CHAPTER – 3

TECHNIQUES OF INVENTORY
MANAGEMENT

3.1 Introduction

The term ‘inventory’ originates from the French word

‘Inventaire’ and Latin word ‘Inventariom”, which implies a
list of things found.

The term ‘inventory’ can be defined as,

“The term inventory includes materials like – raw, in

process, finished packaging, spares and others;

stocked in order to meet an unexpected demand or

distribution in the future.”

Inventory includes the following categories of items:

a. Production Inventories: Raw materials, parts and

components which enter the firm’s product in the
production process. These may consist of two types –
special items manufactured to company specifications
and standard industrial items purchased ‘off the shell’.

b. MRO Inventories: Maintenance, Repair, and

Operating supplies which are consumed in the
production process but which do not become the part

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 of the product. (e.g. lubricating oil, soap, machine
repair parts)

c. In-process Inventories: Semi-finished products found

at various stages in the production operation.

d. Finished goods Inventories: Completed products

ready for shipment.

3.2 Process of Inventory Management and

Control
Inventory management and control refers to the
planning for optimum quantities of materials at all stages in
the production cycle and evolving techniques which would
ensure the availability of planned inventories. Following
four steps are involved in the process:

a. Determination of optimum inventory levels and

procedures of their review and adjustment: It is a
significant step but a difficult one. Too much
inventory results in locking up of working capital
accompanied by increased carrying costs (but
reduced ordering costs). Excess inventories,
however, guarantee uninterrupted supply of
materials and components, to meet production
schedules and finished goods to meet customers
demand. Too less of inventory releases working
capital for alternative uses and reduces carrying

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 costs and increases ordering costs. But there is the
risk of stock out costs.

b. Determination of the degree of control that is

required for the best results: The second aspect of
inventory management is to decide just how much
control is needed to realize the objectives of
inventory management. The difficulty is best
overcome by categorization of inventory on the basis
of value. Popularly called the ABC categorization,
this approach is useful in deciding the degree of
control. ‘A’ class items are ‘high’ in value but ‘low’ in
quantity, ‘C’ class inventories are the opposite of ‘A’
group i.e. ‘high’ in quantity and ‘low’ in value. In
between are the ‘B’ group stocks which are more or
less equal in quantity and value proportion to the
total inventory. Tight control is exercised on ‘A’
category items through accurate records of receipts
and issues and by co-ordination of incoming
shipments with production managements.

c. Planning and design of the Inventory control

system: An inventory system provides the
organizational structure and the operating policies
for maintaining and controlling goods to be
inventoried. The system is responsible for ordering
and receipt of goods, timing the order placement,

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 and keeping track of what has been ordered, how
much, and from whom.

d. Planning of the Inventory control organization: It

is yet another important aspect of inventory
management because choosing the panel to control
is very difficult.

3.3 Inventory Control Techniques

Inventory control techniques are employed by the

inventory control organization within the framework of one
of the basic inventory models, viz., fixed order quantity
system or fixed order period system. Inventory control
techniques represent the operational aspect of inventory
management and help realize the objectives of inventory
management and control.

Several techniques of inventory control are in use and

it depends on the convenience of the firm to adopt any of
the techniques. What should be stressed, however, is the
need to cover all items of inventory and all stages, i.e. from
the stage of receipt from suppliers to the stage of their use.
The techniques most commonly used are the following:

a. ABC Analysis: ABC analysis is a business term used to

define an inventory categorization technique often used in
materials management. It is also known as ‘Selective
Inventory Control.’

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 ABC analysis provides a mechanism for identifying
items which will have a significant impact on overall
inventory cost21 whilst also providing a mechanism for
identifying different categories of stock that will require
different management and controls.22 When carrying out an
ABC analysis, inventory items are valued (item cost
multiplied by quantity issued/consumed in period) with the
results then ranked. The results are then grouped typically
into three bands.23 These bands are called ABC codes.

ABC CODES

"A class" inventory will typically contain items that

account for 80% of total value, or 20% of total items.

"B class" inventory will have around 15% of total

value, or 30% of total items.

"C class" inventory will account for the remaining 5%,

or 50% of total items.

