Inventory Management

1. SOURCING AND INVENTORY

2. INVENTORY MANAGEMENT IN SUPPLY
CHAIN
Inventory can be defined as a stock of commodity which has got some
economic value, but withdrawal of which requires an authorization.
Implications of the definition:
i. A detailed, itemized list, report, or record of things in one’s possession especially a
periodic survey of all goods and materials in stock.
ii. The process of making such a list, report, or record.
iii. The items listed in such a report or record.
iv. The quantity of goods and materials on hand, stock, or in pipeline.
v. An evaluation or a survey, as of abilities, assets, or resources.
vi. To make an itemized report or record.
vii. To include in an itemized report or record.

3. The amount of raw materials, work in process and finished goods being held for
sale at a given time is inventory.
Inventory = cumulative supply – cumulative demand
Inventory can be negative as well,
i.e. I(t)< 0
If consumers are willing to order without receiving product, then we can allow
demand to exceed supply.
Then I(t) can become negative, -I(t) represents the total quantity on back order.
In simple terms, positive inventory is a pile of goods that are waiting for orders and
a negative inventory as a pile of orders that are waiting for goods.

4. IMPORTANCE OF INVENTORY
Managing inventory has become very important due to following factors.
 Resource availability (finance and space) has forced management to consider how best to
lower the levels of inventory.
 The changes in manufacturing philosophy, concepts like JIT and lean manufacturing have
reduced the need for inventory.
 The realization by many companies that a greater ROI can be obtained by developing the core
business, rather than in working capitals such as inventory and debtors, who’s returns are far
less.
 The developments on the front of information technology (IT), which provides a potential tool
to reduce the inventory. The better the information lower is the need for inventory,
Information systems such as POS, ERO can significantly reduce the inventory.

5. TYPES OF INVENTORY
The inventories can be categorized based on the reason for existing in a supply chain system.
Cycle Stock: If the demand and the supply lead time are known, this inventory is only
necessary to service the regular demand. Ex: Retailers on-hand inventory
In transit inventories: More the distance between the production and the consumption centers
and larger the channel, the greater will be the level of in transit inventories. Ex: Finished
goods being shipped from plant to distribution center
Safety Stock: It is held over the levels of cycle stock because of unpredictability in demand and
lead-time.
Speculative Stock: This stock is often kept because of unpredictability in consumption or
supply due to extraneous reasons such as suppliers strikes, transportation strikes, natural
calamities, etc

6. TYPES OF INVENTORY
Seasonal Stock: This stock involves the accumulation of inventory prior to a
particular season to meet the market demand. Ex: Ganapati decoration
items, umbrellas, Walkers way
Dead/Obsolete Stock: Specifically non-moving items whose future demand
are almost non-existent. Ex: Expired, Old chargers.
The inventory types mix will vary among different business.
For example: a retailer selling commodity items will have a different
inventory mix to that of a fashion retailer targeting teenagers.

7. IMBALANCES IN A SUPPLY CHAIN
The primary motive behind carrying inventory in a supply chain is to
eventuate a balanced transaction between supply and demand.
We can have a balanced transaction only when we have full
information on supply and demand side.
Depending upon the combination of the state of nature, the size and
location of inventory are normally decided.

8. PLANNED IMBALANCES
Operations managers often deliberately create supply/demand imbalances.
Short – run demand often exceeds the capacity of the supply process.
To meet this demand, manufacturers begin building inventories months in
advance.
By doing this they ensure cumulative output is sufficient to meet cumulative
demand.

9. PLANNED IMBALANCES
A second reason for deliberately creating imbalances is to take advantage of
changes (either real or anticipated) in the cost of materials or products.
For example, grocery chains will “forward buy” large quantities of consumer
products when manufacturers offer trade discounts.
Supply and demand imbalances also occur when the input and output of
some portion of the supply chain are separated by time and/or distance.
For example, we are supplying an overseas market from a domestic
distribution center.

10. PLANNED IMBALANCES
Assume we use container ships and total one-way transportation time is 7
weeks.
We start up operations, begin shipping the product to our overseas market
at a rate of 4000 units per week and hold our breath! What happens.
In week 8, our overseas partners would receive products shipped in week 1,
in the 9th week products shipped on week 2, etc.
Out put is the input delayed by 7 weeks: D(0;t) = S(0;t-7). Hence, I(t)=
S(0;t)- S(0;t-7) ie. the inventory “on the ocean” is simply the cumulative
shipments made over the weeks

11. INVENTORY COSTS
In any business analysis-involving inventory, physical inventory levels
must be converted to inventory costs.
Inventory costs can be classified into direct and indirect costs.
Direct costs include: capital costs, storage space costs, service costs
and risk costs.
Indirect costs include: business risk due to lost sales and loss of
customers, opportunity cost due to inability to invest in alternatives,
infrastructure costs such as facilities, transportation and other
services.

12. DIFFERENT TYPES OF INVENTORY
CONTROL SYSTEM
There are two basic categories of policies for controlling inventories: Fixed
order quantity policies & Fixed time period policies.
Fixed order Quantity: In this type of system, the order quantity is same.
Based on lead-time involved, the reorder point will be decided and every time
the quantum of order placed is the same.
Inventory levels are continuously monitored and an order is placed whenever
the inventory level drops below predetermined reorder point.
For this reason, this type of policy is also called a continuous policy.

