Inventory Control

GCET/Mech./202090603/DAD 1
 Classification of Inventories

Direct Inventories Indirect Inventories

Play major role in manufacturing of products and Help the raw materials get converted into
become integral part of the finished products finished products but do not become
integral part of the finished products

Eg.: Raw materials, WIP, FG, Eg.: Tools, Gauges, Various

Bought out parts & Consumables, Stationeries and
subassemblies etc. General Office Materials etc.

GCET/Mech./202090603/DAD 2
The value and impact of inventory
Every industry/business need to maintain adequate inventories for
following reasons….

To ensure against delays in deliveries

To allow for possible increase in output
To maintain smooth production flow
To avoid stock-outs and keep better customer relations
To take advantage of quantity discounts
To utilize/absorb price fluctuations
To ensure against scarcity of the materials
GCET/Mech./202090603/DAD 3
Advantages of Inventory Control
No shortages of materials at any stage of production

Materials are made available at economical rates

Delay in production due to non-availability of materials can be avoided

Effective planning of production and estimation of delivery dates

Protection of materials from spoilage, deterioration, pilferage etc.

Help improve overall efficiency of the industry

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 Inventory Levels
Reorder Level
= Min. Inv. + (Procurement Time X
Consumption Trend
Consumption Rate)
A
For eg. : 1 month reqd. to deliver 500 units
and monthly consumption rate is 200 units
and Safety Stock is 100 units.
B
Quantity

So, Reorder Point

C = 100 + (1 X 200) = 300 units

D So from above…
Min. Inv. = 100 units
Rt Pt Safety Stock Reorder point = 300 units
Lead Time (Rt+Pt)
Reorder quantity = 500 units
O
Max. Inv. at any one time = 600 units
Time
Reorder Level indicates that at this time purchase order should be initiated, and if not done, the inventory
may get exhausted and even the safety stock may get utilized before the new materials arrive.
GCET/Mech./202090603/DAD 5
Lead Time : time interval between the time the need of the material is
determined and the time the material is actually received.
Total Lead Time = Requisition time + Procurement time
Preparing purchase Delivering purchase order to supplier
requisition and placing Mfg. by supplier
the order Despatch of material by supplier
Transportation time & receipt at final destination

Safety Stock: extra inventory to protect against unreliable forecast and

stock outs. Also known as, Reserve stock, Base or Buffer stock.

Excess Safety Stock

Trade-off results into excess Less Safety Stock fails
investments to protect against
stock-outs

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 Costs associated with inventories:

Ordering Cost Carrying Cost

It includes… It includes…
Receiving quotations Inventory storage cost (Rent of storage facilities,
Processing purchase order Maintenance of facilities and records, Salaries of
stores personnel etc)
Follow-up with supplier
Cost of obsolesce
Receiving material and inspecting
Cost od deterioration, spoilage etc.
Processing suppliers’ bills
Cost of insurance
Interest lost on capital invested
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Ordering Cost Co = Cost of placing an order
q = Order quantity

Unit cost of placing an order = Co/q

Co/q If S is the annual requirement, then…

Ordering
Cost
Annual Cost of Ordering = Co/q X S

Order Qty. Carrying cost are almost directly proportional to order

quantity and expressed as annual % of the unit
Carrying Cost purchase cost.

Carrying Cu = Unit purchase cost

Cost i = Interest rate
Annual  Cui = Annual Carrying Cost per unit
Cost  Annual Carrying Cost = Cui X q/2
(where q/2 is average inventory)

Order Qty. GCET/Mech./202090603/DAD 8

 Total Cost
Economic Order Quantity (EOQ)
Carrying Cost
Total Cost = Carrying Cost + Ordering Cost
Annual
Cost
EOQ Total Cost will be minimum at EOQ
Ordering Cost

Order Qty.