ABC Analysis is similar to the Pareto principle in that

the "A class" group will typically account for a large

21
Manufacturing planning and control systems for supply chain management By
Thomas E. Vollmann
22
http://www.supplychainmechanic.com/?p=46 How to carry out an ABC analysis of
inventory
23
Oracle E-Business Suite Manufacturing & Supply Chain Management By Bastin
Gerald, Nigel King, Dan Natchek

69
proportion of the overall value but a small percentage of the
overall volume of inventory.24

USAGE OF ABC ANALYSIS

1. In day to day warehouse operations, materials are

some time under issued, over issued, issued and not
accounted into the system, misplaced, stolen etc. This
results into inaccuracy in the inventory. Cycle counting
is the process to count and reconcile the materials.
Ideally, every material in the warehouse should be
counted during a fixed interval (every year) for
maintaining 100% accuracy, but counting &
reconciling every material is not cost effective and very
expensive. To count the accuracy of the inventory in a
cost effective manner, it is recommended to count the
materials based on inventory classification. If A class
materials are counted within a fixed interval (could be
six months or a year) then the firm needs to count only
5% to 10% of the total materials and it will cover 60%
to 80% of the inventory value. It means that firm only
counts 5 % to 10% of the materials and remove the
inaccuracy from the inventory value from 60% to 80%.
Similarly B class materials can also be counted on a
less frequency ( from once in 18 months to 24 Months)
as the number of materials become higher and C class

24
Purchasing and Supply Chain Management By Kenneth Lysons, Brian Farrington

70
 materials at even lesser frequency (once in 27 months
to 36 months) as number of material becomes more
(60% to 85% of the total materials).

2. An inventory controller shall be concentrating more on

the A class items for reducing the inventory as he/she
shall be concentrating only 5% to 10% of the total
items and shall be getting the opportunity to reduce
inventory on 60% to 80% of the value.

3. Any reduction in lead time of A class items shall result

in reduction in inventory, so procurement manager will
work out with suppliers to reduce the lead time.

4. On issue of materials, tight control on A class,

Moderate control on B class, Loose Control on C class.
So ‘A’ class items may be issued after getting the
approvals from Senior Executives of the company. B
may be moderately controlled. Very little control can be
exercised while issuing C class item

b. High, Medium and Low Classification: 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 unit value is
the criterion 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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 The HML analysis is useful for keeping control over
consumption at departmental levels, for deciding the
frequency of physical verification, and for controlling
purchases.

Procurement department is more concerned with

prices of materials so this analysis helps them to take
them the decisions such as, who will procure what based
on the hierarchy and price of material.

Some of the other objective can be as under

Helps in taking the decision such as whether to

procure in exact requirement or opt for EOQ or
purchase only when needed

When it is desired to evolve purchasing policies

then also HML analysis is carried out i.e. whether
to purchase in exact quantities as required or to
purchase in EOQ or purchase only when
absolutely necessary

When the objective is to keep control over

consumption at the department level then
authorization to draw materials from the stores
will be given to senior staff for H item, next lower
level in seniority for M class item and junior level
staff for L class items.

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 Cycle counting can also be planned based on
HML analysis. H class items shall be counted
very frequently, M class shall be counted at lesser
frequency and L class shall be counted at least
frequency as compared to H & M class.

c. VED Classification: While in ABC, classification

inventories are classified on the basis of their
consumption value and in HML analysis the unit value is
the basis, criticality of inventories is the basis for vital,
essential and desirable categorization.

The VED analysis is done to determine the criticality of

an item and its effect on production and other services. It
is specially used for classification of spare parts.

d. SDE Classification: The SDE analysis is based upon the

availability of items and is very useful in the context of
scarcity of supply. In this analysis, items, generally
imported, and those which are in short supply. It refers
to difficult items which are available indigenously but are
difficult items to procure. Items which have to come from
distant places or for which reliable suppliers are difficult
to come by fall into category. It also refers to items which
are easy to acquire and which are available in the local
markets.

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 The SDE classification, based on problems faced in
procurement, is vital to the lead time analysis and in
deciding on purchasing strategies.

SDE analysis is done based on purchasing problems

associated with items on day-to-day basis. Some of the
purchasing problems are as under: -

Long Lead Times.

Scarcity and hardly available

Sourcing the same material from many

geographically scattered sources

Uncertain and unreliable sources of supply

Purchasing department classifies these materials

and formulates the strategy and policy of procurement of
these items accordingly. So classification of materials is
done based on level of difficulty in sourcing

e. FSN Classification: FSN stands for fast moving, slow

moving and non-moving. Here, classification is based on
the pattern of issues from stores and is useful in
controlling obsolescence.

To carry out an FSN analysis, the date of receipt or

the last date of issue, whichever is later, is taken to
determine the number of months, which have lapsed
since the last transaction. The items are usually grouped
in periods of 12 months.

