Project and Finance Management– 1MEHS409

Unit III: Materials Management

Dr. L. Y. Waghmode

Professor, Department of Mechanical Engineering

Annasaheb Dange College of Engineering and Technology,

Ashta
Materials Management
Introduction
 Material management is the process of planning, organizing, directing and controlling the flow
of materials within an organization.
 In the manufacturing field, material managers perform a vital role in purchasing, obtaining and
maintaining raw materials to use in production processes. 
 The core idea behind this process is to control the movement of materials and equipment by
requesting them in advance, purchasing or renting them at a reasonable price and making sure
they are available when needed.
 Material management is a key part of the supply chain process and ensures that professionals
efficiently and correctly direct materials required for manufacturing procedures.

“Material management is the integrated functioning of the various sections of an organization

dealing with the supply of materials and allied activities in order to achieve maximum co-
ordination.”
Introduction
Definition and Scope
Materials management is defined as “the function responsible for the coordination of planning,
sourcing, purchasing, moving, storing and controlling materials in an optimum manner so as to
provide a pre-decided service to the customer at a minimum cost”.

Scope of materials management

Introduction
Functions of Materials Management
From the definition it is clear that the scope of materials management is vast. The functions of
materials management can be categorized in the following ways:

1. Material Planning and Control

2. Purchasing
3. Stores Management
4. Inventory Control or Management
5. Standardization
6. Simplification
7. Value Analysis
8. Ergonomics
Introduction
Functions of Materials Management
1. Materials planning and control:
Based on the sales forecast and production plans, the materials planning and control is done. This
involves estimating the individual requirements of parts, preparing materials budget, forecasting
the levels of inventories, scheduling the orders and monitoring the performance in relation to
production and sales.
2. Purchasing:
This includes selection of sources of supply finalization in terms of purchase, placement of
purchase orders, follow-up, maintenance of smooth relations with suppliers, approval of
payments to suppliers, evaluating and rating suppliers.
3. Stores management:
This involves physical control of materials, preservation of stores, minimization of obsolescence
and damage through timely disposal and efficient handling, maintenance of stores records,
proper location and stocking. A store is also responsible for the physical verification of stocks and
reconciling them with book figures. A store plays a vital role in the operations of a company.
Introduction
Functions of Materials Management
4. Inventory control or management:
• 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.
Introduction
Functions of Materials Management

5. Standardization:
Standardization means producing maximum variety of products from the minimum variety of
materials, parts, tools and processes. It is the process of establishing standards or units of measure
by which extent, quality, quantity, value, performance etc. may be compared and measured.
6. Simplification:
The concept of simplification is closely related to standardization. Simplification is the process of
reducing the variety of products manufactured. Simplification is concerned with the reduction of
product range, assemblies, parts, materials and design.
7. Value analysis: Value analysis is concerned with the costs added due to inefficient or unnecessary
specifications and features. It makes its contribution in the last stage of product cycle, namely, the
maturity stage.
8. Ergonomics (Human Engineering): Ergonomics is “the design of human tasks, man-machine
system, and effective accomplishment of the job, including displays for presenting information to
human sensors, controls for human operations and complex man-machine systems.”
Introduction
Objectives of Materials Management

 To ensure continuous uninterrupted production or operation or project work by

maintaining a steady flow of materials;
 To effect economies in the cost of materials by purchasing materials of the right quality,
in the right quantity, at the right time, from the right source, at the right price;
 To minimize the costs incurred on materials after they have been purchased, through
storage, processing and warehousing, till the finished goods ultimately reach the
customer.
 To reduce working capital requirements through proper and scientific inventory control;
 To improve the quality of manufactured goods by use of better raw materials or
components and thereby the increase the competitiveness on such goods put of sale;
Introduction

Objectives of Materials Management

 To increase the competitiveness of manufactured goods by making it possible to

reduce their prices through cost reduction, especially by value analysis;
 To save foreign exchange through import substitution and economizing on foreign
purchases;
 To ensure cooperation among all departments of the enterprise to meet materials
management objectives both at the corporate and functional levels and to ensure
proper coordination in respect of such activities;
 To conserve materials resources within enterprise, thereby contributing to the
conservation of national resources.
Material Requirement Planning