GCET/Mech./202090603/DAD 9
 Inventory Models

Static Inventory Model Dynamic Inventory Model

Applicable where only one order can Applicable for items where repeat orders can
be placed to meet the demand, be placed to replenish the stock.
for eg. Perishable goods, food and
Deterministic Model Probabilistic Model
vegetables, seasonal products etc. Based on assumption Takes into account the
that demand as well as variations in demand
lead time are and lead time of items.
deterministic (known
with certainty)

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 Assumptions in Deterministic Model

 Demand of the item is known exactly for a given period

 Demand of the item occurs uniformly over a period of

Deterministic time
Model
 Cost of placing an order is fixed and does not vary with
lot size (Same way set up costs are also constant)

Purchase Inventory Production Inventory  Inventory carrying charges are directly proportional to
Model Model order quantity
Fixed price inventory Single product
models  Price per unit is fixed and is independent of the order
inventory models
size (for Fixed price model)
Quantity discounts Multiple product
inventory models inventory models  Replenishment is instantaneous

 Items can be purchased free from any kind of

restrictions

 Items have fairly long shelf-life so no deterioration or

spoilage
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Economic Order Quantity (EOQ)
EOQ is that order quantity which will minimize the total variable cost of managing the inventory

For EOQ calculation, assume that inventory decreases

EOQ at a constant rate from the order quantity to zero and
then again replenished
Quantity

Let…
S = Annual consumption in units
Co = Cost of placing an order
Average
Reorder Cu = Unit cost of item (Rs./pc.)
Inventory Q/2
point q = Order quantity in units
i = Interest rate charged per unit per year
Time

Total variable cost of managing the inventory per year “E” = Annual ordering cost + Annual inventory carrying cost
 E = [(No. of orders / yr) x Cost of placing an order] + [Avg. inventory x Inv. Carrying cost]

 E = [(S/q) x Co] + [q/2 x Cui]

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To determine EOQ (qo), that minimizes the total cost of managing the inventory, we need to differentiate E with
respect to decision variable q and set the first derivative to zero…

dE / dq = 0

 - CoS / q2 + Cui /2 = 0

 CoS / q2 = Cui /2

 q = √(2CoS/Cui)
So, EOQ (qo) = √ (2 x Annual consumption in units x Cost of placing an order)/(Unit price x Inv. Carrying cost)
EOQ in rupees  qo x Cu = [√(2CoS/Cui)] x Cu (multiplying both sides by unit price Cu)

 Qo (in rupees) = √(2Co A /i) where A = Annual consumption in Rs. = S x Cu

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A firm requires 16000 pins costing Rs. 2/pin. The cost of placing an order is Rs. 45/- and
carrying costs are 10% per year per unit of the average inventory. Calculate following…
1) Economic order quantity
2) Order cycle time
3) Total variable cost of managing the inventory

S = 16000 Co = 45 Cu = 2 i = 10%

1) q = √(2CoS/Cui) = √(2x45x16000/2x0.1) = 2684 units

2) No. of orders per year = S/q = 16000/2684 = 6

 Cycle time = 2 months

3) Total variable cost of managing the inventory = E = [(S/q) x Co] + [q/2 x Cui]
= (6 x 45) + (2684X2X0.1/2) = Rs. 538.7

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A firm requires ball bearings of worth Rs.28,800 per year. The cost of placing an order is
Rs.48 and inventory cost as a percentage of average inventory investment is 12%. Calculate
number of orders to be placed per year considering economic order value. What will be the
value of each order?

Qo (in rupees) = √(2Co A /i)

= √(2x48x28800/0.12)
= Rs. 4800

 No. of orders /year = 28800/4800

=6
And value of each order = Rs. 4800/-

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 Inventory model considering quantity discount
A firm requires 300 special washers annually. Each washer is costing Rs. 36. The procurement cost
and inventory carrying cost are estimated as Rs. 30 and 20% respectively. The supplier has offered
a discount of Rs.2 per washer on the order quantity of 200 or above. --- Will this offer be advisable
to accept?
Price Quantity
S = 300 Co = 30 Cu1 = 36 Cu2 = 34 (36-2) i = 20%
36 0 < q < 200
EOQ2 = √(2CoS/Cu2i) = √(2x30x300/34x0.20) = 51 34 200 ≤ q

EOQ2 is not equal to or more than 200  to decide based on total cost calculation for two different quantity levels

