INVENTORY MANAGEMENT

HYDERALI C.K
106004
 INTRODUCTION
• Significant part of the current asset
• Large amount of inventory leads to
considerable lapse of fund
• Imperative to manage to avoid
unnecessary investment
 Cont………..
• Inventory Control measure and
regulate to predetermine
 -size for order or production,
 -safety stock
 - minimum level of order
 - maximum level of order


•
 Nature of inventories


• Raw material


• Work in process


• Finished goods
 NEED TO HOLD
INVENTORIES
•
•
• Transaction motive(smooth
production)
• Precautionary motive(demand)
• Precautionary motive (price)
 PRODUCTION CYCLE
• Time span between introduction raw
material to the conversion into the
finished product
 OBJECTIVE OF INVENTORY
MANAGEMENT
• To meet unforeseen future demand
due to variation in forecast figures
and actual figures.
• To meet the customer requirement
timely, effectively, efficiently and
smoothly
• To smoothen the production process.
• To facilitate intermittent production
of several products on the same
facility.
 Cont……..
• To gain economy of production or
purchase in lots.
• To reduce loss due to changes in
prices of inventory items.
• To meet the time lag for
transportation of goods.
• To balance various costs of inventory
such as order cost or set up cost
and inventory carrying cost
•
 Cont……..
• To balance the stock out
cost/opportunity cost due to loss of
sales against the costs of inventory.
• To minimize losses due to
deterioration, obsolescence,
damage etc.
•
•
Optimum level of inventory
•
•
•
• It lies between two danger point,i.e
between excessive and inadequate
level
 Major danger in the
overinvesment
• Unnecessary tie-up of firm’s fund and
loss of profit
• Excessive carrying cost
• Risk of liquidity
Major danger in the inadequate
level
•


• Production hold-up
• Failure to meet delivery commitment
•
 Effective inventory
management
• Continues supply of raw material to
facilitate production
• Maintain sufficient stock 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
 Cont……..
•
•
• Minimise the carrying cost and time
• Control investment in inventories and
keep it an optimum level
•
 Inventory management
techniques
• Aim to maximise the shareholder
wealth
• For efficient inventory management,
we have to answer
 -how much should be ordered ?
(ans;EOQ)
 -when should it be ordered ?
(ans;reorder point)
 Economic order quantity
• ordering materials whenever stock
reaches the reorder point
• It tells how production to be schedule
• optimum level of inventory involves
two types of cost
 1.ordering cost
 2.carrying cost
 Ordering cost
• It is the entire cost to acquire the raw
material(supplies).
• It include
 -Requisitioning
 -order placing
 -Transportation
 -Receiving, inspecting and storing
 -clerical and staff
 Carrying cost
• It is the cost incurred to maintain the
given level of inventory
• It include
 -Warehousing
 -Handling
 -clerical and staff
 -Insurance
 -Deterioration and obsolescene
 Ordering and carrying cost
trade off
• Optimum level of inventory referred
to EOQ
• To determine EOQ-three approaches
 -Trial and error approach
 -Formula approach
 -Graphical approach
 Trial and error approach
• Assumptions
 -known annual requirement
 -steady usage
 -ordering and carrying cost to be
constant through the entire period
•
Example – illustrating the trial
and error approach
•
• Estimated annual requirement, A
=1200unit
• Purchasing cost per unit, P(Rs)
=50
• Ordering cost (per order),O(Rs)
=37.50
• Carrying cost per unit,c(Re)
=1
 Total cost in the various
orders
Order 1200 600 400 300 240 200 150 120 100
size(Q)
Average 600 300 200 150 120 100 75 60 50
inventory(Q/
No.of
2) orders 1 2 3 4 5 6 8 10 12
(A/Q)
Annual 600 300 200 150 120 100 75 60 50
carrying
Cost (Rs)
(cQ/2)
Annual 37.5 75 112.5 150 187.5 225 300 375 450
ordering cost
(Rs)(OA/Q)
Total annual 637.5 375 312.5 300 307.5 325 375 435 500
costs (Rs)
GRAPH-Trial & err
 Inference from the TC table
 Order
Total cost
1.For single order(once in year)

637.5
2.12 order (once in a month)

500
3.4 order(once in every 3 month)

300
 i.e.the third option is the most
economic
 Order formula approach
• It is more easier way compared to
trial and error approach
• Assumption
 -carrying cost per unit constant
 -ordering cost per order fixed
 Cont…………


