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UNIT – IV
Production and Inventory Control
PART A: Core Concept Notes
1. Basic Types of Production Systems
Type Meaning Example
Job Production Single unit made to customer's specific order; high Ship building, tailored suit, bridge
variety, low volume construction
Batch Production Products made in groups/batches; equipment set up Bakery items, pharmaceuticals,
once, batch run through textbook printing
Mass/Flow Production Continuous, standardized output on an assembly line; Automobiles, consumer electronics
large volume, low variety
Continuous/Process Uninterrupted flow of highly standardized product, Oil refining, chemicals, cement,
Production 24x7 operation steel
Key distinguishing factors: volume, variety, equipment flexibility, cost of setup, skill level of labour.
2. Basic Inventory Models
Inventory models help decide how much to order (Q) and when to order (reorder point) so that total inventory cost (ordering
cost + carrying cost + shortage cost) is minimized.
Main models:
● Deterministic models – demand and lead time known with certainty (e.g., EOQ, EBQ)
● Probabilistic models – demand/lead time uncertain, need safety stock
● Fixed Order Quantity System (Q-system) – order a fixed quantity when stock hits reorder level
● Fixed Order Period System (P-system) – order at fixed time intervals, quantity varies
3. Economic Order Quantity (EOQ)
The order quantity that minimizes total inventory cost = Ordering Cost + Carrying (Holding) Cost.
EOQ = √(2DCₒ / Cₕ)
Where: D = Annual demand (units), Cₒ = Ordering cost per order, Cₕ = Carrying/holding cost per unit per year.
Assumptions of EOQ model:
1. Demand is known and constant
2. Lead time is constant
3. Price per unit is constant (no discounts)
4. Ordering cost and carrying cost are constant
5. No stock-outs allowed
6. Entire order received at once
Total Cost equation:
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TC = (D/Q)Cₒ + (Q/2)Cₕ + (D × Price)
4. Economic Batch Quantity (EBQ) / Economic Production Quantity (EPQ)
Used when items are produced internally (not purchased) and production rate > demand rate, so stock builds up gradually
while some is consumed simultaneously.
EBQ = √(2DCₒ / Cₕ) × √(p / (p − d))
Where: p = production rate per period, d = demand/consumption rate per period.
EBQ is always larger than EOQ because stock accumulates gradually, not instantaneously.
5. Reorder Point (ROP)
The stock level at which a new order must be placed so that the order arrives just as stock reaches zero (or safety stock level).
Formula (no safety stock):
ROP = d × L (d = average daily demand, L = lead time in days)
Formula (with safety stock):
ROP = (d × L) + Safety Stock
6. Safety Stock (Buffer Stock)
Extra stock kept as a cushion against uncertainty in demand or lead time, to avoid stock-outs.
Safety Stock = (Maximum daily usage − Average daily usage) × Lead time
Factors affecting safety stock: demand variability, lead time variability, service level desired, cost of stock-out vs cost of
holding.
7. Classification and Codification of Stock
Classification: Grouping inventory items based on common characteristics (nature, usage, value, source) to enable
systematic control.
Codification: Assigning a unique code/number to each item for easy identification, storage, retrieval, and computerized
tracking.
Methods of codification:
● Numeric codes
● Alphabetic codes
● Alpha-numeric (mnemonic) codes
● Colour codes
Benefits: avoids duplication, ensures quick identification, aids in standardization, simplifies storekeeping, helps in
computerized inventory systems.
8. ABC Classification (Always Better Control)
Classifies inventory based on value and usage, applying the Pareto (80/20) principle.
Category % of Items % of Value Control Level
A ~10% ~70% Tight control, frequent review, low safety stock
B ~20% ~20% Moderate control, periodic review
C ~70% ~10% Loose control, bulk ordering, high safety stock ok
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Steps to develop ABC analysis:
7. List all items with annual usage quantity and unit cost
8. Compute annual usage value (Quantity × Unit Cost) for each item
9. Rank items in descending order of usage value
10. Calculate cumulative % of items and cumulative % of value
11. Classify into A, B, C bands
Other related techniques: VED (Vital, Essential, Desirable), FSN (Fast, Slow, Non-moving), HML (High, Medium, Low unit
price), SDE (Scarce, Difficult, Easy to obtain).
