INVENTORY MANAGEMENT

Presented By:Shruti Gupta

What is Inventory??

It refers to the stockpile of products a firm would sell in future in normal course of business operations and the components that makeup the product.

It includes:

i. Raw material

ii. Work in progress

iii. Finished goods

Inventory management

Successful inventory management involves creating a purchasing plan that will ensure that items are available when they are needed (but that neither too much nor too little is purchased) and keeping track of existing inventory and its use. 

Objectives

Two counterbalancing parts:

1. To minimise investments in inventory

2. To meet the demand for products by efficiently organising the production and sales operations.

Costs involved in holding inventory: Ordering cost: is the fixed cost of placing and

receiving an order.

Following costs are included in ordering cost:

i. Preparing a purchase order or requisition form.

ii. Receiving, inspecting and recording the goods received to ensure both quantity & quality.

Carrying costs: are variable costs per unit of holding an item in inventory for a specified time period.

It can be divided into two categories:

i. Those that arise due to storing of inventory: storage, insurance, deterioration, serving costs.

ii. The opportunity cost of funds

Total cost: is the sum of the ordering cost and carrying cost. This is compared with the benefits arising out of inventory to determine the optimum level of inventory.

Benefits of holding inventory: Benefits in Purchasing Benefits in Production Benefits in Work - in – progress Benefits in Sales

Techniques:

Classification System: ABC System

It is an inventory management technique that divides inventory into three categories of descending importance based on the rupee investment in each.

Inventory Breakdown

Group Number of items (%)

Inventory value (%)

A 15 70

B 30 20

C 55 10

Total 100 100

Order Quantity Problem

Economic Order Quantity (EOQ) Model

It is the technique for determining optimum order quantity which is the one that minimises the total of its order and carrying costs; it balances fixed ordering cost against variable carrying cost.

Assumptions for EOQ Model: Firm knows with certainty the annual usage of a

particular item of inventory.

Rate at which the firm uses inventory is steady over time.

Orders placed to replenish inventory stocks are received at exactly that point in time when inventories reach zero.

Ordering & carrying costs are constant over the range of possible inventory level being considered.

Approaches to illustrate EOQ: Trial & Error (Analytical) Approach:

A firm’s inventory planning period is one year. Its inventory requirement for this period is 1,600 units. Assume that its acquisition costs are Rs. 50 per order. Carrying costs are expected to be Re. 1 per unit per year.

Firm can procure inventory in following lots:

(i) 1,600 (ii) 800 (iii) 400 (iv) 200 (v) 100.

which of these is EOQ?

1.Size of order (units) 1,600 800 400 200 100

2.Number of orders1 2 4 8 16

3.Cost per order (Rs.)50 50 50 50 50

4.Total ordering cost (2×3) (Rs.) 50 100 200 400 800

5.Carrying cost per unit (Rs.) 1 1 1 1 1

6.Average inventory(units) 800 400 200 100 50

7.Total carrying cost (5×6) (Rs.) 800 400 200 100 50

8.Total cost (4+7) (Rs.) 850 500 400 500 850

Mathematical (Shortcut) Approach:

Where A = Annual usage of inventory (units) B = Buying Cost per Order C = Carrying Cost per Order

C

2AB = EOQ

Using the facts in previous example, we can find out EOQ as follows:

EOQ = √ 2×1,600×50 = 400 units 1

Limitations of EOQ Model: Assumption of constant consumption &

instantaneous replenishment of inventories are of doubtful validity.

Assumption of a known annual demand for inventories is another limitation.

There are some computational problems. For instance formula can give EOQ in fractions, say, 232.5 units.

Order Point Problem:

Reorder Point: is the point at which to order inventory expressed equationally as:

Lead time in days × daily usage

Safety Stock

It implies extra inventories that can be drawn down when actual lead time &/or usage rates are greater than expected.

Illustration

Two components, A & B are used as follows:

Normal usage: 50 units each p.w. Minimum usage: 25 units each p.w. Maximum usage: 75 units each p.w. Re – order quantity: A: 300 units

B: 500 units

Re – order period: A: 4 to 6 weeks

B: 2 to 4 weeks

Solution

Reorder level = (max. usage × max. delivery time)

A = 75 × 6 weeks = 450 units B = 75 × 4 weeks = 300 units

Minimum level = reorder level – (normal usage × avg. delivery time in weeks)

A = 450 – (50 × 5) = 200 units B = 300 – (50 × 3) = 150 units

Maximum level = reorder level – (min. usage × min. delivery time) + reorder quantity

A = 450 – (25 × 4) + 300 = 650 units B = 300 – (25 × 2) + 500 = 750 units

Average stock level = min. level + (reorder qty./2)

A = 200 + 300/2 = 350 units B = 150 + 500/2 = 400 units