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 FSN analysis is helpful in identifying active items
which need to be reviewed regularly and surplus items
which have to be examined further. Non-moving items
may be examined further and their disposal can be
considered.

f. SOS Analysis: ‘S’ stands for Seasonal items and ‘OS’

stands for off-seasonal items. It may be advantageous to
buy seasonal items at low prices and keep inventory or
buy at high price during off seasons. Based on the
fluctuation in prices and availability, suitable decision
has to be taken regarding how much to purchase and at
what prices.

g. XYZ Analysis: XYZ analysis is calculated by dividing an

item's current stock value by the total stock value of the
stores. The items are first sorted on descending order of
their current stock value. The values are then
accumulated till values reach say 60% of the total stock
value. These items are grouped as 'X'. Similarly, other
items are grouped as 'Y' and 'Z' items based on their
accumulated value reaching another 30% & 10%
respectively. The XYZ analysis gives an immediate view of
which items are expensive to hold. Through this analysis,
firm can reduce its money locked up by keeping as little
as possible of these expensive items.

h. GOLF Analysis: This stands for Government, Open

market, Local or Foreign source of supply. For many

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 items imports are canalized through government agencies
such as State Trading Corporations, Mineral and Metals
Trading Corporations, Indian Drugs and Pharmaceuticals
etc.

For such items, the buying firms cannot apply any

inventory control techniques and have to accept the
quota allotted by the Government. ‘Open market’
categories are those who form bulk of suppliers and
procurement is rather easy. ‘L’ category includes those
local suppliers from whom items can be purchased off-
the – shell on cash purchase basis. ‘F’ category indicates
foreign suppliers. Since an elaborate import procedure is
involved, it is better to buy imported items in bigger lots
usually covering the annual requirements.

i. Economic Order Quantity: Economic order quantity is

the level of inventory that minimizes the total inventory
holding costs and ordering costs. It is one of the oldest
classical production scheduling models. The framework
used to determine this order quantity is also known as
Wilson EOQ Model or Wilson Formula. The model was
developed by F. W. Harris in 1913. But still R. H. Wilson,
a consultant who applied it extensively, is given credit for
his early in-depth analysis of the model.

Assume that the demand for a product is constant

over the year and that each new order is delivered in full
when the inventory reaches zero. There is a fixed cost

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charged for each order placed, regardless of the number
of units ordered. There is also a holding or storage cost
for each unit held in storage (sometimes expressed as a
percentage of the purchase cost of the item).

An organization wants to determine the optimal

number of units of the product to order so that it
minimize the total cost associated with the purchase,
delivery and storage of the product

The required parameters to the solution are the

total demand for the year, the purchase cost for each
item, the fixed cost to place the order and the storage
cost for each item per year. It is worth noteable that the
number of times an order is placed will also affect the
total cost; however, this number can be determined from
the other parameters-

The ordering cost is constant.

The rate of demand is constant

The lead time is fixed

The purchase price of the item is constant i.e. no

discount is available

The replenishment is made instantaneously; the

whole batch is delivered at once.

EOQ is the quantity to order, so that ordering cost

+ carrying cost finds its minimum. (A common

77
misunderstanding is that formula tries to find when these
are equal.)

Inventory models for calculating optimal order

quantities and reorder points have been in existence long
before the arrival of the computer. When the first Model
T Fords were rolling off the assembly line, manufacturers
were already reaping the financial benefits of inventory
management by determining the most cost effective
answers to the questions of when? and how much? Yes
long before JIT, TQM, TOC, and MRP, companies were
using these same (then unnamed) concepts in managing
their production and inventory.

Corporate goals and strategies may sometimes

conflict with EOQ. Measuring performance solely by
inventory turns is one of the most prolific mistakes made
in the name of inventory management. Many companies
have achieved aggressive goals in increasing inventory
turns only to find their bottom line has shrunk due to
increased operational costs.

EOQ is essentially an accounting formula that

determines the point at which the combination of order
costs and inventory carrying costs are the least. The
result is the most cost effective quantity to order. In
purchasing this is known as the order quantity, in
manufacturing it is known as the production lot size.

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 While EOQ may not apply to every inventory
situation, most organizations will find it beneficial in at
least some aspect of their operation. Anytime firm has
repetitive purchasing or planning of an item, EOQ should
be considered. Obvious applications for EOQ are
purchase-to-stock distributors and make-to-stock
manufacturers, however, make-to-order manufacturers
should also consider EOQ when they have multiple
orders or release dates for the same items and when
planning components and sub-assemblies. Repetitive
buy maintenance, repair, and operating (MRO) inventory
is also a good application for EOQ. Though EOQ is
generally recommended in operations where demand is
relatively steady, items with demand variability such as
seasonality can still use the model by going to shorter
time periods for the EOQ calculation. Just make sure
their usage and carrying costs are based on the same
time period.

The basic Economic Order Quantity (EOQ)

formula is as follows:

THE INPUTS

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 While the calculation itself is fairly simple the task of
determining the correct data inputs to accurately represent
your inventory and operation is a bit of a project.
Exaggerated order costs and carrying costs are common
mistakes made in EOQ calculations. Using all costs
associated with your purchasing and receiving departments
to calculate order cost or using all costs associated with
storage and material handling to calculate carrying cost will
give firm highly inflated costs resulting in inaccurate results
from its EOQ calculation. Often these references trace back
to studies performed by advocacy agencies working for
business that directly benefit from these exaggerated (my
opinion) costs used in ROI calculations for their products or
services.

