Unit-4

Inventory Planning & Control

Inventory Definition
• A stock of items held to meet future demand
• Inventory is a list for goods and materials, or those goods and
materials themselves, held available in stock by a business.
Nature of Inventories
◼ Raw Materials – Basic inputs that are converted into finished product
through the manufacturing process
◼ Work-in-progress – Semi-manufactured products need some
more works before they become finished goods for sale
◼ Finished Goods – Completely manufactured products ready for
sale
◼ Supplies – Office and plant cleaning materials not directly enter
production but are necessary for production process and do not
involve significant investment.
Reasons To Hold Inventory
-
◼ Meet variations in customer demand:
❑ Meet unexpected demand
Smooth seasonal or cyclical demand
Pricing related:
❑ Temporary price discounts
Hedge against price increases
Take advantage of quantity discounts
Process & supply surprises
❑ Internal – upsets in parts of or our own processes
❑ External – delays in incoming goods
Why Do We Need Inventories?
• Time lag between placing orders and getting supplies at the point of
consumption
• Variability of lead times
• Demand variability
• Seasonal inventory
• Pipeline inventory
Objective of Inventory Management
◼ To maintain a 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
 Concept of Inventory
• Inventory generally refers to the materials in stock.
• Inventory constitutes Supplies, Raw Materials, in Process goods,
components, finished goods including the man power.
• Inventories are processed to add values further in to it.
• Inventory denotes the idle resources which can be put to some future
use.
• Inventory ties up capital, and capital is required for handling, storage space,
deterioration, sometimes obsolete, requires insurance (loss/expiry), incurs taxes,
can be stolen or gets lost.
• The primary function of inventory is buffering and decoupling (intermediate
stocks).
 Concept of Inventory
• Dominance of Materials cost in total cost of
Manufacturing (50-60%)
• Inventory cost is nothing but the cost of current assets
• Higher the inventory is higher the total cost to company
• Higher the inventory is, lower the ROI will be to company
• Lower level of inventory causes shortages, costs to the
company due to loss of demand vs. supply

Inventory is nothing but MONEY

Need of Inventory Management
• Avoid loss of sales
• Gaining quantity discounts
• Reducing order costs
• Reducing risk of production shortages
• Gaining from seasonal reduction in price
 Continuous & Intermittent Demand System
j

• Continuous Demand : Demand for the product which is quite

consistent over the period and does not demand too much
customization.
For Ex: Sugar, Edible Oil, Petrol etc.

• Intermittent Demand : Demand which is not consistent over a period

is called intermittent demand.
For Ex: Food Items in Restaurant, Grocery items, Racing Bicycles etc.
Independent & Dependent Demand

Independent Demand
(Demand not related to other items)

X
Dependent Demand
(Derived/Calculated)
A B

2C 3D 1E 2F
Types of Inventory

Vendors Raw Work in Finished Customer

Materials process goods
 Types of Inventory (By Categories)
• Raw Material Inventory:
- Materials that are obtained from the suppliers, which can be put in the process of
transformation in to finished products.
- RM are often acquired in quantities that are sufficient to last for some period of time.
- The resulting stock of raw materials on hand, which are available for use, constitute
inventory
Ex: Glass, Tyres, Iron sheet, Mirrors, Screws & Nuts-Bolts etc are the inventory for
Automobile company
 Types of Inventory (By Categories)
• Work in Process (WIP) Materials:
- Materials which are in the manufacturing process in various stages of
completion, they are referred to as work-in-process inventory (Clay)
• Semi-Finished Assemblies : Often, in manufacturing processes, raw materials are
processed, fabricated, or assembled into intermediate parts
or subassemblies, which may be restocked temporarily until used for
further process (Clay mugs before heating up)
 Types of Inventory (By Categories)
• Finished Goods : Finished goods inventories are products ready to be
delivered to distribution centers or ultimate users.

• Maintenance, Repair and Operating Supplies (MRO): Those items used

in production but are not the part of product like hand tools, lubricants,
spare parts, or even food for company-run cafeterias.
Types of Inventory (By Function)
• Transit / Pipeline Inventory:
- Sometimes called transportation stock.
- Pipeline inventories represent materials that are in
transit, such as from a plant to a distribution center or a
customer.
- Pipeline stocks are most prevalent with distribution
inventories of finished goods.
 Types of Inventory (By Function)
• Safety Stocks Inventory:
- Safety stock, also referred to as buffer stock.
- It is used to protect against the possibility of stock-outs when demand
or supplies are subject to uncertainty or fluctuation.
- It constitutes extra inventory held just in case anticipated demands
exceed those that were forecast or in case a replenishment order is
tardy or in a quantity less than requested.
 Types of Inventory (By Function)
• Cycle / Lot Size Inventory:
- Cycle stock gets its name from the cyclic reordering practice associated with
most goods.
- It is sometimes referred to as lot-size stock and results from ordering on
quantities that are in excess of current needs.