13. DIFFERENT TYPES OF INVENTORY
CONTROL SYSTEM
Fixed Interval System: In this system, the ordering interval is same.
Ex: Every week, every month, etc.
The order quantity may be different every time based on the costs involved.
The time between the order remains same but quantity ordered each time varies
with demand and current level of inventory.
These policies are also called periodic-review policies.

14. DIFFERENT TYPES OF INVENTORY
CONTROL SYSTEM
Two-bin system: Notionally, there are two bins kept full of items.
Items form the first bin are used first, the moment the first bin is
exhausted, an order is placed for items and the second bin acts as a buffer
or safety cushion.
MRP: For dependent demand situations, normally, Material Requirement
Planning (MRP) system is a basically used.
Ex: The demand, for a picture tube is dependent on the demand of TV. If
one knows the demand for TV, one can derive the demand for picture tubes
and other components required for assembling a TV.

15. INVENTORY POLICIES FOR VARIOUS
TYPES OF DEMAND

16. VENDOR MANAGED INVENTORY
SYSTEMS
In traditional replenishment process the customer does not give prior
notification for requirements, which means that vendor is compelled to store
safety stock that acts as a buffer.
The customers also have safety stock available of the same items as a
protective mechanism in case they do not receive the required stock.
This leads to a larger amount of stock in the entire goods supply chain,
reduced level of customer service and a poorer response level.
Through vendor managed inventory programs, manufacturers can offer their
customers a value-added service by performing the replenishment-planning
task for their business partners.

17. VENDOR MANAGED INVENTORY
SYSTEMS
Vendors give better visibility into actual customer demand to the
manufacturers, also vendors may have better decision support systems in
place and more knowledge and control over the logistical processes.
VMI programs allow manufacturers to make better decisions on how to
deploy goods across various customers, which leads to increased customer
service levels, lower transportation costs, reduced inventory levels and lower
sales costs.
Both parties benefit from reduced cycle times and lower overhead, since the
process can be highly automated.

18. VENDOR MANAGED INVENTORY
SYSTEMS
With VMI, the vendor specifies delivery quantities sent to customers through
the distribution channel using data obtained from EDI.
Vendor Managed Inventory, Just –in-time Distribution (JITD) and efficient
Consumer Response (ECR) all refer to similar concepts, but applied to
different industries.
Ex: The grocery and apparel industries tend to use ECR, whereas the
automobile industry tends to use VMI and JITD.

19. FEATURES OF VMI
Shortening of the supply chain.
Centralized forecasting.
Frequent communication of inventory, stock-outs, and planned promotions, EDI
linkages facilitate this communication.
No manufacturer promotions.
Trucks are filled in prioritized order. For example, items that are expected to stock
out have top priority, then items that are furthest below targeted stock levels, then
advance shipments of promotional items (promotions allowed only in transition
phase), and finally items that are least above targeted stock levels.
Relationship with downstream distribution channels.
Result: Inventory reduction and stock-out reduction.

20. INVENTORY TURNOVER RATIO (ITR)
ITR is an important performance measure for inventory.
Let us consider a company A, which sells Rs. 10,000 worth of product
(at cost)in a year. Assume that the total revenue received from sale sis
12,500.
If A bought entire 10,000 worth of the product on Jan 1st, at the end
of the year, A would have made a gross profit of 2,500 on an
investment of Rs. 10,000.
Does A have to buy entire Rs. 10,000 worth of product at one time?

21. INVENTORY TURNOVER RATIO (ITR)
What if A bought 5,000 worth of product on Jan 1st and then, just
before running out of stock, A buys additional 5,000 worth of
product with part of the revenue earned from first shipment.
At the end of the year A still sold 10,000 worth of product and made
a gross profit of 2,500 but on an investment of 5,000.
What if A were to buy 2,500 worth of product, sell and repeat 4 times
before the end of the year. The annual gross profit of Rs. 2,500 is
now generated with an investment of about Rs.2,500.

22. INVENTORY TURNOVER RATIO (ITR)
Which Investment Option is better for A?
Every time A sells an amount of product , product line, or other group of
items equal to the average amount of money it has invested in them, A has
“turned” that inventory/
The ITR measures the number of times inventory has turned over during
past 12 months.
Annual Cost of Goods
Sold
Inventory Investment ITR
Rs 10,000 Rs 10,000 1
Rs 5,000 2
Rs 2,500 4

23. INVENTORY TURNOVER RATIO (ITR)
ITR is defined as, The ratio of Cost of Gods Sold from stock sales during the
year to the average inventory investment during the year.
While considering ITR only consider cost of goods sold from stock sales,
which are filled from warehouse inventory. Non-stock items and direct
shipments are not included.
ITR is calculated separately for every product line in every warehouse.
ITR will improve when one buys less of product, more often. Thus in JIT the
ITR will be very high

24. ITR PROBLEM
Compute the inventory turnover ratio and average selling period from the
following data of a trading company:
Sales: $75,000
Gross profit: $35,000
Opening inventory: $9,000
Closing inventory: $7,000

25. ITR PROBLEM
Solution:
ITR = $40,000* / $8,000**
ITR = 5 times
Computation of cost of goods sold and average inventory:
*$75,000 – $35,000 = $40,000
**($9,000 + $7,000) / 2

26. ITR PROBLEM
Average selling period is computed by dividing 365 by inventory turnover
ratio:
365 days / 5 times
73 days
The company will take 73 days to sell average inventory.