It is relevant to keep in mind that even though

accuracy is crucial, small variances in the data inputs
generally have very little effect on the outputs. The
following breaks down the data inputs in more detail and
gives insight into the aspects of each.

ANNUAL USAGE
Expressed in units, this is generally the easiest part of
the equation. Firm can simply use its forecasted annual
usage data for computational purposes.

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ORDER COST
Also known as purchase cost or set up cost, this is the
sum of the fixed costs that are incurred each time an item is
ordered. These costs are not associated with the quantity
ordered but primarily with physical activities required to
process the order.

For purchased items, these would include the cost to

enter the purchase order and/or requisition, any approval
steps, the cost to process the receipt, incoming inspection,
invoice processing and vendor payment, and in some cases
a portion of the inbound freight may also be included in
order cost. It is important to understand that these are
costs associated with the frequency of the orders and not
the quantities ordered. For example, in firm’s receiving
department the time spent checking in the receipt, entering
the receipt, and doing any other related paperwork would be
included, while the time spent repacking materials,
unloading trucks, and delivery to other departments would
likely not be included. If firm has inbound quality
inspection where it inspects a percentage of the quantity
received it would include the time to get the specs and
process the paperwork and not include time spent actually
inspecting, however if it inspects a fixed quantity per receipt
it would then include the entire time including inspecting,
repacking, etc. In the purchasing department it would
include all time associated with creating the purchase order,
approval steps, contacting the vendor, expediting, and

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reviewing order reports, it would not include time spent
reviewing forecasts, sourcing, getting quotes (unless it gets
quotes each time it order), and setting up new items. All
time spent dealing with vendor invoices would be included
in order cost.

Associating actual costs to the activities associated

with order cost is where many an EOQ formula runs afoul.
Do not make a list of all of the activities and then ask the
people performing the activities "how long does it take you
to do this?" The results of this type of measurement are
rarely even close to accurate. It has been found it to be more
effective to determine the percentage of time within the
department consumed performing the specific activities and
multiplying this by the total labor costs for a certain time
period (usually a month) and then dividing by the line items
processed during that same period.

It is extremely difficult to associate inbound freight

costs with order costs in an automated EOQ program and it
is suggested it only if the inbound freight cost has a
significant effect on unit cost and its effect on unit cost
varies significantly based upon the order quantity.

In manufacturing, the order cost would include the

time to initiate the work order, time associated with picking
and issuing components excluding time associated with
counting and handling specific quantities, all production
scheduling time, machine set up time, and inspection time.

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Production scrap directly associated with the machine setup
should also be included in order cost as would be any
tooling that is discarded after each production run. There
may be times when firm wants to artificially inflate or
deflate set-up costs. If it lacks the capacity to meet the
production schedule using the EOQ, it may want to
artificially increase set-up costs to increase lot sizes and
reduce overall set up time. If firm has excess capacity it
may want to artificially decrease set up costs, this will
increase overall set up time and reduce inventory
investment. The idea being that if it is paying for the labor
and machine overhead, anyway it would make sense to take
advantage of the savings in the reduced inventories.

For the most part, order cost is primarily the labor

associated with processing the order; however, it can
include the other costs such as the costs of phone calls,
faxes, postage, envelopes, etc.

CARRYING COST
Also called Holding Cost, carrying cost is the cost
associated with having inventory on hand. It is primarily
made up of the costs associated with the inventory
investment and storage cost. For the purpose of the EOQ
calculation, if the cost does not change based upon the
quantity of inventory on hand it should not be included in
carrying cost. In the EOQ formula, carrying cost is
represented as the annual cost per average on hand

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inventory unit. Below are the primary components of
carrying cost.

Interest: If firm had to borrow money to pay for its

inventory, the interest rate would be part of the carrying
cost. If it did not borrow on the inventory, but have loans
on other capital items, it can use the interest rate on those
loans since a reduction in inventory would free up money
that could be used to pay these loans. If by some miracle
firms are debt free, they would need to determine how much
they could make if the money was invested.

Insurance: Since insurance costs are directly related

to the total value of the inventory, firm would include this as
part of carrying cost.

Taxes: If firms are required to pay any taxes on the

value of their inventory they would also be included.

Storage Costs: Mistakes in calculating storage costs

are common in EOQ implementations. Generally companies
take all costs associated with the warehouse and divide it by
the average inventory to determine a storage cost percentage
for the EOQ calculation. This tends to include costs that
are not directly affected by the inventory levels and does not
compensate for storage characteristics. Carrying costs for
the purpose of the EOQ calculation should only include
costs that are variable based upon inventory levels.

