Chapter – 4

Material Management
and
Inventory Control

By Gebeyaw T.
What is Materials Management ?

Material management is a scientific technique,

concerned with Planning, Organizing &Control of flow
of materials, from their initial purchase to destination.
AIM OF MATERIAL MANAGEMENT
To get
1. The Right quality
2. Right quantity of supplies
3. At the Right time
4. At the Right place
5. For the Right cost
6. For the right user
Purchasing Cycle
Points to be noted before purchase of an equipment:
• Latest technology
• Availability of maintenance & repair facility, with
minimum down time
• Post warranty repair at reasonable cost
• Upgradeability
• Reputed manufacturer
• Availability of consumables
• Low operating costs
• Proper installation as per guidelines
• Quantity & payment discounts
• Payment terms
 Inventory Control
Inventory: generally refers to the materials in stock.
An inventory is an idle stock of material in store used to facilitate
production or to satisfy customer future demands.
Inventory is any stored resource that is used to satisfy a current or
future need.
• Independent demand – finished goods, items that are ready to be sold.
Dependent demand – components of finished products.

Independent demand is uncertain.

Dependent demand is certain. Independent Demand

A Dependent Demand

B(4) C(2)

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

3
 INVENTORY CONTROL
Inventory Management: Scientific method of finding out how
much stock should be maintained in order to meet the
production demands and be able to provide right type of
material at right time, in right quantities & at competitive prices.
Inventory control is a planned approach of determining what to
order, when to order, how much to order and how much to stock.
Thecosts associated with buying and storing are optimal without
interrupting productions and sales.
Inventory control is concerned with achieving an optimum
balance between two competing objectives.
Minimizing the investment in inventory (Inventory cost).
Maximizing the service levels to customer’s and it’s operating
departments. 4
 Differences
Material Inventory Inventory
Aspect
Management Management Control
Operational –
Broadest – covers Strategic – focuses
focuses on daily
Scope entire flow of on planning and
handling of
materials stock optimization
inventory
Forecasting, Tracking,
Procurement,
Main ordering, and organizing, and
storage, flow, and
Focus maintaining right securing actual
usage of materials
stock levels stock
Manages everything Ensures right Ensures physical
Function from raw materials inventory at right inventory
to production time & place matches records
Select supplier, Set reorder point, Count stock,
Example
inspect materials, calculate safety prevent theft,
Task
plan logistics stock update system
 TYPES OF INVENTORY
Raw material
Purchased but not processed
Work-in-process
Undergone some change but not completed
Finished goods
Completed product awaiting shipment
Goods-in-transit to warehouses or customers
Distribution inventories; finished goods that are located in the
distribution system.
Maintenance/repair/operating (MRO)
Replacement parts, tools, & supplies
Necessary to keep machinery and processes productive
5
FUNCTIONS/ PURPOSE OF INVENTORY
 To meet anticipated demand.

 To meet variation in product demand.

 To allow flexibility in production scheduling.

 To provide a safeguard for variation in raw

material delivery time.

 To take advantage of order cycles or to take

advantage of quantity discounts.

6
 Inventory Classification and Counting

 Inventory classification is defined as a process of classifying

items into different categories, thereby directing appropriate
attention to the materials in the context of company’s viability.

 In this system, the items are categorized in a groups depending

upon the selected criteria such as value, usage or consumption,
and frequency.

 Such grouping helps the organization for scientific inventory control.

