INVENTORY

MANAGEMENT

By Rahul Sengupta
 INVENTORY MANAGEMENT

 A set of policies and controls that

monitors levels of inventory and
determines what levels should be
maintained, when stock should be
replenished, and how large orders
should be.
 Inventory Positions in the Supply Chain
Production Processes

Work in

To Customer
process
From Suppliers

Stores WIP Finished

warehouse goods
WIP

Inventory in transit
 Why We Want to Hold
Inventories
 Finished Goods
– Essential in produce-to-stock positioning strategies
– Improve Customer Service
– Unplanned shocks (labor strikes, natural disasters, surges in
demand, etc.)
 Work-in-Process
– Necessary in process-focused production
 Contribute to the efficient and effective operation
of the production system
Buffers to feed processes and enable efficient scheduling

 Raw Material
– Suppliers may produce/ship materials in batches
(Transportation saving)
– Quantity discounts for reducing ordering cost
Adding Value through
Inventory

 Quality - inventory can be a “buffer”

against poor quality; conversely, low
inventory levels may force high quality
 Speed - location of inventory has gigantic
effect on speed
 Cost – purchasing
 Why We Do Not Want to Hold Invent

Certain costs increase such as

– carrying costs
– cost of coordinating production
– large-lot quality cost
Independent Demand Inventory Systems

Demand for an item carried in

inventory is independent of the
demand for any other item in
inventory
Finished goods inventory is an
example
Dependent Demand Inventory Systems

Items whose demand depends on

the demands for other items
For example, the demand for raw
materials and components can be
calculated from the demand for
finished goods
Independent vs. Dependent
Demand
Independent Demand
(finished goods and spare parts)

A Dependent Demand
(components)

B(4) C(2)

D(2) E(1) D(3) F(2)

Design of Inventory Mgmt. Systems:
EOQ

 Economic Order Quantity -

The quantity per order (in units) that minimizes
the total costs of processing orders and holding
inventory.
D = demand in units per year
C = holding cost in INR/unit/year
S = cost of placing an order in INR

EOQ = 2DS/C
 EOQ EXAMPLE

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.
 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
Design of Inventory Mgmt. Systems:
ROP

 Order Timing
Reorder Point - Quantity to which inventory
is allowed to drop before replenishment
order is made.

Need to order EOQ at the Reorder Point.

ROP = D X LT
D = Demand rate per period
LT = lead time in periods
 Reorder Point Example

Demand = D =10,000 yds/year

Lead time = LT = 10 days
Daily demand = 10,000 / 365 =
27.4 yds/day
ROP = D*LT = (27.4)(10) = 274
yds
(usually can neglect issues of
 EOQ Inventory Order
Cycle
Demand
Order qty, Q
rate
Inventory
Level

avg = Q/2
Reorder
level

0 Lead Lead Time

time time
As Q increases, average Order Order Order Order
inventory level
increases, but number of Placed Received Placed Received
orders placed decreases
 SAFETY STOCK
It allows manager to determine the
probability of stock levels - based on
desired customer service levels

reorder Qm
point

safety stock
time
 Just-in-Time
It approach to inventory management & control in which inventories are
acquired & inserted in production at exact time when needed.
Requirement :
 Accurate production & inventory information system
 Highly efficient purchasing
 Reliable suppliers
 Efficient inventory-handling system
 Stock : Input (Flow in), Storage (Holding) and Flow out (Usage)

Inventory Level

Supply Rate

Stock Level

Rate of Demand (Usage)

ABC Classification (Pareto
Principle- 20/80)

 A Items: very tight control, complete and accurate

records, frequent review required. A small percentage of
the items make up a large percentage of the inventory
value.
 B Items: less tightly controlled, good records, regular
review required . A medium percentage of the items make
up a medium percentage of the inventory value.
 C Items: simplest controls possible, minimal records,
large inventories, periodic review and reorder is required.
A large percentage of the items make up a small
percentage of the inventory value.
 Annual Usage by INR Value

Percentageof
Annual Usagein
Item Unit Cost INR Usage Total INR
Units
Usage
1 5,000 INR 1.50 INR 7,500.00 2.9%
2 1,500 INR 8.00 INR 12,000.00 4.7%
3 10,000 INR 10.50 INR 105,000.00 41.2%
4 6,000 INR 2.00 INR 12,000.00 4.7%
5 7,500 INR 0.50 INR 3,750.00 1.5%
6 6,000 INR 13.60 INR 81,600.00 32.0%
7 5,000 INR 0.75 INR 3,750.00 1.5%
8 4,500 INR 1.25 INR 5,625.00 2.2%
9 7,000 INR 2.50 INR 17,500.00 6.9%
10 3,000 INR 2.00 INR 6,000.00 2.4%
Total INR 254,725.00 100.0%
 ABC Chart

45.0% 120.0%

C
40.0%

35.0%

30.0%
A B 100.0%

80.0%

25.0%
60.0%
20.0%

15.0% 40.0%
tU
g
a
snP
rc
e

10.0%

%
U
g
s
e
tivm
C
u
la
20.0%
5.0%

0.0% 0.0%
3 6 9 2 4 1 10 8 5 7
Item No.

