Inventory management tools and techniques

1. INVENTORY MANAGEMENT
Dr S S N Raju Indukoori

2. Inventory
 Inventory or stock is the quantity of goods or
materials held by a business firm for
processing and resale.
 This is relevant to manufacturing and trading
companies rather than servicing companies.
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3. Inventory Nature
• Part of current assets
• Liquidity
• High liquidity compared to fixed assets
• Low liquidity compared to other current assets
• Part of operating cycle.
• Liquidity lag
• Creation lag: payment lag to the supplier, a benefit to the firm
• Storage lag: Pay to supplier before the sale
• Sale lag:Credit sales
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4. Inventory Types
Primary Inventory or Stock
 Raw Material
 Stores and Spares
Processed Inventory or Stock
 Work-In-Process orWork in progress (WIP)
 Finished Goods
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5. Raw Materials
• Tangible inputs or material which are in
natural form needed for manufacturing
process.
• Also known as
• Unprocessed material
• Primary Commodity
• Feed Stock
• All manufacturing companies need not have
raw materials
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6. Raw Materials Examples
• Steel – Iron Ore
• Textile – Cotton
• Cement – Limestone
• Glass – Sand
• Sugar – Sugarcane
• Edible Oil – Seeds like groundnuts & sunflower
• Plastic – Oil, natural gas, coal
• Rubber – Latex from trees
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7. 2. Stores and Spares
• These are the basic inputs required for the
manufacturing process.
• These are not raw materials.
• Stores and spares are the finished goods
bought from suppliers.
• Manufacturing companies may have both
raw materials and stores & spares as the
inputs.
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8. Stores and Spares examples
Wires, watchers, nuts and bolts are the
common stores and spares for many
manufacturing companies.
• Automobile – Tyre, Battery, lamp, wire, disc,
and drum
• Aircraft – Fiber glass, passenger seats and
tyres.
• Shipping – Steel bars and sheets.
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9. 3. Work in Process (WIP)
• This is the inventory or stock forWIP.
• It is also known as semi finished goods.
• This has minimum storage compared to raw
material and stores & spares.
• This is a moving inventory.
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10. Work In Process of a car maker
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11. 4. Finished Goods
• This is the stock of final goods or finished
goods ready to be sold.
• They are stored due the lag in transportation
or handling for delivery.
• They are also stored to meet unforeseen
demands and expected fall in production.
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12. Car Maker’s Stock
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13. Need for inventory
All types of inventory
• Absorb planning errors
• Meet unforeseen fluctuations in supply and demand
Primary and WIP
• Facilitate smooth production
• Avoid risk of production shortages
• Reduce Ordering cost
• Increase Productivity
• Bulk purchase for discounts
Finished Goods
• Sales cushion
• Support marketing operations
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14. Inventory Costs
Direct costs
 Material cost (M)
 Ordering cost (O)
 Carrying cost (C)
Indirect Costs
 Cost of funds tied up with inventory
 Cost of running out of stock
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15. Material Costs (M)
• Costs of purchasing the goods at an agreed
price.
• It includes transportation and handling costs.
• Material cost = Price per unit * Quantity
M = P*C
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16. Ordering Costs (O)
• It is related to ordering the material
• It includes the following
• Purchase requisition
• Preparing purchase order
• Order follow
• Transportation
• Inspection
• Total Ordering Cost = Cost per order * number of orders
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17. Carrying Cost (C)
• It is the cost of storing the goods.
• It includes the following
• Ware house charges
• Insurance
• Depreciation
• Store keeper wages Salary
• Security costs
• Pilferage
• Theft
• Obsolescence
Total Carrying Cost = Average Inventory * Unit Price * % Carrying cost
= Q/2 * P * C
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18. Cost of funds
 Cost of funds tied up with inventory.
 Higher the cost lower the profitability and vice versa.
 Funding the inventory or working capital funding is
crucial in inventory management.
 It includes
 Cost of borrowing funds
 Opportunity cost
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19. Cost of running out of stock
 Primary goal of inventory management is to
provide liquidity in the process of manufacturing.
 Manufacturing process is uninterrupted with
enough levels of inventory is maintained.
 Lack of inventory cushion or running out of stock
disturbs the production process and it may also
lead to shutdown.
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20. Inventory Management
 It is a management discipline which primarily
deals with the timing, quantity and
placement of stocked goods for value
addition resulting in maximizing the firm’s
profits.
 The scope of inventory management
depends on the nature of the manufacturing
process and product.
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21. Inventory Management Goals
• Promote liquidity
• Minimize or reduce inventory costs
• Direct cost : Material cost, ordering cost, ware
housing, transportation, etc.