9. Procedure for Stock Control
Typical stock control cycle:
1. Purchase requisition – identify need, raise indent
2. Purchase order – place order with approved supplier
3. Receipt and inspection – goods received, checked for quality/quantity (GRN – Goods Received Note)
4. Storage – bin cards, stock ledgers maintained
5. Issue of material – against requisition slips (FIFO/LIFO basis)
6. Stock verification – periodic/perpetual physical checking
7. Stock records – Bin card (quantity) and Stores Ledger (quantity + value)
Tools used: Bin cards, Stores ledger, Min-Max levels, Reorder level, Perpetual inventory system, Periodic stock-taking.
10. Materials Requirement Planning (MRP)
A computerized, push-type production planning and inventory control system used for dependent demand items (raw
materials, components, sub-assemblies) whose demand depends on the demand of the finished product.
Inputs (MRP requires three):
1. Master Production Schedule (MPS) – what and how much finished product to produce, and when
2. Bill of Materials (BOM) – list of components/materials needed per unit of finished product
3. Inventory Records File – current stock, on-order quantities, lead times
Output: a time-phased schedule stating what to order/produce, how much, and when (Order Release Schedule).
Objectives of MRP:
● Ensure materials/components are available for production as and when needed
● Minimize inventory levels
● Plan manufacturing activities, delivery schedules, purchasing activities
MRP II is an extension that integrates financial and capacity planning with material planning.
11. Just-In-Time (JIT)
A pull-based production and inventory philosophy (originated in Toyota, Japan) aiming to produce and deliver the right
items, in the right quantity, at the right time — eliminating all forms of waste (including excess inventory).
Key elements:
● Kanban (pull signal/card system)
● Zero/minimal inventory
● Small lot sizes, frequent deliveries
● Close relationship with suppliers
● Total Quality Management support
● Continuous improvement (Kaizen)
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Benefits: reduced inventory carrying cost, less waste, better quality, faster response, reduced space requirement.
Limitations: requires very reliable suppliers, vulnerable to supply disruptions, needs strong discipline and coordination, high
dependency on demand forecasting accuracy.
MRP vs JIT (quick comparison):
Basis MRP JIT
Approach Push system Pull system
Focus Planning based on forecast/MPS Actual demand-driven
Inventory Planned buffer stock Near-zero inventory
Best suited for Complex products, many components Repetitive manufacturing
PART B: Exam Question Bank
Section 1 — 5 Mark Questions (Short Answers)
Q1. What are the basic types of production systems?
There are four basic types: (1) Job production – single custom units, high variety, low volume, e.g. shipbuilding; (2) Batch
production – goods made in batches with equipment reset between batches, e.g. bakery goods; (3) Mass/Flow production –
continuous assembly-line output of standardized goods, e.g. cars; (4) Continuous/Process production – uninterrupted 24x7
output of highly standardized product, e.g. oil refining. They differ in volume, variety, flexibility and cost structure.
Q2. Define EOQ and give its formula.
Economic Order Quantity is the order size that minimizes the sum of ordering cost and carrying cost. It answers "how much
to order." Formula: EOQ = √(2DCₒ/Cₕ), where D = annual demand, Cₒ = cost per order, Cₕ = annual carrying cost per unit.
At EOQ, ordering cost equals carrying cost, giving the lowest total inventory cost.
Q3. What is Reorder Point? How is it calculated?
Reorder Point (ROP) is the inventory level at which a fresh purchase/production order must be triggered so that stock does
not run out before the new supply arrives. ROP = (Average daily demand × Lead time) + Safety Stock. It ensures continuity
of operations by accounting for the time needed to replenish stock.
Q4. Explain Safety Stock and its purpose.
Safety stock (buffer stock) is extra inventory held above expected demand during lead time, to protect against uncertainty in
demand fluctuation or delivery delays. It prevents stock-outs and production/sales disruption. It is calculated as: (Maximum
daily usage − Average daily usage) × Lead time. Higher variability or higher desired service level requires more safety stock,
but it also increases carrying cost.
Q5. What is ABC Classification of inventory?
ABC analysis classifies inventory items into three categories based on annual consumption value, following the 80/20
(Pareto) rule. Category A (~10% items, ~70% value) needs tight control; Category B (~20% items, ~20% value) needs
moderate control; Category C (~70% items, ~10% value) needs simple, loose control. It helps managers focus control efforts
where they matter most.
