: costs when demand
exceeds supply
12-16
 ABC Classification System

Classifying inventory according to some

measure of importance and allocating
control efforts accordingly.
A - very important
B - mod. important High
A
C - least important Annual
$ value B
of items

Low C
Low High
12-17 Percentage of Items
 Cycle Counting
• A physical count of items in inventory
• Cycle counting management
– How much accuracy is needed?
– When should cycle counting be performed?
– Who should do it?

12-18
 Economic Order Quantity Models

• Economic order quantity (EOQ) model

– The order size that minimizes total annual cost

• Economic production model

• Quantity discount model

12-19
 Assumptions of EOQ Model

• Only one product is involved

• Annual demand requirements known
• Demand is even throughout the year
• Lead time does not vary
• Each order is received in a single delivery
• There are no quantity discounts

12-20
 The Inventory Cycle
Figure 12.2

Profile of Inventory Level Over Time

Q Usage
Quantity rate
on hand

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time
12-21
 Total Cost

Annual Annual
Total cost = carrying + ordering
cost cost
Q + DS
TC = H
2 Q

12-22
 Cost Minimization Goal
Figure 12.4C

The Total-Cost Curve is U-Shaped

Q D
TC  H  S
2 Q
Annual Cost

Carrying costs

Ordering Costs

Order Quantity (Q)

QO (optimal order quantity)

12-23
 Deriving the EOQ

Using calculus, we take the derivative of the

total cost function and set the derivative
(slope) equal to zero and solve for Q.

2DS 2( Annual Demand )(Order or Setup Cost )

Q OPT = =
H Annual Holding Cost

12-24
 EOQ- Example
• A firm’s annual inventory is 1,600 units. The cost of placing
an order is Rs 50, purchase price of raw material/unit is
Rs.10 and the carrying costs is expected to be 10% per unit
p.a. Calculate EOQ?

U=1600, P= Rs. 50, S= .10 x Rs.10=Rs.1

EOQ = 2 x 1600 x 50
1

= 400 units
 Minimum Total Cost

The total cost curve reaches its minimum

where the carrying and ordering costs are
equal.

Q = DS
H
2 Q

12-26
 Economic Production Quantity (EPQ)

• Production done in batches or lots

• Capacity to produce a part exceeds the
part’s usage or demand rate
• Assumptions of EPQ are similar to EOQ
except orders are received incrementally
during production

12-27
 Economic Production Quantity
Assumptions
• Only one item is involved
• Annual demand is known
• Usage rate is constant
• Usage occurs continually
• Production rate is constant
• Lead time does not vary
• No quantity discounts

12-28
 Determinants of the Reorder Point
• The rate of demand
• The lead time
• Demand and/or lead time variability
• Stockout risk (safety stock)

12-29
 Safety Stock
Quantity

Maximum probable demand

during lead time

Expected demand
during lead time

ROP

Safety stock
LT Time
Safety stock reduces risk of
12-30
stockout during lead time
 Inventory Control Definition
• Inventory is an accounting term that refers to
goods – finished, semi finished, raw material,
other assets etc.
• Inventory is the term for the goods available
for sale and raw materials used to produce
goods available for sale.
•
 Inventory Control
• Inventory Control is the activity of checking a
shop’s stock.
• It is a regulating and maximizing company’s
inventory.
• It is to maximize profits with minimum
inventory investment, without impacting
customer satisfaction levels.
 What does good inventory control look
like?

• A retailer’s worst nightmare is to go out of stock.

Lost sales and lost goodwill can tarnish a brand’s
reputation in record time.
• H&M manufactures 80% of its retail inventory in
advance and introduces the remaining 20% based
on the most current market trends. These
manufacturing strategies help the company to
reduce lead times, keeping them at the top of
their inventory control game.
 Function of Invt Control
• Keeping track of the stock that is already in the
warehouse.
• Aspects of warehousing designs.- space, racking,
mapping
– Stocking the right amount of inventory
– Paying the right amount for inventory (Economic
Order Quantity)
– Knowing reorder point
– Ensuring the right amount of inventory in the right
place
 H&M
• 950 stores in 19 countries, AND raked in a
whopping turnover of 14.6 billion Euros in
2013. With such staggering figures, one can
only wonder how the retail giant manages to
successfully stay afloat and ensure adequate
stock control for its fleet of stores.
 Question ?
• With over 11,000 stores in 27 countries and
an average of $32 billion in inventory,
Walmart’s inventory supply chain is an
impressive logistical accomplishment.
Nevertheless, Walmart’s has experienced out-
of-stock problems. Find out what went wrong.