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INTRODUCTION
• Inventory is an idle stock of physical goods that
contain economic value, and are held in various forms
by an organization in its custody awaiting packing,
processing, transformation, use or sale in a future
point of time.

• A physical resource that a firm holds in stock with the

intent of selling it or transforming it into a more
valuable state.

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• Inventory includes – Production inventory, MRO
(Maintenance Repair Operating ) Inventory, In-
process Inventory, Finished Goods Inventory.

• Any organization which is into production, trading, sale

and service of a product will necessarily hold stock of
various physical resources to aid in future consumption
and sale.

• Organizations hold inventories for various reasons,

which include speculative purposes, functional
purposes, physical necessities etc.

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Functions of Inventory :-
1. To meet anticipated demand – to ensure goods are
always available to satisfy demand and avoid lost of
sale or customer.
2. To smooth production requirement – to ensure
production are running smoothly
3. To protect against stock-out – to meet unforeseen
circumstances that arise due to inconsistent of
demand or delivery time of raw materials
4. To hedge against price increase – buy more when
price is low
5. To take advantage of quantity discount – suppliers
offer discount to encourage bilk buying 4
 Inventory System
• A set of policies and controls that monitors levels of
inventory and determines what levels should be
maintained, when stock should be replenished, and how
large orders should be placed.

• Inventory System can be of two types :

1. Periodic
2. Perpetual or Cyclic

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1. Periodic Inventory Counting System
• Under this system, stock taking is undertaken at the end
of the accounting year.

• Some firms temporarily suspend plant operations when

this is done because it is rarely feasible to take stocks
while production continues.

• Therefore should be organised well in advance to

minimise production hold-up.

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Cycle Counting Or Perpetual Inventory
Counting System
• More recently, providing the company can prove that its
cycle counting is accurate, auditors have agreed in some
cases that if each stock line is counted and audited at
least once per annum that will be sufficient for their
needs.

• When undertaking cycle counts it is prudent to use an

ABC analysis to ensure that your fast-moving and high-
value items are counted more frequently than your
slow-moving, inexpensive items.

• Mis-picks are more likely with fast-moving goods, and

high-value items are prone to shrinkage. 7
 Inventory Control
• The fact or process of ensuring that appropriate
amounts of stock are maintained by a business,
so as to be able to meet customer demand
without delay while keeping the costs associated
with holding stock to a minimum.

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 Objectives Of Inventory Control
(i) To minimize capital investment in inventory by eliminating
excessive stocks;
(ii) To ensure availability of needed inventory for uninterrupted
production and for meeting consumer demand;
(iii) To provide a scientific basis for planning of inventory needs;
(iv) To tiding over the demand fluctuations by maintaining
reasonable safety stock;
(v) To minimize risk of loss due to obsolescence, deterioration,
etc.;
(vi) To maintain necessary records for protecting against thefts,
wastes leakages of inventories and to decide timely
replenishment of stocks.
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Advantages of Inventory Control:
1. It improves the liquidity position of the firm by reducing
unnecessary tying up of capital in excess inventories.
2. It ensures smooth production operations by maintaining
reasonable stocks of materials.
3. It facilitates regular and timely supply to customers through
adequate stocks of finished products.
4. It protects the firm against variations in raw materials
delivery time.
5. It facilitates production scheduling, avoids shortage of
materials and duplicate ordering.
6. It helps to minimise loss by obsolescence, deterioration,
damage, etc.

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Limitations of Inventory Control:

(i) Efficient inventory control methods can reduce but

cannot eliminate business risk.
(ii) The objectives of better sales through improved service
to customer; reduction in inventories to reduce size of
investment and reducing cost of production by
smoother production operations are conflicting with
each other.
(iii) The control of inventories is complex because of the
many functions it performs. It should be viewed as
shared responsibilities.

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 Inventory Management
Inventory management is a discipline primarily about
specifying the shape and placement of stocked goods.

 It is the practice overseeing and controlling of the ordering,

storage and use of components that a company uses in the
production of the items it sells.

 Inventory management is a very important function that

determines the health of the supply chain as well as the
impacts the financial health of the balance sheet.

Inventory is always dynamic. Inventory management requires

constant and careful evaluation of external and internal factors
and control through planning and review. 12
Following points stand out with reference
to inventory:
• All organizations engaged in production or sale of products
hold inventory in one form or other.

• Inventory can be in complete state or incomplete state.

• Inventory is held to facilitate future consumption, sale or

further processing/value addition.

• All inventoried resources have economic value and can be

considered as assets of the organization.

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 Objectives: Inventory Management

• To maintain an 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.