Percentage of Total INR Usage Cumulative Percentage

 Bin Systems
Two-Bin System

Order One Bin of

Inventory when one
Full Empty is emptied
One-Bin System

Order Enough to
Refill Bin
Periodic Check (e.g. check book)
 Inventory Costs

Procurement costs
Carrying costs
Out-of-stock costs
 Procurement Costs

 Order processing
 Shipping
 Handling
 Purchasing cost
 Mfg. cost
 Carrying Costs

 Capital costs
 Inventory risk costs
 Space costs
 Inventory service costs
 Out-of-Stock Costs

Lost sales cost

 Costs included in Inventory
 The carrying cost of inventory should include all
costs required to obtain physical possession and to
put the merchandise in saleable condition.
 The inventory costs of a manufacturer is included
raw material, W.I.P. , Finished Goods , labor, and
certain overhead items.
 General administrative costs and selling costs are
expensed in the period in which they are incurred.
 Inventory costing method

Important of inventory valuation

• Costing method has important effect on net income and asset valuation.

Beginning + Inv. =
Goods Available for Sale
Inv. Purchase
Costing method Needs to be allocated
Weighted Average
LIFO
FIFO Ending Inv. Cost of Goods Sold
 Inventory costing Example
Closing Stock as on 31st Oct.09

Opening Stock Raw Material : Add 96,655,856.88

Material Purchased ( Import ) : Add 34,825,551.70

Material Purchased ( Local ) : Add 2,902,584.75

Material Consumption (Fan assembly) : Less 23,014,904.66

Material Consumption (FBD Dispatch) : Less 5,847,471.51

Accessories Consumption : Less 8,873,108.94

Finished Goods : Add 14,206,902.46

Closing Stock as on on 31st Oct.09 INR 110,855,410.68

 Inventories LIFO
 Assumes the most recent units produced or
purchased are the first sold or used.
 Charging cost of goods sold (COGS) with the most
recent costs incurred.
 On the balance sheet, LIFO inventory consists of
the oldest costs
 For firms that have used LIFO for many years, the
LIFO inventory amount reflect only a small
fraction of the cost at today’s price.
 Inventories
First-In, First-Out (FIFO)

Oldest
Oldest Costs
Costs of
of
Costs
Costs Goods
Goods Sold
Sold

Recent
Recent Ending
Ending
Costs
Costs Inventory
Inventory
 Inventories FIFO
 Assumes the oldest units available in
inventory are the first unites that are sold.
 The ending inventory consists of the cost of
the most recently acquired unites.
 FIFO changes the oldest costs against
revenues on the income statement.
 Inventories Weighted Average Method

When
When aa unit
unit isis sold,
sold, the
the
average
average costcost of of each
each unit
unit
in
in inventory
inventory isis assigned
assigned to to
cost
cost of
of goods
goods sold.sold.

The
The average
average price
price of
of aa unit
unit isis
simply
simply the
the total
total cost
cost of
of
materials
materials in in stores
stores divided
divided
by
by the
the total
total quantity.
quantity.
 Stores Ledger
Valuation Of Inventory as per Weighted Avg. Method

Date Receipts Issues Balance

Qty Rate. Rs. Value Rs. Qty Rate. Rs. Value Rs. Qty Rate. Rs. Value Rs.

03.02.08 100 5 500 - - - 100 5 500

06.02.08 200 5.50 1100 - - - 300 5.33 1599

10.02.08 - - - 150 5.33 800 150 5.33 800

GOODS RECEIPT NOTE
 Physical Count Or Stock Take
 Most companies take a
physical count of inventory
at least once each year.
 When the physical count
does not match the
Merchandise Inventory
account, an adjustment
must be made.
Stock Take – Tag Book
Tag Control Report
STOCK CARD
STOCK REPORT
Dictated by the conservatism principle

Inventory must be reported

at market value when
market is lower than cost.
Compute LCM for individual items, inventory
groups, and overall inventory.
 Calculation
Cost of Beginning Cost of Beginning
Inventory Inventory
+Cost of Purchases +Cost of Purchases
___________________ ___________________
=Cost of Goods Available =Cost of Goods Available
for Sale for Sale
- Cost of Ending Inventory - Cost of Goods Sold
___________________ ___________________
=Cost of Goods Sold =Cost of Ending Inventory
INVENTORY