INVENTORY MANAGEMENT

HYDERALI C.K106004

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)• Production 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 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(A/Q)

1 2 3 4 5 6 8 10 12

Annual carryingCost (Rs)(cQ/2)

600 300 200 150 120 100 75 60 50

Annual ordering cost(Rs)(OA/Q)

37.5 75 112.5 150 187.5 225 300 375 450

Total annual costs (Rs)

637.5 375 312.5 300 307.5 325 375 435 500

Inference from the TC table

Order Total cost 1.For single order(once in year) 637.52.12 order (once in a month) 5003.4 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……

Order Quantity Size (Q)

Cost

(Rs.

)

EOQ

Tc (Total Cost)

Carrying Cost (Q/2)H

DS/Q (Ordering Cost)

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)• Combine on the basis of relative values (A,B,C)

ABC analysis tableItem Units % of

TotalCumula-tive %

Unit price Rs

Total cost Rs

% of Total

Cumula-tive %

1 10000 10 30.40 304000 38.00

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

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