The document discusses inventory management and its key components, including definitions, functions, and importance in business operations. It covers various inventory types such as production, MRO, in-process, and finished goods inventories, as well as management techniques like ABC analysis, VED, and others, aimed at optimizing inventory levels and ensuring efficient supply chain operations. The process involves determining optimal inventory levels, the degree of control required, system planning and design, and the use of selective inventory control methods tailored to different items' criticality.

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Inventory Management & Selective Control/ABC Analysis
MEANING AND DEFINITION

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The term inventory has been defined by several authors. The more popular of them are
“the term inventory includes material-raw, in process, finished packaging, spare and other stock
in order to meet an unexpected demand or distribution in future”.
Yet another definition is that the term inventory includes the following categories of items:
1. Production inventories: Raw materials, parts, and components which enter the firm’s items
manufactured to company specification, and standard industrial items purchased ‘off the shelf’
2. MRO inventories: Maintenance, repairs and operating supplies which are consumed in the
production process but which do not become part of the product. (e.g., lubricating oil, soap,
machine repairs parts)
3. In-process inventories: Semi-finished products found at various stages in the production
operation.
4. Finished goods inventories: Completed products ready for shipments.
FUNCTIONS OF INVENTORY
One reason organizations maintain inventory is that it is rarely possible to predict sales
levels, demand and usage patterns exactly. In such situations, inventory serves as a buffer against
uncertain and fluctuating demand and keeps a supply of items available in case items are needed
by the organization or its customers.
The many functions that inventories perform can be summarized as follows:
a) Smoothing out irregularities in supply: Inventories provide a buffer to overcome the
problems of uncertainties I supplies such as delayed deliveries and supply of short
quantities by vendors as against the promised delivery schedules and quantities. Also,
the customer demand for the goods may increase suddenly which affects the ability of
the manufacturer to meet the customer demand. In such cases also, an inventory of
finished goods held in the warehouses will act as a buffer against the uncertainties in
demand. Thus, inventories fill the gap between supply and demand.
b) Buying or producing in lots or batches: When the demand for an item does not justify its
continued production throughout the year, it is produced in batches or lots on an
intermittent basis. During the time when the item is not being produced, demands are
met from the inventory which is accumulated by batch production.
c) To meet seasonal or cyclical demand: Companies will produce items at a constant
production rate more than the demand rate in order to meet the seasonal demand
occurring at a later period for which the production capacity is insufficient.

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d) To take advantage of price discounts while buying items: A company will often
purchases large amounts of inventory to take advantage of price discounts, as a hedge
against anticipated price increases in the future.
e) To maintain continuity to operations in production process: Many companies find it
necessary to maintain in-process inventories at different stages in a manufacturing
process to provide independence between operations and to avoid work stoppages or
delays and to continue production smoothly if there are temporary machine breakdowns
or other work stoppages.
INVENTORY MANAGEMENT AND CONTROL
Because of high cost involved in inventories, their proper management and control
assume considerable importance. In fact, the management of inventory is given such an
importance, that, it is often treated synonymous with materials management.
Inventory management involves the ‘development and administration of policies, systems, and
customer service requirement, productions scheduling, purchasing and traffic’.
Inventory control, on the other hand, is defined in a narrower sense then inventories management
pertains primarily to the administration of establish policies, system and procedures. For e.g., the
actual steps taken to maintain the stock levels or stock records refers to inventory control.
FACTORS INFLUENCING INVENTORY MANAGEMENT AND
CONTROL
Several factors influence inventory management and control. The principle effects of this
factor are reflected most strongly on the levels of inventories and the degree of control, planned
in the inventory control system. The factors include type of product, type of manufacture,
volume of output and others.
Type of Product
Among the factors influencing inventory management and control, the type of product is
fundamental. If the material used in the manufacture of the product has a high unit value when
purchased, a much closer control is usually in order. Jewelers are much more careful of their
stocks of diamonds then are with display cases full of low- priced costume jewelry this same
principle hold manufacturing also.
If the material used in the product is in short supply or is rationed by the government, this may
influence the purchase of this material and it stock maintained.