EOQ1 = √(2CoS/Cu1i) = √(2x30x300/36x0.20) = 50

Total Annual Cost E1 = [(S/q1) x Co] + [q1/2 x Cu1i] + Cost of material Cu1S
(for 50 units) = [(300/50)x30] + [50/2x36x0.2] + 36x300 The firm should
= Rs. 11160/- accept the offer as
total annual cost is
Total Annual Cost E2 = [(S/q2) x Co] + [q2/2 x Cu2i] + Cost of material Cu2S less when purchased
(for 200 units) = [(300/200)x30] + [200/2x34x0.2] + 34x300 quantity is 200.
= Rs. 10925/- GCET/Mech./202090603/DAD 16
Annual demand for product is 200 units. The cost of placing an order is Rs.350 and
inventory cost as a percentage of average inventory investment is 2%. The supplier has
offered following price breaks. Find the optimum order quantity.
Price (Rs./pc) Quantity
10 0 ≤ q1 < 500
9.25 500 ≤ q2

EOQ2 = √(2CoS/Cu2i) = √(2x350x200/9.25x0.02) = 870

Since EOQ2 > 500  Optimum purchase quantity is 870

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 EOQ with gradual replenishment
 More general and realistic situation
 Each order cycle is equal to time
T = t1 + t2
where t1 = replenishment time
t2 = consumption time
 Demand rate in each cycle is assumed to be
uniform

S = Annual consumption in units Total variable cost of managing the inventory per year
Co = Cost of placing an order E = Annual ordering cost + Annual inventory carrying cost
Cu = Unit cost of item (Rs./pc.) E = (S/q)Co + q/2(1 –d/p)Cui
q = Order quantity in units
i = Interest rate charged per unit per year Now, dE / dq = 0
p = daily rate at which order is received (inventory replenished)
d = daily rate at which inventory is consumed (inventory depleted) q = √2CoS/(1-d/p)Cui
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A manufacturing firm requires 1000 units of particular item per month. Average demand
of that item occurs at the rate of 30 units per day and production process is capable of
producing 50 units per day. Each item produced in the plant costs rupees 10. The setup
cost per order is Rs. 100. The inventory carrying cost is 15% of the average inventory cost.
Calculate the quantity to be produced in each production run and number of production
runs per year.

S = 1000 x 12 = 12000 q = √2CoS/(1-d/p)Cui

Co = 100
Cu = 10 = √2x100x12000/(1-30/50)x10x0.15
i = 0.15 = 2000 units
p = 50
d = 30
No. of production run = 12000/2000 = 6

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 EOQ when shortages are allowed
 As such a shortage (stock out) is considered
undesirable and is avoided, if possible
 But sometimes customers allow the shortages and
wait until next shipment arrives --- this is called
“back-ordering”
 With assumption of back-ordering, shortages are
deliberately planned
 Shortages are advisable specially when the value of
the item is very high resulting in high carrying cost.
 So it is setting off the cost of shortages against the
saving in the carrying cost.

EOQ = q = √(2CoS/Cui) [(Cui + Cs)/Cs]

where Cs = per unit shortage cost
Optimum level of shortages = q X [Cs / (Cui + Cs)]
Min. Total Variable Cost Tc = √2CoSCui x √ Cs/(Cui + Cs)
GCET/Mech./202090603/DAD 20
A dealer supplied you the following information with regards to an item of inventory.
Annual demand = 12000 units, Ordering cost = Rs. 15/order, Price = Rs. 25/unit, Inventory holding cost = 20% of
the value of inventory per year, Inventory stock-out cost = 30% of the value of inventory per year.
Find out following…
1) Economic order quantity – when stock-outs are not permitted and when stock-outs are permitted
2) What quantity of the product should be back-ordered, if any?
3) What will be the maximum inventory at any particular time of the year?
4) Would you recommend to allow back ordering? If so what would be the cost saving through back ordering?