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 If firms are running a pick/pack operation where they
have fixed picking locations assigned to each item where the
locations are sized for picking efficiency and are not
designed to hold the entire inventory, this portion of the
warehouse should not be included in carrying cost since
changes to inventory levels do not effect costs here. Their
overflow storage areas would be included in carrying cost.
Operations that use purely random storage for their product
would include the entire storage area in the calculation.
Areas such as shipping/receiving and staging areas are
usually not included in the storage calculations. However, if
they have to add an additional warehouse just for overflow
inventory then they would include all areas of the second
warehouse as well as freight and labor costs associated with
moving the material between the warehouses.

Since storage costs are generally applied as a

percentage of the inventory value you may need to classify
your inventory based upon a ratio of storage space
requirements to value in order to assess storage costs
accurately.

There are situations where firm may not want to

include any storage costs in its EOQ calculation. If firm’s
operation has excess storage space of which it has no other
uses it may decide not to include storage costs since
reducing your inventory does not provide any actual savings
in storage costs. As firm’s operation grows near a point at

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which it would need to expand its physical operations it
may then start including storage in the calculation.

A portion of the time spent on cycle counting should

also be included in carrying cost, remember to apply costs
which change based upon changes to the average inventory
level. So with cycle counting, it would include the time
spent physically counting and not the time spent filling out
paperwork, data entry, and travel time between locations.

Other costs that can be included in carrying cost are

risk factors associated with obsolescence, damage and theft.

IMPLEMENTING EOQ
There are primarily two ways to implement EOQ. Both
methods obviously require that firm has already determined
the associated costs. The simplest method is to set up its
calculation in a spreadsheet program, manually calculate
EOQ one item at a time, and then manually enter the order
quantity into its inventory system. If its inventory has fairly
steady demand and costs and it has less than one or two
thousand SKUs it can probably get by using this method
once per year. If it has more than a couple thousand SKUs
and/or higher variability in demand and costs it will need to
program the EOQ formula into its existing inventory system.
This allows it to quickly re-calculate EOQ automatically as
often as needed. It can also use a hybrid of the two systems
by downloading its data to a spreadsheet or database
program, perform the calculations and then update its

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inventory system either manually or through a batch
program. Whichever method it uses, it should make sure to
follow the following steps:

Test the formula: Prior to final implementation it

must test the programming and setup. Run the EOQ
program and then manually check the results using
sample items that are representative of the variations
of its inventory base.

Project results: Firm will need to run a simulation or

use a representative sampling of items to determine
the overall short-term and long-term effects, the EOQ
calculation will have on warehouse space, cash flow,
and operations. Dramatic increases in inventory
levels may not be immediately feasible, if this is the
case, it may temporarily adjust the formula until
arrangements can be made to handle the additional
storage requirements and compensate for the effects
on cash flow. If the projection shows inventory levels
dropping and order frequency increasing, it may need
to evaluate staffing, equipment, and process changes
to handle the increased activity.

Maintain EOQ: The values for Order cost and

Carrying cost should be evaluated at least once per
year taking into account any changes in interest
rates, storage costs, and operational costs.

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j. Minimum-Maximum Technique: The minimum-
maximum system is often used in connection with
manual inventory control systems. The minimum
quantity plus the optimum lot size. In practice, a
requisition is initiated when a withdrawal reduces the
inventory below the minimum level; the order quantity is
the maximum minus the inventory status after the
withdrawal. If the final withdrawal reduces the stock level
substantially below the minimum level, the order
quantity will be longer than the calculated EOQ.

The effectiveness of a minimum-maximum system is

determined by the method and precision with which the
minimum and maximum parameters are established. If
these parameters are based upon arbitrary judgments
with a limited basis, the system will be limited in its
effectiveness. If the minimum are based on an objective
rational basis, the system can be very effective.

k. Two-bin Technique: One of the oldest systems of

inventory control is the two bin system which is adopted
to control ‘C’ group inventories. In the two – bin system,
stock of each item is separated into two bins. One bin
contains stock, just enough to last from the date a new
order is placed until it is received in inventory. The other
bin contains a quantity of stock enough to satisfy
probable demand during the period of replenishment.

3.4 Application of Inventory Management

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 Techniques

Small businesses, both manufacturers and retailers,

now have the opportunity to reduce inventory-related costs
significantly through the use of various inventory
techniques implemented on a micro- or mini-computer.
Inventory techniques are divided into two categories--those
for independent demand items (finished goods) and those
for dependent demand items (manufacturing-in-process
items and raw material). The use of micro-computers is
growing rapidly, with material requirements planning (MRP)
systems currently available for use on micro-and mini-
computers. These MRP systems assist the small
manufacturer in planning and controlling inventory levels of
dependent demand items and in scheduling work centers.25
Several techniques offer potential for savings with
independent demand items. Independent demand item
techniques are subdivided into continuous review models,
periodic review models, and mixed models.

