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Definition of Inventory.
Inventories are materials that business institutions carry either for sales or to provide
input to other process or the finished goods products. They are raw materials , semi
finished products , finished goods , spares , machines , equipments. Inventory carries
substantial manufacturing cost , between 20-30 % Of total assets , 4-10 % of
production cost.
In the present competitive business environment inventory management and control
is one of the important function of management being led by very efficient and
effective personnel . Varieties of inventories in the production processes poses a
bigger challenge now-a-days to the management for competitive pricing of the
finished product thereby improving their profit portfolio.
INVENTORY MANAGEMENT
Types of Inventory.
1) Production Inventories.
Raw materials, spare parts, components which enter to production process for making finished goods.
These may consist of two general types : A ) special items supplied as per company specifications. B) Standard
industrial items directly purchased from market.
2) MRO Inventories.
Maintenance, Repair, operating machineries which are consumed in the production process but don’t become
a part of the finished goods. ( Lubricants, oi l, soap, machine repair parts.).
3) In-process inventories.
Semi-finished products found at various stages in the production process.
These cost factors must be considered while taking decisions regarding planning and procuring inventories.
INVENTORY MANAGEMENT
It is a major offence for inventory control personnel if the plant is shutdown for the lack of required inventory.
On the other hand intermittent manufacture permits greater flexibility in the management and control of
material.
Volume of production:-
Volume of production also influence management decisions and practices. Ex. For bulb manufacturing unit ,
millions of brass bases are required each month . Even though large volume of inventory of brass bases
are required by Bulb Manufacturing unit , its management and control is relatively easy. Because only one
or two nos of inventories are required to be controlled.
On the other hand for manufacture of a large locomotives, involves planning and control of thousands of
items of inventory. Hence needs very efficient and stringent management procedures and practices to
inventory problem.
Nature of Inventory. Inventories like Electronics items, pharmaceuticals items, paints and other liquid items,
perishable items needs different types of inventory management practices for its effective usage in the
production processes.
INVENTORY MANAGEMENT
Inventory Systems.
An inventory system provides the organizational structure , operating policies for maintaining and controlling
goods to be inventoried. The system is also responsible for ordering and receipts of goods , timing the
order placements, keeping track of order supply status.
There are two approaches to inventory system. 1) Fixed order quantity system 2) fixed time period system.
These are called multiperiod inventory systems. This is to ensure that an item is available to ongoing
production process through out the year. The items are ordered multiple times in a year where the logic in
the system dictates the actual quantity ordered and timing of the order.
The carrying cost or Holding cost increases if the order quantity increases. Beause
1) Requires more storing area.
2) Taxes, insurance, cost increases.
3) Capital cost , inventory service cost , handling cost , risk cost etc increases.
In the graphical representation a point where carrying cost curve and ordering cost curve meet , represent the
least cost . The quantity at this point is called the Economic order quantity.
Assumptions.
1) Demand of the inventory is constant and uniform throughout the period.
2) Lead time ( Time from ordering to receipt ) constant.
3) Price for unit of product is constant.
INVENTORY MANAGEMENT
In the graph the point where the two curves of ordering cost and holding cost is intersected is the minimum of
all costs.
Hence it can be written at this point ( D/Q) S = ( Q/2 )H.
Q (EOQ) = Square root (2 DS/H).
When more complex cost equations are involved , this single algebraic approach is not sufficient. Different
calculus must be used.
EOQ technique is vey much useful for knowing how much quantity is to be ordered.
It is applicable for single inventory item. It can be for group of items with similar holding cost and procurement
cost.
Limitations of EOQ system. (Fixed order quantity System ).
1) Not applicable for erratic demand pattern of inventory.
2) It ‘s accuracy depends upon the accuracy of ordering cost, carrying cost which are cumbersome to
calculate. Sometimes carting cost is linked to opportunity cost of capital invested.
3) Needs experienced and skilled cost accountants , which is costly calculations.
4) Sime times require human common sense. May be long term order is less costly, joint orders may be
favourable for suppliers ,hence price preferences may be obtained.
5) EOQ ordering must be tempered with judgement. Like for less self life items, critically required items may
over-ride EOQ sometimes.
INVENTORY MANAGEMENT
Reorder Level :-
In the fixed quantity inventory system the EOQ is calculated on the basis of constant demand and lead time and
no safety stock is necessary. The Reorder level is simply
R = dL
d = Average daily demand (Constant).
L = Lead time in days (Constant).
Numericals 1:-
An auto industry purchases spark plugs at the rate of Rs.25/- per piece. The annual consumption of spark plug
is 18,000 nos . If the ordering cost is Rs.250/- per order and carrying cost is 25% P.A. what would be the EOQ ?
If the supplier of spark plugs offers a 5% discount for order quantity of 3000 no’s per order , do you accept the
discount offer ?
