Constitute significant part of current assets
A considerable amount of fund is required
Effective and efficient management is imperative to avoid
Improper inventory management affects long term profitability
and may fail ultimately
10 to 20% of inventory can be reduced without any adverse effect
on production and sales by using simple inventory planning and
3. Meaning and Function
Inventories are resources of any kind having an economic
“Properly maintaining adequate stocks to ensure uninterrupted service”
Inventory functions as a bank and decouples successive stages
Operating sub-systems – Materials, Manufacturing and Marketing
Non-operating sub-systems – Finance and Personnel
4. Need for inventory
Inventory is held for transaction purposes.
To maintain a given volume of sales to satisfy customers.
As a precaution or contingency for increase in lead time or
a consumption rate.
To decouple the materials department from the consuming
5. Scope and Importance
New effective tools and techniques evolved for efficient
management of inventories.
Private and Public undertaking sectors can make savings in
inventories by effecting internal and external economies.
Savings can be achieved in –
Material purchase by competitive bidding, value analysis
Obsolescence in storage
i.e. reducing working capital blocked up
6. Inventory Problem
Inventory problem is one of balancing various costs so that total cost
should be minimized. These costs are :-
Cost of ordering - Cost of carrying -
Quotation or tendering Warehousing or storage
Order Placing Clerical and staff
Receiving inspecting & Storing Interest
Quality control Deterioration, wastage
Clerical and staff Taxes
Under stocking and Overstocking cost -
Loss of sale
Failure to meet delivery commitments
7. Lead Time influences the Inventories
“Lead time – Time between placing an order and receiving it”
Influence of various types of lead time on inventory decisions are :-
Administrative lead time – due to identification of needs and
Manufacturing lead time – due to dependability on the supplier of
Transporting lead time – depends on the mode of transport and
Inspection lead time – arises due non-availability the standard
to compare the quality of the received
8. Techniques of Inventory Management
1. Selective Inventory Control
2. Setting up various stock levels
3. Systems of Inventory Control
4. Economic Ordering Quantity or E.O.Q. Formula
5. Re-order Point and Safety Stock
6. Application of Computers for Inventory
7. Just-in-Time Inventory Management
8. Inventory Ratio
9. Aging Schedule of Inventory
10. Inventory Audit
9. 1. Selective Inventory Control
Analysis and classification of inventory for effective inventory management :-
Title Use Main use
ABC (Always Better Control) Value of conception to control raw material, components and
work-in-progress inventories in the business
HML(High, Medium, Low) Material Unit price to control purchase
XYZ Value of the items to review the inventories and their uses at
in storage scheduled intervals
VED(Vital, Essential, Criticality of the to determine the stocking level of the spare
FSN(Fast, Slow, Non moving) consumption pattern to control obsolescence
of the component
SDE(Scarce, Difficult, Easy to problems faced in lead time analysis and purchasing strategies
GOLF(Govt Ordinary, Local, source of the procurement strategies
Foreign Sources) material
SOS(Seasonal, Off-Seasonal) Nature of supplies procurement strategies for seasonal items
10. Selective Inventory Control (contd..)
ABC Analysis :-
ABC (Always Better Control) –
ABC analysis divides the total inventory into 3 classes A,B and C using the rupee
volume, as follows –
'A' items are very important for an organization because of the high value of these
„A‟ items – 20% of the items accounts for 70% of the annual consumption value of
'B' items are important, but of course less important, than ‘A’ items and more
important than ‘C’ items. Therefore ‘B’ items are intergroup items.
„B‟ items - 30% of the items accounts for 25% of the annual consumption value of
'C' items are marginally important.
„C‟ items - 50% of the items accounts for 5% of the annual consumption value of
11. Selective Inventory Control (contd..)
ABC Analysis :-
12. Selective Inventory Control (contd..)
ABC Analysis :-
13. Selective Inventory Control (contd..)
Advantages of ABC Analysis :-
Control - Stocking a better mix of the right inventory allows a company to
control over-supply and under-supply of important stock keeping units.
Costs - Once a company has determined which items fall into each ABC
category it can establish cost-reduction initiatives at the stock keeping units
Improved service - ABC analysis provides a company with information to
stock the right-mix of inventory. When a company has the right inventory at
the right time it reduces backorders and unfilled orders. This has a positive
impact on customer service and gives a competitive advantage to the
company that uses this methodology.
Warehouse - Implementing ABC inventory management in the warehouse
reduces labor cost and increases productivity.