7
 The different techniques of inventory control are:
(1) ABC analysis
(2) VED analysis
(3) SDE analysis
(4) FSN analysis
(5) HML analysis
(6) SOS analysis
(7) GOLF analysis
 1. ABC ANALYSIS (Most widely used and classification is
based on annual consumption and the annual value of the items.)
 Hence we obtain the quantity of inventory item consumed during
the year and multiply it by unit cost to obtain annual usage cost.
 The items are then arranged in the descending order of such
annual usage cost.
 ABC ANALYSIS
(ABC = Always Better Control)
This is based on cost criteria.
It helps to exercise selective control when confronted with large number
of items it rationalizes the number of orders, number of items & reduce
the inventory.
About 10 % of materials consume 70 % of resources
About 20 % of materials consume 20 % of resources
About 70 % of materials consume 10 % of resources
‘A’ ITEMS
Small in number, but consume large amount of
resources
Must have:
• Tight control
• Rigid estimate of requirements
• Strict & closer watch
• Low safety stocks
8/23/2024 • Managed by top management 10
 ‘C’ ITEMS
Larger in number, but consume lesser amount of
resources
Must have:
• Ordinary control measures
• Purchase based on usage estimates
• High safety stocks
ABC analysis does not stress on items those
are less costly but may be vital
‘B’ ITEM
Intermediate
Must have:
• Moderate control
• Purchase based on rigid requirements
• Reasonably strict watch & control
• Moderate safety stocks
8/23/2024 • Managed by middle level management 11
 Steps in A B C Analysis
a) Compute Annual Usage for each item and Compute Total Annual
Usage.
b) Sort the list of items by the Annual Usage, from largest to smallest.
c) Compute the percentage of Annual Usage for each item.
c) Calculate the Cumulative Percentage of Annual Usage for the
first item, first 2 items, first 3 items, etc. For the last item, the
cumulative % should be 100%.
d) Using Cumulative % as a guide, assign the items to A, B, and C
categories.

9
Example on A B C Analysis

16
a) Compute annual usage for each item and Compute total annual usage.

17
b) Sort the list of items by the Annual Usage , from largest to
smallest.

14
C) Compute the percentage of Annual Usage for each item.
ABC problem Solution
Annual usage
Item Units $ Value in units value %value
106 75 220 16500 34.42161
110 25 500 12500 26.07698
115 15 300 4500 9.387713
105 40 80 3200 6.675707
111 5 450 2250 4.693856
104 50 40 2000 4.172317
114 1 1200 1200 2.50339
107 4 250 1000 2.086158
101 12 80 960 2.002712
113 3.5 250 875 1.825389
103 15 50 750 1.564619
108 1.5 400 600 1.251695
112 7.5 80 600 1.251695
102 50 10 500 1.043079
109 2 250 500 1.043079
15 4160 47935 100
15
D) Calculate the Cumulative Percentage of Annual Usage for each item.

ABC problem Solution

Annual usage

Item Units $ Value in units value %value Com.% Value

106 75 220 16500 34.42161 34.42161
110 25 500 12500 26.07698 60.49859
115 15 300 4500 9.387713 69.8863
105 40 80 3200 6.675707 76.56201
111 5 450 2250 4.693856 81.25587
104 50 40 2000 4.172317 85.42818
114 1 1200 1200 2.50339 87.93157
107 4 250 1000 2.086158 90.01773
101 12 80 960 2.002712 92.02044
113 3.5 250 875 1.825389 93.84583
103 15 50 750 1.564619 95.41045
108 1.5 400 600 1.251695 96.66215
112 7.5 80 600 1.251695 97.91384
102 50 10 500 1.043079 98.95692
109 2 250 500 1.043079 100
15 4160 47935 100
20
E) Using Cumulative % , assign the items to A, B, and C categories
ABC problem Solution
Annual usage
Item Units $ Value in units value %value Com.% Value Categories
106 75 220 16500 34.42161 34.42161 A
110 25 500 12500 26.07698 60.49859 A
115 15 300 4500 9.387713 69.8863 A
105 40 80 3200 6.675707 76.56201 B
111 5 450 2250 4.693856 81.25587 B
104 50 40 2000 4.172317 85.42818 B
114 1 1200 1200 2.50339 87.93157 B
107 4 250 1000 2.086158 90.01773 C
101 12 80 960 2.002712 92.02044 C
113 3.5 250 875 1.825389 93.84583 C
103 15 50 750 1.564619 95.41045 C
108 1.5 400 600 1.251695 96.66215 C
112 7.5 80 600 1.251695 97.91384 C
102 50 10 500 1.043079 98.95692 C
109 2 250 500 1.043079 100 C
15 4160 47935 100

