The re-order level is the inventory level at which an order should be placed to replenish the stock. It is calculated as: Re-order level = Average usage per lead time + Safety stock Where: - Average usage per lead time is the expected consumption during the time it takes to receive new stock after placing an order. It is calculated as Average daily/weekly/monthly usage x Lead time. - Safety stock is the additional inventory maintained to mitigate risks of stock-outs due to uncertainties in demand or lead time. It depends on factors like demand variability, lead time variability, service level required etc. So in summary, the re-order level is the inventory level at which a new

1. Inventory Management
umermushtaqlone@gmil.com

2. Defining Inventory
Institute of Chartered Accountants of India (ICAI) has defined inventory as “tangible
property” held
(i) for the sale in the ordinary course of business or
(ii) in the process of production for sale or
(iii) for consumption in the production of goods or services for sale, including maintenance
supplies and consumables other than machinery spares”.
INVENTORY
a) Raw Material b) Work-in-Progress c) Finished Goods and d) Supplies or stores and spares*.

3. Need/Motives to hold inventories
 Transaction Motives: For smooth production and sale.
 Precautionary Motives: To guard against the risk of unpredictable
changes in supply and demand
 Speculative Motives: To take advantage of price fluctuations by either
increasing or decreasing the inventory levels depending upon the
situation.

4. Need/Motives to hold inventories
Firms hold inventory of
a) Raw Material
b) Work in Progress
c) Finished Goods
Purchase
Production
Sales
Avoid Short Sales
Achieve Timely & Efficient
Production
Obtain Quantity Discounts
Reduce Ordering Costs
to
separate
out
In
order
to

5. Inventory Management
 Inventory management is the practice involving overseeing and controlling of
the ordering, storage and use of components that a company uses in the
production of the items it sells.
 Inventory management is also the practice of overseeing and controlling of
quantities of finished products for sale*.

6. Objectives of Inventory Management
1. To maintain a large size of inventories for uninterrupted
production operations and sales
2. To minimize investment in inventories
Conflicting Objectives

7. Dangers of Overinvestment and
Underinvestment in Inventories
Dangers of Overinvestment:
1. Unnecessary tie-up of the firm funds and loss of profitability
2. Excessive carrying cost
3. Risk of liquidity
Dangers of Underinvestment:
1. Production hold-ups
2. Failure to meet delivery commitments
3. Stock-Outs

8. Cost of inventories
The costs associated with the inventory fall into two big categories
1. Ordering/Acquisition/Set-up Costs:
 These costs are associated with the acquisition or ordering of inventory^.
 The components of ordering costs are:
 Preparing a purchase order or requisition form
 Receiving, inspecting, and recording the goods received to ensure both quantity and quality
There is inverse relationship between acquisition/ordering costs and the size of the
inventory*.

9. Cost of inventories
2. Carrying/Holding Costs:
These are the variable costs per unit of holding an item in inventory for a
specified time period. It has following two elements (i.e. CCPUPA):
a) Costs arising due to storing of inventory:
 Storage costs (tax, depreciation, insurance maintenance of the building, utilities and
janitorial services)
 Insurance of inventory against fire and theft
 Deterioration in inventory due to pilferage, fire, technical obsolescence, style
obsolescence and price decline
 Servicing cost like labor for handling inventory, clerical and accounting costs.

10. Cost of inventories
b) The opportunity Cost of Funds:
This consists of expenses in raising funds (interest on capital) to finance the
acquisition of inventory. If funds were not locked up in inventory, they would
have earned a return. This is the opportunity cost of funds.
The carrying/holding costs and inventory size are positively related*
3. Cost of Stock-outs: The loss of sales due to stock-out (it refers to a demand
for an item whose inventory level already reduced to zero)
Total Cost = Ordering cost + Carrying Cost

11. Demand
The starting point for management of inventory is customer
demand*.
 Inside customers**
 Outside customers***
Bottom Line: Effective Demand Forecast^

12. Demand*
 Dependent Demand**
 Independent Demand***

13. Techniques of Inventory management*
 ABC Analysis{Classification Problem}
 Economic Order Quantity (EOQ) {Ordering Quantity Problem}
 Just in Time (JIT) System
 VED (Vital, Essential and Desirable) Analysis

14. ABC Analysis*
(Inventory Categorization Technique)
ABC analysis is based on the following propositions:
 Managerial time and efforts are scarce and limited
 Some items of inventory are more important than others.