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Functions of Inventory Management

1. Track inventory
2. How much to order
3. When to order

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 Types of inventory by functions
INPUT PROCESS OUTPUT
Raw Materials Work In Process Finished Goods
Consumables required for Semi Finished Production in Finished Goods at Distribution
processing. E.g. : Fuel, Stationary, various stages, lying with various Centers through out Supply Chain
Bolts & Nuts etc. required in departments like Production, WIP
manufacturing Stores, QC, Final Assembly, Paint
Shop, Packing, Outbound Store etc.

Maintenance Items/Consumables Production Waste and Scrap Finished Goods in transit

Packing Materials Rejections and Defectives Finished Goods with Stockiest and
Dealers
Local purchased Items required for Spare Parts Stocks & Bought Out
production items
Defectives, Rejects and Sales
Returns
Repaired Stock and Parts
Sales Promotion & Sample 16
Stocks
 Classification of inventory
• ABC Classification(consumption) (25/80+15/15+70/05)
• XYZ Classification(value stored) (Hi, Med, Low)
• HML Classification(unit-value stored) (Hi, Med, Low)
• VED Classification(spare parts mainly) (Vital, Ess, Des)
• FSN Classification(consumption) (Fast, Slow, Non)
• SOS Classification(agriculture) (Seasonal, Non)
• SDF Classification(availability) (Scarce, Difficult, Easy)
• GOLF Classification (source of supply) Govt., Ordinarily
available, Local and Foreign) 17
1. ABC - ANNUAL CONSUMPTION VALUE
2. XYZ - ACTUAL VALUE OF INVENTORY IN THE
STORES AT A GIVEN POINT OF TIME.
3. VED - CRITICAL NATURE OF THE COMPONENT.
4. HML - UNIT PRICE OF MATERIAL.
5. FSN - FREQUENCY OF ISSUE FROM STORES
6. SDE - AVAILABILITY
7. SOS - SEASONALITY
8. GOLF - CHANNEL FOR PROCURING MATERIAL

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 ABC ANALYSIS (ANNUAL CONSUMPTION VALUE)

• Always Better Control.

• DIVIDES INVENTORY INTO THREE CATEGORIES- A, B
AND C……. ON THE BASIS OF THEIR ANNUAL
CONSUMPTION VALUE….!!!
• Objective is to vary expenses associated with maintaining
appropriate control.
• This idea has drawn from VILFREDO PARETO ,an Italian
economist…

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• ABC classification is a ranking system for identifying and
grouping items in terms of how useful they are for
achieving business goals.

The system requires grouping things into three categories:

• A - extremely important
• B - moderately important
• C - relatively unimportant

• ABC classification is closely associated with the 80/20

rule, a business metric that proposes 80% of the
outcomes are determined by 20% of the inputs.
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• 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 annual
rupees usage, represent 80% of total annual
rupees usage.

• Next 15% of items reflect 15% of annual rupees.

• Next 70% accounts only for 5% usage

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 Procedure for ABC analysis:

1. List each inventory item with number

2. Determine the annual volume of usage and rupee value of
usage.
3. Multiply each item of annual volume usage with rupee
volume,
4. Calculate each item’s percentage of total inventory on terms
of the usage.
5. Categorize===“A “ to 10% of all items with high %
6. “B”20% of all items with high %
7. “c” rest of all 70% of all the items

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 Example:
Inventory item Annual use (in Rs.) % of total inventory Classification
usage

1 3000 1.33
2 4000 1.77
3 6000 2.66
4 2000 0.88
5 10,000 4.44 B
6 18,000 8 A
7 5000 2.22
8 12000 5.33 B
9 1000 0.44
10 2000 0.88
Total 10 items Total=2,25,000 REST ALL ARE IN C
CATEGORRY 24
 Example:
ITEMS IN A ITEMS IN B ITEMS IN C
ITEM NUMBER 6 5 AND 8 NUMBER ITEM ITEM
NUMBER=.1,2,3,4,7,9,10

•VERY STRICT CONTROL 1. MODERATE CONTROL 1. LOOSE CONTROL

•HANDLED BY SENIOR 2. LOW SAFETY 2. HIGH SAFETY STOCK
•MAXIMUM EFFORTS TO 3. ORDER ONCE IN 3 3.BULK ORDERING CAN
REDUCE LEAD TIME MONTH BE MADE
•ACCURATE FORECAST 4. QUATERLY REVIEW 4 ROUGH ESTIMATE
•NO SAFETY STOCK 5. MODERATE EFFORTS 5 REVIEW
•WEEKLY CONTROL 6. ESTIMATE BASED ON ANUALLY,QUATERLY
STATEMENTS PAST DATA 6 MINNMUM EFFORTS