Advantages of ABC classification

 This approach helps the manager to exercise selective control and
focus his attention only on few items.
 It results in reduced costs, saves time and effort and results in
better planning and control.
 Quiz One
Assign the items to A, B, and C categories and draw
recommendation with justification. (15 minute)

Item no. Annual volume/ Unit cost

unit usage (Birr)
1 1000 90
2 500 154
3 1550 17
4 350 42.86
5 1000 12.50
6 600 14.17
7 2000 0.60
8 100 8.50
9 1200 0.42
10 250 0.60
18
 2. VED ANALYSIS
• Based on critical value & shortage cost of an item
–It is a subjective analysis.
Vital:
• Shortage cannot be tolerated.
Essential:
• Shortage can be tolerated for a short period.
Desirable:
 Shortage will not adversely affect, but may be using
more resources. These must be strictly Scrutinized

8/23/2024 23
3.
SDE ANALYIS Based on availability
Scarce
• Managed by top level management
• Maintain big safety stocks
Difficult to produce
• Maintain sufficient safety stocks
Easily available / Easy to Produce
• Minimum safety stocks.

8/23/2024 24
 Scarce items are characterized by limited supply, long lead
times, and potential disruptions in procurement. These items
often require specialized manufacturing processes, import
restrictions, or sourcing from remote locations
Examples of Scarce Items:
1. Specialized components: Electronic components with unique specifications or
limited production capacity
2. Raw materials from remote locations: Raw materials sourced from distant
regions with limited transportation options
3. Products with fluctuating demand: Seasonal products or those subject to sudden
spikes in demand
Difficult items are readily available domestically but may pose
procurement challenges due to limited suppliers, transportation
constraints, or complex quality control requirements.
Example Items sourced from a single supplier: Products that rely
on a single supplier, increasing risk of supply disruptions.
8/23/2024 25
4. FSN ANALYSIS Based on consumption or utilization of the items.
Fast moving.
Slow moving.
Non-moving
- items must be periodically reviewed to prevent expiry &
obsolescence
5. HML Analysis - Based unit price of the item
• High Value
• Midium Value
• Low Value
26
6. SOS Analysis – Based on Seasonality
• Seasonal Items and Off-Seasonal Items

7. GOLF Analysis - Based sources of the items.

• Government supply,
• Ordinarily available,
• Local availability and
• Foreign source of supply items

8/23/2024 27
 INVENTORY MODELS
Inventory models deals with determining optimum
inventory level that should be kept to keep the
inventory cost to the minimum and customer
satisfaction or service level to the maximum.
 When to order? or when to produce?
 How much to order? or How much produce?
 Level of inventory
 Types of Inventory Models
 Economic Order Quantity (EOQ) (When to order?
How much to order?)
 Economic Production Quantity (EPQ) (when to
produce? How much produce?)
 Price Discount Models

26
 1. ECONOMIC ORDER QUANTITY (EOQ)
 These models are concerned with two decisions:
 how much to order (purchase or produce) and
 When to order so as to minimize the total cost.
 For the first decision; how much to order, there are two basic costs are
considered namely, inventory carrying costs and the ordering costs.
 The ‘order quantity’ means the procured during one production cycle.
 Economic order quantity is calculated by balancing the two costs.
 Economic Order Quantity (EOQ) is that size of order which
minimizes total costs of carrying and cost of ordering.
8/23/2024 27
 INVENTORY COSTS
 Ordering costs: the costs of placing an order and receiving goods,
Fixed, constant amount incurred for each order placed.

 Developing and sending purchase orders, Processing and

inspecting incoming inventory, Inventory inquiries, Utilities,
phone bills, and so on.

 Holding costs: costs of holding or “carrying” inventory over

time.