14. 2. Setting up Various Stock Levels
Maximum Level = Re-order Level – Expected minimum consumption in
units during minimum weeks to obtain delivery + Re-order qty
Normal usage100 units per day. Max. usage130 units per day. Minimum usage70 units
per day. Re-order period 25 to 30 days. Economic order quantity 5,000 units.
Calculate maximum limit or level. In order to calculate maximum limit of stock we
must calculate re-order point or re-order level first.
Ordering point or re-order level = Maximum daily or weekly or monthly usage
= 130 30
= 39,000 units
Maximum limit or level = Re-order level or ordering point – Minimum quantity used in
re-order period usage + Economic order quantity
= 3900 – (70 25) + 5,000
= 7150 units
15. Setting up Various Stock Levels (contd…)
Minimum Level = Re-order Level - (Avg usage per period x Avg time to obtain
Normal usage100 units per day. Max usage130 units per day. Min. usage 70 units per
day. Re-order period 25 to 30 days
Calculate: minimum limit or level. To calculate minimum limit of materials we must
calculate re-order point or re-order first.
Ordering point or re-order level = Maximum daily or weekly or monthly usage
= 130 30
= 3,900 units
Minimum limit or level = Re-order level or ordering point – Average or normal usage
Normal re-order period
= 3900 – (100 27.5*)
*(25 + 30 ) / 2
16. Setting up Various Stock Levels (contd…)
Re-order Level = Max Re-order period x Max usage
Minimum daily requirement 800 units. Time required to receive
emergency supplies 4 days. Avg daily requirement 700 units. Min. daily
requirement 600 units. Time required for refresh supplies One month (30
days). Calculate ordering point or re-order level.
Ordering point = Ordering point or re-order level = Maximum daily or
weekly or monthly usage Lead time
= 800 30
= 24,000 units
17. Setting up Various Stock Levels
Various stock levels fixed to control Inventory holding are :-
Avg Stock Level = Maximum Level + Minimum Level
18. 3. Systems of Inventory Control
The Main systems of Inventory control are :-
a) Perpetual Inventory (Automatic Inventory) system –
Main Functions -
i. Recording store receipts and issues to determine at any time the stock
ii. Continues verification of physical stock with reference to the balance
recorded in the stores record.
b) Double Bin (Fixed Order Quantity) System –
i. Used for low consumption value items.
ii. Ideal for items for which demand and lead time are regular.
iii. Avoids necessity of taking physical inventories.
19. 4. Economic Ordering Quantity or EOQ Formula
Economic Order Quantity is one of the techniques of inventory control
which minimizes total holding and ordering costs for the year.
Definition of EOQ :-
EOQ is essentially an accounting formula that determines at which the
combination of order, costs and inventory carrying cost are at the least.
EOQ Formula :- EOQ or D = √ 2Q(a) / c
Q = Annual requirements in units
a = Unit cost of placing an order
c = Annual carrying cost
D = Optimum lot quantity or Batch Size
20. Economic Ordering Quantity or EOQ Formula (contd..)
Tabular presentation of Economic Order Qty of 200 Units
No o f Orders Order Qty Avg Stock
1 40,000 20,000 4,000 10 4,010
2 20,000 10,000 2,000 20 2,020
3 13,333 6,667 1,333 30 1,363
4 10,000 5,000 1,000 40 1,040
5 8,000 4,000 800 50 850
10 4,000 2,000 400 100 500
15 2,667 1,334 267 150 417
20 2,000 1,000 200 200 400
25 1,600 800 160 250 410
30 1,333 667 133 300
21. Economic Ordering Quantity or EOQ Formula (contd..)
Cost of each article is one rupee. Annual demand is 40,000 units. Cost of
carrying inventory is 20%. Cost per order is Rs. 10/-
Using the formula :-
D = √ 2Q(a) / c = √2x10x40,000 / 1x0.20
D = √40,00,000
D = 2,000 units
Here, EOQ is 2,000 units. When EOQ is 2,000 units, the no. of orders to
be placed in a year is 20 and the total cost is Rs. 400/- ( ordering and
inventory carrying cost are the same)
22. 5. Re-order Point & Safety Stock
Re-order point = Average Daily usage x Lead Time in days + Safety Stock
Safety Stock – extra inventory held as a protection against possibility of a
23. 6. Application of Computers for Inventory
Immense scope in areas like Inventory Management
Speed and Efficiency
Reliance on Technology
Risk of fraud
24. 7. Just-in-Time ( JIT ) Inventory Management
JIT is aimed at monitoring the inventory process in such a manner as to
minimize the costs associated with inventory control and maintenance.