S = 12000 unit/year, Co = 15/order, Cui = 25 x 0.2 = 5/year, Cs = 25 x 0.3 = 7.5/year

1) q = √(2CoS/Cui) = √(2x15x12000/5) = 268 units ---- when stock-outs are not permitted

q = √(2CoS/Cui) [(Cui + Cs)/Cs] = √(2x15x12000/5) [(5 + 7.5)/7.5] = 346 units

--- when stock-outs are not permitted

2) Optimum order quantity to be back ordered = q X [Cs / (Cui + Cs)] = 346 x [(7.5/(5 + 7.5)]
= 208 units
GCET/Mech./202090603/DAD 21
3) Max. inventory level = q – Back order qty. = 346 – 208 = 138 units

4) Min. Total Variable Cost (when stock-outs are not permitted)

= √2CoSCui = √2x15x12000x5 = 1341.64 ---- (a)

Min. Total Variable Cost (when stock-outs are permitted)

= (√2CoSCui) x √[Cs/(Cui+Cs)] = 1341.64 x √[7.5/(7.5+5)] = 1039.23 ---- (b)

 Yes, back ordering is recommend, as (b) is less than (a) and the saving through back
ordering would be (a) – (b) = 1341.64 – 1039.23 = Rs. 302.41

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 EOQ with different rate of demand in different cycles
With varying demand rate stock will be exhausted at
different time periods.
Inv. Level

Let, S1 +S2+…..+Sn = Total demand in time T

t1 + t2+…..+ tn = T
Cost of ordering in time T = S/q x Co
Cot of purchasing S units = S x Cu

t1 t2 t3 Inv. Carrying Cost for time T = (Avg. Inv. In time t1)Cui + (Avg. Inv. In time t2)Cui +
(Avg. Inv. In time t3)Cui +.. (Avg. Inv. In time tn)Cui
Time = ½ q CuiT
Based on above….

EOQ = √2CoS/CuiT here, S/T = Avg. demand in different periods

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Reordering systems (Two bin system, Periodic ordering system)
 EOQ gives us optimum quantity for reordering, but does not provide any information
about the time – when reordering should be done?

 In real-life scenario inventory control becomes complex due to variations in consumption

rate and delivery period.

 Systematic inventory ordering system to be designed to answer following questions…

How much to order?
When to order?

Two bin system

Reordering
Systems Periodic
inventory
ordering system
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 Two bin system
 Also called as fixed order quantity system or min-max system
 Stock location of each item is dived in two sections (Bins)
1st Reorder  1st Bin holds he normal issue stock and it is intended for satisfying
Point
Bin current demand
Inv. Level

 2nd Bin holds the reserve supply of materials equal to the amount
that will be consumed during the lead-time plus safety stock, if any
2nd  2nd Bin comes into use only after 1st Bin is emptied
Bin  So, when the first piece is withdrawn from the 2nd Bin, purchase
Safety Stock
order is to be initiated
Time  When fresh stock is received, level of 2nd Bin is restored to its
original level and balance is put in the 1st Bin

Advantages of Two-Bin System Disadvantages of Two-Bin System

• Simplicity and reliability • Ordering different items from same supplier to get
• Economical to operate discount and transportation cost reduction will be
• Reorder point can be indicated difficult as reorder points will be different
easily • Accurate and adequate stock level and consumption data
are required
GCET/Mech./202090603/DAD 25
Two Bin example : Stocking Hospital Supply Rooms

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Periodic Inventory Ordering System (Ordering Cycle System)

 Orders for replenishment are placed at fixed intervals of time

 Order quantity is not fixed but the ordering interval is fixed
Inv. Level

 Order quantity is determined such that total inventory is always

brought up to certain level
 Fixed ordering interval my be fortnightly, monthly, quarterly etc. and
order quantity is decided based on balance stock
Time

Advantages of Periodic Inventory Ordering System Disadvantages of Periodic Inventory Ordering System
• All orders for replenishment can be issued at • Usually more stock is held when this system is
the sae time, which was a problem in 2-Bin adopted compared to 2-Bin system
system
• Ordering mechanism is regular and not
subjected to warning signals from the stores

GCET/Mech./202090603/DAD 27
ABC analysis of inventory control

 Divides inventories into three groupings in terms of

parentage of number of items and percentage of
total value

 Based on Pareto Analysis inventory control is

exercised on the principle of “management by
exception” – rigorous control on A-class items
moderate control on B-class items and
routine/loose control on C-class items

Category % of item % of value

(approx.) (approx.)
A 10 70
B 20 20
C 70 10

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Following table lists the number of items used in a small scale industry. Classify the items
under ABC category.

