Subject- Production Management

Unit-3

INVENTORY CONTROL OR MANAGEMENT

Meaning of Inventory
Inventory generally refers to the materials in stock. It is also called the idle resource of an
enterprise. Inventories represent those items which are either stocked for sale or they are in the
process of manufacturing or they are in the form of materials, which are yet to be utilised. The
interval between receiving the purchased parts and transforming them into final products varies
from industries to industries depending upon the cycle time of manufacture. It is, therefore,
necessary to hold inventories of various kinds to act as a buffer between supply and demand for
efficient operation of the system. Thus, an effective control on inventory is a must for smooth
and efficient running of the production cycle with least interruptions.
Reasons for Keeping Inventories
1. To stabilise production: The demand for an item fluctuates because of the number of factors,
e.g., seasonality, production schedule etc. The inventories (raw materials and components)
should be made available to the production as per the demand failing which results in stock out
and the production stoppage takes place for want of materials. Hence, the inventory is kept to
take care of this fluctuation so that the production is smooth.
2. To take advantage of price discounts: Usually the manufacturers offer discount for bulk
buying and to gain this price advantage the materials are bought in bulk even though it is not
required immediately. Thus, inventory is maintained to gain economy in purchasing.
3. To meet the demand during the replenishment period: The lead time for procurement of
materials depends upon many factors like location of the source, demand supply condition, etc.
So inventory is maintained to meet the demand during the procurement (replenishment) period.
4. To prevent loss of orders (sales): In this competitive scenario, one has to meet the delivery
schedules at 100 per cent service level, means they cannot afford to miss the delivery schedule
which may result in loss of sales. To avoid the organizations have to maintain inventory.
5. To keep pace with changing market conditions: The organizations have to anticipate the
changing market sentiments and they have to stock materials in anticipation of non-availability
of materials or sudden increase in prices.
6. Sometimes the organizations have to stock materials due to other reasons like suppliers
minimum quantity condition, seasonal availability of materials or sudden increase in prices.
Meaning of Inventory Control
Inventory control is a planned approach of determining what to order, when to order and how
much to order and how much to stock so that costs associated with buying and storing are
optimal without interrupting production and sales. Inventory control basically deals with two
problems: (i) When should an order be placed? (Order level), and (ii) How much should be
ordered? (Order quantity).
These questions are answered by the use of inventory models. The scientific inventory control
system strikes the balance between the loss due to non-availability of an item and cost of
carrying the stock of an item. Scientific inventory control aims at maintaining optimum level of
stock of goods required by the company at minimum cost to the company.
Objectives of Inventory Control
1. To ensure adequate supply of products to customer and avoid shortages as far as possible.
2. To make sure that the financial investment in inventories is minimum (i.e., to see that the
working capital is blocked to the minimum possible extent).
3. Efficient purchasing, storing, consumption and accounting for materials is an important
objective.

Subject- Production Management

Unit-3

4. To maintain timely record of inventories of all the items and to maintain the stock within the
desired limits.
5. To ensure timely action for replenishment.
6. To provide a reserve stock for variations in lead times of delivery of materials.
7. To provide a scientific base for both short-term and long-term planning of materials.
Benefits of Inventory Control
It is an established fact that through the practice of scientific inventory control, following are the
benefits of inventory control:
1. Improvement in customers relationship because of the timely delivery of goods and service.
2. Smooth and uninterrupted production and, hence, no stock out.
3. Efficient utilisation of working capital. Helps in minimising loss due to deterioration,
obsolescence damage and pilferage.
4. Economy in purchasing.
5. Eliminates the possibility of duplicate ordering.
Relevant costs
Relevant costs are those that are avoidable or can be eliminated by choosing one alternative over
another. Relevant costs are also known as differential, or incremental, costs. In general, variable
costs are relevant in production decisions because they vary with the level of production.
Likewise, fixed costs are generally not relevant, because they typically do not change as
production changes. However, variable costs can remain the same between two alternatives, and
fixed costs can vary between alternatives.
So, relevant costs are future costs that differ across alternatives. The can consist of both variable
and fixed costs. Additional fixed costs associated with an alternative are relevant. Changes in
supply and demand for resources must be considered. Costs which fluctuate with changes in
supply and demand across alternatives are relevant costs. Relevant costs are also known as
incremental costs. One type of relevant cost is opportunity cost. Opportunity cost is the benefit
sacrificed or foregone when one alternative is chosen over another.
Economic Lot Size
Only necessary quantity of items are not always ordered (instructed for manufactured items) for
each necessary item. In most cases, the order quantity (manufacturing quantity for manufactured
items) is determined by the balance between the order cost (the cost for preparation such as
logistics for manufactured items) for the necessary items and the inventory carrying cost. This
order quantity is generally called lot or lot size. Economic Lot Size (ELS for short) refers to the
best lot quantity to make the total cost minimum by considering the balance between ordering
cost and inventory carrying cost, which are contradictory. As shown in the figure, for example,
the larger the lot size is, the higher the average inventory level is and its inventory carrying cost
also increase by a certain ratio. But the ordering cost a unit decreases because the transportation
and logistics costs are allocated to many items. On the other hand, the smaller the lot size is, the
lower the average inventory level is. However, on the contrary, the ordering cost a unit increases.
When the total cost of ordering cost and inventory carrying cost is minimum, the lot size is the