INVENTORY MANAGEMENT
Solution 1 :-
a) Calculation of EOQ:-
Annual Demand (D) = 18,000 nos.
Unit Price (C ) = Rs.25/-
Ordering cost per order (S) = Rs.250/-
Carrying cost (as %) (O) = 25%
EOQ = Square root 2 DS/ C.i.
= Square root ( 2X18000X250 ) / 25X0.25
= 90,00,000/6.25 = 1200 units
b) Decision Regarding discount offer Q = 3000
With EOQ = 1200 units the total cost of inventory is
TC1 = ( 18000 X 25 ) +{ ( 18000/1200 ) x250 ) + (1200/2 X ( 25 x 25/100) }.
= 4,50,000 + 3750 + 3750
= 4,57,500/-
With discounted qty = 3000 having 5% discount total cost of inventory is
New price after discount = 25 x 0.95 = Rs.23.75.
TC2 = ( 18000 x 23.75) +{ ( 18000/3000 ) x 250 ) } + { ( 3000/2) X (23.75 x 25/100) }
INVENTORY MANAGEMENT
Numerical 2.
Find the Economic order quantity , reorder point and total annual inventory cost , given the following .
Annual Demand = 1000 units.
ordering cost = Rs.5/- per order.
Holding cost = Rs. 1.25 per unit per year.
Lead time = 5 days.
Solution 2.
The Economic order quantity EOQ = Square root of ( 2X D x S)/ H.
= Square root of ( 2 X 1000 X 5 ) / 1.25 = 89.4 units.
The Reorder level = dL = ( 1000/ 365 ) X 5 = 13.7 units.
Result and conclusion. The inventory policy is , when the inventory level drops to 14 units (Rounded off
reorder level ) , place an order for 89 units (Rounded off EOQ ).
Total Annual inventory cost TC = DC + ( D/Q )S + (Q/2 )H. = ( 1000 X12.50 ) + { (1000/89) X 5 ) } + ( 89/2 ) X1.25
= Rs.12611.81/- .
he cost per unit of inventory is taken as purchase price.
INVENTORY MANAGEMENT
In contrast when inventory order is placed only once for a whole time period may be for one financial year, for
particular season, particular event is called single period inventory system.
A retailer keeps inventory of particular types of T-shirts designed for a specific event like world cup matches,
Olympic , by ordering once at a time till that event occurs ie a single order for the T-shirts for that event only.
A retailer selling fashion items makes a single order for the entire season. This is because of long lead time and
limited life of the products. They also take care the lost profit due to sales not made or discounted sales after
the season.
INVENTORY MANAGEMENT
Uncertainties demand situation is also managed by arranging alternative source of procurements (alternative
vendors) by rate contracts or empanelment.
Inventory Analysis and classifications.
In order to have better control and management of inventory it is very much essential to analyse the inventory
And classify them . There are following inventory classifications.
ABC analysis and classifications.- Based on annual consumption value.
“A” class items constitute 20% of total no of items but consumption value accounts 80%.
“B” class items constitute 30% of total no of items but consumption value accounts 15%.
“C” class items constitute 50% of total no of items but consumption value accounts 5% only.
It is obvious that “A” class items are extremely important and deserves highest control and most frequent
review.
“B” class items are important but needs moderate control on it.
“C” class items are least important and have low priority on control.
XYZ analysis and classifications. This analysis is based on inventory stock value of the items.
“X” categories items are 10% in nos. but constitute 70% of total inventory value.
“Y” categories items are 20% in nos. but constitute 20% of total inventory value.
“Z” categories items are 70% in nos. but constitute 10% pf total inventory value.
INVENTORY MANAGEMENT
“X” categories items are even less in nos. but needs more control and review to reduce inventory cost.
FSN analysis and classification . FSN stands for fast , slow and non-moving . Here the classification in done
based on pattern of issues from stores and is useful to control obsolescence. Fast consumption items are also
called active items. Slow moving items generate surplus which needs examined, for consumption else where .
Non-moving items are examined further and their disposal is considered.
VED analysis and classification. VED analysis is done to determine the criticality of an item and its effect on
production and services. V stands for vital , E stands for essential, D stands for desirable. Normally sufficient
inventory is maintained for V category items, for D items minimum item is maintained. This is specially used for
spare parts.
SDE analysis and classification. The SDE analysis is based on upon the availability of items an is very useful in
the context of scarcity of supply. The “S” refers to “SCACRE” items ,generally imported and which are of short
supply. “D” refers to difficult items which are available indigenously but are difficult to procure. Items which are
coming from distant places and vendors are difficulty to come by. “E” refers to items which are easily available.
The SDE analysis is done based on problems faced in procurement , this is also vital to lead time analysis.