The model most frequently presented is the continuous

review model (reorder point/economic order quantity
model). However, an assumption implicit in continuous
review models is that a perpetual inventory is maintained so
that it is practical to release a replenishment order on the

25
James F. Cox and Steven J. Clark, "Material Requirements Planning System
Development,' Computers and Industrial Engineering, vol. 2 (1978), pp. 123-139.

89
day the reorder point is reached. Thus, continuous review
models assume that point-of-sale information is being
collected.

The continuous review technique, while very practical

for a computerized inventory system collecting point-of-sale
data, is not practical for manual systems handling
numerous different items.

CONTINUOUS REVIEW MODEL

There are dozens of variations of the continuous review
inventory model.26 The version discussed here is derived
from the following assumptions:

The item under consideration is independent of all

other items (no joint replenishment).

Demand for the item varies (is random), but the

average demand is constant over time.

Lead time is known and constant.

Holding costs and replenishment costs are known and

constant.

The inventory position is maintained at all times.

26
This article discusses only the simplest model. More complete discussions can be
found in Rein Peterson and Edward A. Silver, Decision Systems for Inventory
Management and Production Planning (New York: John Wiley & Sons, 1979), and E.
Naddor, Inventory Systems (New York: John Wiley & Sons, 1966).

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SUCCESSFUL INVENTORY MANAGEMENT
Successful inventory management involves balancing
the costs of inventory with the benefits of inventory. Many
small business owners fail to appreciate fully the true costs
of carrying inventory, which include not only direct costs of
storage, insurance and taxes, but also the cost of money
tied up in inventory. This fine line between keeping too
much inventory and not enough is not the manager's only
concern. Others include:

Maintaining a wide assortment of stock -- but not

spreading the rapidly moving ones too thin;

Increasing inventory turnover -- but not sacrificing the

service level;

Keeping stock low -- but not sacrificing service or

performance.

Obtaining lower prices by making volume purchases --

but not ending up with slow-moving inventory; and

Having an adequate inventory on hand -- but not

getting caught with obsolete items.

The degree of success in addressing these concerns is

easier to gauge for some than for others. For example,
computing the inventory turnover ratio is a simple measure
of managerial performance. This value gives a rough
guideline by which managers can set goals and evaluate

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performance, but it must be realized that the turnover rate
varies with the function of inventory, the type of business
and how the ratio is calculated (whether on sales or cost of
goods sold). Average inventory turnover ratios for individual
industries can be obtained from trade associations.

THE PURCHASING PLAN

One of the most important aspects of inventory control
is to have the items in stock at the moment they are needed.
This includes going into the market to buy the goods early
enough to ensure delivery at the proper time. Thus, buying
requires advance planning to determine inventory needs for
each time period and then making the commitments
without procrastination.

For retailers, planning ahead is very crucial. Since they

offer new items for sale months before the actual calendar
date for the beginning of the new season, it is imperative
that buying plans be formulated early enough to allow for
intelligent buying without any last minute panic purchases.
The main reason for this early offering for sale of new items
is that the retailer regards the calendar date for the
beginning of the new season as the merchandise date for
the end of the old season. For example, many retailers view
March 21 as the end of the spring season, June 21 as the
end of summer and December 21 as the end of winter.

Part of your purchasing plan must include accounting

for the depletion of the inventory. Before a decision can be

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made as to the level of inventory to order, you must
determine how long the inventory you have in stock will
last. For instance, a retail firm must formulate a plan to
ensure the sale of the greatest number of units. Likewise, a
manufacturing business must formulate a plan to ensure
enough inventories are on hand for production of a finished
product.

In summary, the purchasing plans details:

When commitments should be placed;

When the first delivery should be received;

When the inventory should be peaked;

When reorders should no longer be placed; and

When the item should no longer be in stock.

Well planned purchases affect the price, delivery and

availability of products for sale.

CONTROLLING THE INVENTORY

To maintain an in-stock position of wanted items and
to dispose of unwanted items, it is necessary to establish
adequate controls over inventory on order and inventory in
stock. There are several proven methods for inventory

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control. They are listed below, from simplest to most
complex.

Visual control enables the manager to examine the

inventory visually to determine if additional inventory
is required. In very small businesses where this
method is used, records may not be needed at all or
only for slow moving or expensive items.

Tickler control enables the manager to physically

count a small portion of the inventory each day so that
each segment of the inventory is counted every so
many days on a regular basis.

Click sheet control enables the manager to record the

item as it is used on a sheet of paper. Such
information is then used for reorder purposes.

Stub control (used by retailers) enables the manager to

retain a portion of the price ticket when the item is
sold. The manager can then use the stub to record the
item that was sold.

