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Methods and
Techniques of
Inventory Control
| Business
Management
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Read this article to learn about
the advance method and
techniques of inventory control:
ABC analysis, EOQ model, safety
stocks and the reorder point!

2. Inventories occupy the most prominent
position in the working capital
structure of manufacturing and
distributive business enterprises.
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For example, on an average inventories
are approximately 60 per cent of the
current assets in public limited
companies in India.
Inventory Control is a science- based
art of ensuring that sufficient inventory
is held by an organization to meet both
its internal and external demand
commitments economically. Gopalan
and Sandhilya are of the opinion that
uncontrolled inventory can become an
organization’s cancer. ”Managing the

3. level of investment in inventory is like
maintaining the level of water in a
bathtub with an open drain. The water
is flowing out continuously. If water is
let in too slowly, the tub is soon empty.
If water is let in too fast, the tub
overflows. Like the water in the tub,
the particular items in inventory keep
changing, but the level may stay the
same. The basic financial problems are
to determine the proper level of
investment in inventory and to decide
how much inventory must be acquired
during each period to maintain the
level.”
In fact, stock management is
essentially the production manager’s
concern. The finance manager’s
interest is simply that the stock balance
which results is an investment that
needs financing. Thus, the finance
manager should expect to be handed
an optimal stock figure by the
production manager.
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4. The financial manager is a kind of
watch-dog over other functional areas
in conformity with the goal of wealth
and profit maximization. The top level
management should, therefore, keep a
bird’s eye view over inventory with the
principle of “neither too much nor too
little” by cost-benefit analysis.
The momentous decisions faced by
management are how much to order
when to order, what safety stocks to
keep, and what stock-out probabilities
and levels are acceptable. The major
production oriented methods and
techniques of inventory control for
managing inventories efficiently are:
the ABC analysis, the EOQ model,
safety stocks, and the re-order point.
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5. Inventory Control
1. ABC analysis:
The basic work in this always better
control analysis is the classification
and identification of different types of
inventories, for determining the degree
of control required for each. In many
firms it is found that they have stocks
which are used at very different rates.
So items are classified under three
broad categories A, B and C, on the
basis of usage, bulk, value, size,
durability, utility, availability,
criticality etc.; and should be
controlled with due weightage to
differential characteristics.
The items included in group A involve
largest investments and the inventory
control should be most severe to these
items. C group consists of inventory
items which involve relatively small
investments although the number of
items remains large. These items
deserve minimum attention of control.
In B group that items are included
which are neither of A nor C. This
method can be explained by the
following exhibit.

6. ADVERTISEMENTS:
Exhibit II:
Classification of Inventory Items:
Class No.
of
Items
(per
cent
of
total)
Value
of
Items
(per
cent
of
total)
A 20 85
В 30 10
С 50 5
Total 100 100

7. From the figure it can be observed that
there are compara​tively few items in A
but they constitute a large proportion
of the total rupee value; B items are in
the intermediate range and C items are
numerous but inexpensive.
The purpose behind the ‘distribution
by value’ analysis is ‘Always Better
Control’. Donald G. Hall recommends
that different attitudes shall be adopted
in inventory management—aggressive
for class A items, active for class B
items and loose for class C items; and
that each category should be given the
attention as deserves. R.S. Chadda
recommends the following order for
selective control:
A Items B Items C Items
1. Control Tight Moderate Loose
2.
Requirements
Exact Exact Estimated
3. Postings Individual Individual Group

8. 4. Check Close Some Little
5. Expediting Regular Some None
6. Safety
Stocks
Low Medium Large
(Adapted from P.V. Kulkarni, Financial
Management—A Conceptual
Approach).
2. Economic order quantity
model:
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The basic decision in an economic
order quantity (EOQ) procedure is to
determine the amount of stock to be
ordered, at a particular time so that the
total of ordering and carrying costs

