INVENTORY
MANAGEMENT
Meaning, Objectives, Types, Importance, Costs, Stock levels,
Tools, Advantages, Disadvantages
Meaning & Concept
• Generally refers to the materials in stock
• Inventory means stock of direct or indirect material
• Inventory is a stock of materials used to satisfy customer demand or support
the production of goods or services.
• It is mainly done to support the production process and to satisfy customer
needs or demands
Objectives of Inventory Management
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To ensure adequate supply of products to customers
To avoid shortages
To ensure minimum financial investment in inventories
Efficient purchasing, storing, consumption and accounting of material
Maintain timely record of inventories
Ensure timely action for replenishment
Provide reserve stock for variations in lead times of delivery(Lead time: refers to the interval
between placing the order for a particular item and its actual receipt)
• Provide scientific base for short term & long term planning of materials
Types of Inventory
• Raw material Inventory: parts and raw materials obtained from suppliers
• Work in progress/ process Inventory: constitutes semi- finished parts, components,
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assemblies or modules that have been inducted into production process
Finished goods Inventory: finished products or end items
Replacement parts Inventory: Maintenance parts meant to replace other parts in machinery
or equipment.
Supplies Inventory: Parts or materials used to support production process and not usually a
component of the product
Transportation (Pipeline) Inventory: Items that are in the distribution system but are in the
process of being shipped from supplier to customers
Importance of Inventory Management
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Improves Liquidity position
Smooth Production
Timely shipment
Timely arrival
Avoids shortage
Minimize Loss
Economic buying
Meaning of Inventory Control
• Inventory Control is a planned approach of determining what to order, when to
order, how much to order and how much to stock so that costs associated with
buying and storing are optimal without interrupting production and sale.
• Basically deals with 2 problems
When should an order be placed (Reorder Level)?
How much should we order(Order Quantity)?
Inventory control can be defined as” the systematic control over the procurement,
storage and usage of materials so as to maintain a continuous flow of material”.
Meaning & Definition of Inventory Control
Inventory control includes control over raw material, spare parts, partly
finished goods and finished goods. It is a system which ensures the required
quantity of inventories of required quality , at the required time and with the
minimum amount of capital.
Factors affecting Inventory Control
• TYPES OF PRODUCT
It refers to high value and low unit value. If the materials used in the
manufacturing of the products having a high unit value when purchased, a
much closer inventory control is essential.
• TYPES OF MANUFACTURING PROCESS
Based on manufacturing process the manager should ensure smooth flow of
material, if there is proper inventory control, there is no stoppage of
production.
Factors affecting Inventory Control
• VOLUME OF PRODUCTION
The volume determines the movement of materials.
• OBJECTIVES OF THE COMPANY
The degree of commitment by management person to reduce overall cost of
production.
Inventory Costs
• Holding Costs/ Carrying Costs- Cost associated with holding inventory or stock in
storage or a warehouse in order to fulfil the demand of the customers
Costs include cost of storage facilities, handling, insurance, pilferage, breakage,
obsolescence, depreciation, taxes, opportunity cost of capital etc.
 Capital Costs
 Storage Costs
 Service Costs
 Cost of Inventory risk
Inventory Costs
• Ordering Cost
Costs associated with placing the order with the factory or the supplier
Costs such as preparation of supplier order, cost of placing the order, inspection order,
documentation costs etc.
 Cost of preparation of Purchase Order
 Transportation Costs
 Receiving Costs
 Cost of EDI
 Other Costs
Inventory Costs
• Set up costs/ Production Change Costs
In cases of sub assemblies, ordering cost is actually represented by the costs
associated with changing over equipment from producing one item to another.
These costs are usually referred to as Set up costs
They include obtaining necessary material, arranging specific equipment set
ups, filling out required papers, charging time and materials etc.
Inventory Costs
• Shortage/ Stock Out Costs
Includes rent of go down, clerical cost of maintaining stock records, cost of air
conditioning to protect inventory, etc.
Costs that are incurred as a result of running out of stock are known as stock
out or shortage stock
Stock Levels- Safety Stock
• Safety Stock
Refers to extra inventory held for protection against possibility of stock outs
SS is defined as the difference between the amount stocked to satisfy demand
during a certain time interval and the mean expected demand for that period
Also known as Buffer stock or Minimum Stock
Safety stock = (Maximum daily usage * Maximum lead time in days)
– (Average daily usage * Average lead time in days).
Stock Levels- Minimum Stock Level
• Minimum Stock Level
The minimum level of inventory decided to be taken depending upon the
factors like usage value of an item, normal lead time, availability of substitutes
etc.
If stock is less than the minimum level work will stop due to shortage of
materials
Minimum Stock Level = Re-order Level – (Normal consumption per
day/per week, etc. X Normal delivery time)
Stock Levels-Minimum Stock Level
Main factors involve in fixing the minimum stock level
(a) The average rate of consumption of materials.
(b) The time required to obtain fresh supplies under top priority conditions.
(c) Re-order level
(d) The production requirements as to materials.
(e) The minimum quantity of materials which could be procured
advantageously.
Stock Levels-Maximum Stock Level
• The quantity of materials that a firm should not exceed in stock levels.
• A firm should avoid over stocking as it leads to high material cost,
requirement of more capital, more space for stocking materials, more
charges of losses from obsolescence (outdated)etc.
• Maximum Stock Level = Reordering Level + Reorder Quantity –
(Minimum Consumption x Reorder period)
Stock Levels-Maximum Stock Level
Main factors involve in fixing the maximum stock level
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Availability of capital for purchase of materials in the firm
Maximum requirement of materials at any point of time
Availability of space for storing the materials as inventory
Rate of consumption of material during lead time
Cost of maintaining the stores
Possibility of fluctuations in prices of various materials
Stock Levels- Reorder Level
When the quantity of goods reaches a certain level then a fresh order is placed
The reorder level should be the minimum level plus a safety margin
It is fixed between minimum level and maximum level
Therefore, Reorder level of stock (also known as reorder point or ordering
point) in a business is a pre-set level of stock or inventory at which the business
places a new order with its suppliers to obtain the delivery of raw materials or
finished goods inventory.
Stock Levels- Reorder Level
• Formula:
The two formulas used to calculate the re-order level are given below:
1. When the business does not need to maintain safety stock:
Maximum demand or usage (in days, weeks or months) × Maximum lead time (in days,
weeks or months)
2. When the business needs to maintain a safety stock:
[Maximum demand or usage (in days, weeks or months) × Maximum lead time (in
days, weeks or months)] + Safety stock
Stock Levels- Reorder Level
Main factors involve in fixing the reorder stock level
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Maximum Usage of materials
Maximum Lead time
Maximum Stock Level
Minimum Stock Level
Stock Levels- Danger Level
Level below which stock should not fall
Immediate steps should be taken to buy the stock and action should be initiated
Danger Level = Average Consumption x Maximum reorder period for
emergency purchases.
Stock Levels- The Standard Order Quantity
In order to minimize the cost of acquiring inventory the size of the order
should be decided.
Discounts offered by suppliers and transport costs should be considered in
deciding this quantity