• Material planning is a scientific technique of determining in advance the requirements of raw

materials, ancillary parts and components, spares etc. as directed by the production
programme.
• It is a sub-system in the overall planning activity.
• There are many factors, which influence the activity of material planning.
• These factors can be classified as macro and micro systems.
1. Macro factors: Some of the micro factors which affect material planning, are price trends,
business cycles Govt. import policy etc.
2. Micro factors: Some of the micro factors that affect material planning are plant capacity
utilization, rejection rates, lead times, inventory levels, working capital, delegation of
powers and communication.
The purpose of material requirements planning is to determine the components needed,
quantities, and due dates so items in the master production schedule are made on time.
Material Requirement Planning
Techniques of Material Planning

Material planning
Material Requirement Planning
Techniques of Material Planning

 The basis for material planning is the forecast demand for the end products.

 Forecasting techniques such as weighted average method, exponential smoothening and

time series models are used for the same.
 Once the demand forecast is made, it is possible go through the exercise of material
planning. Bill of materials is a document which shows list of materials required, unit
consumption location code for a given product.
 An explosive chart is a series of bill of material grouped in a matrix form so that combined
requirements for different components can be done.
 Thus material requirement plan will lead to be the development of delivery schedule of the
materials and purchasing of those material requirements.
Purchasing
Introduction

 Purchasing is an important function of materials management.

 In any industry purchase means buying of equipments, materials, tools, parts etc. required for
industry.
 The importance of the purchase function varies with nature and size of industry.

 In small industry, this function is performed by works manager and in large manufacturing
concern; this function is done by a separate department.
 Purchasing function ensures continuity of supply of raw materials, sub-contracted items and
spare parts and to reduce the ultimate cost of the finished goods.
 In other words, the objective is not only to procure the raw materials at the lowest price but
to reduce the cost of the final product.
Purchasing
Objectives of Purchasing

1. To avail the materials, suppliers and equipments at the minimum possible costs:
These are the inputs in the manufacturing operations. The minimization of the input cost
increases the productivity and resultantly the profitability of the operations.
2. To ensure the continuous flow of production through continuous supply of raw materials,
components, tools etc. with repair and maintenance service.
3. To increase the asset turnover:
The investment in the inventories should be kept minimum in relation to the volume of sales. This
will increase the turnover of the assets and thus the profitability of the company.
4. To develop an alternative source of supply:
Exploration of alternative sources of supply of materials increases the bargaining ability of the
buyer, minimization of cost of materials and increases the ability to meet the emergencies.
Purchasing
Objectives of Purchasing

5. To establish and maintain the good relations with the suppliers:

Maintenance of good relations with the supplier helps in evolving a favorable image in the
business circles. Such relations are beneficial to the buyer in terms of changing the reasonable
price, preferential allocation of material in case of material shortages, etc.
6. To achieve maximum integration with other department of the company:
The purchase function is related with production department for specifications and flow of
material, engineering department for the purchase of tools, equipments and machines,
marketing department for the forecasts of sales and its impact on procurement of materials,
financial department for the purpose of maintaining levels of materials and estimating the
working capital required, personnel department for the purpose of manning and developing
the personnel of purchase department and maintaining good vendor relationship.
Purchasing
Objectives of Purchasing

7. To train and develop the personnel:

Purchasing department is manned with varied types of personnel. The company should
try to build the imaginative employee force through training and development.
8. Efficient record keeping and management reporting:

Paper processing is inherent in the purchase function. Such paper processing should be
standardized so that record keeping can be facilitated. Periodic reporting to the
management about the purchase activities justifies the independent existence of the
department.
Purchasing
Parameters of Purchasing
The success of any manufacturing activity is largely dependent on the procurement of raw
materials of:
• Right quality, in the
• Right quantities, from
• Right source, at the
• Right time and at
• Right price popularly known as 5 ‘R’s’ of the art of efficient purchasing.
They are described as the basic principles of purchasing.