9. may be reduced to a minimum point. A
firm should place optimum orders and
neither too large nor to small. The EOQ
is the level of inventory order that
minimizes the total cost associated
with inventory. The EOQ model is
based on following four assumptions:
(i) A firm has a steady and known
demand of D units each period for a
particular input.
(ii) The firm consumes the input at a
uniform rate.
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(iii) The costs of carrying stocks are a
constant amount C per unit per period.
(iv) The costs of ordering more inputs
are a fixed amount O per order. Orders

10. are delivered instantly.
A useful formula for calculating the
optimum order quantity is:
EOQ = √2DO/ C
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To show how we might use the formula
consider exhibit III in which a firm has
an annual inventory requirement of
10,000 units. The accounting costs
associated with placing an order with
the supplier come to Rs. 200 per order
and the carrying costs of holding stocks
are expected to be Rs. 4 per unit.
Hence, D=10,000 units
0=Rs. 200
C=Rs. 4

11. ADVERTISEMENTS:
EOQ = √2 x 10,000 x 200/ 4
= √10,00.000
= 1,000 units
Therefore, 1000 units should be
ordered every 37 days.
The EOQ model is very simple one and
its assumptions will be unrealistic in
many applications, in practice orders
are not delivered instantly. The
assumption of a constant usage of
inventory and known annual demand
are of doubtful validity.
3. Minimum Safety Stocks:
To avoid stock-outs firms maintain
safety stocks of inventory. The safety

12. stock is the minimum level of inventory
desired for an item given the expected
usage rate and the expected time to
receive an order. If an order is placed
when the inventory reaches 12,000
units instead of 10,000 units, the
additional 2,000 units constitute a
safety stock.
The manager expects to have 2,000
units in stock when the new order
arrives at the scheduled time. The
safety stock protects as a safe-guard
against stock-outs ‘position due to
unanticipated increase in usage
resulting from an unusually high
demand and/or an uncontrollable late
delivery of inventories.
The increase in the amount of
inventory held as safety stock reduces
the chances of stock-out and therefore,
reduces stock-out costs over the long-
run. The level of inventory investment
is, however increased by the amount of
safety stock. The optimum level of
safety stock is determined by the trade-
off between the stock-out and the
carrying costs.
Thus the best level of safety stock for a

13. given item depends on stock-out costs,
variability of usage rates and delivery
times. The safety stock level is the
multiplication of the average demand
during a period of the maximum delay
and the probability of its occurrence.
If the usage rate and delivery time or
lead time can be forecasted with a high
degree of accuracy and if the cost of
stock-out is estimated to be small, then
little or no safety stock will needed. If
the circumstances are not so
favourable, then the significant
investment in safety stock will be
desirable.
4. Re-order point:
In addition to set EOQ, the inventory
management must know when to place
the order for avoiding the stock-out
position. Especially in the Indian
context where there is a considerable
time lag between placing the order and
actual receipt of the inventory,
determining the re-order point (ROP)
is momentous as well as intricate. The
ROP may be defined as that level of
inventory at which a fresh order should
be placed to the suppliers for

14. replenishing the current stock.
The ROP is calculated as the lead time
X daily usage. The lead time is the time
lag between raising an order and the
goods being delivered. For example, if
the normal daily usage of materials is
100 units and it takes 30 days for the
supplier to deliver the goods, then an
order must be sent out when the stock
level reaches 3,000 units. If safety
stocks are held then re-order level
should be: safety stock+ (lead time x
daily usage).
Another method of ordering is the ‘two
bin’ and ‘three bin systems. These
involve putting a quantity equal to the
re-order level in a separate bag or bin
which is sealed or put in a separate
location; the rest of the stock is
withdrawn as needed with no record of
individual usage being kept.
Opening the sealed bin, however, gives
the indication for a replenishment
order. This method is cheap as it does
not entail continuous, monitoring and
is easy to understand—it has therefore
gained a fair amount of acceptance.
There are also other types of system in

15. use known as ‘the ‘min-max’ or ‘S-s’
‘method. However, an organization will
have to take care of the lead time with
sufficient initial stock and then follow
it up regularly with EOQ cycles.
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Related Articles:
Derivation of EOQ Formula | Inventory
Control | Materials Management
Term Paper on Inventory Management |
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