Inventory Management

SANJAY VARDANI
Accman Institute of Mangement
Acknowledgement Letter

Dear Sir/Madam,

Subject: Project on Inventory Management,

I deeply acknowledge the support of Prof. Subir Guha who initially helped and
motivated us to embark on this strenuous .I would like to give thanks to
providing me an opportunity to make this project.

Name & Title of Authorised Representative:

Signature:

College Name and Address:

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 Inventory :-
An inventory can be defined as a stock of goods which is held for the
purpose of future production or sales. The stock of goods may be kept in
the following forms:
 Raw Materials
 Partly finished goods
 Finished goods
 Spare parts etc.
OR

1. A stock of items held to meet future demand

2. Inventory is a list for goods and materials, or those goods and
materials themselves, held available in stock by a business.
 Variables in an Inventory Problem:
The variables associated with the inventory problems are classified into
two categories.
a. The Controlled variables
b. The uncontrolled variables

a) The variables that may be controlled, separately or in combination

are following:
1. The quantity acquired – By purchase, production, or some other means.
The decision maker may have a control over the production or purchase
level.
2. The frequency of timing of acquisition – The decision maker may have
control over how often or when the inventory should be replenished.
3. The stage of completion of stocked items – The decision maker may
have a control over the stage at which the unfinished items be held so that
there is no delay in supplying customers.
b) The uncontrolled variables – The variable that may not be controlled in
an inventory problem are divisible into cost variables and others.

 Inventory management:
1. Inventory management is the branch of business management
concerned with planning and controlling inventories.
2. Inventory is stock of items held to meet future demand.
3. It deals with two basic questions:
 How much to order
 When to order?
 Types of Inventory:
1. Raw Material
2. Work in progress
3. Finished Goods

 Nature of Inventories
1. Raw Materials – Basic inputs that are converted into finished
product through the manufacturing process.

2. Work-in-progress – Semi-manufactured products need some more

work before they become finished goods for sale.

3. Finished Goods – Completely manufactured products ready for

sale.

4. 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

1. Meet variations in customer demand:

o Meet unexpected demand
o Smooth seasonal or cyclical demand
2. Pricing related:
o Temporary price discounts
o Hedge against price increases
o Take advantage of quantity discounts
3. Process & supply surprises
o Internal – upsets in parts of or our own processes
o External – delays in incoming goods.

 Objective of Inventory Management

1. To maintain a optimum size of inventory for efficient and smooth

production and sales operations.

2. To maintain a minimum investment in inventories to maximize the

profitability.
3. 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.

 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.

 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 cost
 Loss of sale
 Failure to meet delivery commitments
Carrying costs:-
 Warehousing or storage
 Handling
 Clerical and staff
 Insurance
 Interest
 Deterioration,shrinkage,

 Taxes
 Cost of capital
  Dangers of Over investment:-

 Unnecessary tie-up of firm’s fund 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

 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

 Functions of Inventory Management:-

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

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

 Inventory management:-
 Two system followed
 Periodic review
 Fix order quantity
 In periodic stock position is reviewed periodically rather
than continuously. A new order is always placed at the end
of the each review.
 In Fixed order quantity system the stock of an item is
continuously reviewed. A reorder level is decided on.
Whenever the stock of the item equals the reorder level, a
new order is placed. The time between orders can vary. In
this system, the order quantity ordered is always fixe and is
equal to the EOQ. EOQ (Economic Order Quantity) is
calculated by a formula which ensures that the total cost is
minimum.
 Lead time is the lapsed time between the placement of an
order and its actual delivery.
 Safety stock level is also known as buffer stock. It is the
extra quantity of merchandise that is stocked to take care of
delay in delivery and higher demand during the lead time.

 Lead time is the lapsed time between the placement of an

order and its actual delivery.
 Safety stock level is also known as buffer stock. It is the
extra quantity of merchandise that is stocked to take care of
delay in delivery and higher demand during the lead time.

 Types of Inventory

 Movement inventory:-This inventory is known as transit or

pipeline inventory arises due to shipment of inventory items
to distribution centres and from various production centers.

 Buffer inventory:- This inventory is maintained to meet

uncertainties of demand and supply. Such buffer inventory
which are in excess of those necessary to just meet the
average demand during the lead time.

 Anticipation inventory:-This is known as seasonal

inventories held because of future demand which is
anticipated.
 Decoupling inventory:-This is used to reduce
interdependence of various stage of production systems are
known as decoupling inventories.

 Lot size inventory:-These are held for the reason that

purchases are usually made in lots rather than for the exact
amounts which may be needed at appoint of time.

 EOQ – Three Approaches

 Trial and Error method

 Order-formula approach
 Graphical approach

 Model I: Basic EOQ

 Typical assumptions made:-

o Annual demand (D), carrying cost (C) and ordering
cost (S) can be estimated
o Average inventory level is the fixed order quantity (Q)
divided by 2 which implies
 No safety stock
 Orders are received all at once
 Demand occurs at a uniform rate
 No inventory when an order arrives
 Assumptions (continued)
 Stock out, customer responsiveness, and other
costs are inconsequential
 Acquisition cost is fixed, i.e., no quantity
discounts
 Annual carrying cost = (average inventory
level) x (carrying cost) = (Q/2)C
 Annual ordering cost = (average number of
orders per year) x (ordering cost) = (D/Q)S
 Total annual stocking cost (TSC) = annual
carrying cost + annual ordering cost = (Q/2)C +
(D/Q)S
 The order quantity where the TSC is at a
minimum (EOQ) can be found using calculus
(take the first derivative, set it equal to zero and
solve for Q)
 EOQ:− √2 DS/C
 Example: Basic EOQ

Zartex Co. produces fertilizer to sell to wholesalers. One

raw material – calcium nitrate – is purchased from a nearby
supplier at $22.50 per ton. Zartex estimates it will need
5,750,000 tons of calcium nitrate next year.
The annual carrying cost for this material is 40% of the
acquisition cost, and the ordering cost is $595.
a) What is the most economical order quantity?
b) How many orders will be placed per year?
c) How much time will elapse between orders?

 Economical Order Quantity (EOQ)

D = 5,750,000 tons/year
C = .40(22.50) = $9.00/ton/year
S = $595/order
EOQ = 2DS/C
EOQ = 2(5,750,000)(595)/9.00
= 27,573.135 tons per order

 Total Annual Stocking Cost (TSC)

TSC = (Q/2)C + (D/Q)S
= (27,573.135/2)(9.00)
+ (5,750,000/27,573.135)(595)
= 124,079.11 + 124,079.11
= $248,158.22
 Number of Orders Per Year
= D/Q
= 5,750,000/27,573.135
= 208.5 orders/year
  Time Between Orders
= Q/D
= 1/208.5
= .004796 years/order
= .004796(365 days/year)
= 1.75 days/order

Refrences:-
 Google.com
 Operation Management by Prof. Subir Guha
 Production and Operations Management by
EVERETT E. ADAM , Jr. RONALD J. EBERT

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