There are other well known parameters such as:

• Right contractual terms,
• Right material,
• Right place,
• Right mode of transportation and
• Right attitude are also considered for purchasing.
Purchasing
Parameters of Purchasing
Purchasing
Parameters of Purchasing
1. RIGHT PRICE
It is the primary concern of any manufacturing organization to get an item at the right price. But
right price need not be the lowest price. It is very difficult to determine the right price; general
guidance can be had from the cost structure of the product. The ‘tender system’ of buying is
normally used in public sector organizations but the objective should be to identify the lowest
‘responsible’ bidder and not the lowest bidder. The price can be kept low by proper planning
and not by rush buying. Price negotiation also helps to determine the right prices.

2. RIGHT QUALITY
Right quality implies that quality should be available, measurable and understandable as far as
practicable. In order to determine the quality of a product sampling schemes will be useful. The
right quality is determined by the cost of materials and the technical characteristics as suited to
the specific requirements. Since the objective of purchasing is to ensure continuity of supply to
the user departments, the time at which the material is provided to the user department assumes
great importance.
Purchasing
Parameters of Purchasing
3. RIGHT TIME
For determining the right time, the purchase manager should have lead time information for all
products and analyze its components for reducing the same. Lead time is the total time elapsed
between the recognition of the need of an item till the item arrives and is provided for use. This
covers the entire duration of the materials cycle and consists of pre-contractual administrative lead
time, manufacturing and transporting lead time and inspection lead time. Since the inventory
increases with higher lead time, it is desirable to analyze each component of the lead time so as to
reduce the first and third components which are controllable.

4. RIGHT SOURCE
The source from which the material is procured should be dependable and capable of supplying
items of uniform quality. The buyer has to decide which item should be directly obtained from the
manufacturer. Source selection, source development and vendor rating play an important role in
buyer-seller relationships. In emergencies, open market purchases and bazaar purchases are
restored to.
Purchasing
Parameters of Purchasing
5. RIGHT QUANTITY
The right quantity is the most important parameter in buying. Concepts, such as, economic order
quantity, economic purchase quantity, fixed period and fixed quantity systems, will serve as broad
guidelines. But the buyer has to use his knowledge, experience and common sense to determine
the quantity after considering factors such as price structure, discounts, availability of the item,
favorable reciprocal relations, and make or buy consideration.

6. RIGHT ATTITUDE
Developing the right attitude, too, is necessary as one often comes across such statement:
‘Purchasing knows the price of everything and value of nothing’; ‘We buy price and not cost’;
‘When will our order placers become purchase managers?’; ‘Purchasing acts like a post box’.
Therefore, purchasing should keep ‘progress’ as its key activity and should be future-oriented. The
purchase manager should be innovative and his long-term objective should be to minimize the
cost of the ultimate product.
Purchasing
Parameters of Purchasing
7. RIGHT CONTRACTS
The buyer has to adopt separate policies and procedures for capital and consumer items. He
should be able to distinguish between indigenous and international purchasing procedures. He
should be aware of the legal and contractual aspects in international practices.
8. RIGHT MATERIAL
Right type of material required for the production is an important parameter in purchasing.
Techniques, such as, value analysis will enable the buyer to locate the right material.
9. RIGHT TRANSPORTATION
Right mode of transportation have to be identified as this forms a critical segment in the cost
profile of an item. It is an established fact that the cost of the shipping of ore, gravel, sand, etc., is
normally more than the cost of the item itself.
10. RIGHT PLACE OF DELIVERY
Specifying the right place of delivery, like head office or works, would often minimize the handling
and transportation cost.
Purchasing
Purchasing Procedure
Purchasing
Purchasing Procedure