15. ABC Analysis*
A: Highly Important (High Consumption Value items)
B: Moderately Important (Moderate consumption value items)
C: Least Important (Low Consumption value items)

16. Basic principles of ABC analysis
1. The analysis does not depend upon the unit cost of the items but
only on its annual consumption value.
2. It does not depend on the importance of the item*.
3. The limits** of ABC categorization are not uniform but will depend
upon the size of the undertaking, its inventory as well as the
number of items controlled.

17. Course of action for each category

18. A items: High consumption value
1. Very strict control
2. No safety stocks
3. Frequent ordering or weekly deliveries
4. Weekly control statements
5. Maximum follow-up and expediting
6. Rigorous value analysis
7. As many sources as possible for each item
8. Accurate forecasts in material planning
9. Minimization of waste, obsolete and surplus
10. Central purchasing and storage
11. Maximum efforts to reduce lead time
12. Must be handled by senior officers

19. B items: moderate value
1. Moderate control
2. Low safety stocks
3. Once in three months
4. Monthly control report
5. Periodic follow-up
6. Moderate value analysis
7. Two or more reliable sources
8. Estimates based on past data on present plans
9. Quarterly control over surplus and obsolete items
10. Combination purchasing
11. Can be handled by middle management

20. C items : low consumption value
1. Loose control
2. High safety stock
3. Bulk ordering once in six months
4. Quarterly control reports
5. Follow-up and expediting in exceptional cases
6. Minimum value analysis
7. Two reliable sources for each other item
8. Rough estimates for planning
9. Annual review over surplus and obsolete material
10. Decentralized purchasing
11. Minimum clerical efforts
12. Can be fully delegated

21. Advantage & Disadvantages of ABC
analysis
Advantages:
 By Controlling the inventory of A category items, the total inventory cost can be
considerably reduced
Disadvantages:
 Importance to item is given on its annual consumption and not on its criticality for the
production
 Periodical review is necessary to take into the account the changes in prices and
consumption

22. Step-wise mechanics of the ABC
Step – 1: Obtain a list of items along with information on their cost and the periodic consumption (usually
annual consumption)
Step – 2: Determine the annual usage value for each of the items by multiplying unit cost with number of
units.
Step – 3: Express the value for each item as percentage of the aggregate/total usage value
Step – 4: Place the items in the descending order and calculate the cumulative value for each item including
the percentage values.
Step – 5: Determine an appropriate division for the A, B and C categories.
After having done the classification of inventories, the inventory decisions are made on the basis of their
classification
A item would call for a strict control and maximum attention and protection for stock-outs related to them
should be kept as high as possible, since the cost involved is substantial. Then next should be placed on
category B items and lastly category C items
Note: The general rule for “classification ratio” could be taken as A:65-75%, B:20-25% and remaining for
Category C (Subject to change).

23. Practical Problems
Problem: 01#: The following is the information regarding the consumption and price per unit of
different items of inventory. Classify the items as per ABC analysis:
Item Units Unit Price
(₹)
Total Value
(₹)
I 6,000 100 6,00,000
II 10,000 65 6,50,000
III 5,000 50 2,50,000
IV 25,000 2 50,000
V 4,000 25 1,00,000
VI 15,000 10 1,50,000
VII 25,000 6 1,50,000
VIII 10,000 5 50,000
Total 1,00,000 20,00,000
Item Class of Items
I
Class A Items
II
III
VI Class B Items
VII
IV
Class C Items
V
VIII

24. Practical Problems
Problem: 02#: Perform ABC analysis using the following data:
Item Units Unit Price
(₹)
Item Units Unit
Price (₹)
01 700 5.00 07 6,000 0.20
02 2,400 3.00 08 300 3.5
03 150 10.00 09 30 8.00
04 60 22.00 10 2,900 0.4
05 3,800 1.50 11 1,150 7.10
06 4,000 0.50 12 410 6.20