• O=ordering cost per order

• A=Total annual requirement
• Q=order size
• Per unit carrying cost=c
• Number of order=A/Q
• TOC(Total order cost)=(A/Q)XO
 Cont……..
•
•
• Average inventory =Q/2
• TCC(Total carrying cost)=(Q/2)Xc
• TC(Total cost) =TOC+TCC
• TC =(A/Q)XO + (Q/2)Xc
 Inference from the equation
• For larger quantity order =carrying
cost increases


=ordering cost
decreases
• For lower quantity order=carrying
cost decreases


=ordering cost
increase
 Cont……….
• EOQ should lie between larger &
lower quantity order
• So EOQ = differentiate TC and
equate to zero
• TC =(A/Q)XO + (Q/2)Xc
• EOQ=-(AO)/Q^2+c/2=0
• c/2=(AO)/Q^2
• EOQ=Q=((2AO)/c)^.5
•
 In the earlier problem
• A=1200
• O=37.5
• c=1
• EOQ=((2AO)/c)^.5
 =((2X1200X37.5)/1)^.5
 =300
 Graphical method
• Vertical axis =costs
 -carrying cost
(TCC)
 -ordering cost
(TOC)
 -Total cost (TC)
• Horizontal axis =order size (Q)
 Cont……

Tc (Total
Cost)
Cost (Rs.)

Carrying Cost
(Q/2)H

DS/Q (Ordering Cost)

EOQ

Order Quantity Size (Q)

 Cont……
• Carrying cost increases with increase
order size, because of large have
to be maintained
• Ordering cost decline with increase in
order size, because larger order
size means lesser no of order
• Total cost has the behaviour of both
ordering cost and carrying cost
• EOQ=deviating point of TC
•
 Quantity discount
• Supplier offer discount for large order
size (above EOQ)
• Net return=discount savings –
additional carrying
cost
• If return +ve = can avail the discount
offer
• If return –ve= order size should be
EOQ level
 Example

• d=discount rate (.005)

• Discount on
savings=dXPXA=(.005X50X1200)
 =300
• Savings on the ordering cost=(OA/Q)-
(OA/q)
• Here Q=EOQ & q=discount
quantity(400)
• =O[A/Q-A/q]
• =37.5[1200/300-1200/400]
 =37.5

 Cont……….
• Additional carrying cost=(cq/2)-
(cQ/2)
 =c/2(q-Q)
 =1/2(400-
300)
 =50
 Cont……
• Net return=[dPA+ savings on -
additional
 discount]
carrying cost
 =(300+37.5)-50
 =287.5
• Here net return is +ve= firm should
order 400


unit
 Important Terms
• Minimum Level – It is the minimum
stock to be maintained for smooth
production.
• Maximum Level – It is the level of
stock, beyond which a firm should
not maintain the stock.
• Reorder Level – The stock level at
which an order should be placed.
• Safety Stock – Stock for usage at
normal rate during the extension of
lead time.
Case study of inventory control
(ABC)
• Several types of inventories are there
in ABC
• Classify the inventories into
 -High value =A
 -Least value =C
 -reasonable attention=B(A&C)
 Cont…….
•
•
• ABC analysis concentrate on
important items
 =Control by important
exception(CIE)
• Classified in the importance of their
relative value=Proportion Value
Analysis(PVA)
Step involved in implementing
the ABC analysis
• Classify ,determine expected use &
price of the inventories
• Determine total value of
item(expected
unitXunit price)
• Rank the items (according to total
value)
• Compute the ratios (no.of unit/total
unit) & (each value of item/total
value of all item)
 ABC analysis table
Item Units % of Cumula Unit Total % of Cumula
Total - price cost Rs Total -
1 10000 10 tive % 30.40
Rs 304000 38.00 tive %
2 5000 5 15 51.20 256000 32.00 70
3 16000 16 5.50 88000 11.00
4 14000 14 45 5.14 72000 9.00 90
5 30000 30 1.70 51000 6.38

6 15000 15 1.50 22500 2.81

7 10000 10 100 0.65 6500 0.81 100

Total 100000 800000

 ABC Method of
Inventory Control
ABC method of
100
inventory
control 90

Cumulative Percentage
of Inventory Value
Method which controls
expensive inventory
C
items more closely than
70
B
less expensive items.

– Review “A” items

most A
frequently
0 15 45 1
– Review “B” and
“C” items less Cumulative Percentage
of Items in Inventory
rigorously
and/or less
 Inference
• Assumption =1&2 ,3,4&5,6&7 fall in
the same category
• 1&2=item A
• 3,4&5=item B
• 6&7 =item C
•
•
•
•
 Thank you