• Indirect costs: insurance, obsolescence, pilferage,
theft, etc.
• Maximize profitability
• Minimize the investment in inventory
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22. Inventory Management Tools
A. Qualitative Measures
B. Inventory Systems
C. QuantitativeTools
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23. A. Qualitative Measures
1. Accurate Demand Forecast
2. Production Budget
3. Control Procedure
4. Avoid Inadequate inventories and excess inventories
5. Timely supply of quality materials
6. Economic rates in material purchase
7. Selection of right vendors
8. Optimize Inventory Investment.
9. Timely payment of vendors Bills.
10. Co-ordination between purchase, stores and users.
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24. B. Inventory Systems
1. Bin System
2. ABC System
3. XYZ System
4. FSN System
5. VED System
6. GOLF System
7. SDE System
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25. 1. Bin System
Two bin systems
When one bin is emptied, a second bin necessitates a
reorder process.
Redline System
It is a painted bin at a reorder level.
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26. 2. ABC Technique
 This is related to Pareto’s law or 80/20 principle.
 This method gives attention to the matters to the
degree of their importance instead of giving equal
attention to all matters.
 The value for the inventory depends on their degree
of importance and classified into 3 categories into A,
B and C.
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27. ABC Techniques
The ABC method is practiced in two forms as follows
 Based on the unit price
 Based on annual consumption
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28. Based on Unit Price Method
 A class Items have high value and B class Items have
medium Value. The low value items are classified as
C class items.
 A B C items in an automobile company can be seen
as follows
 A: Engine, gear box, crank shaft etc.
 B: Battery, fuel pipe, head lamps etc
 C: Nuts, bolts, washers, gaskets etc.
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29. Based on Annual Consumption Value Method
All the items are compiled and then arranged in a descending
order as per the previous year’s annual consumption level with
cut off points.
 A - High value items - 10% in number but 70% in value
 B - Medium value items - 20% in number but 20% in value
 C - LowValue items - 70% in number but 10% in value.
Example
 A Class Items: Rs 10 Lakhs and above
 B Class Items: Rs.1 Lakh to Rs 10 Lakh
 C Class Items: Less than Rs 1 lakh
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30. Stock Maintenance and Ordering
Class wise Maintenance
A : 2 Days
B : 5 Days
C : 10 Days
Class wise Order Levels
A: Frequent ordering close follow up of Safety Stock.
B : Slightly more with periodical follow up of safety stock.
C: Annual orders and higher stocks.
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31. 3. XYZ
Inventory categorized based on the value as on
date as follows
X – HighValue Item
Y – MediumValue item
Z – LowValue Item.
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32. 4. FSN
Inventory categorized based on the issue of
materials by users for a given period.
F – Fast
S – Slow
N – Non Moving
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33. 5. VED
Inventory is classified based on the importance
and criticality of usage.
V –Vital
E – Essential
D – Desirable
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34. 6. GOLF
Inventory is classified based on the source of
Procurement of the material.
G – Government
O – Ordinary
L – Local
F – Foreign
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35. 7. SDE
Inventory is classified based on the availability
of the material.
S – Scarce
D – Difficult
E – Easy
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36. C. Quantitative Tools
1. Reorder Point / Quantity
2. Margin of Safety
3. EOQ
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37. 1. Re order point
• This is point above the daily usage depending on the lag in
delivery.
 Reorder quantity is kept in a special package when ever it is
opened.
 Re order point is attached to purchase requisition as
replenishment.
 Reorder point = Average daily usage rate * lead time in days.
 Ex: 100 units * 7 days = 700 units is the reorder point.
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38. 2. Margin of Safety
• This is over the reorder point and depends on the
following.
 Carrying cost
 Stock out costs
 This is derived based on the conditions in the
economy, industry and business
 It is forecasted using probability of normal, average
and worst situations.
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39. 3. Economic Order Quantity (EOQ)
 EOQ is the optimum order size that will result in the lowest
total of ordering cost and carrying cost resulting in cost
reduction profit maximization.
 It works when the costs and other factors constant including
 Annual demand
 Unit price
 Carrying cost
 It also assumes the following
 Independent orders
 Instantaneous delivery
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40. EOQ Formulae

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41. EOQ Problem
An automobile ancillary company has an annual production of
1,00,000 units. For each production cycle the ordering cost is Rs
120. If the cost of carrying is Rs 5 per unit, find the Optimum
quantity to order.
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42. EOQ Solution

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43. Dr Raju Indukoori
Post your questions in the comments box
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