OPERATION MANAGEMENT

Course Leader: Dr. B Dayal

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Yardstick International College

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Lecture 5

INVENTORY CONTROL

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Lecture 5: Inventory control
● Introduction
● Typical material delays
● Features of good inventory system
● Requirements of inventory system
● Benefits of inventory system
● System approach for inventory management
● Inventory accounting system
● Inventory control
● Economic order quantity

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INVENTORY MANAGEMENT: AN OVERVIEW
● Inventory is one of the most expensive assets of many companies,
representing as much as 50% of total invested capital. Operations managers
around the globe have long recognized that good inventory management is
crucial. On the one hand, a firm can reduce costs by reducing inventory. On the
other hand, production may stop and customers become dissatisfied when an
item is out of stock. The objective of inventory management is to strike a
balance between inventory investment and customer service. One can never
achieve a low-cost strategy without good inventory management.
● All organizations have some type of inventory planning and
control system. A bank has methods to control its inventory of
cash. A hospital has methods to control blood supplies and
pharmaceuticals. Government agencies, schools, and, of course,
virtually every manufacturing and production organization are
concerned with inventory planning and control.
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INVENTORY MANAGEMENT: AN OVERVIEW
DEFINITION OF INVENTORY:
● “Inventory is a detailed list of movable goods”
● “Inventory is a physical stock of items that an enterprise keeps in hand for
efficient running of operations of a firm or its business.”
● An inventory is the quantity of goods, raw materials or other resources
that are idle at any given point of time”
● Thus, inventory consists of raw material, component parts, supplies or
finished products etc., Which are purchased from an outside
source and the goods manufactured in the enterprise itself.
● In other words ‘ inventory’ refers to stocks held by the firm.

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INVENTORY MANAGEMENT: AN OVERVIEW
INVENTORY VS STORES:
● Stores means all those articles which are kept in store while inventory
comprises stores as well as materials in transit, material in process,
finished products and equipment, tools and accessories.
NEED FOR INVENTORY.
● To gain economies in purchasing beyond current requirements.
● To level out production cycles by producing to inventory.
● To carry a reserve in order to prevent stock out or lost sales.
● To maintain service stocks while replacement stocks are
in transit.
● To protect against variations in demand.

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INVENTORY MANAGEMENT: AN OVERVIEW
ADVANTAGES OF KEEPING INVENTORY:
● Lower purchase cost.
● Lower interest expenses.
● Increase in the availability of internal funds.
● Lower operating costs.
● Dependable delivery schedules
● Better customer service in the supply of goods.
DRAWBACKS OF KEEPING INVENTORY.
● Occupying spaces.
● Blocking working capital.
● Increasing risks of obsolescence, spoilage, theft, pilferage.
● Increasing maintenance and preservation costs

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TYPICAL MATERIAL RELATED DELAYS
● Waiting for materials
● Travel time to get materials
● Time to transport materials
● Time required to identify material
● Time to find substitute material
● Time required to find parts in areas stores
● Time required to repair purchase order
● Time to process purchase requisitions (approvals, etc.)
● Lost time due to:
o Other crafts without materials
o Wrong material planned and delivered
o Wrong materials ordered
o Material out of stock

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INVENTORY MANAGEMENT: AN OVERVIEW
● Types of inventory:
o According to needs.
o Economic lot inventories.
o Fluctuation or stabilizing inventories
o Anticipation inventories.
o Transportation inventories.
● Classification as per function.
o Production inventories.
o Maintenance, repair and operation inventories.
o In-process inventories.
o Finished products inventories.
o Material in transit inventories.

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 FEATURES OF A GOOD PRODUCTION
INVENTORY SYSTEM
● Tracks balance of all items including issues
● Maintains part listings for equipment
● Tracks item repair cost and movement history
● Cross references spares to substitutes
● Has the ability to reserve items for jobs
● Has the ability to notify a requester when items are received for a job.
● Has the ability to generate work order to fabricate or service an item
● Has the ability to notify when the item reorder is needed and track
the order to receipt
● Has the ability to track requisitions, purchase orders and special
order receipts
● Has the ability to produce performance reports such as
inventory accuracy, turnover and stock outs.

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INVENTORY MANAGEMENT: AN OVERVIEW
Operations stores options:
● Centralised stores:
o Reduced records keeping
o Reduced stores labour costs
o Increased maintenance travel
● Area or decentralised stores
o Reduced maintenance travel
o Increased records keeping
o Increased stores labour costs
o Increased inventory levels.

