Inventory Control
Module V
By: Dr. ANUPAM JAIN
Associate Professor ABS
M. No. 9414443463
Meaning
Material Control may be defined as the systematic control
over the procurement, storage and usage of material so as
to maintain an even flow of materials and avoiding at the
same time excessive investment in inventories. Thus
material control involves efficient functioning of the
following operations:
Operations involved in Material Control
➢ Purchasing of Material
➢ Receiving of Materials
➢ Inspection of Material
➢ Storage of Material
➢ Issuing of Materials
➢ Maintenance of Inventory Record
➢ Stock Audit
Objectives of Materials Control
To enable uninterrupted production
To ensure requisite quality of materials
To minimise wastage
To fix responsibility
To provide information
Balanced Storage
Reduction in production cost
Regular issue of Material
Needs of Material Control
1. For keeping the stock of raw materials within limits in the stores i.e., to avoid overstocking and
understocking of raw materials, materials control is significant.
2. It ensures proper storage of materials. For the proper preservation and safety of materials,
adequate storage facilities are to be provided. With the help of proper storing of materials,
quantity of materials as and when required can be issued to various jobs.
3. For knowing proper cost of production, control over materials is indispensable.
4. Certain techniques and methods are developed under the system of materials control thereby
ensuring optimum utilisation of materials.
5. In order to undertake continuous checking of materials, the necessity of a proper system of
materials control cannot be ignored.
6. A well managed system of materials control ensures the availability of different kinds of
materials without delay.
Material Control Techniques
Economic
Turnover
Level of Stock Order Quantity ABC Analysis
Analysis
(EOQ)
Two-Bin VED Analysis
JIT Analysis FNSD Analysis
System
1 Level of Stock
In order to have proper control on materials, the following levels are
set:
(a) Re-order Level
(b) Minimum Stock Level
(c) Maximum Stock Level
(d) Average Stock Level
(e) Danger Stock Level
(a) Re-order Level
It is the point at which if stock of a particular material in store
approaches, the storekeeper should initiate the purchase requisition
for fresh supplies of that material.
Re-ordering level can be calculated by applying the following formula:
ROL= Maximum Consumption x Maximum Re-order Period
(b) Minimum Stock Level
This represents the minimum quantity of the material which must be
maintained in hand at all times. The quantity is fixed so that
production may not be held up due to shortage of the material.
Minimum Stock Level can be calculated by applying the following
formula:
Min. St. Level= ROL – Normal Consumption x Normal Re-
order Period
(c) Maximum Stock Level
It represents the maximum quantity of an item of material which can
be held in stock at any time. Stock should not exceed this quantity.
The quantity is fixed so that there may be no overstocking.
Maximum Stock Level can be calculated by applying the following
formula:
Max. St. Level= ROL+ ROQ – (Minimum Consumption x
Minimum Re-ordering Period)
(d) Average Stock Level
It represents the average of maximum and minimum stock level.
This level is calculated by the following formula:
Average Stock Level = Minimum Stock Level + 1/2 of Re-
order Quantity or 1/2 (Minimum Stock Level + Maximum
Stock Level)
(e) Danger Stock Level
This means a level at which normal issues of the material are stopped
and issues are made only under specific instructions. The purchase
officer will make special arrangements to get the materials which
reach at their danger levels so that the production may not stop due to
shortage of materials.
This level is calculated by the following formula:
Danger Level = Min consumption x Min. re-order period for
emergency purchases
Alternate formula for Level of Stock
a) Re-order Level: (L * UR) + S
where : L = Lead Time UR= Usage Rate per day S= Safety Stock
b) Minimum Stock Level= Safety Stock
c) Maximum Stock Level= Safety Stock+ EOQ/ROQ
d) Average Stock Level= ½ (Minimum Stock Level + Maximum Stock
Level)
Examples 1
Solution 1
1 ROL: 3 Min. Stock Level:
Component A: (225*6)= 1350 Units Component A: 1350 – ( 150*5)= 600 Units
Component B: (225*4)= 900 Units Component B: 900 – (150*3)= 450 Units
2 Max. Stock Level: 4 Average Stock Level:
Component A: (1350+1200) - (75*4)= 2250 Units Component A: ½ (600+2250)= 1425 Units
Component B: (900+1800) – (75*2)= 2550 Units Component B: ½ (450+2550)= 1500 Units
Example 2
a) Maximum Stock of A: (8000+10000)-(1750*1)= 16250 Kg
b) Maximum Stock of B: (4750+5000)-(700*3)= 7650 Kg
c) Re-Order Level of C: 1350*4 = 5400 Kg
d) Average Stock Level of A: ½ ( 4000+16250)= 10125 Kg
* Min Stock Level of A: 8000- (2000*2)= 4000 Kg
Example 3
Solution 3
2 Economic Order Quantity (EOQ
Economic order quantity (EOQ) is the order size that minimizes the sum of ordering
and holding costs related to raw materials or merchandise inventories. In other words, it
is the optimal inventory size that should be ordered with the supplier to minimize the
total annual inventory cost of the business. Other names used for economic order
quantity are optimal order size and optimal order quantity.