Subject- Production Management

Unit-3

most economic. Economic Lot Size is also called EOQ (standing for Economic Order Quantity)
and is calculated by means of the following formula:

Inventory Analysis
Inventory is often a large expense for retailers, manufacturers, and other firms with
inventory-based operations. Inventory analysis allows a companys management team to
discover flaws in the system and improve operations. Different aspects exist to this process.
Owners and executives should review the inventory accounting system, internal controls,
and physical flow of goods. Inventory analysis may also require a long-term employee who
constantly reviews the inventory process in order to maintain proper procedures.
Two types of inventory accounting systems are present in business: perpetual and periodic.
An inventory analysis can help a company determine which one to use and whether or not
the current system works properly. The perpetual system makes updates to the companys
generalledger for each sale, purchase, or adjustment of inventory items. The periodic
system only updates the inventory account at month end. A physical inventory count is
necessary for both systems, albeit fewer times for the perpetual system.
During the inventory analysis, a company should review its production process to
determine which system to use. Single batch processes or individual goods produced one at

Subject- Production Management

Unit-3

a time often fall under the perpetual system. Frequent updates to the inventory account help
track financial data. Companies producing large sets of homogeneous goods typically use
the periodic system. Less frequent updates work well because the types of goods produced
are typically the same.
Internal controls are the protective measures a company puts into place for protecting
inventory. These include prenumbered purchase orders, secure physical locations to store
inventory, and security systems or cameras to watch inventory in the business. Hiring
bonded employees and separating inventory duties among employees are also internal
controls. The inventory analysis identifies if current internal controls are working properly
and what internal controls are necessary to further protect inventory. Internal controls are
often different among companies as they use ones specific to their operations.
The physical flow of inventory is another aspect of inventory analysis. This involves
reviewing inventory operations from start to finish. Ordering, receiving, stocking, and
selling inventory practices all need reviewing in order to determine how well they work.
This process also works well with identifying internal control problems. Updates to how
employees complete each task in the inventory process can help a company secure this
asset.
Inventory analysis should not necessarily be an infrequent process in a business.
Companies should actively review and update inventory procedures often to ensure no
fraud or embezzlement exists in the companys practices. Setting a specific schedule for
inventory analysis also ensures proper completion of tasks by employees.
Sales forecasting
Sales Forecasting is the process of estimating what your businesss sales are going to be in the
future.
Sales forecasting is an integral part of business management. Without a solid idea of what your
future sales are going to be, you cant manage your inventory or your cash flow or plan for
growth. The purpose of sales forecasting is to provide information that you can use to make
intelligent business decisions.
Sales forecasting for an established business is easier than sales forecasting for a new business;
the established business already has a sales forecast baseline of past sales. A businesss sales
revenues from the same month in a previous year, combined with knowledge of general
economic and industry trends, work well for predicting a businesss sales in a particular future
month.
Sales forecasting for a new business is more problematical as there is no baseline of past sales.
The process of preparing a sales forecast for a new business involves researching your target
market, your trading area and your competition and analyzing your research to guesstimate your
future sales.
Techniques/Methods of Sales Forecasting
Sales forecasting methods are actually used as self-assessment tools for businesses. These aim
to predict levels of sales and demands accurately for specified periods based on past or current

Subject- Production Management

Unit-3

records. Depending on the volume of sales, companies are able to use various sales forecasting
methods at different times using different information sets
To calculate forecasts of sales you will generally need information about external factors that
impact sales such as raw material price changes, economic forecasts, increased competition
and employee contract re-negotiations. You will also need information about the sales number
that have been cancelled or returned as well as the sales numbers of every product broking
down per month of the year.
Sales forecasting methods gives you information that is quite valuable which can help you
manage and plan for any type of industry and any size of business. Doing a forecast makes you
able to compare your business performance with others in the industry since there will be
available records for evaluating current and past sales. Basically, using sales forecasting
methods gives you an edge over other companies.
Forecast methods are classified as follows:
1. Qualitative Forecasting
2. Quantitative Forecasting
Qualitative forecasting
Qualitative forecasting methods are primarily subjective and the rely on human
expertise and judgment.
Most appropriate when little historical data are available like in the case of demand
forecasts for new products
Popular qualitative forecasting methods are: Delphi, Market research, judgment
methods
Qualitative Forecasting Methods
The qualitative (or judgmental) approach can be useful in formulating short-term forecasts
and can also supplement the projections based on the use of any of the quantitative
methods.
Four of the better-known qualitative forecasting methods are executive opinions, the
Delphi method, sales-force polling, and consumer surveys:
1.