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INVENTORY MANAGEMENT: AN OVERVIEW
● Types of production inventory
o Bin stock – free issue
o Bin stock – controlled issue
o Critical or insurance items
o Rebuildable items
o Consumables
o Tools and equipment
o Residual / surplus parts
o Scrap or useless items

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HIDDEN INVENTORY COSTS
● Cost of interest for capital tied up in inventory 10 – 15%
● Cost of operating ware house space, property tax, energy cost, insurance,
maintenance fees - 5%
● Cost of space occupancy, rent and depreciation - 8%
● Cost of inventory shrinkage, obsolescence, damage, theft, contamination
5 – 10%
● Inventory tax 1 – 2%
● Cost of labour to move in and out 5 – 10%
● Total of real carrying cost of the value of the item per year
30 – 40%

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INVENTORY MANAGEMENT: AN OVERVIEW
SYMPTOMS OF POOR INVENTORY MANAGEMENT:
● High rate of order cancellations.
● Excessive machine down time due to material shortage.
● Periodic lack of adequate storage space.
● Large scale inventory write down because of price decline, distress sales,
disposal of obsolete or slow moving items.
● Widely varying rate of inventory losses.
● Wide write down at the time of physical inventory taking.
Continuous growing inventory quantities.
● Inability to meet delivery schedules.
● Uneven production.

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Practice Question
● Out of these, which is not the feature of a good production inventory
system?
o Has the ability to reserve items for jobs
o Has the ability to notify a requester when items are received for a job.
o Has the ability to generate work order to fabricate or service an item
o Has the ability to track quality, delivery schedule and customer
satisfaction

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 MATERIALS
SERVE
OPERATIONS
STORES SERVE
MATERIALS
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OBJECTIVE OF INVENTORY MANAGEMENT
● The overall objective of inventory management is to achieve satisfactory
levels of customer service while keeping inventory costs within
reasonable limits.

● The performance of inventory management can be measured in the

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 REQUIREMENTS FOR EFFECTIVE
INVENTORY MANAGEMENT
● A system to keep track of the inventory on hand and on order. That is to
find out how much we have, and how much we should have based on
stock-level fluctuations, rate of demands, etc. Then take steps to close
the gap between the two.
● A reliable forecast of demand that includes an indication of possible
forecast error.
● Knowledge of lead times and lead time variability.
● Reasonable estimates of inventory holding costs, ordering costs, and
shortage costs.
● A classification system for inventory items.

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SYSTEM APPROACH FOR INVENTORY MANAGEMENT
● The inventories should be viewed in terms of overall system of
production, operation and marketing. The aim of the system approach is
to reduce the size of inventories without destroying their effectiveness.
o Better forecasting and planning.
o Fewer inventories.
o Centralized inventory.
o Developing a batch of reliable vendors to cater to the needs of a
variety of items ensuring the right quantity, in right place
and particularly in right time.
o Control through reports at a regular frequency.
o Effective budgetary control.

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INVENTORY COUNTING SYSTEMS
A PERPETUAL INVENTORY SYSTEM
● It is also known as a continual system which keeps track of removals from
inventory on a continuous basis. When the amount on hand reaches a
predefined minimum, a fixed quantity Q is ordered. The system provides
continuous monitoring of inventory withdrawals and the setting of optimal
order quantity. However, there is an added cost for record keeping and
physical count is still needed to verify inventory records. Discrepancy
could occur due to errors, pilferage, spoilage, and other factors.
o Two bin system
o Ordering cycle system

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INVENTORY COUNTING SYSTEMS
A Two-Bin System
● A two-bin system is a very elementary and most commonly used system.
It is also called the min-max system. The items are divided into two bins:
the first one is for satisfying the current demand, while the second one is
to satisfy the demand during the replenishment period. Items are
withdrawn from the first bin until its contents are exhausted. It is then time
to reorder by using the order card placed at the bottom of the first bin.
The second bin contains enough stock to satisfy expected
demand until the order is filled, plus an extra cushion of
stock that will reduce the chance of stock-out if the order
is late or if usage is greater than expected.