An inventory strategy companies employ to increase efficiency and
decrease waste by receiving goods only as they are needed in the production
process, thereby reducing inventory costs.
Lower Warehouse Cost
Better Supply Chain Management
Better Customer Satisfaction
25. 8. Inventory Ratio – Inventory Turnover Ratio
This ratio is used to evaluate the performance of the inventory function :-
ITR = Cost of sales during the period/Avg tock held during the period
cost of sales means sales minus gross profit and
avg. stock indicates yearly avg.(average of opening and closing inventory)
- it is used to measure the inventory management efficiency of a business.
- a higher value indicates better performance and lower value means
inefficiency in controlling inventory levels.
- a lower inventory turnover ratio may be an indication of overstocking
which may pose risk of obsolescence and increased inventory holding costs.
26. Inventory Ratio – Inventory Turnover Ratio (contd…)
During the year ended December 31, 2010 Loud Corporation sold goods
costing $324,000. Its average stock of goods during the same period was
$23,432. Calculate the company's inventory turnover ratio.
Formula - ITR = Cost of sales during the period/Avg tock held during the
Inventory Turnover Ratio = $324,000 / $23,432 = 13.83
27. 9. Aging Schedule of Inventory
Classification of inventories in accordance with age (days) assist in
identifying inventories which are moving slowly into production or sale.
Aging Schedule of Inventory as on 31 December 2011
Purchase/ Mfg Amount (Rs.) % of Total
0-20 December 11 10,000 20
21-40 December 7 5,000 10
41-60 November 21 3,000 6
61-80 November 5 25,000 50
81 and above October 20 7000 14
Total 50,000 100
28. 10. Inventory Audit
Aspects of Inventory Audit:-
i. Testing and appraisal of policy pursued for inventory forecasting,
planning and control
ii. Appraisal of inventory valuation method
iii. Testing and appraisal of inventory forecasting and planning models
iv. Testing and appraisal of control aspects
v. Testing the maintenance aspects of inventory & inventory records
29. Inventory Audit (contd..)
30. Inventory Audit (contd…)
Checking points for Auditing –
i. process of manufacture – auditor should be aware of technical aspects
of process of manufacture of main products and by-products and scraps.
ii. Raw Materials – auditor should ascertain that SOPs are followed for
purchasing, consuming raw material and also it should be technically
iii. Stores and Spares – procurement and utilization of stores and spares
should be done for effective savings. Redundant investment should be
iv. Auditors observations and conclusions
31. Inventory Audit (contd…)
Checking points for Auditing –
iv. Auditors observations and conclusions – Cost auditor should observe
following with respect to the inventory audit :-
a) whether firm’s funds have been used in a negligent or inefficient manner.
b) factors which could have controlled due to inventory but not done resulted in
increase in cost of production.
c) whether contracts/agreements related to purchase/selling of inventory items
had any undue benefits.
d) possibility of improvement in performance offering scope for cost reduction
and increase in productivity.
e) whether improved inventory policies will be useful for effective savings.
32. Case Study - McDonald's
There are multiple warehouses (Distribution Centers) located in India
and there exist common suppliers for each product. Also, these
suppliers are located across the country. Warehouses order as per their
requirement. Since the per trip loads are not enough to send a
dedicated truck from supplier to each warehouse, receiving on-time
deliveries and food safety of the products was a challenge. This had
affected inventory holding in warehouses leading to higher inventory
carrying cost, high inventory days, threat of stock-out situation and
in-transit damages, safety of food items in transit and higher inbound
cost. The need to transport products in a cost effective manner and
ensure on-time availability without compromising on the integrity of
the food products, was identified.
33. Case Study - McDonald's
Ensure consolidation of stock at the nearest warehouse and move full
truck loads. To make it happen following steps were taken:
Movement of full truck load (consolidated load from multiple
warehouses) from supplier to the nearest warehouse.
Flexibility of consolidated movement viz. Freezer / Dry, Chiller / Dry,
etc in multi-temperature trucks.
Movement of stocks directly from vendor to the consumption
warehouse in case of high volume / fast moving products.
Planned pickup and delivery from vendors at least 15 days in advance
to ensure capacity utilization.
Fixed schedule of movement from consolidation warehouse to the
respective warehouses on Full Truck Load (FTL) basis.
Inventory days and safety stock maintained in line with the scheduled
34. Case Study - McDonald's
Assured supply of goods, by optimizing inventory and frequency of
Cost benefit due to optimization of truck load.
Assured safety of products in transit.
Inventory under control i.e. reduced inventory holding from 20 days
to 8 days.
Reduction in Inventory carrying cost.