As a business grows, it may find a need for a more

sophisticated and technical form of inventory control.
Today, the use of computer systems to control
inventory is far more feasible for small business than ever
before, both through the widespread existence of computer
service organizations and the decreasing cost of small-sized
computers. Often the justification for such a computer-

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based system is enhanced by the fact that company
accounting and billing procedures can also be handled on
the computer.

Point-of-sale terminals relay information on each item

used or sold. The manager receives information
printouts at regular intervals for review and action.

Off-line point-of-sale terminals relay information

directly to the supplier's computer who uses the
information to ship additional items automatically to
the buyer/inventory manager.

The final method for inventory control is done by an

outside agency. A manufacturer's representative visits the
large retailer on a scheduled basis, takes the stock count
and writes the reorder. Unwanted merchandise is removed
from stock and returned to the manufacturer through a
predetermined, authorized procedure. A principal goal for
many of the methods described above is to determine the
minimum possible annual cost of ordering and stocking
each item. Two major control values are used:

1) The order quantity, that is, the size and frequency of

orders; and

2) The reorder point, that is, the minimum stock level at

which additional quantities is ordered. The Economic Order
Quantity (EOQ) formula is one widely used method of
computing the minimum annual cost for ordering and

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stocking each item. The EOQ computation takes into
account the cost of placing an order, the annual sales rate,
the unit cost, and the cost of carrying inventory. Many
books on management practices describe the EOQ model in
detail.

3.5 Developments in Inventory Management

In recent years, two approaches have had a major

impact on inventory management: Material Requirements
Planning (MRP) and Just-In-Time (JIT). Their application is
primarily within manufacturing but suppliers might find
new requirements placed on them and sometimes buyers of
manufactured items will experience a difference in delivery.

Material requirements planning are basically an

information system in which sales are converted directly
into loads on the facility by sub-unit and time period.
Materials are scheduled more closely, thereby reducing
inventories, and delivery times become shorter and more
predictable. Its primary use is with products composed of
many components. MRP systems are practical for smaller
firms. The computer system is only one part of the total
project which is usually long-term, taking one to three years
to develop.

Just-in-time inventory management is an approach

which works to eliminate inventories rather than optimize
them. The inventory of raw materials and work-in-process

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falls to that needed in a single day. This is accomplished by
reducing set-up times and lead times so that small lots may
be ordered. Suppliers may have to make several deliveries a
day or move close to the user plants to support this plan.

TIPS FOR BETTER INVENTORY MANAGEMENT

At the time of delivery

Verify count -- Make sure you are receiving as many

cartons as are listed on the delivery receipt.

Carefully examine each carton for visible damage -- If

damage is visible, note it on the delivery receipt and
have the driver sign your copy.

After delivery, immediately open all cartons and

inspect for merchandise damage.

When damage is discovered

Retain damaged items -- All damaged materials must

be held at the point received.

Call carrier to report damage and request inspection.

Confirm call in writing--This is not mandatory but it is

one way to protect oneself.

Carrier inspection of damaged items

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 Have all damaged items in the receiving area -- Make
certain the damaged items have not moved from the
receiving area prior to inspection by carrier.

After carrier/inspector prepares damage report,

carefully read before signing.

After inspection

Keep damaged materials -- Damaged materials should

not be used or disposed of without permission by the
carrier.

Do not return damaged items without written

authorization from shipper/supplier.

SPECIAL TIPS FOR MANUFACTURERS

If firm is in the business of bidding, specifications play

a very important role. In writing specifications, the following
elements should be considered.

Do not request features or quality that is not necessary

for the items' intended use.

Include full descriptions of any testing to be performed.

Include procedures for adding optional items.

Describe the quality of the items in clear terms.

The following actions can help save money when firms

are stocking inventory:

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 Substitution of less costly materials without impairing
required quality;

Improvement in quality or changes in specifications

that would lead to savings in process time or other
operating savings;

Developing new sources of supply;

Greater use of bulk shipments;

Quantity savings due to large volume, through

consideration of economic order quantity;

A reduction in unit prices due to negotiations;

Initiating make-or-buy studies;

Application of new purchasing techniques;

Using competition along with price, service and

delivery when making the purchase selection decision.

When firm chooses to implement specific inventory

techniques into the workplace, it’ll find that its job is much
easier and that its entire department runs more smoothly.
Here are a few simple but essential inventory management
techniques that will assist firms in keeping track of their
inventory without a hassle.

STOCK ROTATION

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 Every good department head understands the
importance of stock rotation. When new stock arrives, it is
filed into the inventory kept in the warehouse behind any
current stock of the item. This allows for older product to
move out to the sales floor or to the ordering customer first.
When firm rotates stock, it keeps any of its inventories from
becoming outdated and useless. If anything expires or
becomes outdated, it is no longer usable merchandise and
must be written off as a loss. Therefore, stock rotation is
one of the most important inventory techniques one can
employ to achieve success.