Q6. Distinguish between EOQ and EBQ.
EOQ (Economic Order Quantity) applies when items are purchased externally and the entire order arrives at once. EBQ
(Economic Batch Quantity/EPQ) applies when items are produced internally, with stock building up gradually as production
rate exceeds demand rate. EBQ formula includes an additional factor √(p/(p−d)) and is always larger than EOQ, since
inventory accumulates over the production period rather than arriving instantly.
Q7. What is Codification of stock? State its advantages.
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Codification is the process of assigning a unique alphabetic, numeric, or alpha-numeric code to every inventory item for easy
identification. Advantages: avoids duplication of items, enables quick location and retrieval, facilitates computerization of
stock records, ensures standardization, and reduces clerical errors in stores management.
Q8. What are the inputs required for MRP?
MRP requires three key inputs: (1) Master Production Schedule – specifies what finished products to make, quantity and
timing; (2) Bill of Materials – lists all raw materials/components needed per unit of finished product; (3) Inventory Records
File – shows current stock on hand, quantities on order, and lead times. Using these, MRP generates a time-phased plan of
what to order or produce and when.
Q9. What is JIT? State any two benefits.
Just-In-Time is a pull-based inventory and production philosophy aiming to produce/deliver exact quantities exactly when
needed, minimizing inventory and waste. Two benefits: (1) significantly reduces inventory carrying costs and warehouse
space needs; (2) improves quality and responsiveness since defects are caught immediately due to small lot production, rather
than being hidden in large stockpiles.
Q10. What is the procedure for stock control? (Brief)
Stock control follows a cycle: raising a purchase requisition → placing a purchase order → receiving and inspecting goods
(GRN) → storing with bin card records → issuing materials against requisition slips → periodic physical verification against
stores ledger. This ensures materials are available when needed while minimizing excess stock and pilferage.
Section 2 — 10 Mark Questions (Long / Detailed Answers)
Q1. Explain the various basic types of production systems with suitable examples. Discuss the factors that determine
the choice of a production system.
Answer outline:
● Introduce production system as the method of converting inputs to outputs
● Explain in detail: Job production, Batch production, Mass production, Continuous/Process production — for each
cover: meaning, characteristics (volume/variety), equipment used, labour skill required, examples
● Factors determining choice: nature of product, volume of demand, degree of product standardization required,
capital investment capacity, flexibility needed, delivery time expectations
● Conclude: firms often use a hybrid depending on product life cycle stage
Q2. Derive the EOQ formula and explain its underlying assumptions. Discuss the limitations of the EOQ model.
Answer outline:
● Total Cost = Ordering Cost + Carrying Cost = (D/Q)Cₒ + (Q/2)Cₕ
● Differentiate TC with respect to Q, set to zero → derive EOQ = √(2DCₒ/C ₕ)
● Show graphically: ordering cost curve falls as Q increases, carrying cost curve rises, EOQ is at intersection
(minimum TC point)
● List assumptions: constant demand, constant lead time, no quantity discounts, no stock-outs, instant delivery of full
order
● Limitations: unrealistic in practice — demand fluctuates, prices change (discounts), lead time varies, doesn't factor
in space constraints or perishability
● Mention that real-world firms use EOQ as a starting benchmark, adjusted with safety stock and periodic review
Q3. What is ABC Classification? Explain the procedure for carrying out ABC analysis with an illustration. What are
its advantages and limitations?
Answer outline:
● Definition and Pareto principle basis
● Procedure (steps): list items → compute usage value → rank → cumulative % → classify A/B/C
● Give a small illustrative example table (5-6 items with quantity, unit cost, usage value, % contribution) to
demonstrate classification
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● Advantages: selective control saves managerial time and cost, reduces investment in low-value items, improves
service level for critical items, helps prioritize purchasing effort
● Limitations: purely value-based — may wrongly deprioritize a low-value but critical (VED) item; needs periodic
revision as prices/usage change; ignores lead time and criticality factors
● Suggest combining ABC with VED analysis for more effective control
Q4. Explain Materials Requirement Planning (MRP). Describe its objectives, inputs, process and benefits to an
organization.