25. Just in Time (JIT) - Inventory Management Tool
 A strategy companies employ to increase efficiency and decrease waste by
receiving goods only as they are needed in the production process*
 Requires highly accurate demand forecast on part of producers**. This is done
using KANBAN principle##.
Advantages and Disadvantages
 Production runs remain short^
 Reduces costs^^
 Disruption in the Supply Chain^^^
 Delay in Delivery^^^^

26. Other Selective control techniques
 VED (Vital, Essential and Desirable) Analysis:
 HML (High, Medium and Low) Analysis: Similar to ABC analysis but
here unit cost is considered not the annual consumption. This is useful for
keeping control over consumption at the department level.
 SDE (Scarce, Difficult and Easy) Analysis: This uses the criteria of
the availability of the item.

27. Other Selective control techniques
 S-OS (Seasonal and Off-seasonal) Analysis: This analysis is based on the nature of
supplies. This classification of items is done with the aim of determining proper
procurement strategies.
 FSN Analysis: Based on the consumption of pattern of the items, the FSN Classification
calls for classification of items, as Fast-moving, Slow-moving and Non-moving. The speed
classification helps the arrangement of stocks in the stores and in determining the
distribution and handling patterns.
 XYZ Analysis: It is based on the closing inventory value of different items. Items whose
inventory value are high are classed as X items while those with low in investment in them
are termed as Z items. Other items are the Y items whose inventory value is neither too
high nor too low.

28. Other Selective control techniques
GOLF Analysis (Govt-Ordinary-Local-Foreign)*: Based on nature of suppliers – quality,
terms of payment, continuity otherwise supply and administrative work involved, classification
of inventory is done as under:
G – procured from government (State Trading Corporation) and Public Sector Undertakings.
Involve long lead time; payment in advance or against delivery.
O – procured from non-governmental agencies. Lead time may vary from 30 to 45 days.
L – procured from local supplier.
F – procured from foreign supplier.

29. ECONOMIC ORDER QUANTITY MODEL
An Introduction
1. Effective Inventory Management is directly related to the size of the inventory
2. Effective Inventory Management is essential to the Shareholders Wealth
Maximization
3. Two interrelated problems
a) the order quantity
b) the order point problem

30. Economic Order Quantity (EOQ)
Economic Order Quantity is the size of the lot to be purchased which is economically viable. This is
the quantity of material which can be purchased at minimum cost*.
Parameters:
1. Minimum level of that item depending upon the usage rate of that item, time lag in procuring the item
and unforeseen circumstances, if any
2. The re-order level of that item, at which next order for that item must be placed to avoid any chance of
stock-out, and
3. The re-order quantity for which each order must be placed.
Where
Minimum Stock Level = Re-Ordering Level-(Normal Consumption x Normal Re-Order Period)
Re-Ordering Level = Maximum Consumption x Maximum Re-Order Period
Maximum Level of Stock = Re-Order Level + Re-Ordering Quantity-(Minimum Consumption x Minimum Re-
Ordering Period)

31. Assumption of EOQ Model
1. The total usage of a particular item for a given period (usually a year) is known with certainty and that the
usage rate is even through out the period
2. That there is no gap between placing an order and getting its supply
3. The cost per order of an item is constant and the cost of carrying inventory is also fixed and is given as a
percentage of average value of inventory
4. That there are only two costs associated with the inventory, and these are the cost of ordering and the cost of
carrying the inventory.
EOQ =
2𝐴𝑂
𝐶
Where,
A = Total annual requirement for the item
O = Ordering cost per order that item
C = Carrying cost per unit per annum *Q = EOQ
Total Cost =
𝑫
𝑸
* O +
𝑸
𝟐
* C

32. Graphical Representation of EOQ Model
Order Cost
Size of Order
Costs
(INR)
Total Cost
Carrying Cost
Minimum Total
Cost
(EOQ) Q*

