INVENTORY CONTROL

Soumendra Roy
INVENTORY SYSTEM
Inventory is the stock of any item or resource
used in an organization and can include: raw
materials, finished products, component
parts, supplies, and work-in-process
An inventory system is the set of policies and
controls that monitor levels of inventory and
determines what levels should be maintained,
when stock should be replenished, and how
large orders should be

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 INVENTORY CONTROL
It means stocking adequate number and kind of
stores, so that the materials are available whenever
required and wherever required.
Scientific inventory control results in optimal
balance
FUNCTIONS OF INVENTORY CONTROL
To provide maximum supply service, consistent with
maximum efficiency & optimum investment.

To provide cushion between forecasted & actual

demand for a material
PURPOSES OF INVENTORY
1. To maintain independence of operations
2. To meet variation in product demand
3. To allow flexibility in production scheduling
4. To provide a safeguard for variation in raw
material delivery time
5. To take advantage of economic purchase-order
size
6. To provide better service to customers
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 INVENTORY COSTS
Holding (or carrying) costs
Costs for storage, handling, insurance, etc
Setup (or production change) costs
Costs for arranging specific equipment
setups, etc
Ordering costs
Costs of someone placing an order, etc
Shortage costs
Costs of canceling an order, etc
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 INDEPENDENT VS. DEPENDENT DEMAND
Independent Demand (Demand for the final end-
product or demand not related to other items)
Finished
product

Dependent
Demand
(Derived demand
items for
component
parts,
subassemblies,
Component parts raw materials,
etc)

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 INVENTORY SYSTEMS
Single-Period Inventory Model
One time purchasing decision (Example: vendor selling t-shirts at
a football game)
Seeks to balance the costs of inventory overstock and under
stock
Multi-Period Inventory Models
Fixed-Order Quantity Models
Event triggered (Example: running out of stock)
Fixed-Time Period Models
Time triggered (Example: Monthly sales call by sales
representative)

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 SINGLE-PERIOD INVENTORY MODEL

Cu This model states that we

P should continue to increase
the size of the inventory so
Co Cu long as the probability of
selling the last unit added is
equal to or greater than the
Where : ratio of: Cu/Co+Cu

Co Cost per unit of demand over estimated

Cu Cost per unit of demand under estimated
P Probabilit y that the unit will be sold
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 SINGLE PERIOD MODEL EXAMPLE
Our college basketball team is playing in a tournament
game this weekend. Based on our past experience we sell
on average 2,400 shirts with a standard deviation of 350.
We make Rs. 10 on every shirt we sell at the game, but lose
Rs. 5 on every shirt not sold. How many shirts should we
make for the game?
Cu = Rs. 10 and Co = Rs. 5; P Rs. 10 / (Rs. 10 + Rs. 5) = .667

Z.667 = .432 (use NORMSDIST(.667)

therefore we need 2,400 + .432(350) = 2,551 shirts

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Multi-Period Models: Fixed-Order Quantity Model Model
Assumptions (Part 1)

Demand for the product is constant and uniform

throughout the period

Lead time (time from ordering to receipt) is

constant

Price per unit of product is constant

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Multi-Period Models: Fixed-Order Quantity Model Model
Assumptions (Part 2)

Inventory holding cost is based on average

inventory

Ordering or setup costs are constant

All demands for the product will be satisfied (No

back orders are allowed)

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Basic Fixed-Order Quantity Model and Reorder Point Behavior

4. The cycle then repeats.

1. You receive an order quantity Q.

Number
of units
on hand Q Q Q

R
L L
2. Your start using
3. When you reach down to
them up over time.
Time a level of inventory of R,
R = Reorder point you place your next Q
Q = Economic order quantity
L = Lead time sized order.
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 COST MINIMIZATION GOAL
By adding the item, holding, and ordering costs together, we determine the total
cost curve, which in turn is used to find the Qopt inventory order point that
minimizes total costs

Total Cost
C
O
S
T Holding
Costs
Annual Cost of
Items (DC)
Ordering
Costs
QOPT Order Quantity (Q)
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Basic Fixed-Order Quantity (EOQ) Model Formula
Total
Annual = Annual Annual Annual TC=Total annual cost
Cost Purchase + Ordering + Holding D =Demand
Cost Cost Cost
C =Cost per unit
Q =Order quantity
S =Cost of placing
an order or setup
cost
R =Reorder point
L =Lead time
D Q H=Annual holding
TC = DC + S+ H and storage cost per
Q 2 unit of inventory

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 DERIVING THE EOQ

Using calculus, we take the first derivative of the total cost

function with respect to Q, and set the derivative (slope)
equal to zero, solving for the optimized (cost minimized)
value of Qopt