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 XYZ Classification(ACTUAL VALUE OF INVENTORY
IN THE STORES AT A GIVEN POINT OF TIME.)
• The XYZ analysis is a way to classify inventory items according
to variability of their demand.
• X – Very little variation: X items are characterised by steady
turnover over time. Future demand can be reliably forecast.
• Y – Some variation: Although demand for Y items is not steady,
variability in demand can be predicted to an extent. This is
usually because demand fluctuations are caused by known
factors, such as seasonality, product lifecycles, competitor action
or economic factors.
• Z – The most variation: Demand for Z items can fluctuate
strongly or occur sporadically

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The aim of the XYZ Analysis is
• To arrange products according to their consumption
(turnover is constant, fluctuating, irregular) to derive an
optimal inventory strategy.
• For example,for Y class items, buffer stocks may need to
be higher, or more manual intervention of an otherwise
automated stock management process may be
required.
Procedure for XYZ Analysis:
• Determine the relevant items
• Calculate the variation coefficients of each item
• Sort the items by increasing variation coefficient
• Graphical representation divided into X, Y and Z ranges
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What benefits does the approach
provide?
• Improves accuracy of forecasting.
• Reduces stock-outs, which:
– Improves production stability and efficiency.
– Improves customer satisfaction.
• Increases stock churn.
• Reduces stock obsolescence.
• Clarifies service levels for items with volatile
demand.
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 HML Classification(UNIT PRICE OF
MATERIAL)
• The High, medium and Low (HML) classification follows
the same procedure as is adopted in ABC classification.

• Only difference is that in HML, the classification

criterion is the “unit value” and not the annual
consumption value.

• The items of inventory should be listed in the

descending order of unit value and it is up to the
management to fix limits for three categories.

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• After this, the management of the company uses its
discretion and judgment to decide the cut off lines for
deciding the three categories.

• For example, the management may decide that all items

of unit price value above Rs 500 should be categorized
as H items, items whose, unit price falls between Rs 50
and Rs 500 should be categorized as M items and items
whose unit price falls below Rs 50 should be
categorized as L items.

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• HML analysis helps an organization to take
decisions on the following:

• It helps to assess the security requirements and the

type of storage for high priced items.

• The frequency of stock checking is decided on the

basis of the cost item.

• A control on purchases and buying policies can be

exercised by the company.

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 VED Classification(CRITICAL NATURE OF
THE COMPONENT)
• VED Analysis attempts to classify the items used into
three broad categories, namely Vital, Essential, and
Desirable.
• Vital: Vital category items are those items without which
the production activities or any other activity of the
company, would come to a halt, or at least be drastically
affected.
• Essential: Essential items are those items whose stock –
out cost is very high for the company.
• Desirable: Desirable items are those items whose stock-
out or shortage causes only a minor disruption for a
short duration in the production schedule 32
• VED Analysis is very useful to categorize items of
spare parts and components.

• In fact, in the inventory control of spare parts

and components it is advisable, for the
organization to use a combination of ABC and
VED Analysis.

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 FSN Classification(FREQUENCY OF
ISSUE FROM STORES)
• The FSN Analysis is based on the rate of issue or rate of
usage of spare parts.

• The alphabets F, S and N stands for Fast Moving, Slow

Moving and Non Moving items.

• The FSN classification system categorizes the items

based on how frequently the parts are issued and how
frequently they are used
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• Usual classification of Items at Inventory can be
classified based on the following criteria :

• Fast Moving – Items which are frequently issued from

inventory which are more than once for a specific time
period.

• Slow Moving – Items which are less frequently issued

which might be once in a specific time period.

• Non Moving – Items which are not issued from the

inventory at all in a specific time period

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• The FSN classification system is extremely helpful in
distributing spare parts which are kept near the
dispensing are having items which belong to the fast
moving category.

• The items which fall into the non moving category can
be discontinued if further scope of use is not
expected.

• As companies in production for longer period have a

specific percentage of non moving spare parts which
are usually disposed at regular intervals.

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 SDE (AVAILABILITY)
• Based on source of procurement
• S – Scarce, D- Difficult, E- Easy.

SOS - SEASONALITY
SEASONAL AND OFF-SEASONAL.

GOLF - CHANNEL FOR PROCURING MATERIA

• G – Government, O – Ordinary, L – Local, F – Foreign.

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 An optimum inventory level involves
three types of costs
Ordering costs Stock-out costs Carrying costs

Quotation or tendering Loss of sale Warehousing or storage

Handling
Requisitioning Failure to meet delivery Clerical and staff
commitments
Order placing Insurance
Transportation Interest
Receiving, inspecting and Deterioration, shrinkage,
storing evaporation and
obsolescence
Quality control Taxes
Clerical and staff Cost of capital 38
 Dangers of over investment

• Unnecessary tie-up of firm’s 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

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 Dangers of under-investment

• Production hold-ups – loss of labor hours

• Failure to meet delivery commitments
• Customers may shift to competitors which will amount to a
permanent loss to the firm
• May affect the goodwill and image of the firm

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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

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