1. RECOGNITION OF THE NEED

• The initiation of procedure starts with the recognition of the need by the needy section.
• The demand is lodged with the purchase department in the prescribed Purchase Requisition
Form forwarded by the authorized person either directly or through the Stores Department.
• The purchase requisition clearly specifies the details, such as, specification of materials,
quality and quantity, suggested supplier, etc.
• Generally, the low value sundries and items of common use are purchased for stock while
costlier and special items are purchased according the production programmes.
• Generally, the corporate level executives are authorized signatories to such demands. Such
purchases are approved by the Board of Directors.
• The reference of the approval is made on requisition and a copy of the requisition is sent to
the secretary for the purpose of overall planning and budgeting.
Purchasing
Purchasing Procedure

2. THE SELECTION OF THE SUPPLIER

• The process of selection of supplier involves two basic aspects: searching for all possible
sources and short listing out of the identified sources.
• The complete information about the supplier is available from various sources, such as, trade
directories, advertisement in trade journals, direct mailing by the suppliers, interview with
suppliers, salesmen, suggestions from business associates, visit to trade fair, participation in
industries convention, etc.
• Identification of more and more sources helps in selecting better and economical supplier.
• It should be noted that the low bidder is not always the best bidder.
Purchasing
Purchasing Procedure

2. THE SELECTION OF THE SUPPLIER

• When everything except price is equal, the low bidder will be selected.
• The important considerations in the selection are the price, ability to supply the
required quantity, maintenance of quality standards, financial standing etc.
• It should be noted that it is not necessary to go for this process for all types of
purchases.
• For the repetitive orders and for the purchases of low-value, small lot items, generally
the previous suppliers with good records are preferred.
Purchasing
Purchasing Procedure

3. PLACING THE ORDER

• Once the supplier is selected the next step is to place the purchase order.
• Purchase order is a letter sent to the supplier asking to supply the said material.
• At least six copies of purchase order are prepared by the purchase section and each
copy is separately signed by the purchase officer.
• Out these copies, one copy each is sent to store-keeper, supplier, accounts section,
inspection department and to the department placing the requisition and one copy is
retained by the purchase department for record.
Purchasing
Purchasing Procedure

4. FOLLOW-UP OF THE ORDER

• Follow-up procedure should be employed wherever the costs and risks resulting from the
delayed deliveries of materials are greater than the cost of follow-up procedure.
• The follow-up procedure tries to see that the purchase order is confirmed by the supplier and
the delivery is promised.
• It is also necessary to review the outstanding orders at regular intervals and to communicate
with the supplier in case of need.
• Generally, a routine urge is made to the supplier by sending a printed post card or a circular
letter asking him to confirm that the delivery is on the way or will be made as per agreement.
• In absence of any reply or unsatisfactory reply, the supplier may be contact through personal
letter, phone, telegram and/or even personal visit.
Purchasing
Purchasing Procedure

5. RECEIVING AND INSPECTION OF THE MATERIALS

The receiving department receives the materials supplied by the vendor. The quantity are verified
and tallied with the purchase order. The receipt of the materials is recorded on the specially
designed receiving slips or forms which also specify the name of the vendor and the purchase
order number. It also records any discrepancy, damaged condition of the consignment or inferiority
of the materials. The purchase department is informed immediately about the receipt of the
materials. Usually a copy of the receiving slip is sent to the purchase department.

6. PAYMENT OF THE INVOICE

When the goods are received in satisfactory condition, the invoice is checked before it is approved
for the payment. The invoice is checked to see that the goods were duly authorized to purchase,
they were properly ordered, they are priced as per the agreed terms, the quantity and quality
confirm to the order, the calculations are arithmetically correct etc.
Purchasing
Purchasing Procedure

7. MAINTENANCE OF THE RECORDS

Maintenance of the records is an important part and parcel of the efficient purchase function. In
the industrial firms, most of the purchases are repeat orders and hence the past records serve as a
good guide for the future action. They are very useful for deciding the timings of the purchases
and in selecting the best source of the supply.

8. MAINTENANCE OF VENDOR RELATIONS

The quantum and frequency of the transactions with the same key suppliers provide a platform
for the purchase department to establish and maintain good relations with them. Good relations
develop mutual trust and confidence in the course of the time which is beneficial to both the
parties. The efficiency of the purchase department can be measured by the amount of the
goodwill it has with its suppliers.
Purchasing
Selection of Suppliers

• Selection of the right supplier is the responsibility of the purchase department.