BIN 2 BIN 1

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INVENTORY COUNTING SYSTEMS
A Two-Bin System
● When the ordered batch arrives, the level of the second bin is restored to its
original high value, and the balance is put in the first bin from which the current
demand is fulfilled again. This division into bins may be either physical or just
on the paper.
● Advantages:
o It is simple, reliable, and easy to explain and operate,
o There is no need to record each withdrawal from inventory.
● Disadvantages:
o • The reorder card may not be turned in for a variety
of reasons (e.g., misplaced, the person responsible
forgets to turn it in),
● Absence of adequate data on stock levels and consumption
rates. This affects the evaluation of batch sizes for orders.
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INVENTORY COUNTING SYSTEMS
ORDERING CYCLE SYSTEM
● It is based on periodic reordering of all items. With every cycle the stock of
each item is brought up to its level, which is dependent on the length of the
cycle, the replenishment period, and the consumption rate. When the
replenishment period and demand rate do not change, the reorder quantity
obviously increases with the cycle time, so that short cycles are required if
rapid turnover of stock is desirable. [Samuel Eilon].
● Advantages:
o All orders for replenishment are issued at the same time.
o Ordering mechanism is regular and not subject to sporadic
arrivals of warning signals from the store
● Disadvantages:
o Usually more stock is held when this system is adopted
than with the 2-bin system.
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INVENTORY CONTROL
Definition.
● Inventory control is the means by which materials of the correct quantity
and quality is made available as and when required with due regard to
economy in storage and ordering cost and working capital.
● It may also be defined as “the systematic location, storage and recording
of goods in such a way that desired degree of service can be made to the
operating shops at minimum ultimate cost.”
● Advantages of inventory control.
o To run the stores effectively.
o To ensure timely availability of material and avoid
build up of stock levels.
o Technical responsibility for the state of materials.

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INVENTORY CONTROL
Functions of inventory control.
● Stock control system. Includes maintenance of records, ordering policies
and purchase procedure.
● Maintenance of specified materials. Sufficient quantities to meet the
demand of production.
● Protecting the inventory from losses.
● Pricing all materials supplied to the shops so as to estimate material cost.

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TYPES OF INVENTORY CONTROL TECHNIQUES
● ABC classification. Based on the usage of inventory
● FNS classification. Based on the rate of consumption.
● VED classification. Based on the criticality in the production of individual
items.
● SDE classification. Based on the availability

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TYPES OF INVENTORY CONTROL TECHNIQUES
ABC classification
● ABC stands for ‘always better control’. The items on hand are classified into A,
B, and C types on the basis of the value in terms of capital or annual dollar
usage (i.e., dollar value per unit multiplied by annual usage rate), and then
allocates control efforts accordingly.
● Thus, the items with high value and low volume are kept in A-type, items with
low value and high volume are kept in C-type, and the items with moderate
value and moderate volumes belong to the B-type. A-type items are given the
maximum attention while ordering for purchase, and C-type the
least. B-type gets the moderate attention.
● Typically, three classes of items are called: A (very important),
B (moderately important), and C (least important).A items
generally account for about 15 to 20% of the number

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 TYPES OF INVENTORY CONTROL TECHNIQUES
ABC classification
● of items in inventory but about 60 to 70% of the dollar usage. At the other
end of the scale, C items might account for about 60% of the number of
items but only about 10% of the dollar usage of an inventory.
A Items
High

Annual dollar B Items

C Items
Low
Few Number of items Many
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TYPES OF INVENTORY CONTROL TECHNIQUES
EXAMPLE:
● A computer hardware company has organized its 10 items on an annual
dollar volume basis. Details like item numbers, their annual demand, unit
cost are given in the table. Complete the A, B, C classification.
Item no. % of no. of items stocked Annual volume (units) Unit cost ($)
(1) (2) (3) (4)
1 20% 1000 90.0
2 500 154.00
3 30% 1550 17.00
4 350 42.86
5 1000 12.50
6 50% 600 14.17
7 2000 0.60
8 100 8.50
9 1200 0.42
10 250 0.60
8550
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TYPES OF INVENTORY CONTROL TECHNIQUES
● Solution: The items are classified as A, B, and C In the Table below and
the same is shown graphically in the accompanied figure.
Item % of no. of Annual Unit Annual % of Combin Class
no. items volume cost ($) volume annual ed %
(1) stocked (2) (units) (4) (units) Dollar
(3) (3) X (4) volume
1 20% 1000 90.0 90,000 38.8% 72% A
2 500 154.00 77,000 33.2% A
3 30% 1550 17.00 26,350 11.3% 23% B
4 350 42.86 15,001 6.4% B
5 1000 12.50 12,500 5.4% B
6 50% 600 14.17 8,502 3.7% 5% C
7 2000 0.60 1,200 0.5% C
8 100 8.50 850 0.4% C
9 1200 0.42 504 0.2% C
10 250 0.60 150 0.1% C
8550 $232,057 100%

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TYPES OF INVENTORY CONTROL TECHNIQUES
● Solution: The items are classified as A, B, and C In the Table below and
the same is shown graphically in the accompanied figure.

