This document discusses various inventory classifications and the economic order quantity (EOQ) model. It defines different types of inventories like raw materials, work-in-progress, and finished goods. It also outlines objectives of inventory management like maintaining optimal inventory levels. The document then explains the costs involved in inventory like ordering, stock-out, and carrying costs. It discusses dangers of over-investment and under-investment in inventory. Finally, it provides an overview of different inventory classification systems and approaches to calculating EOQ.

1. INVENTORY CLASSIFICATIONS
AND EOQ

2. Nature of Inventories
Raw Materials – Basic inputs that are converted into finished
product through the manufacturing process
Work-in-progress – Semi-manufactured products need some
more works before they become finished goods for sale
Finished Goods – Completely manufactured products ready
for sale
MRO Supplies – Office and plant cleaning materials not
directly enter production but are necessary for production
process and do not involve significant investment.

3. Objectives of Inventory Management
• To maintain a optimum size of inventory for efficient and smooth
production and sales operations
• To maintain a minimum investment in inventories to maximize the
profitability
• Effort should be made to place an order at the right time with right
source to acquire the right quantity at the right price and right quality

4. An optimum inventory level involves three
types of costs
Ordering costs:-
• Quotation or tendering
• Requisitioning
• Order placing
• Transportation
• Receiving, inspecting and storing
• Quality control
• Clerical and staff
Stock-out costs
• Loss of sale
• Failure to meet delivery commitments
Carrying costs:-
• Warehousing or storage
• Handling
• Clerical and staff
• Insurance
• Interest
• Deterioration, shrinkage, evaporation
and obsolescence
• Taxes
• Cost of capital

5. Dangers of Over investment
• Unnecessary tie-up of firm’s fund and loss of profit – involves
opportunity cost
• Excessive carrying cost
• Risk of liquidity- difficult to convert into cash
• Physical deterioration of inventories while in storage due to
mishandling and improper storage facilities

6. Dangers of under-investment
• Production hold-ups – loss of labor hours
• Failure to meet delivery commitments
• Customers may shift to competitors which will amount to a
permanent loss to the firm
• May affect the goodwill and image of the firm

7. Classification of inventory
• ABC Classification
• HML Classification
• XYZ Classification
• VED Classification
• FSN Classification
• SDF Classification
• GOLF Classification
• SOS Classification

8. ABC Classification
• In most of the cases 10 to 20 % of the inventory account for 70 to
80% of the annual activity.
• A typical manufacturing operation shows that the top 15% of the line
items, in terms of annual rupees usage, represent 80% of total annual
rupees usage.
• Next 15% of items reflect 15% of annual rupees
• Next 70% accounts only for 5% usage

9. XYZ Classification
On the basis of value of inventory stored
Whereas ABC was on the basis of value of consumption to value.
• X – High Value
• Y – Medium value
• Z – Least value Aimed to identify items which are extensively stocked.

10. HML Classification
On the basis of unit value of item
• There is 1000 unit of Q @ Rs. 100 and 10,000 units of W @ Rs. 5.
• Controls will be tighter on high unit value products.
• Aimed to control the purchase of raw materials.
• H – High, M- Medium, L - Low

11. VED Classification
Mainly for spare parts because their consumption
pattern is different from raw materials.
• Raw materials on market demand
•
• Spare parts on performance of plant and machinery.
• V – Vital E – Essential D – Desirable

12. FSN Classification
According to the consumption pattern
To combat obsolete items
• F – Fast moving
• S – Slow moving
• N – Non Moving

13. SDF & GOLF Classification
Based on source of procurement
SDF
S – Scarce, D- Difficult, E- Easy.
GOLF
G – Government, O – Ordinary, L – Local, F – Foreign.

14. SOS Classification
Raw materials especially for agriculture units
S – Seasonal
OS – Off seasonal

15. Deciding on the Inventory model
• Assume an analyst applies an inventory model that
does not allow for spoilage to a grocery chain’s
ordering policy for lettuce and formulates the strategy
of ordering lettuce in large amounts every 14 days.
• A little thought will show that this is obliviously
foolish. This strategy implies that lettuce will be
spoiled. However it is not a failure of inventory, it is a
failure to apply the correct model.

16. EOQ – Three Approaches
• Trial and Error method
• Order-formula approach
• Graphical approach

17. Assumptions in EOQ Models
• Seasonal fluctuation in demand are ruled out
• Zero lead time – Time lapsed between purchase order and inventory
usage
• Cost of placing an order and receiving are same and independent of
the units ordered
• Cost of carrying the inventory is constant
• Total inventory cost = Ordering cost + carrying cost

18. Trial & Error Method
Assumptions:- Annual requirement (C)=1200 units
Carrying cost (I) = Rs.1 Ordering cost (O) =Rs.37.5
• Order size Q 1200 600 400 300 240 200 150 120 100
• Avg. inventory Q/2 600 300 200 150 120 100 75 60 50
• No. of orders C/Q 1 2 3 4 5 6 8 10 12
• Ann. carry cost I* Q/2 600 300 200 150 120 100 75 60 50
• Ann.ordercost O*C/Q 37.5 75 112 150 187 225 300 375 450
• Total Inventory cost 637 375 312 300 307 325 375 435 500

19. Order- Formula approach
• EOQ=Q = 2CO/I*R
• C = Annual demand
• O = Ordering cost per order
• I = Carrying cost
• R = Rate per unit.

20. Example
Demand C =1,000 units/month
Annual Demand= 12,000 units/year
Fixed cost, O = $4,000/order
Unit cost, R = $500
Holding cost, I = 20% = 0.2
》Optimal order size
》Cycle inventory
》Numbers of orders per year
》Average flow time Q / 2C = 490 / 12000 =0.041 (year)
=0.49(month)
Q = = 980
0.2X500
2X12000X4000
Q/2 =490
C / Q = 12000 / 980 =12.24
20
IR
CO
Q
2
*
=

24. Probabilistic inventory model
• In practical Inventory management assumption may not be strictly
correct.
• Demand may fluctuate over time due to seasonal, cyclical and
random influences.
• Lead time may also fluctuate because of transportation delay, strikes
or natural disaster.
• For such reasons most of the companies use safety stock.