 Housing costs (rent, operating costs, taxes, insurance),

Material handling costs (equipment lease or depreciation,
power, operating cost), obsolescence, borrowing costs, 28
 Assumptions of the basic EOQ model
 Only one product is involved
 demand is known and constant over time,
 the lead time, that is, the time between the placement of the order
and the receipt of the goods, is known and constant,
 the receipt of the inventory is instantaneous; i.e., the goods arrive in
a single batch, at one instant in time,
 quantity discounts are not possible,
 The only variable costs are the cost of setting up or placing an order
and the cost of holding or storing inventory over time, and
 if orders are placed at the right time, stock outs or shortages can
be completely avoided. 29
8/23/2024 33
Total inventory carrying cost = Average inventory ×
Inventory carrying cost per unit

Total inventory carrying cost = Q/2 × H= QH /2 …(1)

1

Total annual ordering costs = Number of orders per year ×

Ordering cost per order

Total annual ordering costs = (D/Q) × S= (D/Q)S…(2)

Total cost of production run = Total inventory carrying

cost + Total annual ordering costs
TC= QH/2 + (D/Q)S
8/23/2024 34
8/23/2024 35
8/23/2024 36
8/23/2024 37
 EOQ Model Equations
Optimal Order Quantity = Q* = 2 ×D ×S
H
Expected Number of Orders = N = D*
Q
Expected Time Between Orders = T = Working Days / Year
N
d= D
Working Days / Year
ROP = d × L

Where
 Reorder point (Rop): Level of inventory on hand at which the next order should be placed.

 Cycle Interval (T): the total time between one order receipt period and next order receipt.

 Order frequency (N): total number of orders per year (per full inventory cycle).

 Cycle Inventory (Q/2): Average inventory kept per cycle interval.

35
Example1
 Annual Demand = 1,000 units;  Holding cost per unit
 Days per year considered in per year = $2.50;
average 365;  Lead time = 7 days;
 Cost to place an order = $10;  Cost per unit = $15;

Given the information above, what are the E O Q , reorder point (R),
Cycle inventory, Order frequency (N) and Cycle interval (T)?

2DS 2(1,000 )(10)

Q OPT = = = 89.443 units or 90 units
H 2.50

1,000 units/year
d= = 2.74 units/day
365 days/year Cycle Inventory = Q/2 = 45 Units

_
R = d L = 2.74units/ day (7days) = 19.18 or 20 units

N = D/Q = 11.1 Orders T= Q/d = 32.85 days 36

 Example2
The soft goods department of a large department store sells 175
units per month of a certain large bath towel. The unit cost of a
towel to the store is $2.50 and the cost of placing an order has
been estimated to be $12.00. The store uses an inventory carrying
charge of 27% per year. Determine the optimal order quantity,
order frequency, and the annual cost of inventory management.

8/23/2024 37
2. Economic Production Quantity (EPQ)
 An optimizing method used for determining production
quantity and reorder points.
 Production done in batches or lots.
 Capacity to produce a part exceeds the part’s usage or demand
rate.
 Assumptions of EPQ are similar to EOQ except orders are
received incrementally during production.
 Only one item is involved
 Annual demand is known
 Usage rate d is constant
 Usage occurs continually
 Production rate p is constant
 Lead time does not vary

38
39
8/23/2024 40
 Example1
D = 1,000 units p = 8 units per day
S = $10 d = 4 units per day
H = $0.50 per unit per year

2DS
Q 
*

H 1d p  
p

2(1,000)(10)
Q*p 
0.501(4 8)  

20,000
  80,000
0.50(1 2)
282.8 hubcaps, or 283 hubcaps
 Example2
Some Manufacturing industry produces a product for which the
annual demand is 10,000 units. Production averages 100 per day,
while demand is 40 per day. Holding costs are $2.00 per unit per
year; set-up costs $200.00. If they wish to produce this product in
economic batches, what size batch should be used? What is the
maximum inventory level? How many order cycles are there per
year? How much does management of this good in inventory cost
the firm each year?

