Inventory 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 utilized. 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

To stabilize 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.

To take advantage of price discounts:

Usually the manufacturers offer discount for bulk buying and to gain this price advantage the materials is
bought in bulk even though it is not required immediately. Thus, inventory is maintained to gain economy
in purchasing.

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.

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.

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.

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.
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EOQ Model

Assumptions

1. Demand for the product is constant and uniform throughout the period
2. Lead time is constant
3. Price per unit of product is constant
4. Inventory holding cost is based on average inventory
5. Ordering costs are constant
6. All demands for the product will be satisfied

Holding inventory has cost implications.The cost components are material cost , holding cost,
and ordering costs.

Material cost ( C ) is the cost incurred per unit of the inventory of materials held.

Holding cost (H) is the cost incurred for storing the material which includes fixed and variable
cost elements. Cost of capital , cost of physically storing the inventory and the cost resulting
from product becoming obsolete. It is measured as a percentage (h) of the cost of material. H = h
xC

 Cost connected directly with materials-Obsolescence,deterioration,pilferage

Ordering cost (S) is the cost incurred per order . One has to place orders for purchasing the
inventory. Every order has cost involved. As the number of orders (n)increases the ordering cost
increases proportionately.

 Cost of placing an order with a vendor of materials-preparing a purchase order,processing

Therefor the total cost of Inventory TC when D is the demand per year and Q is the lot size is
given by

TC = DC + Ch (Q/2) + ( D/Q )S

Normally the purchase quantities are kept more than the demand with an intention to avail
advantages of economies of scale.EOQ is the optimum quantity to be purchased in a lot to
optimise the total cost for cycle inventory for a fixed period say year.D is the demand for the
product per year , which is purchased in lots of size Q each. On an average Q/2 items are stored
as inventory incurring holding cost.

EOQ = √(2DS/H) =√(2DS/hC) H=hxC

Inventory Management

Safety Inventory
It is held to meet the demand when demand exceeds expectations.

The safety inventory may go unsold incurring unnecessary holding costs. But absence of it may
lead to lose of sales.

Hence choosing safety inventory involves a trade off between costs of having too much
inventory and cost of losing sales.

Safety stock simply is inventory that is carried to prevent stock outs. Stock outs stem from
factors such as fluctuating customer demand, forecast inaccuracy, and variability in lead times
for raw materials or manufacturing.

Safety stock determinations are not intended to eliminate all stock outs—just the majority of
them.

There are two basic approaches to build up inventory.

Inventory may be topped up at the end of a fixed period System – P system

Inventory replenishment may be done for fixed quantities irrespective of the time elapsed Fixed
Quantity system – Q system.

ROP
Quantity Discounts

Quantity Discounts A quantity discount is an incentive offered to a buyer that results in a

A quantity discount is often offered by sellers to entice buyers to purchase in larger quantities.
Our objective is to minimize the total annual costs

TC = SxD/Q + HxQ/2 + PxD