ABC Curve: % of items Vs % of Value

80
60
40
20
0
0 20 50 100 150
% of Items
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Practice Question
● Out of these, which classification of inventory is based on the usage of
inventory?
o ABC classification
o FNS classification
o VED classification
o SDE classification

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 QUANTITY STANDARDS FOR INVENTORY CONTROL
USAGE MAXIMUM STOCK

MINIMUM STOCK
QUANTITY

REORDER STANDARD
POINT
ORDER

RESERVE STOCK

PROCUREMENT TIME TIME

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QUANTITY STANDARDS FOR INVENTORY CONTROL
● The maximum stores. Upper limit of inventory. Represents largest
quantity to be kept in the stores.
● The minimum stores. Lower limit. Represents reserve or margin of safety.
● The standard order. The quantity to be purchased at any time.
● The ordering point. Represents the quantity required to ensure against
exhaustion of the supply during the interval between the placement of an
order and delivery. When the balance fall to this level, it is an indication
that a new purchase order is must be placed.
● Lead time. The time taken for the stock to reach from
reorder point to minimum stock level.
● Reserve stock. To cater for emergency.

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ECONOMIC ORDER QUANTITY
● The most economic quantity to be purchased without disturbing the
production plan is called as ‘economic order quantity’.
Involves following two costs:
1. Procurement cost. Includes the expenditure made on:
o Calling quotations
o Placing purchase orders
o Receipt and inspection.
o Payment of bills.
2. Inventory carrying cost.
o Insurance
o Storage and handling
o Deterioration.
o Taxes
● This cost varies from 10 to 15%.
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ECONOMIC ORDER QUANTITY

Total Cost
cost

Order Cost Folding Cost

Order quantity
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ECONOMIC ORDER QUANTITY
● The economic order quantity is obtained by the quantity whose
procurement cost is equal to inventory carrying cost.
● Let A = Total items consumed per year.
● P = Procurement cost per order.
● C = Inventory carrying cost per item.
● Q = ECONOMIC ORDER QUANTITY.

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ECONOMIC ORDER QUANTITY
● Then,
Procurement cost/ year = no. Of orders placed in a year x cost per order.
= (A/Q) x P
Inventory carrying cost/year = average value of the inventory / year x annual
inventory carrying cost / item
= (Q/2) X C
The total cost = A X P/Q + Q X C/2
THIS TOTAL COST WILL BE MINIMUM WHEN
A X P/Q = Q X C/2
Or, Q2 = 2AP/C
Or Q = [2AP/C]1/2
Hence, most economic order quantity = √(2AP/C)

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ECONOMIC ORDER QUANTITY
● Important assumptions in applying the economic order quantity model
o Demand is continuous and constant and does not change with time.
o Lead time is constant.
o Delivery of all the items is instantaneous.
o Replenishment of one item has no effect on the replenishment of
any other item of the inventory.
o Purchase price and other parameters , i.e., P and c are constant

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ECONOMIC ORDER QUANTITY
Example.
● A retailer expects to sell about 200 units of a product per year. The storage
space taken up in his premises by one unit of this product cost at $20 per year.
If the cost associated with ordering is $35 per order what is the economic order
quantity given that interest rates are expected to remain close to 10% per year
and the total cost of one unit is $100.
● Solution: We use the EOQ formula, EOQ = (2AP/C)0.5
Here A = 200 units, P = $ 35 and the holding cost C is given by C = $20
(direct storage cost per unit per year) + $100 × 0.10 (this term indicates
the money interest lost if one unit sits in stock for one year)
= i.e. C = $30 per unit per year
EOQ = (2AP/C)0.5 = (2 × 200 × 35/30)0.5 = 21.602
But as we must order a whole number of units we have:
EOQ = 22
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Practice Question
● Out of these, which is not the correct assumption in applying the economic
order quantity model
o Demand is continuous and constant and does not change with time.
o Lead time is flexible.
o Delivery of all the items is instantaneous.
o Replenishment of one item has no effect on the replenishment of any
other item of the inventory.

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CONCLUSIONS

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ANY QUESTIONS

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THANK YOU!

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