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Type of Manufacture
Beside type of product, types of manufacture also influence inventory management and
control. Where continuous manufacture is employed the rate of production is the key factor. Here
inventory control is of major importance and in reality controls the production of the product.
The economic advantage of this type of manufacture is the uninterrupted operation of the
machines and assembly lines in the plant. It is a major offence on the part of the inventory
personnel to have the plant shut down for the lack of material.
Volume of Production
The volume of product to be made as represented by the rate of production may have
little effect on the complexity of the inventory problem. Literally, millions of brass bases for
lights bulbs manufactured each month involving the control of only two principle item of raw
material inventory. On the other hand manufacturer of a large locomotive involves the planning
and control of thousands of items of inventory. Both the inventory problems and the difficulty of
controlling production increase in difficulty of controlling production increase in difficulty with
the number of components parts of the product and not with quantity of products to be made.
BENEFITS OF INVENTORY MANAGEMENT CONTROL
Proper management and control of inventories will result in the following benefits to an
organization.
1. Inventory control ensures an adequate supply of materials, stores, etc., minimizes stock outs
and shortages, and avoids costly interruptions in operations.
2. It keeps down investment in inventories, inventory carrying costs and obsolescence loses to
the minimum.
3. If facilitates purchasing economies through the measurement of requirements on the basis of
recorded experience.
4. It eliminates duplication in ordering or in replenishing stocks by centralizing the source from
which purchase requisitions emanate.
5. It permits a better utilization of available stocks by facilitating inter-department transfers
within a company.
6. It provides a check against the loss of materials through carelessness or pilferage.
7. It facilitates cost accounting activities by providing a means for allocating material costs to
products, departments or other operating accounts.

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8. It enables management to make cost and consumption comparisons between operations and
periods.
9. It serves as a means for the location and disposition of inactive and obsolete items of stores.
10. Perpetual inventory values provide a consistent and reliable basis for preparing rapt
restatements.
PROCESS OF INVENTORY MANAGEMENT AND CONTROL
As mentioned earlier, inventory management and control refers to the planning for
optimum quantities of materials at all stages in the production cycle and evolving techniques
which would ensure the availability of planned inventories. Four steps are involved in the
process, viz.
Step 1.Determination of optimum inventory levels and procedures of their review and
adjustment.
Step 2 Determination of the degree of control that is required for the best results.
Step 3 Planning and design of the inventory control system.
Step 4 Planning of the inventory control organization.
Step1. Determination of Optimum Inventory Levels
Determination of inventory that an organization should hold is a significant but difficult
step. Too much of inventory results in locking up of working capital a company by increased
cost (but reduce ordering cost). Excess inventories, however, guarantee uninterrupted supply of
materials and components, to meet production schedule and finished goods to meet customers
demand. Too less of inventory releases working capital for alternative uses and reduces carrying
cost and increase ordering cost. But there is a risk of stock out of costs
A few suggestions may be offered which might help to overcome this problem. The trend of
sales must be watched closely and inventories adjusted in advance of the change in rate of
production as determined by actual sales. Hence, inventory management must plan for the
review of the stock often.
Step2. Determination of Degree of Control

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The second aspect of inventory management is too decided just how much control is
needed to realize the objectives of inventory management. The difficulties are best overcome by
classification of inventory on the basis of value. Popularly called the ABC classification, this
approach is useful in deciding the degree of control. ‘A’ class items are ‘high’ in value but ‘low’
in quantity, ‘C’ class inventories are the opposite of ‘A’ group, i.e., ‘high’ in quantity and ‘low’
in value. In between are the ‘B’ groups stocks which are more or less equal in quantity and value
proportion to the total inventory. Tight control is exercise on ‘A’ category items through accurate
records of receipts and issues and by coordination of incoming shipments with production
requirements. On the other hand, ‘C ’class items may simply ordered in large quantities covering
several months need, no record being made of their issue to manufacturing. More stock is simply
requested when the existing stock reaches a reorder point. The ‘B’ class items received not so
tight control, but are not neglected either.
Step3. Planning and Design of the Inventory System
An inventory system provides the organizational restructure and the operating policies for
maintaining and controlling goods to be inventoried. The system is responsible for ordering and
receipts of goods, timing the order placement and keeping track of what has been ordered, how
much, and from whom.
Further, the system must provide follow up to enable the answering such question as: Has the
vendor received the order? Has it been shipped? Are the items correct? Is the procedure
established for reordering or returning undesirable merchandise?
SELECTIVE INVENTORY CONTROL
Because of the large number of materials used in production at many manufacturing
plants, it is desirable to classify materials according to the amount of analysis that can be
justified. Selective inventory control means that the method of inventory control varies from item
to item and the differentiation should be on selective basis.
Several techniques of inventory control are in use and it depends on the convenience of
the firm to adopt any of the techniques. The techniques more commonly used are the following:
Always better control (ABC) classification
High, medium and low (HML) classification
Vital, essential and desirable (VED) classification
Fast moving, slow moving and non-moving (FSN)
Mix- minimum system