Answer outline:
● Definition: computerized push-based system for planning dependent-demand inventory
● Objectives: ensure material availability, minimize inventory investment, plan production/purchasing/delivery
schedules
● Inputs: MPS, BOM, Inventory records file (explain each in detail)
● Process/Logic: MRP explodes the BOM against the MPS, nets off available inventory and open orders, offsets by
lead time to generate time-phased order release schedule (gross requirement → net requirement → planned order)
● Outputs: primary reports (order release schedule) and secondary reports (exception reports, performance reports)
● Benefits: reduced inventory levels, improved customer service, better coordination between purchasing/production,
reduced expediting, supports complex multi-level product structures
● Mention evolution to MRP II and ERP systems
Q5. What is Just-In-Time (JIT)? Explain its philosophy, key elements, and compare it with the traditional/MRP
approach to inventory management.
Answer outline:
● Origin (Toyota Production System) and core philosophy: eliminate waste (muda), produce only what's needed, when
needed, in the quantity needed
● Key elements: Kanban pull system, small lot production, setup time reduction, supplier partnerships, quality at
source, continuous improvement (Kaizen), levelled production
● Comparison: JIT vs MRP/Traditional — push vs pull, buffer stock vs zero stock, forecast-driven vs demand-driven,
supplier relationship (few, close, frequent deliveries vs many, arm's length)
● Advantages: lower holding cost, less waste, faster problem detection, improved quality, reduced lead times
● Limitations/Challenges: high dependency on reliable suppliers, vulnerable to disruptions (e.g., strikes, transport
delays), demands high discipline, not suitable for all industries (e.g., seasonal/unpredictable demand)
● Conclude: JIT works best in stable, repetitive, high-volume manufacturing environments
Q6. Discuss the concept of Safety Stock and Reorder Point. How are they determined? Explain with the help of a
numerical example.
Answer outline:
● Explain uncertainty in demand and lead time as the rationale for safety stock
● Formula and factors affecting safety stock level (service level, variability, stockout cost vs holding cost tradeoff)
● Formula for ROP with and without safety stock
● Worked numerical example: Average daily demand = 100 units, Lead time = 5 days, Maximum daily demand = 120
units → Safety Stock = (120−100) × 5 = 100 units → ROP = (100×5) + 100 = 600 units
● Interpret: when stock level falls to 600 units, a new order should be placed
● Discuss the trade-off: higher safety stock reduces stockout risk but increases carrying cost — link back to service
level policy
Q7. Explain the classification and codification of stock. Discuss different methods of codification with their
advantages.
Answer outline:
● Explain need for scientific classification (large variety of items, need for systematic control)
● Bases of classification: nature of item, source, value, usage, criticality
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● Explain codification: definition, purpose (unique identification)
● Methods: Numeric, Alphabetic, Alpha-numeric/mnemonic, Colour coding — explain each with example
● Advantages: eliminates duplication, aids computerization, quick identification, reduces errors, supports
standardization
● Mention relationship with ABC/VED/FSN classification for comprehensive inventory control system
Q8. Describe the complete procedure of stock control in an organization, from purchase requisition to physical
verification.
Answer outline:
● Explain stock control objectives: right quantity, right time, minimum cost, avoiding both overstocking and stockouts
● Step-by-step procedure (expand each in detail): requisition → purchase order → receipt & inspection (GRN) →
storage & bin card → issue against requisition → stores ledger updating → physical verification (perpetual
inventory system vs periodic stock-taking)
● Discuss documents used: Bin card, Stores Ledger, Goods Received Note, Material Requisition Slip
● Explain min-max stock levels: Minimum level, Maximum level, Reorder level, Danger level, Average stock level
with brief formulas
● Conclude with importance of an effective stock control procedure for cost efficiency and uninterrupted operations
Quick Formula Sheet (for last-minute revision)
Concept Formula
EOQ √(2DCₒ/Cₕ)
EBQ/EPQ √(2DCₒ/Cₕ) × √(p/(p−d))
Reorder Point (Avg. daily demand × Lead time) + Safety Stock
Safety Stock (Max. daily usage − Avg. daily usage) × Lead time
Total Inventory Cost (D/Q)Cₒ + (Q/2)Cₕ
Minimum Stock Level Reorder Level − (Avg. usage × Avg. lead time)
Maximum Stock Level Reorder Level + Reorder Qty − (Min. usage × Min. lead time)
Danger Level Avg. usage × Lead time for emergency purchase