2D S 2(A nnual D em and)(O rder or Setup C ost)

Q O PT = =
H A nnual H olding C ost
_
We also need a R e o rd e r p o in t, R = d L
_
reorder point to d = average daily demand (constant)
tell us when to
L = Lead time (constant)
place an order
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 Economic order of quantity
EOQ = Average Monthly Consumption X Lead Time [in
months] + Buffer Stock Stock on hand
 ECONOMIC ORDER OF QUANTITY
Re-order level: stock level at which fresh order is
placed.
Average consumption per day x lead time + buffer
stock
Lead time: Duration time between placing an order
& receipt of material
Ideal 2 to 6 weeks.
 EOQ EXAMPLE (1) PROBLEM DATA
Given the information below, what are the EOQ and
reorder point?

Annual Demand = 1,000 units

Days per year considered in average daily
demand = 365
Cost to place an order = Rs. 10
Holding cost per unit per year = Rs. 2.50
Lead time = 7 days
Cost per unit = Rs. 15

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 EOQ EXAMPLE (1) SOLUTION
2D S 2(1,000 )(10)
Q OPT = = = 89.443 un its or 90 u n its
H 2.50

1,000 units / year

d = = 2.74 units / day
365 days / year

_
R eorder point, R = d L = 2.74units / day (7days) = 19.18 or 20 u n its

In summary, you place an optimal order of 90 units. In the course

of using the units to meet demand, when you only have 20 units
left, place the next order of 90 units.

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 EOQ EXAMPLE (2) PROBLEM DATA
Determine the economic order quantity
and the reorder point given the following

Annual Demand = 10,000 units

Days per year considered in average daily
demand = 365
Cost to place an order = Rs. 10
Holding cost per unit per year = 10% of cost per
unit
Lead time = 10 days
Cost per unit = Rs. 15
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 EOQ EXAMPLE (2) SOLUTION

2D S 2 (1 0 ,0 0 0 )(1 0 )
Q OPT = = = 3 6 5 .1 4 8 u n its, o r 3 6 6 u n its
H 1 .5 0

10,000 units / year

d = = 27.397 units / day
365 days / year

_
R = d L = 27.397 units / day (10 days) = 273.97 or 274 u n its

Place an order for 366 units. When in the course of using the
inventory you are left with only 274 units, place the next order
of 366 units.

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 If delivery is not instantaneous, but there is a lead time L:
When to order? How much to order?

Order
Quantity
Q
Inventory

Lead Time
Time
Place Receive
order order
 If demand is known exactly, place an order when
inventory equals demand during lead time.

Order Q: When shall we order?

Quantity A: When inventory = ROP
Q Q: How much shall we order?
A: Q = EOQ
Inventory

Reorder
Point
(ROP)
ROP = LxD

Lead Time
Time
D: demand per period
L: Lead time in periods Place Receive
order order
 Example (continued)

What if the lead time to receive cars is 10 days? (when should you place your order?)

Since D is given in years, first convert: 10 days = 10/365yrs

10 10
R = D = 5000 = 137
365 365

So, when the number of cars on the lot reaches 137, order 548 more cars.
 But demand is rarely predictable!

Inventory
Level

Order
Quantity

ROP = ???
Demand???

Place Receive Time

order Lead Time order
 Actual Demand < Expected Demand
Inventory
Level

Order
Quantity
Lead Time Demand X

ROP

Inventory at time of receipt

Lead Time Time

Place Receive
order order
If Actual Demand > Expected, we Stock Out
Order
Quantity

Stockout
Point
Inventory

Time

Lead Time Unfilled demand

Place Receive
order order
 If ROP = expected demand, service level is
50%. Inventory left 50% of the time, stock
outs 50% of the time.
Inventory
Level

Order
Quantity
ROP = Expected Demand

Uncertain Demand
Average

Time
 To reduce stockouts we add safety stock
Inventory
Level

Order Quantity
ROP = Q = EOQ
Safety
Stock + Expected
Expected LT Demand
LT
Demand Safety Stock
Lead Time Time

Place Receive
order order
Decide what Service Level you want to provide
(Service level = probability of NOT stocking out)

Service level Probability

of stock-out

Safety
Stock
 Safety stock =
(safety factor z)(std deviation in LT demand)

Service level Probability

of stock-out

Safety
Stock

Read z from Normal table for a given service level

 Caution: Std deviation in LT demand

Variance over multiple periods = the sum of

the variances of each period (assuming
independence)