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Two bin system
ABC ANALYSIS –
One of the widely used techniques for control of inventories is the ABC (Always better
control) analysis. The objective of ABC control is to vary the expenses associated with
maintaining appropriate control according to the potential savings associated with proper level of
such control. For example, an item having an inventory cost of Rs. 1000000 such as sheet steel,
has a much greater potential for savings expenses related to maintaining inventories than an item
with a cost of Rs.100 the ABC approach is a means of categorizing inventory items into three
classes ‘A’, ‘B’ and ‘C’ according to the potential amount to be controlled.
Once inventory is classified, we have a firm base for deciding where we will put our effort.
Logically, we expect to maintain strong controls over the ‘A’ items talking whatever special
actions needed to maintain availability of these items and hold stocks at the lowest possible level
consistent with meeting demands. At the other end of the scale, we cannot afford the expense of
rigid controls, frequent ordering, expediting, etc. because of the low amounts in this area. Thus,
with the ‘C’ group we may maintain somewhat higher safety stocks, order more months of
supply; expect lower levels of customer service, or all the three. It is for this selective approach,
ABC analysis is often called the selective Inventory Control Method (SIM).
Extending pareto’s principle to inventory, it is always possible and necessary to separate “vital
few” from “trivial many” of the stock items for their effective control. Separating vital few from
trivial many is what is precisely done in ABC analysis.
Pareto’s principle was brought to the attention of people concerned with inventory management
by H. Ford Dickie, who applied pareto’s law inventory and developed the general concept of
ABC analysis. Like so many ideas, however it has not been completely understood. Many people
refer to the ABC system or the ABC technique. The idea of distribution of value for inventory
stratification is neither a system nor a technique; it is a fundamental management principle with
universal application potential.
Advantage of ABC Analysis
This approach helps the materials manager to exercise selective control and focus
attention on ‘A’ category items. By controlling the inventory of ‘A’ category items, the total
inventory costs can be considerably reduced. Usually, fixed order quantity system or ‘Q’ system
of inventory control is used for ‘A’ category items advising the supplier to follow staggered
supplies (i.e. EOQ is ordered and the supplier is asked to supply fraction of EOQ on weekly
basis to match the consumption rate). For ‘B’ category items the fixed order cycle system on ‘P’
system is used without appreciably increasing the average inventory value. For ‘C’ category
items “two-bin system” is used wherein the annual requirement of the item is ordered in one or
two lots and the quantity received is distributed into two bins-bin number one keeping the re-

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order level inventory and bin number two keeping he balance quantity. The item is consumed
from bin number two and once it becomes empty, the repeat order is placed for the annual or six
month’s requirement. Item is issued from the first bin till the supply is received.
Limitations of ABC Analysis
i. To be fully effective, it should be carried out with standardization and codification.
ii. Importance is given to an item based only on its annual consumption in value and not on
its criticality for the production.
iii. It should be reviewed periodically so that changes in prices and consumption are taken
into account.
iv. It does not apply to dependent demand inventory which is controlled by Material
Requirement Planning (MRP) system.
MINIMUM-MAXIMUM TECHNIQUE
The minimum-maximum system is often used in connection with manual inventory
control system. The minimum quantity is established in the same way as any re-order point. The
maximum is the minimum quantity plus the optimum lot size. In practice, a requisition is
initiated when a withdrawal reduces the inventory below the minimum level, the order quantity
is the maximum minus the inventory status after the withdrawn reduce the stock level
substantially below the minimum level, the order quantity will be longer than the calculated
EOQ.
The effectiveness of a minimum-maximum system is determined by the method and precision
with which the minimum and maximum parameters are established. If these parameters are based
upon arbitrary judgments with the limited factual basis, the system will be limited in its
effectiveness. If the minimum are based on an objective rational basis, the system can be very
effective.
TWO-BIN TECHNIQUE
Once of the oldest system of inventory control is the two-bin system which is mainly
adopted to control ‘C’ group inventories. In the two-bin system, stock of each item is separated
into two-bins. One bin contains stock, just enough to last from the date a new order is placed
until it is received in inventory. The other bin contains a quantity of stock enough to satisfy
probable demand during the period of replenishment is placed, and the stock in the second bin is
utilized until the ordered material is received.
Such a method is appropriate to ideal conditions in which rate of consumption is fairly constant
and for items lead time of which is fairly established and regular.