- This stock gets depleted gradually upon serving

customer orders and replenished cyclically when
supplier orders are received
- Cycle stock is used to take advantage of quantity discounts, reduce shipping,
clerical and setup costs and where supply rate is lower than the demand rate.
Types of Inventory (By Function)

• Seasonal / Anticipation Inventory:

• The term anticipation stock is usually applied to inventory
buildups that are produced and accumulated based on some
strategy as preparing for peak season, planned sales promotional
campaign.

• Seasonal product buildup is one of the best examples of

anticipation stock.
 Types of Inventory (By Function)

• Decouple (Supply and Demand):

- The term, decoupling stock, is sometimes used instead of safety
stock to represent a separation, or buffer, of product demand
from product supply.
- Most often, however, it is used to denote work-in- process
inventories that act as buffers between successive work
operations in a factory, especially in job- shop production.
- The objective is to prevent idle time in the factory.
 Inventory Costs
• Inventory can be asset used to accomplish the objective of an
organization or a liability depending upon on its management.
• Inventory can cost or even benefits to the company.
• The problem is to balance the cost of carrying inventory.
 Inventory Costs
• Customer service: Higher inventory levels result in higher customer
service levels.
- Lower levels of inventory can cause potential stock-out, backorders, lost
sales and lost customers.
• Operating efficiency: Higher inventory levels allow leveling production,
longer production runs and reduced set-up time.
- Inventory lets manufacturers purchase in larger quantities availing
volume discounts.
 Inventory Costs
• Cost of placing orders: Ordering smaller quantities each time in an
order placed can reduce inventory.

- However, this increases the annual ordering costs.

• Transportation and handling cost: The more often goods have to be
moved and smaller the quantities moved, the greater the transportation
and materials handling cost.

- However, moving larger lots leads to higher inventory.

 Shortage / Stock Out Costs
• If demand during the lead-time exceeds forecast, we can expect a
stock-out.
• A stock-out can potentially be expensive because of back-order
costs, lost sales, and possibly lost customers.
• There is possibility of additional losses due to future orders
being placed with competitors.
• Repeated inability to deliver in competitive manner can generate a
poor delivery reputation, loss of goodwill, and loss of sales.
• Stock-outs can be reduced by carrying extra inventory
 Ordering Costs
• The costs associated with placing orders to replenish inventory
stocks
• Ordering cost differs between orders placed by purchasing on outside
suppliers and orders placed on a factory for production of the needed
product.
• The cost of placing an order does not depend upon the quantity
ordered.
• Ordering cost depends upon the number of orders placed in a year.
• It can be reduced by ordering more at a time, resulting in placing of
fewer orders, but my increase inventory levels.
 Ordering Costs
• Ordering cost may include;
1) Purchase order Costs :
◊ Supplier selection, follow-up, expediting and other contacts
◊ Account payables and collection
◊ Receiving, inspecting, and handling
◊ Preparation and handling of an order / authorization document
 Ordering Costs
• Ordering cost may include;
1) Production Order Costs :
◊ Lost capacity cost due to re-setup of equipment or assembly-line
changeover
◊ Preparation of production paperwork
◊ Tracking and reporting work orders in the plant
◊ “Scrap” that results from start-up after a new setup.
 Carrying Costs
• There are several kinds of costs associated with carrying inventory.
• Inventory carrying cost increases as levels of inventory
increases.
• Inventory carrying cost is usually expressed for one year & as a
percentage (%) of the cost of the inventory item
being ordered.
 Carrying Costs
• Storage costs : Storing inventory requires various resources like equipment,
space and workers. As inventory goes up so do these costs.
• Transporting and handling Costs:
• Risk Costs : Risk costs comprises of

• ◊ Obsolescence ◊ Damage
• ◊ Pilferage ◊ Deterioration
• These costs vary from industry to industry and even from
product to product.
 Various Other Costs
• Opportunity Cost (Capital Cost) : These are the rate of returns
possible from the alternative investments that could be made with the
money tied up in the inventory.
• The average expected return from feasible alternative investment is
used as an estimate of opportunity costs

• Insurance and taxes:

Functions of Inventory Management

-Track inventory
–How much to order
–When to order
Classification of inventory

• ABC Classification
• HML Classification
• XYZ Classification
• VED Classification
• FSN Classification
• SDF Classification
• GOLF Classification
• SOS Classification
 ABC Classification

In most of the cases 10 to 20 % of the

A
•
inventory account for 70 to 80% of the annual
activity.
• A typical manufacturing operation shows that
the top 15% of the lin e items, in terms of
annual rupees usag e, r epresent 80% of total
annual rupees usag e.
B • Next 15% of items reflect 15% of annual
rupees
Next 70% accounts only for 5% usage
C
•
XYZ Classification