Standard deviation over multiple periods is

the square root of the sum of the variances,
not the sum of the standard deviations!!!
 Average Inventory =
(Order Qty)/2 + Safety Stock
Inventory
Level

Order
Quantity

EOQ/2
Average
Inventory

Safety Stock (SS)

Lead Time Time

Place Receive
order order
 How to find ROP & Q
1. Order quantity Q = EOQ 2SD H
2. To find ROP, determine the service level (i.e., the
probability of NOT stocking out.)
Find the safety factor from a z-table or from the graph.
Find std deviation in LT demand: square root law.

std dev in LT demand ( std dev in daily demand ) days in LT

LT D LT
Safety stock is given by:
SS = (safety factor)(std dev in LT demand)
Reorder point is: ROP = Expected LT demand + SS
3. Average Inventory is: SS + EOQ/2
 Example (continued)

Back to the car lot recall that the lead time is 10 days and the
expected yearly demand is 5000. You estimate the standard deviation of
daily demand demand to be d = 6. When should you re-order if you
want to be 95% sure you dont run out of cars?

Since the expected yearly demand is 5000, the expected demand over
the lead time is 5000(10/365) = 137. The z-value corresponding to a
service level of 0.95 is 1.65. So

ROP 137 1.65 10(36) 168

Order 548 cars when the inventory level drops to 168.

 ABC CLASSIFICATION SYSTEM
Items kept in inventory are
not of equal importance in
terms of: % of
60

rupees invested Rs Value 30

A
profit potential
0
sales or usage volume B
% of 30 C
stock-out penalties
Use 60

So, identify inventory items based on percentage of total

dollar value, where A items are roughly top 15 %, B
items as next 35 %, and the lower 65% are the C items
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 ABC ANALYSIS
(ABC = Always Better Control)
This is based on cost criteria.
It helps to exercise selective control when confronted
with large number of items it rationalizes the number
of orders, number of items & reduce the inventory.
About 10 % of materials consume 70 % of resources

About 20 % of materials consume 20 % of resources

About 70 % of materials consume 10 % of resources

 ABC ANALYSIS
A ITEMS
Small in number, but consume large amount of resources
Must have:
Tight control
Rigid estimate of requirements
Strict & closer watch
Low safety stocks
Managed by top management
B ITEM
Intermediate
Must have:
Moderate control
Purchase based on rigid requirements
Reasonably strict watch & control
Moderate safety stocks
Managed by middle level management
 ABC ANALYSIS
C ITEMS
Larger in number, but consume lesser amount of
resources
Must have:
Ordinary control measures
Purchase based on usage estimates
High safety stocks
ABC analysis does not stress on items those are less costly
but may be vital
 ANNUAL COST CUMMULATIVE
ITEM % ITEM
[Rs.] COST [Rs.]
COST %
ABC
1 90000 90000
10 % 70 %
A 2 50000 140000
3 20000 160000
N 4 7500 167500
20 % 20 %
A 5 7500 175000
6 5000 180000
L
7 4500 184500
Y 8 4000 188500
9 2750 191250
S
10 1750 193000
I 11 1500 194500

S 12 1500 196000
13 500 196500 10 %
70 %
14 500 197000
15 500 197500
WORK 16 500 198000
SHEET 17 500 198500
18 500 199000
19 500 199500
20 500 200000
 VED ANALYSIS
Based on critical value & shortage cost of an item
It is a subjective analysis.
Items are classified into:
Vital:
Shortage cannot be tolerated.
Essential:
Shortage can be tolerated for a short period.
Desirable:
Shortage will not adversely affect, but may be using more resources. These must be
strictly Scrutinized