Annual Consumption Unit price

Item
( units) (Rs/pc.)
a 30000 100
b 280000 150
c 3000 100
d 110000 50
e 4000 50
f 220000 100
g 15000 50
h 80000 50
i 60000 150
j 8000 100

GCET/Mech./202090603/DAD 29
 Annual Annual
Unit price
Item Consumption Usage value
(Rs/pc.)
( units) (Rs.)
a 30000 100 3000000
b 280000 150 42000000
c 3000 100 300000
d 110000 50 5500000
e 4000 50 200000
f 220000 100 22000000
g 15000 50 750000
h 80000 50 4000000
i 60000 150 9000000
j 8000 100 800000

GCET/Mech./202090603/DAD 30
 % of Cumulative
Annual Unit Annual Cumulative % Cumulative
item % of
Item Consumption price Usage Annual Usage Usage Category
(100/nos. item
(units) (Rs/pc.) value (Rs.) value (Rs.) (Value)
of items)
b 280000 150 42000000 42000000 48.0 10 10
f 220000 100 22000000 64000000 73.1 10 20
A
i 60000 150 9000000 73000000 83.4 10 30
d 110000 50 5500000 78500000 89.7 10 40
h 80000 50 4000000 82500000 94.2 10 50
B
a 30000 100 3000000 85500000 97.7 10 60
j 8000 100 800000 86300000 98.6 10 70
g 15000 50 750000 87050000 99.4 10 80
c 3000 100 300000 87350000 99.8 10 90
C
e 4000 50 200000 87550000 100.0 10 100
% of % Cumulative
item Usage (Value)
20 73
40 24
40 3
GCET/Mech./202090603/DAD 100 100 31
Introduction to other methods of stock control…
VED, SDE, HML, MNG/FSN analysis
Vital items are those without which production
VED analysis would come to halt and if these items go out of
stock or are not readily available, there is loss of
Vital – Essential – Desirable classifications
production for the whole period.
especially for maintenance spare parts and
denotes the essentiality of stocking spares Essential items are those without which the
performance or efficiency of the equipment will be
Categorizes in order of importance - From the reduced and non –availability of these items may
view-points of functional utility, the effects of result in temporary loss of production.
non-availability at the time of requirement or
the operation, process, production, plant or Desirable items are those which do not cause any
equipment and the urgency of replacement in immediate loss in production and are mostly non-
case of breakdown. functional and do not affect the performance of
the equipment.

GCET/Mech./202090603/DAD 32
SDE analysis - The criterion for this analysis is the
availability of the materials in the market.
HML analysis - The criterion for this analysis is the unit
Scare items which are in short supply. Usually these are raw cost of the item to find out the importance of the items
materials, spare parts and imported items. (in ABC total annual usage is considered).

Difficult items which are not readily available in local High – Medium – Low categories of items are based on
markets and have to be procured from faraway places, or their unit cost.
items for which there are a limited number of suppliers; or
items for which quality suppliers are difficult to get. This analysis is quite useful in deciding the safety stock in
relation to the availability of the material (SDE analysis)
Easy items which are easily available in the local markets.

MNG/FSN analysis - Moving and Non Moving items / Fast moving, Slow moving and Non-moving Analysis

Moving items - The rate of consumption of this items is quite high

Non-moving items - These items are those which are not consumed in the last 1 year.
Ghost items - This are those items which have nil balance and there was no transaction during the year. These are non-
existing items for which the store people keep bin cards showing the nil balance.

Fast-moving (F), Slow-moving (S) and Non-moving (N) items on the basis of quantity and rate of consumption. The non-
moving items (usually, not consumed over a period of two years) are responsible for blocking quite a lot of capital.
The classification of fast and slow moving items helps in arrangement of stocks in stores and their distribution and
GCET/Mech./202090603/DAD 33
handling methods.