33. Inventory Level under EOQ Model
EOQ
Time
Replenishment of Inventory
Inventory
Level

34. Quantity Discounts and Order Quantity
The EOQ model assumes that the purchase price per unit is fixed and constant irrespective of the number of
units purchased by the firm. However, in practice, it is not so and very often, the seller offers a discount for
purchase of a particular quantity. Thus greater the order size, the lower will be the cost per unit and total
cost will also be low. But on the other hand total carrying cost of the inventory will increase. Thus the
quantity discount is worth taking only if the savings exceed the additional cost of holding stock. For this, the
following procedure may be followed:
1. Find out the EOQ (i.e. Q) as usual as if there is no quantity discount available
2. If this quantity, Q, is the quantity that helps the firm availing discount, then the ‘Q’ is the optimal order
size
3. If the ‘Q’ is less than the minimum quantity for availing discount, then the discount offer should be
evaluated in terms of the total cost of maintaining inventory with and without discount.

35. Practical Problems
Problem:01: From the following information, find the EOQ.
Annual Usage, 10,000 Units
Cost of placing and receiving one order Rs 50
Cost of material per unit Rs 25
Annual Carrying Cost of one unit: 10% of inventory value (i.e. Cost of Material per unit)
Problem:02: Following information is given about materials
Annual Demand = Rs 2,00,000
Cost of placing and receiving one order = Rs 80
Annual carrying cost = 10% of inventory value
Find out EOQ

36. Practical Problems
Problem: 03: The annual demand for a product is 6,400 units. The unit cost is INR 6 and inventory
carrying cost per unit per annum is 25% of the average inventory cost. If the cost of procurement is INR
75, determine:
a) EOQ
b) Number of order per annum; and
c) Time between two orders
Problem: 04: ABC Ltd produces a product which has monthly demand of 4,000 units. The product requires
a component X which is purchased at INR 20. For every finished product, one unit of the component is
required. The ordering cost is INR 120 per order and the holding cost is 10% p.a.
You are required to calculate:
a) EOQ
b) If the minimum lot size to be supplied is 4,000 units, what is the extra cost, the company has to
incur?

37. Practical Problems
Problem: 05: Economic Enterprises requires 90,000 units of a certain item annually. The cost per
unit is Rs 3, the cost per purchase order is INR 300, and the inventory carrying cost is INR 6 per unit
per year.
Required:
a) What is the EOQ?
b) What should the firm do if the supplier offers discount as below:
Order Quantity Discount
4500 – 5999 2%
6000 above 3%

38. Practical Problems
Problem: 06: The following information is available in respect of the inventory costs of
a firm:
Total annual consumption = 600 units
Cost per unit = INR 6
Order cost = INR 10 per order
Carrying cost = 20% per unit per annum
Discount of 5% has been offered on an order of 200 units. Evaluate the discount
offer.

39. The Re-Order Level
QUESTION: When should an order be placed so that the firm doesn’t run out of
stock?
ANSWER: Determine the Re-Order Level*
Re-Order Level depends on two things:
a. Length of time between the placement of an order and receiving the supply,
b. The usage rate of the item**
R = M + tU
R = Re-Order Level
M = Minimum (Safety) level of inventory
t = Time gap/delivery time
U = Average Usage rate

40. The Re-Order Level and the Inventory
Pattern
EOQ
Re-Order Level
Minimum Inventory Level
Time
Time Lag
Inventory
Level

41. Some Useful Formulas
 Minimum Stock Level = Re-Ordering Level - (Normal Consumption x Normal Re-Order
Period)
 Re-Ordering Level = Maximum Consumption x Re-Order Period*
 Maximum Level of Stock = Re-Order Level + Re-Ordering Quantity - (Minimum
Consumption x Re-Ordering Period)

42. Practical Problems
Problem: 01#: Following information is available about a raw material item being used by
ABC Ltd:
Normal Consumption 1600 Units per month
Maximum Consumption 1850 Units per month
Minimum Consumption 1300 Units per month
Re-Order Quantity 7000 Units
Normal Re-Order Period 2 months
Required: Find out Minimum, Maximum, Re-ordering and Average Stock levels for the
firm.