• It can contribute substantially to the fundamental objectives of the business enterprise.
• Different strategies are required for acquiring different types of materials.

Following factors are considered for the selection of suppliers:

A. Sources of Supplier
• The best buying is possible only when the decision maker is familiar with all possible
sources of supply and their respective terms and conditions.
• The purchase department should try to locate the appropriate sources of the supplier
of various types of materials.
Purchasing
Selection of Suppliers

A survey of the following will help in developing the possible sources of supply:

1. Specialized trade directories.

2. Assistance of professional bodies or consultants.
3. The buyer’s guide or purchase handbook.
4. The manufacturer’s or distributor’s catalogue.
5. Advertisements in dailies.
6. Advertisement in specialized trade journals.
7. Trade fair exhibitions.
Purchasing
Selection of Suppliers

B. Development of Approved List of Suppliers

• The survey stage highlights the existence of the source. A business inquiry is made with the
appropriate supplier. It is known as ‘Inquiry Stage’.
• Here a short listing is made out of the given sources of suppliers in terms of production
facilities and capacity, financial standing, product quality, possibility of timely supply, technical
competence, manufacturing efficiency, general business policies followed, standing in the
industry, competitive attitude, and interest in buying orders etc.

C. Evaluation and Selection of the Supplier

• The purchase policy and procedure differ according to the type of items to be purchased.
Hence, evolution and selection of the supplier differ accordingly.
Following variables to be considered while evaluating the quotations of the suppliers:
Purchasing
Selection of Suppliers
1. Cost Factors
Price, transportation cost, installation cost if any, tooling and other operations cost, incidence of sales tax and
excise duty, terms of payment and cash discount are considered in cost factor.
2. Delivery
Routing is important in determining the point at which the title to the goods passes from vendor to the buyer
and the responsibility for the payment of the payment charges.
3. Design and Specification Factors
Specification compliance, specification deviations, specification advantages, important dimensions and
weights are considered in line with the demonstration of sample, experience of other users, after sale
services etc.
4. Legal Factors
Legal factors include warranty, cancellation provision, patent protection, public liability, federal laws and
reputation compliance.
5. Vendor Rating
The evaluation of supplier or vendor rating provides valuable information which help in improving the quality
of the decision. In the vendor rating three basic aspects are considered namely quality, service and price.
Purchasing
Vendor Rating

The categorical plan:

 Under this method the members of the buying staff related with the supplier like receiving
section, quality control department, manufacturing department etc., are required to assess the
performance of each supplier.
 The rating sheets are provided with the record of the supplier, their product and the list of
factors for the evaluation purposes.
 The members of the buying staff are required to assign the plus or minus notations against each
factor.
 The periodic meetings, usually at the interval of one month, are held by senior man of the
buying staff to consider the individual rating of each section.
 The consolidation of the individual rating is done on the basis of the net plus value and
accordingly, the suppliers are assigned the categories such as ‘preferred’, ‘neutral’ or
‘unsatisfactory’.
 Such ratings are used for the future guidance.
Purchasing
Vendor Rating

The weighted-point method:

The weighted-point method provides the quantitative data for each factor of evaluation. The
weights are assigned to each factor of evaluation according to the need of the organization, e.g., a
company decides the three factors to be considered— quality, price and timely delivery.
It assigns the relative weight to each of these factors as under:
Quality ……… 50 points
Price ……… 30 points
Timely delivery ……… 20 points
The evaluation of each supplier is made in accordance with the aforesaid factors and weights and
the composite weighted-points are ascertained for each suppliers—A, B and C— are rated under
this method.
Inventory Control
Introduction

 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.
Inventory Control
Purpose
1. 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.
2. To take advantage of price discounts:
Usually the manufacturers offer discount for bulk buying and to gain this price advantage the
materials are bought in bulk even though it is not required immediately. Thus, inventory is
maintained to gain economy in purchasing.
3. 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.
Inventory Control
Purpose

4. 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.
5. 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.
6. 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.
Inventory Control
Objectives