8/23/2024 42
 [Link] Discount Models
 These models are used where the price of the item ordered
varies with the order size.
 Reduced prices are often available when larger quantities are
ordered.
 The buyer must weigh the potential benefits of reduced purchase
price and fewer orders that will result from buying in large
quantities against the increase in carrying cost caused by
higher average inventories.
 Hence, three is trade-off is between reduced purchasing ,
ordering and increased holding cost

47
 EOQ when carrying cost is constant

1. Compute the common minimum point by using the basic

economic order quantity model.
2. Only one of the unit prices will have minimum point in its
feasible range since the ranges do not overlap. Identify that
range:
a. if the feasible minimum point is on the lowest price range, that
is the optimal order quantity.
b. if the feasible minimum point is any other range, compute
the total cost for the minimum point and for the price breaks
of all lower unit cost. Compare the total costs; the quantity
that yields the lowest cost is the optimal order quantity.
48
 EOQ when carrying cost is a percentage of the unit price

Steps in analyzing a quantity discount

1. For each discount, calculate Q*

2. If Q* for a discount doesn’t qualify, choose the lowest
possible quantity to get the discount
3. Compute the total cost for each Q* or adjusted value
from Step 2
4. Select the Q* that gives the lowest total cost

49
 Total Costs with Purchasing Cost
Annual Annual Purchasing
+
TC = carrying + ordering cost
cost cost

QH + DS cD
TC = +
2 Q
Where c is the unit price.
Remember that the basic EOQ model does not take into
consideration the purchasing cost. Because this model works
under the assumption of no quantity discounts, price per unit is
the same for all order size. Note that including purchasing cost
would merely increase the total cost by the amount c times the
demand (D).
50
D= Annualdemand
S = Order cost per order
H= Holding (carrying) cost = hc
h= Inventory holding cost %per year
c = Price per unit

2 ×D ×S
Order Quantity = Q* =
hc
Annual purchase cost

Total Cost ($/yr) = D S + Q hc + cD

Q 2

51
Example1
• Annual Demand = 5000 units per year
• Ordering cost = $49 per order
• Annual carrying charge = 20%
• Unit price schedule:
Quantity UnitPrice
0 to 999 $5.00
1000 to 1999 $4.80
2000 andover $4.75

52
Quantity Discount Example
Step 1 2DS
Q* =
Calculate Q* first for the lowest price range c*h

2(5,000)(49)
Q3* = = 718 cars/order (not feasible)
(.2)(4.75)

2(5,000)(49)
Q2* = = 714 cars/order(not feasible)
(.2)(4.80)

2(5,000)(49)
Q1* = = 700 cars/order (feasible)
(.2)(5.00)
53
Quantity Discount Example
2DS
Q* =
c*h

2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80) 1,000 — adjusted
2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75) 2,000 — adjusted
54
 Example Solution (Cont.)
• Step 2
5,000 700
TC Q700   49   0.2  5.00  5.00 5000  $25,700
700 2
5,000 1000
TC Q1000   49   0.2  4.80  4.80  5000  $24,725
1000 2
5,000 2000
TC Q2000   49   0.2 4.75  4.75 5000  $24,822.50
2000 2
• Choose the price and quantity that gives the
lowest total cost
• Buy 1,000 units at $4.80 per unit

55
 Quantity Discount Example 2
D = 1000/year Q c H
S = $100/order <500 $100 $20
h = 20% per year 500-999 $ 95 $19
 1000 $ 90 $18
1. c = $100 H = $20
EOQ = 100 in range!
Total Cost = 1,000 + 1,000 + 100,000 = $102,000/year

2. c = $95 H = $19
EOQ = 102.6 not in range (500-1000)!
Adjust to Q = 500
Total Cost = 200 + 4,750 + 95,000 = $99,950/year

56
3. c = $90 IP = $18
EOQ= 105.4 not in range (>1000)!
Adjust to Q= 1000
Total Cost = 100 + 9,000 + 90,000 = $99,100/year

Q Total costs
<500 $102,100
500-1000 $ 99,950
 1000 $ 99,100

57