Inventory SUJIT KUMAR DAS
Control
Introduction to Inventory Control
❑Decoupling: involves using inventory to separate different
stages of a production or distribution process
❑Smooth production: Inventory allows a company to
maintain a steady output even when demand fluctuates
wildly, preventing the need to constantly hire, fire, or shut
down machines
❑Bulk purchase advantage: Buying in large quantities often
reduces the "unit cost" through economies of scale and vendor
discounts
❑Handling uncertainty:This is often called Safety Stock. It
acts as a safety net against "stockouts" caused by unexpected
spikes in customer demand or delays in the supply chain
Advantages vs Disadvantages
Advantages
• Prevents stockouts: Maintaining inventory ensures product availability and avoids lost sales.
• Economies of scale: Bulk purchasing reduces per-unit cost through discounts and lower
ordering frequency.
• Better customer satisfaction: Timely product availability improves service level and customer
trust.
Disadvantages
• Holding cost : Storing inventory incurs costs like warehousing, insurance, and maintenance.
• Obsolescence : Inventory may lose value due to damage, expiry, or technological changes.
• Capital blocking: Money invested in inventory cannot be used for other productive purposes.
Class Importance
Typical Share of Typical Share of ABC Analysis
Items Value ❑ABC analysis is a method of
Very inventory classification based on
A ~10% ~70% the annual consumption value (or
important importance) of items,
Moderately o so that management effort can be
B ~20% ~20% focused where it matters most.
important
❑Inventory items are divided into
Less three categories:
C ~70% ~10%
important
How ABC Classification is Done
Step 1: Compute Annual
Usage Value
Step 2: Arrange Items in
For each item:
Descending Order
Annual Value=Annual
Demand x Unit Cost /
Step 4: Classification Rule
A-class → top contributors
(≈70% value)
Step 3: Compute
B-class → next moderate
Cumulative Percentage
group
C-class → remaining low-
value items
Numerical Example
Item Demand Cost Value
X 100 50 5000
Y 200 20 4000
Z 500 5 2500
W 1000 1 1000
Inventory Costs
Costs associated with ordering, purchasing, storing, and shortage
of inventory
Key objective: Minimize total inventory cost
Holding Cost
Ordering Cost
Four main types:
Purchase Cost
Shortage Cost
Item Value Cumulative %
Step 1: Sort by value X → Y → Z → W
X 5000 40%
Step 2: Total value = 12500
Y 9000 72% Classification:
Z 11500 92% X, Y → A-class
Z → B-class
W 12500 100%
W → C-class
Holding Cost (H)
❑Cost of storing and maintaining inventory over time
❑Includes:
o Warehousing, rent, insurance
o Damage, deterioration, obsolescence
❑Formula:
o Holding Cost = (Q / 2) × H
❑Example:
o Storing goods in a warehouse incurs storage and maintenance
cost
Ordering Cost (S)
❑Cost incurred each time an order is placed
❑Includes:
o Administrative cost
o Transportation setup cost
❑Formula:
o Ordering Cost = (D / Q) × S
❑Example:
o Placing an order involves paperwork and supplier coordination
Purchase Cost
❑Cost of acquiring inventory from supplier
❑Depends on unit price and demand
❑Formula:
o Purchase Cost = D × C
❑Example:
Buying 100 units at ₹50 each = ₹5000
Shortage Cost
❑Cost when demand cannot be satisfied
❑Includes:
o Lost sales
o Loss of goodwill
o Emergency procurement cost
❑Formula:
o Shortage Cost = Shortage Units × Cost per unit
❑Example:
o Customer leaves due to unavailability of product
Total Inventory Cost
❑Total Cost = Holding + Ordering + Purchase (+ Shortage if
applicable)
❑Objective:
o Find optimal order quantity to minimize total cost
❑EOQ helps achieve this balance
Basic Inventory Concepts
❑Fundamental ideas used in inventory management
❑Helps in determining when and how much to order
❑Key concepts:
◦ Lead Time
◦ Reorder Point
◦ Order Quantity
◦ Types of Inventory
❑Lead Time (L):
◦ Time between placing an order and receiving it
◦ Includes
▪ Order processing time
▪ Transportation time
Basic Inventory Concepts
❑Demand Rate (D):
o Number of units required per unit time
o Can be:
▪ Constant (deterministic)
▪ Variable (probabilistic)
❑Order Quantity (Q):
o Number of units ordered each time
o Decision variable in inventory models
❑Reorder Point (ROP) :
o Inventory level at which a new order is placed
o Formula:
▪ ROP = Demand during lead time
▪ ROP = d × L
Basic Inventory Concepts
❑Safety Stock:
o Extra inventory kept to handle uncertainty
o Protects against:
▪ Demand fluctuations
▪ Lead time delays
Types of Inventory
RAW MATERIALS → BASIC WORK-IN-PROGRESS (WIP) → FINISHED GOODS → READY
INPUTS PARTIALLY FINISHED GOODS FOR SALE
Inventory Cycle
❑Inventory Cycle
o Inventory decreases due to demand
o Replenished when order arrives
o Cycle repeats continuously
o Forms a saw-tooth pattern
EOQ Model
❑Determines optimal order quantity to minimize total inventory cost
❑Balances:
o Ordering Cost
o Holding Cost
❑Assumptions of EOQ
o Demand is known and constant
o Lead time is fixed
o No shortages allowed
o Instantaneous replenishment
o Costs (ordering & holding) are constant
EOQ
Formula
Ordering Cost = (D / Q) × S
Holding Cost = (Q / 2) × H
Cost Total Cost = Ordering + Holding
Components
EOQ Objective
• Minimize total inventory cost
• Achieved when:
• Ordering Cost = Holding Cost
Graphical
Representation
❑Ordering cost ↓ as Q increases
❑Holding cost ↑ as Q increases
❑Total cost curve is U-shaped
❑EOQ is the point of minimum
total cost
Limitations of EOQ
❑Assumes constant demand
❑Ignores shortages
❑Not suitable for variable demand situations
Numerical 1 (Basic EOQ + Total Cost)
Steps of solution
Total Cost
Numerical 2
Solution Steps
Production Order Quantity (POQ)
❑Determines optimal production batch size when items are produced internally
❑Extension of EOQ model
❑Accounts for finite production rate
❑Need for POQ
o EOQ assumes instant replenishment
o In reality, production is gradual
o Inventory builds up while production continues
Assumptions of POQ
❑Demand rate is constant
❑Production rate is constant and greater than demand rate
❑No shortages allowed
❑Setup cost is fixed
❑Holding cost is constant
Formula
D = Annual demand
S = Setup cost
H= Holding cost
d = Demand rate
p= Production rate
Numerical