• To ensure adequate supply of products to customer and avoid shortages as far as possible.
• To make sure that the financial investment in inventories is minimum (i.e., to see that the
working capital is blocked to the minimum possible extent).
• Efficient purchasing, storing, consumption and accounting for materials is an important
objective.
• To maintain timely record of inventories of all the items and to maintain the stock within the
desired limits.
• To ensure timely action for replenishment.
• To provide a reserve stock for variations in lead times of delivery of materials.
• To provide a scientific base for both short-term and long-term planning of materials.
Techniques of Inventory Control
ABC Analysis

 In this analysis, the classification of existing inventory 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.
 The analysis is carried out by drawing a graph based on the cumulative number of items and
cumulative usage of consumption cost.

Once ABC classification has been achieved, the policy control can be formulated as follows:
A-Item:
• Very tight control, the items being of high value.
• The control need be exercised at higher level of authority.
Techniques of Inventory Control
ABC Analysis
B-Item:
• Moderate control, the items being of moderate value.
• The control need be exercised at middle level of authority.
C-Item:
• The items being of low value, the control can be exercised at gross root level of authority, i.e.,
by respective user department managers.
Techniques of Inventory Control
ABC Analysis

ABC classification
Techniques of Inventory Control
Economic Order Quantity (EOQ)
• Inventory models deal with idle resources like men, machines, money and materials.
• 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 or acquisition costs.
• As the quantity ordered is increased, the inventory carrying cost increases while the ordering
cost decreases.
• The ‘order quantity’ means the quantity produced or 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.
i.e., Minimum Total Cost occurs when Inventory Carrying Cost = Ordering Cost
Techniques of Inventory Control
Determination of Economic Order Quantity by Analytical Method

In order to derive an economic lot size formula following assumptions are made:
1. Demand is known and uniform.
2. Let D denotes the total number of units purchase/produced and Q denotes the lot size in each
production run.
3. Shortages are not permitted, i.e., as soon as the level of the inventory reaches zero, the
inventory is replenished.
4. Production or supply of commodity is instantaneous.
5. Lead-time is zero.
6. Set-up cost per production run or procurement cost is C3.
7. Inventory carrying cost is C1 = CI, where C is the unit cost and I is called inventory carrying cost
expressed as a percentage of the value of the average inventory.
Techniques of Inventory Control
Determination of Economic Order Quantity by Analytical Method

The most economic point in terms of total inventory cost exists where,
Inventory carrying cost = Annual ordering cost (set-up cost)
Average inventory = 1/2 (maximum level + minimum level)
= (Q + 0)/2 = Q/2
Total inventory carrying cost = Average inventory × Inventory carrying cost per unit
i.e., Total inventory carrying cost = Q/2 × C1 = QC1/2 …(1)
Total annual ordering costs = Number of orders per year × Ordering cost per order
i.e., Total annual ordering costs = (D/Q) × C3 = (D/Q)C3 …(2)
Now, summing up the total inventory cost and the total ordering cost, we get the total
inventory cost C(Q).
i.e., Total cost of production run = Total inventory carrying cost + Total annual ordering costs
C(Q) = QC1/2 + (D/Q)C3 ……………….(cost equation)
Techniques of Inventory Control
Determination of Economic Order Quantity by Analytical Method
But, the total cost is minimum when the inventory carrying costs becomes equal to the total
annual ordering costs. Therefore,
Economic Order Quantity Example

An oil engine manufacturer purchases lubricants at the rate of Rs. 42 per piece from a vendor. The
requirements of these lubricants are 1800 per year. What should be the ordering quantity per
order, if the cost per placement of an order is Rs. 16 and inventory carrying charges per rupee per
year is 20 paise.
Economic Order Quantity Example

A manufacturing company purchase 9000 parts of a machine for its annual requirements ordering
for month usage at a time, each part costs Rs. 20. The ordering cost per order is Rs. 15 and carrying
charges are 15% of the average inventory per year. You have been assigned to suggest a more
economical purchase policy for the company. What advice you offer and how much would it save
the company per year?
Economic Order Quantity Example