V E D ITEM COST

A AV AE AD CATEGORY 1 10 70%

B BV BE BD CATEGORY 2 20 20%

C CV CE CD CATEGORY 3 70 10%

CATEGORY 1 - NEEDS CLOSE MONITORING & CONTROL

CATEGORY 2 - MODERATE CONTROL.
CATEGORY 3 - NO NEED FOR CONTROL
SDE ANALYIS
Based on availability
Scarce
Managed by top level management
Maintain big safety stocks
Difficult
Maintain sufficient safety stocks
Easily available
Minimum safety stocks
FSN ANALYSIS
Based on utilization.
Fast moving.
Slow moving.
Non-moving.
Non-moving items must be periodically reviewed to prevent expiry
& obsolescence
HML ANALYSIS
Based on cost per unit
Highest
Medium
Low
This is used to keep control over consumption
at departmental level for deciding the frequency of physical verification.
 STORES MANAGEMENT
Introduction
The term stores, storehouse, warehouse etc refer to the physical
place be it a building or a room etc. Where materials of all
variety are kept.
The function of stores is to receive, store and issue materials.
Stores are normally divided into various sections such as -
Receiving section
Tool stores
General stores
Raw materials stores
Finished parts stores etc.
Stores plays a vital role in the operations of a company
Stores networks are incredibly complex and therein lies the
opportunity of improvement.
 STORES MANAGEMENT
Stores function as an element of materials department, has an
interface with many user departments in its daily operations.
The basic purpose served by stores is the provision of
uninterrupted service to manufacturing divisions.
Stores act as a cushion between purchase and manufacturing on
one hand and manufacturing and marketing on the other.
The inherent limitations of forecasts make the stores function a
necessity.
Stores function is an inseparable part of all business and non
business concerns, whether they are industrial or service oriented,
public or private, small or large.
The task of store keeping relates to safe custody and stocking of
materials, their receipts, issues, and accounting with the objective
of efficiently and economically providing the right material at the
right time whenever required in the right condition to all user
departments.
STORES MANAGEMENT - NECESSITY OF STORES
One must always remember that even though store
keeping doesnt add any value to the product in the
normal sense, it is an essential function and just
cannot be wished away.
At times stores may add time utility or value by
preserving scarce material that may be required in
future.
By proper preservation and storage, the store
department avoids any depreciation in the value of
inventory.
The financial view considers stores as an overhead i.e.
A cost with no return.
This all the more highlights the need for economic
operation and efficient stores management.
STORES MANAGEMENT - NECESSITY OF STORES
The cost of stores can be categorized into a capital
cost component and revenue expenditure component.
The capital cost consist of the sunk cost in land
building, roads, yards, material handling equipment and
related facilities.
Because of the very irreversible nature of this cost,
proper planning of stores can go long way in reducing
this capital expenditure that may also have a bearing
on the revenue expenditure in the stores.
The revenue component of stores expenditure consists
of salaries and wages of store personnel, maintenance
cost, stationary cost, communication expenses, and
inventory carrying cost
STORES MANAGEMENT - NECESSITY OF STORES
One must always remember that efficiency in stores operations cannot be
built overnight but has to be thought of right from the initial planning stage.
Stores must be visualized as an integral part of the purchasing
manufacturing marketing link.
Unfortunately, stores management is looked down upon by many as an
operational clerical function and fails to attract appropriate talent because of
its underdog nature.
One has to bear in mind that the stores manager heads the single largest
group of current assets and his performance is the key to smooth production
and subsequent marketing.
Many decisions related to stores have a dramatic impact on the operational
efficiency of the production department and profitability of the entire
organization.
Even seemingly routine decisions such as selection of racks, shells, bins,
material handling equipment, safety practices, inspection procedures etc. Are
reflected in the operational efficiency.
One must appreciate the role of stores in maintaining optimum inventory
and highlighting exception cases through building up of proper mis by
maintaining accurate records.
STORES MANAGEMENT - FUNCTIONS OF STORES
The following are the principal functions of a store;
1. To receive raw materials, components, tools, spares, supplies,
equipments and other items and account for them.
2. To provide adequate, proper and efficient storage and preservation
for all the items.
3. Physical checking of all incoming materials as per the delivery
challan / invoice and proper maintenance of daily goods receipt
register or records.
4. Arrange for inspection of incoming materials.
5. Ensure that goods inward notes (gin) are raised and distributed
without delay
6. Issue materials to the consuming departments against authorized
requisitions and account for the same.
7. Maintain accurate and up to date records of material received,
issued, rejected, disposed, and quantity on hand of all the items.
STORES MANAGEMENT - FUNCTIONS OF STORES
The following are the principal functions of a store;
8. Ensure that all documents relating to receipts and issue are sent to stock
control, accounts and other concerned departments.
9. Undertake stock verification as per approved procedure.
10. To highlight stock accumulation, discrepancies and abnormal consumption
and initiate appropriate control action, wherever necessary.
11. To minimise obsolescence, surplus and scrap through proper codification,
standardization, preservation and handling.
12. To ensure good housekeeping so as to minimize the need for material
handling.
13. To make available a balanced flow of materials so as to economize on