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Although the system itself possesses a high degree of automacy, in practice, we need to allow for
variations in the rate of consumption as well as lead time. A possible disadvantage of the system
in some case is the requirement of additional storage facilities and perhaps some practical
difficulty in keeping the two stocks properly separated.
V-E-D ANALYSIS
‘V’ stands for vital, ‘E’ for essential and ‘D’ for desirable. This classification is usually
applied for spare parts to be stocked for maintenance of machines and equipments based on the
criticality of the spare parts. The vital spare parts are those which can cause stoppage of the plant
if not available. Usually such spare parts are known as capital or insurance spares. The inventory
policy is to keep at least one number of the vital spare irrespective of its value. Also, spare parts
to be supplied by foreign manufactures are treated as vital spares because of the long lead time
required for procurement. Essential spare parts are those whose non-availability may not
adversely affect production. Such spare parts may be available from many sources within the
country and the procurement lead time may not be long. The desirable spare parts are those
which if not available can be manufactured by the maintenance department or may be procured
from local suppliers and hence no stock is held usually.
F-S-N ANALYSIS
It stands for Fast-moving, Slow-moving and Non-moving items. It is based on past
consumption pattern. Items which are usually drawn from stores frequently are classified as fast
moving items; Items which are drawn only once or twice a year are classified as slow moving
items not at all drawn for the past two years are classified as non-moving items. F-S-N analysis
is useful to control obsolescence of raw materials, components, tools and spare parts.
H-M-L ANALYSIS
This stands for High value, medium value and low value items on unit price of the item.
For instance, a firm may decide to categories items having unit price of the item. For instance,
firm may decide to categories items having unit price more than Rs. 5000 as ‘H’ items. From Rs.
1000 to 5000 as ‘M’ items and below Rs. 1000 as ‘L’ items. On the basis, materials management
may delegate authority to various levels of purchase officers/mangers to authorize and sign
purchase orders. Also, for high value items, alternative source of supplier are developed.
MATERIAL REQUIREMENTS PLANNING (MRP-I)

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Material Requirements Planning is a computer based information system designed to
handle ordering and scheduling of dependent-demand inventories (raw materials, sub assemblies,
parts, components). A production plan for a specified number of finished products (usually over
a monthly time period) in the form of a “master production schedule” is translated into
requirements of component parts and raw materials working backward from the due date (need
date in the production process) using lead times and other information (regarding how the
product is built) to determine when to order and how much to order. Hence, requirements of end
items generate the requirements for lower-level components which are broken down by planning
periods so that ordering, fabrication and assembly can be scheduled for timely completion of end
items while inventory levels are kept reasonably low.
Objectives of MRP
The objectives of material requirements planning in operations management are:
1. To improve customer service by meeting delivery schedules promised and shortening
delivery lead times.
2. To reduce inventory costs by reducing inventory levels.
3. To improve plant operating efficiency by better use of productive resources.
MANUFACTURING RESOURCES PLANING OR MRP-II
When the capabilities of closed-loop MRP are extended to integrate financial,
accounting, personnel, engineering and marketing information along with the production
planning and control activities of basic MRP system, the resulting broad-based resource
coordination system is known as manufacturing resource planning or MRPII. MRPII is the heart
of corporate management information system for many companies, as it provides information
about inventory investment levels, plant expansion needs and work force requirements, that is
useful for coordinating marketing, financial, engineering and manufacturing efforts to achieve
the company’s overall business plans.

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MRP SYSTEM INPUTS
1. Master Production Schedule (MPS): The MPS specifies what end products are to be
produced and when. The planning horizon should be long enough to cover the cumulative
lead times of all components that must be purchased or manufactured to meet the end
product requirements.
2. Bill of Material File or Product Structure File: This file provides the information
regarding all the materials, parts and sub assemblies that go into the end product. The
BOM file identifies each component by a unique part number and facilitates processing
by exploding the end product requirements into components requirements.
3. Inventory Status File: The inventory status file gives complete and up-to-date information
on the on-hand quantities, gross requirements, scheduled receipts and planned order
releases for the item. It also includes other information such as lot sizes, lead times,
safety stock levels and scrap allowances, etc.
MRP SYSTEM OUTPUTS
Two primary outputs are:
1. Planned order schedule which is a plan of the quantity of each material to be ordered in
each time period.
2. Change in planned orders-i.e., modification of previous planned orders.
The secondary outputs are:
1. Exception reports which list items requiring management attention to control.
2. Performance reports regarding how well the system is operating- e.g., inventory
turnovers, percentage of delivery promises kept and stock out incidences.
3. Planning reports such as inventory forecasts, purchase commitment reports, etc.