Jury of Executive Opinions

The subjective views of executives or experts from sales, production, finance, purchasing,
and administration are averaged to generate a forecast about future sales. Usually this
method is used in conjunction with some quantitative method, such as trend extrapolation.
The management team modifies the resulting forecast, based on their expectations.

The advantage of this approach: The forecasting is done quickly and easily, without
need of elaborate statistics. Also, the jury of executive opinions may be the only means of
forecasting feasible in the absence of adequate data.
The disadvantage: This, however, is that of group-think. This is a set of problems
inherent to those who meet as a group. Foremost among these are high cohesiveness, strong

Subject- Production Management

Unit-3

leadership, and insulation of the group. With high cohesiveness, the group becomes increasingly
conforming through group pressure that helps stifle dissension and critical thought. Strong
leadership fosters group pressure for unanimous opinion. Insulation of the group tends to
separate the group from outside opinions, if given.

2. Delphi Method
This is a group technique in which a panel of experts is questioned individually about their
perceptions of future events. The experts do not meet as a group, in order to reduce the
possibility that consensus is reached because of dominant personality factors. Instead, the
forecasts and accompanying arguments are summarized by an outside party and returned to
the experts along with further questions. This continues until a consensus is reached.

Advantages: This type of method is useful and quite effective for long-range forecasting.
The technique is done by questionnaire format and eliminates the disadvantages of group think.
There is no committee or debate. The experts are not influenced by peer pressure to forecast a
certain way, as the answer is not intended to be reached by consensus or unanimity.
Disadvantages: Low reliability is cited as the main disadvantage of the Delphi method,
as well as lack of consensus from the returns.

3. Sales Force Polling

Some companies use as a forecast source salespeople who have continual contacts with
customers. They believe that the salespeople who are closest to the ultimate customers may
have significant insights regarding the state of the future market. Forecasts based on sales
force polling may be averaged to develop a future forecast. Or they may be used to modify
other quantitative and/or qualitative forecasts that have been generated internally in the
company.
The advantages of this forecast are:

It is simple to use and understand.

It uses the specialized knowledge of those closest to the action.
It can place responsibility for attaining the forecast in the hands of those who most affect
the actual results.
The information can be broken down easily by territory, product, customer, or
salesperson.
The disadvantages include: salespeoples being overly optimistic or pessimistic regarding
their predictions and inaccuracies due to broader economic events that are largely beyond
their control.

Subject- Production Management

Unit-3

4. Consumer Surveys
Some companies conduct their own market surveys regarding specific consumer purchases.
Surveys may consist of telephone contacts, personal interviews, or questionnaires as a
means of obtaining data. Extensive statistical analysis usually is applied to survey results in
order to test hypotheses regarding consumer behavior
Quantitative Techniques
Considering a companys past sales is one of the best methods for forecasting future sales.
Since the environment of business does not suddenly change, last quarters figures might just
help managers know the kinds of ales they can be expecting in the coming months. This is
known as a quantitative approach of forecasting sales. This also includes components you can
use like Random Factor Analysis, Cycle Analysis, Trend Analysis and Seasonal Analysis.
Usually, components such as these are applied to computations and analysis. Directly asking
people what their future buying intentions and other market research data is another
quantitative method.
Forecasting Methods
Time Series
Time series forecasting methods are based on analysis of historical data (time series: a set
of observations measured at successive times or over successive periods). They make the
assumption that past patterns in data can be used to forecast future data points.
1. moving averages (simple moving average, weighted moving average): forecast is based
on arithmetic average of a given number of past data points
2. exponential smoothing (single exponential smoothing, double exponential smoothing): a
type of weighted moving average that allows inclusion of trends, etc.
3. mathematical models (trend lines, log-linear models, Fourier series, etc.): linear or nonlinear models fitted to time-series data, usually by regression methods
4. Box-Jenkins methods: autocorrelation methods used to identify underlying time series
and to fit the "best" model
Components of Time Series Demand
1. Average: the mean of the observations over time
2. Trend: a gradual increase or decrease in the average over time
3. Seasonal influence: predictable short-term cycling behaviour due to time of day, week,
month, season, year, etc.

Subject- Production Management

Unit-3

4. Cyclical movement: unpredictable long-term cycling behaviour due to business cycle or

product/service life cycle
5. Random error: remaining variation that cannot be explained by the other four
components
Causal Forecasting Methods
Causal forecasting methods are based on a known or perceived relationship between the
factor to be forecast and other external or internal factors
1. Regression: mathematical equation relates a dependent variable to one or more
independent variables that are believed to influence the dependent variable
2. Econometric models: system of interdependent regression equations that describe some
sector of economic activity
3.Iinput-output models: describes the flows from one sector of the economy to another, and
so predicts the inputs required to produce outputs in another sector
4. Simulation modelling