about inventory management and its techniques

1. INVENTORY MANAGEMENT
APARNA LAKSHMANAN
S2,MBA Bhavan’s Royal Institute of Management

2. INVENTORY
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.

3. INTRODUCTION
 Constitute significant part of current assets.
 A considerable amount of fund is required
 On an average approximately 60% of current
assets in Public Limited Companies in India.
 Effective and efficient management is imperative to
avoid unnecessary investment.
 Improper inventory management affects long term
profitability and may fail ultimately.
 10 to 20% of inventory can be reduced without any
adverse effect on production and sales by using
simple inventory planning and control techniques.

5. 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.

6. 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 quality discounts
 Process &supply surprises
 Internal-upsets in parts of our own processes
 External –delays in incoming goods

7. 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.

8. 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.

9. AN OPTIMUM INVENTORY LEVEL INVOLVES
THREE TYPES OF COSTS;
 Ordering costs:-
 Quotation or tendering
 Requisitioning
 Order placing
 Transportation
 Receiving, inspecting and storing
 Quality control
 Clerical and staff
 Stock out costs:-
 Loss of sale
 Failure to meet delivery commitments.
 Carrying costs:-
 Warehousing or storage
 Handling
 Clerical and staff
 Insurance
 Interest
 Taxes
 Cost of capital

10. DANGERS OF OVER INVESTMENT
 Unnecessary tie-up of firm’s 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.

11. 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.

12. FUNCTIONS OF INVENTORY MANAGEMENT
 Track inventory
 How much to order
 When to order

13. CLASSIFICATION OF INVENTORY
 ABC Classification
 HML Classification
 XYZ Classification
 VED Classification
 FSN Classification
 SDF Classification
 GOLF Classification
 SOS Classification

14. ABC CLASSIFICATION
 In most of the cases 10 to 20% of the inventory
account for70 to 80% of the annual activity.
 A -A typical manufacturing operation shows that the
top 15% of the items, in terms of annual rupees
usage represent 80%of annual rupees usage.
 B-15% of items select 15% of annual rupees
 C-70% accounts only 5% usage

15. 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.

16. HML CLASSIFICATION
 On the basis of unit value of firm
 There is 1000 unit of q at Rs.10 and 10,000 units of
w at Rs.5
 Aimed to control the purchase of rawmaterials
 H-high
 M-medium
 L-low

17. VED CLASSIFICATION
 Mainly for spare parts because their consumption
pattern is different from raw materials.
 Spare parts on performance of plant and
machinery.
 V-vital
 E-essential
 D-desirable
 Therefore V items has to be stocked ore and D
items has to be less stocked.

18. FSN CLASSIFICATION
 According to the consumption pattern
 To comat obsolete items
 F-Fast moving
 S-Slow moving
 N-Non moving

19. SDF &GOLF CLASSIFICATION
 SDF
 Based on source of procurement
 S-scarce
 D-Difficult
 E-easy
 GOLF
 G-Government
 O-Ordinary
 L-Local
 F-Foreign

20. SOS CLASSIFICATION
Raw materials especially for agriculture units
 S-Seasonal
 OS-Off seasonal

21. 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
obviously 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.

22. DIFFERENT APPROACHES
 Certainty approach
 Uncertain variables and risk are addressed separately.
 Uncertainty approach
 Uncertain variables and risk are addressed
simultaneously
 Deterministic approach
 Probabilistic approach

23. BASIC EOQ MODEL
Assumption
 Seasonal fluctuation in demand are ruked 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

24. EOQ- THREE APPROACHES
 Trial and error method
 Order-formula approach
 Graphical approach

25. EOQ- RE-ORDER POINT
 EOQ- Gives answer to question “How much to
order”
 Re-order point – gives answer to question “When to
order”

26. ORDER FORMULA APPROACH
ECONOMIC ORDER QUANTITY,
1/2
EOQ=(2CO/I)
 C=Annual demand
 O=ordering cost per order
 I=Carrying cost per unit

27. GRAPHICAL METHOD TO FIND EOQ

28. EXTENSION OF BASIC EOQ MODEL
 This model can be extended to include quantity
discounts, were simple calculation for quantity
discount is added.
 Non zero lead time

29. EXTENSION OF BASIC EOQ MODEL
Non –zero lead time
If the lead time is ‘n’ then procurement must be
done prior to ‘n’ dayside T-n as shown in the
figure

30. PROBABILISTIC INVENTORY MODEL
 In practical inventory management assumptions
may not be strictly correct
 Demand may fluctuate over time due to seasonal,
cyclical and random influences.
 Lead time may also fluctuate because of
transportation delay, strikes or natural disaster. For
such reason most of the companies use safety
stock.

32. SPECIAL INVENTORY MODEL
 Non – instantaneous replenishment
 Quantity Discount
 One – period decision

33. NON – INSTANTANEOUS REPLENISHMENT
 Particularly in situation were manufactures use
continues production process
 Eg; FACT makes Ammonium on a continual basis.

34. DISCOUNT QUANTITIES
 If discount quantities increases with the order
quantity, then the price of inventory is no more
constant.
 Hence a new approach is needed to find the best
lot size
 Total cost = Annual holding cost +Annual ordering
cost+ Annual cost of materials

35. ONE PERIOD DECISIONS
 Applicable to fashion goods, seasonal goods and
due to change in technology

36. INVENTORY MANAGEMENT UNDER
UNCERTAINITY
 Option price model
 Risk adjusted discount cash flow (DFC) model.
 Dynamic inventory model.

37. EMERGING TRENDS IN INVENTORY
MANAGEMENT
 Entering into long term contract at a fixed price to
reduce uncertainties.
 Just in time
 Kanbans- Japanese technique (only produce when
demand comes)
 Internet based ordering system
 Vendor development
 Investment in plant and machinery

38. INVENTORY CONTROL RESPONSIBILITY
 Purchasing naturally has vest interest in
inventories, even to the extend that in some
companies the purchasing and stores functions.
 In effect the responsibility cannot be kept on one
head since inventory management is a integrated
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.