Module 2-Class 1 - 5370832 - 2024 - 01 - 21 - 14 - 10

Warehousing and Inventory
Management
Module 2: INVENTORY MANAGEMENT
Objectives: After studying this unit, you will be able to:

• Explain the Different Inventory Costs
• Discuss Inventory Models and EOQ
• Explain Safety Stock and Its Optimum Level
Module 2: INVENTORY MANAGEMENT
 In this unit, you will study about inventory management, EOQ, buffer stocks, safety
stocks and its optimum level.
 Inventory is the major source of cost in the supply chain and also the basis for
improving customer service and enhancing customer satisfaction
 High inventory at retail outlets may help in making the goods easily available to customers
and also result in a growth in sales, but it will also increase costs and bring down
profitability.
 These are two major issues in conflict with each other that need to be resolved, in order to
optimize the inventory carried by the organization.
Different Cost of Inventory
Different Cost of Inventory
5 Types of Inventory Costs
 1. Ordering Costs
 2. Inventory Holding Costs
 3. Shortage Costs
 4. Spoilage Costs
 5. Inventory Carrying Costs

Ordering Costs
Ordering costs include payroll taxes, benefits and the wages of the procurement department,
labor costs etc. These costs are typically included in an overhead cost pool and allocated to the
number of units produced in each period.
 Transportation costs
 Cost of finding suppliers and expediting orders
 Receiving costs
 Clerical costs of preparing purchase orders
 Cost of electronic data interchange

Inventory Holding Costs
 This is simply the amount of rent a business pays for the storage area where they hold the
inventory. This can be either the direct rent the company pays for all the warehouses put
together or a percentage of the total rent of the office area utilized for storing inventory.
Inventory Holding Costs
 Inventory services costs
 Inventory risk costs
 Opportunity cost - money invested in inventory
 Storage space costs
 Inventory financing costs

Shortage Costs
 Shortage costs, also known as stock-out costs, occurs when businesses become out of stock
for various reasons. Some of the reasons might be as below :
 Emergency shipments costs
 Disrupted production costs
 Customer loyalty and reputation

Spoilage Costs
 Perishable inventory stock can rot or spoil if not sold in time, so controlling inventory to
prevent spoilage is essential. Products that expire are a concern for many industries.
Industries such as the food and beverage, pharmaceutical, healthcare and cosmetic
industries, are affected by the expiration and use-by dates of their products.
Inventory Carrying Costs
 This is the lesser-known aspect of inventory cost. This cost requires a certain amount of
calculation to understand the extent of its impact on your P&L statement. Inventory carrying
costs refers to the amount of interest a business loses out on the unsold stock value lying in
the warehouses.
 Business owners often miss out on understanding the impact of the above factors while
calculating the impact inventory has on their business. The inventory holding costs does
show up as part of rental expense in the Profit & Loss statement.
 While the inventory carrying cost is seldom considered while calculating the gross profit,
we usually take into account only the principle cost of the goods held in the warehouses.
FIXED AND VARIABLE HOLDING COSTS
 Variable costs change based on the amount of output produced. Variable costs
may include labor, commissions, and raw materials. Fixed costs remain the same
regardless of production output.
INVENTORY MODEL
INVENTORY MODEL
 The primary function of inventory management is to determine:
 1. When to order?
 2. How much to order?

When to Order?
 The problem of ‘when to order’ is solved by fixing the appropriate re- order level
of each type of inventory.
 It is determined by compromising the cost of maintaining these stocks and the
disservice to the customer if this order is not delivered in time
 Re-order level = Average usage × Lead time = Au × L
Re-order Point example
 Demand = 10000 units/year Store open = 320 days/year
 Average usage (Au) = 10000/320 = 33.33 units/day
 Lead time (L) =10days

 Therefore,
R = Re-order level = Average usage × Lead time = Au × L = (33.33) × 10 = 333.33
units.
ECONOMIC ORDER QUANTITY (EOQ):
 EOQ is an important technique of inventory management.
 The EOQ refers to the optimal order size that will result in the lowest total of
order and carrying cost for an item of inventory given its expected usage,
carrying cost and ordering cost.
 Economic order quantity (EOQ) is the ideal quantity of units a company
should purchase to meet demand while minimizing inventory costs such
as holding costs, shortage costs, and order costs.
EOQ model assumptions
 The inventory costs are assumed in EOQ to be constant.

 The delivery of the ordered inventory takes place in one go.
 The total ordering cost shall remain constant.
 The total units, whose consumption is to take place, are certain.
 Any type of discount is not available in EOQ, whether it is on cash or on quantity.
 The computation of every stock item’s maximum quantity takes place on a separate basis.
 Lead time does not fluctuate in EOQ.
Objective of Basic EOQ Model
 The objective of most inventory models is to minimize the total cost.
 With the assumptions just given, the significant costs are the ordering cost and the
inventory carrying cost.
 All other costs, such as the cost of the inventory itself, are constant.
 Thus, if we minimize the sum of the ordering and carrying costs, we also minimize the
total cost.

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Warehousing and Inventory

Objectives: After studying this unit, you will be able to:

 2. Inventory Holding Costs

 5. Inventory Carrying Costs

 Cost of finding suppliers and expediting orders

 Clerical costs of preparing purchase orders

 Cost of electronic data interchange

 Inventory services costs

 Inventory risk costs

 Opportunity cost - money invested in inventory

 Storage space costs

 Inventory financing costs

 Emergency shipments costs

 Disrupted production costs

 Customer loyalty and reputation

 The primary function of inventory management is to determine:

 2. How much to order?

 Demand = 10000 units/year Store open = 320 days/year

 Average usage (Au) = 10000/320 = 33.33 units/day

 Lead time (L) =10days

 EOQ is an important technique of inventory management.

 The inventory costs are assumed in EOQ to be constant.

 The objective of most inventory models is to minimize the total cost.

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