CREATING A SYSTEM

When new inventory arrives, it cannot be placed in any

open area of firm’s warehouse. Firms must employ some
sort of systematic stocking agenda so that all replenishment
of stock is regulated. If a new item is to be shelved in the
warehouse, room must be made for it in an area of similar
items. This system must be made clear to all employees who
handle the inventory in your department or supply house so
that there are no errors resulting in lost or misplaced
inventory. This sort of organization is obviously one of the
more important inventory management techniques involved
in keeping track of current stock.

LABELING
Of all the inventory management techniques firm could
employ in its workplace, labeling is probably the most

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important. Especially if firm has a large warehouse of
merchandise, it is absolutely essential that everything is
clearly labeled so that all replenishment stock can be placed
in the proper area with no hesitation or uncertainty, and
also so that any outgoing merchandise can easily be located
for shipping. On top of that, when an inventory check is
completed, it will make the process of reconciliation that
much simpler to handle.

INVENTORY MANAGEMENT SOFTWARE

Using any kind of software that assists firm in tracking

its inventory can be helpful as well, making it simple to just
scan in and out any moving merchandise on a daily basis.
Using a database or other software can make the other
inventory management techniques that much easier for it by
cataloguing all the information for it, including quantity on
hand, cost of the item, and location within your warehouse.
It also gives a clearer picture of how quickly items are sold
and allows inventory checks to be processed more quickly
and efficiently.

As one can see, some of the inventory management

techniques, that are best suited to help firm maintain its
responsibility without any hassle, are not all that difficult to
employ. Especially if it has a good management software
package, all the other techniques can easily fall into place.
With a robust training program for employees and a drive to

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follow these pointers, managing your inventory will be a
breeze.

Inventory control has been a must in running a

business or an organization. This involves small business
software (for small and medium businesses), lean
manufacturing, business accounting software, and
inventory systems.

There are techniques involved in managing your

inventory, such as the following (with their definitions):

1. Stock rotation: As new stock arrives, it is recorded into

the inventory (usually stored in a warehouse) and placed
behind any existing stock of such items, to allow older
products to move out to the sales floor and pass on to the
ordering customer. Stock rotation keeps your inventory
updated, as if anything expires; it would no longer be usable
and must be declared as a loss.

2. System creation: Creating a system must be specific to

the type of business. Firm could apply a system where a
new item would be shelved and should create room for
similar items. This must be cleared with those handling its
inventory to minimize errors, like misplaced inventory.
System creation is a must in keeping track of its current
stock.

3. Labeling: When firm has a huge warehouse of

merchandise, it is a must that everything is appropriately

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and clearly labeled so that all stock designated as
replenishment stock would be stored in its assigned area.
Labeling would also help it identify outgoing stock and such
make it easily tracked when delivered or shipped. Properly
labeled stock would make reconciliation of items simpler to
manage.

4. Inventory Management Software: Use technology to

one’s advantage by employing inventory management
software that would track one’s item. Create a database or
use other software when cataloguing its items, including
information such as firm item’s quantity, item’s cost, and
item’s location in your storehouse. Inventory management
software would also help to know which items are sold
faster. Such would allow the inventory checks to be
efficiently processed.

The inventory management techniques cited here are

easy to apply. Complement that with a reliable inventory
management software package and such techniques could
be easier, even seamlessly implemented. Couple its
inventory management techniques with a training program
for its employees, so they would diligently and accurately
perform their inventory jobs.

Attending inventory management seminars; checking

and applying inventory management resources from Web
sites, papers, books, and publications; joining management
forums, and availing of management training are some of

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the means where firm could enhance the inventory
management techniques for its business success.

Additional lessons that could be covered in attending

such inventory management seminars include (but are not
limited to) the strategic role of inventory management; front-
end optimization of inventory levels; systems for inventory
planning and replenishment; automating order processes;
distribution and service inventories, and inventory accuracy
and audits.

In addition, when efficient inventory management

techniques are employed, one would be able to enjoy the
benefits of reducing one’s costs; becoming responsive to
one’s clients’ needs; making one’s scheduling and shop
loading efficient; narrowing the gap between sales and stock
replenishment, and fine-tuning the record-keeping
accuracy.

CONCLUSIONS

"Inventory" to many small business owners is one of

the more visible and tangible aspects of doing business.
Raw materials, goods in process and finished goods all
represent various forms of inventory. Each type represents
money tied up until the inventory leaves the company as
purchased products. Likewise, merchandise stocks in a
retail store contribute to profits only when their sale puts
money into the cash register.

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 In a literal sense, inventory refers to stocks of anything
necessary to do business. These stocks represent a large
portion of the business investment and must be well
managed in order to maximize profits. In fact, many small
businesses cannot absorb the types of losses arising from
poor inventory management. Unless inventories are
controlled, they are unreliable, inefficient and costly.

*******

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