◼ On the basis of value of inventory stored

◼ Whereas ABC was on the basis of value of
consumption to value.
◼ X – High Value
◼ Y – Medium value
◼ Z – Least value
Aimed to identify items which are extensively
stocked.
HML Classification

◼ On the basis of unit value of item

◼ There is 1000 unit of Q @ Rs. 10 and
10,000 units of W @ Rs. 5.
Aimed to control the purchase of raw materials.
H – High, M- Medium, L - Low
VED Classification

• Mainly for spare parts because their

consumption pattern is different from raw
materials.
Therefore V items has to be stocked more
• Raw materials on market demand
and D Items has to be less stocked
• Spare parts on performance of plant and

machinery.
• V – Vital, E – Essential, D – Desirable
FSN Classification

◼ According to the consumption pattern

◼ To combat obsolete items
◼ F – Fast moving
◼ S – Slow moving
◼ N – Non Moving
SDF & GOLF Classification

◼ Based on source of procurement

◼ S – Scarce, D- Difficult, E- Easy.

◼ GOLF
◼ G – Government, O – Ordinary, L – Local, F
– Foreign.
SOS Classification

◼ Raw materials especially for agriculture units

◼ S – Seasonal
◼ OS – Off seasonal
Deciding on the inventory model

◼ Assume an analyst applies an inventory

model that does not allow for spoilage to a
grocery chain’s ordering policy for lettuce and
formulates the strategy of ordering lettuce in
large amounts every 14 days. A little thought
will show that this is obliviously foolish. This
strategy implies that lettuce will be spoiled.
However it is not a failure of inventory, it is a
failure to apply the correct model.
Different approaches

◼ Certainty approach
Uncertain variables and risk are addressed
separately
◼ Uncertainty approach
Uncertain variables and risk are addressed
simultaneously
◼ Deterministic approach
◼ Probabilistic approach
Basic EOQ Model

Assumption
• Seasonal fluctuation in demand are ruled out
• Zero lead time – Time lapsed between purchase

order and inventory usage

• Cost of placing an order and receiving are same

and independent of the units ordered

• Annual cost of carrying the inventory is constant

• Total inventory cost = Ordering cost + carrying

cost
EOQ – Three Approaches

◼ Trial
and Error method
◼ Order-formula approach

◼ Graphical approach
EOQ & Re-order point

◼ EOQ – gives answer to

question “How much to Order”
◼ Re-order point – gives answer
to question “when to order”
 Trial & Error Method
Assumptions:-
Annual requirement (C)=1200 units
Carrying cost (I) = Rs.1
Ordering cost (O) =Rs.37.5
Order size Q 1200 600 400 300 240 200 150 120 100

Average inventory Q/2 600 300 200 150 120 100 75 60 50

No. of orders C/Q 1 2 3 4 5 6 8 10 12

Annual carrying cost 600 300 200 150 120 100 75 60 50

I* Q/2
Annual ordering cost 37.5 75 112.5 150 187.5 225 300 375 450
O*C/Q
Total annual cost 637.5 375 312.5 300 307.5 325 375 435 500
 Order- Formula approach
1/2
EOQ =(2CO/I)
C = Annual demand
O = Ordering cost per order
I = Carrying cost per unit
1/2
EOQ =(2*1200*37.5/1) = 300 units

12/10/09 27
 Certainty case of the inventory cycle

Inventory level
order quantity
Q
Average inventory = Q/2

0 T1 T2 T3 T4
Time

1. Here the negative slope from Q to T1 represents the

inventory being used up
2. T1, T2, T3, T4 represents the replenishment points
3. The inventory varies between 0 and Q
Graphical method to find EOQ

Cost in RS.

0 EOQ
Order quantity
Extension of basic EOQ model

◼ This model can be extended to include

quantity discounts, were simple calculation
for quantity discount is added.

Non zerolead
leadtime
time
◼ Non zero
 Extension of basic EOQ model
◼ Non – zero lead time
If the lead time is ‘n’ then procurement must be
done prior to ‘n’ days, i.e. T-n as shown in the
figure
Q

Reorder point

0 T1 - n T1 T2 - n T2 T3 - n T3 T4 - n T4

Time
Placement of a order
Emerging trends in inventory management

• Entering into log term contract at a fixed price

to reduce uncertainties
• Just-in-time
• Kanbans – Japanese technique (Only
produce when demand comes)
• Internet based ordering system
• Supply chain management
• Vendor development
• Investment in plant and machinery
Inventory control responsibility
• Purchasing naturally has vest interest in
inventories, even to the extend that in some
companies the purchasing and stores functions
are
In combined.
effect the responsibility cannot be kept
• Production
on one headlooks after
since the workmanagement
inventory in progress
• Logistics plays
is a aintegrated in inventory contro l
major role effort
• Inventories are economic importance to finance
department
• The fact that materials must be moved from one
place to another is of importance to materials
department