2. LEARNING OBJECTIVES
• Highlight the need for and nature of inventory
• Explain the techniques of inventory management
• Focus on the need for analyzing inventory problem
as an investment decision
• Discuss the process for managing inventory
2
3. Nature of Inventory
• Stocks of manufactured products and the material
that make up the product.
• Components:
– raw materials
– work-in-process
– finished goods
– stores and spares (supplies)
3
5. Objectives of Inventory Management
• To maintain a large size of inventories of raw
material and work-in-process for efficient and
smooth production and of finished goods for
uninterrupted sales operations.
• To maintain a minimum investment in
inventories to maximize profitability.
5
6. Effective Inventory Management
The aim of inventory management, should be to avoid excessive and
inadequate levels of inventories and to maintain sufficient inventory for
the smooth production and sales operations. An effective inventory
management should:
• Ensure a continuous supply of raw materials to facilitate
uninterrupted production
• Maintain sufficient stock of raw materials in periods of short supply
and anticipate price changes
7. Contd……
• Maintain sufficient finished goods inventory for smooth
sales operations and efficient customer service
• Minimize the inventory costs
• control investment in inventories and keep it at an
optimum level
8. Techniques of IM
• FM require to answer:
– All items of inventory equally important or some items
need more attention
– What should be the size of each order
– At what level should order be placed
• Economic order model
9. Inventory Management Techniques
Economic order quantity (EOQ): The EOQ is the inventory
level that minimizes the total of ordering and carrying costs.
Ordering costs: requisitioning, order placing, transportation,
receiving, inspecting and storing, administration
Carrying costs: warehousing, handling, clerical and staff, insurance,
depreciation and obsolescence
Ordering and Carrying costs trade-off: A = total requirements, O
= order cost, C = carrying cost
2
EOQ =
AO
c
10. Illustration
The John Sports Inc. purchases tennis balls at $20 per dozen from its
suppliers. The John Sports will sell 34,300 dozens of tennis balls evenly
throughout the year. The total cost to handle a purchase order is $10.
The insurance, property tax and rent for each dozen tennis balls in the
average inventory is $0.40. The company wants a 5% return on
average inventory investment.
1) Compute the economic order quantity.
2) Compute the total annual inventory expenses to sell 34,300 dozens
of tennis balls if orders are placed according to economic order
quantity computed in part 1.
12. 2. Total annual inventory expenses to sell 34,300 dozens
of tennis balls:
= Annual ordering cost + Annual holding cost
= (Number of orders × Cost per order) + (Average units × Holding cost
per unit)
= (*49 orders × $10) + [(700/2) × 1.4]
= $490 + $490
= $980
*Number of orders to be placed: 34,300/700 = 49 orders
13. Inventory Management Techniques
• Reorder point : Reorder point is that inventory level at which an order should be
placed to replenish the inventory
– Lead time: Time taken in replenishing the inventory after the order has been
placed.
– Average usage:
Reorder point under certainty:
= Lead time x Average usage
For example.
EOQ is 500 units, Lead time is three weeks and average usage is 50 units per
week.
Reorder point =3*50=150 units
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15. Cont…
• Reorder point under uncertainty
– Safety stock: In order to guard against the stock-out
situation, the firm may maintain a safety stock
(buffer/minimum inventory as a cushion against expected
increased usage and /or delay in delivery time.)
Reorder point = (Lead time x average usage) + safety stock
• For example, continuing with the above example, the reasonable expected stock
out is 25 units per week. The firm should maintain the safety stock of 3weeks*25
units=75 units
• Thus the reorder point will be 150+75=225 units
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16. MCQ
Inventory holding costs include:
A. Cost of capital tied up
B. Insurance costs
C. Cost of warehousing, obsolescence, deterioration and theft
D. All of the above
18. MCQ
Pam runs a mail-order business for gym equipment. Annual demand
for the Trico Flexers is 16,000. The annual holding cost per unit is $2.50
and the cost to place an order is $50. What is the economic order
quantity?
A. 700
B. 800
C. 900
D. 1000
23. Just-in-Time (JIT) Inventory
• The basis philosophy behind “Just In Time” is that
the Firm should keep a minimum level of inventory
on hand, relying on suppliers to furnish stock “Just
In Time’ as and when required
• https://www.youtube.com/watch?v=zCTmN17ZDek
24. Methods of Inventory Valuation
• Inventory valuation is the accounting process of assigning
value to a company’s inventory. There are several methods for
calculating inventory value. For example,
• First In, First Out (FIFO) method values inventory as though the
first inventory items purchased are the first to be sold.
• Last In, First Out (LIFO) method values inventory as though the
last purchased inventory items are the first to be sold
• The Weighted Average Cost (WAC) method is based on the
average cost of items purchased.