capital tied up in inventory.
14. To accept and store scrap and other discarded materials.
Depending upon the nature of business (i.e. Manufacturing, trading
services, etc,) one or more of these functions may gain primacy over the
rest.
DUTIES AND RESPONSIBILITIES OF
STOREKEEPER
Receiving material: The primary duty of the store keeper is to
receive the material from the supplier. At the time of receipt
of material, he has to see that the materials have been sent
by the supplier on the basis of purchase order.
Arranging materials: The materials received by the store
keeper must be arranged in a proper manner. Bins should be
allotted to each and every item.
Preservation of the material: After the receipt of material
they are to be preserved properly. It is the duty of the store-
keeper to keep the material in store on safe custody. Unless
the quality may deteriorate loss of material may be possible.
Recording: It is the duty of the store keeper to record the
receipt and issue of material in the respective bin card
regularly. It will indicate the quantity of stock held by the
store every time. For recording, the store keeper maintains
store ledger and bin cards.
DUTIES AND RESPONSIBILITIES OF
STOREKEEPER
Issue of material: The store keeper issues the material
as per the requisition of the production. When store
keeper received requisition he issues material from the
store.
Issuing purchasing requisition: When the stock reaches
at ordering level the store keeper sends purchase
requisition to the purchasing department for the fresh
purchase of the materials. Accordingly, the purchasing
departments purchases materials as per quantity and
quality stated there in.
Supervision: The store keeper must be coordinate and
supervise the duty of the staff under his control. As he
is the head of the store department, he manages the
entire department.
 GUIDING PRINCIPLES OF STORES LOCATION
The following decisions are a part of the location decision
1. One store or many stores?
2. Should it report to the production department or to the materials
department ?
3. What transport facilities are to be used ?
4. Is there a chance or need for future expansion ?
5. What is the number and variety of materials used in the firm ?
Guiding principles of store location :
1. Basic objective of stores is to maximise service to user departments at
optimum overall cost.
2. Priority must be given to minimum material handling and transportation
expenditure.
3. Incorporate in built flexibility to deal with futuristic requirements,
4. Adequate communication links must be arranged for.
5. Adequate safety measures must be available at hand,
6. Preplan about the nature, quantity of materials to be dealt with.
7. Factor in the number of end users and suppliers.
 STORES LEDGER
A stores ledger is a manual or computer record of
the raw materials and production supplies stored in
a production facility.
It is maintained by the person responsible for these
assets, such as the warehouse manager.
A stores ledger is particularly useful for maintaining
a perpetual inventory system, since it tracks the
current quantity of items on hand.
 USES OF STORES LEDGER
By auditors, to see how well the company's
inventory records compare to its on-hand
quantities.
By the purchasing staff, to determine when and in
what quantities to purchase additional inventory
items.
By the accounting staff, to use as the basis for
calculating the ending cost of inventory on hand.
 STORES LEDGER
The information listed on a stores ledger can follow
one of two formats:
Unit quantities only. The ledger shows the
beginning unit quantity of an inventory or supplies
item, plus or minus any subsequent additions to or
subtractions from stock. When used for this
purpose, the stores ledger may instead be referred
to as a bin card.
Costed quantities. The same as the first format,
except that the cost of the items is also listed in the
ledger.
 BIN CARD
Bin card is a record of receipt and issue of materials Quantity of
store received is entered with receipt column and the quantity of
store issued is recorded in the issue column of Bin Card.
Balance of quantity of stores is ascertained after every receipt or
issue. It shows the balance of the stock at any moment of time.
Bin Card is maintained by the store-keeper. He is answerable for
any difference between physical store and the balance shown by
the Bin Card.
Thus Bin Card does not only records the receipt an issue of the
stores but also assist the store keeper for control of the stock.
For each item of stores minimum level maximum level, and
ordering level are shown in the part of the Bin Card.
By seeing the Bin Card the store keeper sends the material
requisition for the purchase of materials from time to time.
 STORES LEDGER Vs BIN CARD
1. Bin card is prepared by the store keeper, whereas
Stores ledger is prepared by cost department
2. Entries are first made in bin card, whereas In stores
ledger entries are made after got recorded in bin card.
3. In bin card only the units of closing stock are recorded,
on the other hand. Stores ledger records the units as
well as the value of closing stock.
4. Bin card records only the physical movement of stock
in respect of receipts, issues and balance, whereas
Stores ledger records the receipts, issues and balance
in respect of units, per unit rate and amount.
 STORES LEDGER Vs BIN CARD
5. In case of any discrepancy of stock, store keeper is
responsible as he maintains the bin card which is the
first entry card for stock, on the other hand In stores
ledger discrepancy, cost accountant cannot be held
liable, because all entries are made after got entered
in bin card, so stores ledger in the second entry book.
6. In bin card, entry is made as and when transaction
happens, on the other hand, In stores ledger, entry
may be made periodically.
7. Bin card is kept close to the material stock, whereas
Store ledger is kept in cost department as it is needed
by cost department and not store keeper.
Soumendra Roy INC Asansol