Thus EOQ is that quantity which is to be ordered economically. This consist of two
factors namely:
➢ Carrying Cost (CC)
➢ Ordering Cost (OC)
We will discuss the above in next slides…
Carrying Cost
The Carrying Costs (also known as holding costs ) are the costs
that are incurred to hold the inventory in a store or warehouse. The
total holding cost usually depends upon the size of the order placed
for inventory. Mostly, the larger the order size, the higher the annual
holding cost and vice versa. The total holding cost is some time
expressed as a percentage of total investment in inventory.
Carrying Cost Includes….
➢ Material Handling Cost
➢ Cost of storage space which could have been utilised for some other purpose.
➢ Cost of bins and racks that have to be provided for the storage of materials.
➢ Cost of maintaining the materials to avoid deterioration.
➢ Amount of interest payable on the money locked up in the materials.
➢ Cost of spoilage in stores and handling.
➢ Cost of obsolescence on account of some of the materials becoming obsolete after some time of
storage either due to change in the process or product.
➢ Insurance cost.
➢ Clerical cost etc.
Ordering Cost
The Ordering Costs are the costs that are incurred every time an
order for inventory is placed with the supplier. The total ordering cost
usually varies according to the frequency of placing orders. Mostly, it
is directly proportional to the number of orders placed during the year
which means If the number of orders placed during the year
increases, the annual ordering cost will also increase and if, on the
other hand, the number of orders placed during the year decreases,
the annual ordering cost will also decrease.
Ordering Cost Includes….
➢ The salaries of the staff associated with the placing, processing
and expediting of purchase orders.
➢Freight costs incurred with respect to every purchase.
Relation between the ordering and
holding cost:
There is an inverse relationship between ordering cost and holding cost.
Keeping the annual demand constant if for example the number of orders
decreases, the ordering cost will also decrease but the holding cost will rise
and vice versa.
Thus, The quantity to be ordered should be such which minimises the
carrying and ordering costs. This quantity is known as “Economic Order
Quantity”
Therefore EOQ is that Quantity on which OC is equal to CC.
Formula of EOQ
𝟐𝑹𝑶
EOQ=
𝑪 𝒐𝒓 𝑼𝑰
EOQ = Quantity to be ordered.
R = Annual Consumption of the material concerned in units.
O = Cost of placing one order.
C = Carrying Cost Per Unit i.e. holding costs of inventory per unit.
U= Cost Per Unit
I = percentage of Carrying Cost
Example 4
A unit of material X costs Rs 50 and the yearly consumption is
20,000 units. The cost of placing one order including the cost of
receiving the material is Rs 20 and the interest including variable
storage cost is 10% per annum. Find the EOQ.
𝟐∗𝟐𝟎𝟎𝟎𝟎 ∗𝟐𝟎
EOQ= = 400 Units Ans.
𝟓𝟎 ∗𝟏𝟎% 𝒐𝒓 𝟓
Example 5
Solution 5
𝟐∗𝟖𝟎𝟎 ∗𝟏𝟎𝟎
EOQ=
𝟑𝟎 ∗𝟏𝟎%+𝟏
𝟏𝟔𝟎𝟎𝟎𝟎
Thus EOQ= = 200 Units Ans.
𝟒
Example 6
About 50 items are required every day for a machine. A fixed cost of
Rs. 50 per order is incurred for placing an order. The inventory
carrying cost per item amounts to Rs. 0.02 per day. The lead period is
32 days. Compute:
(i) Economic Order Quantity
(ii) Re-order Level.
Solution 6
Costs related to EOQ
𝑅
1. Numbers of Orders in a year = 𝐸𝑂𝑄
𝑅
2. Ordering Cost (OC) = 𝐸𝑂𝑄 * O
𝐸𝑂𝑄
3. Carrying Cost (CC) = 2
*C
4. Total Variable Cost = OC + CC
5. Purchasing Cost (PC) = R * PP/Unit
6. Total Cost (TC) = PC + OC + CC
Example 7
Solution 7
Calculation of Total Cost
Calculate the Total Cost from Example Number 5:
TC= PC + OC + CC
PC= R * PP/Unit = 800 * 30 = 24000
𝑅 800
OC = *O= * 100 = 400
𝐸𝑂𝑄 200
𝐸𝑂𝑄 200
CC = *C= * 4 = 400
2 2
Thus TC = 24000 + 400 + 400 = 24800 Rupees Ans
Quantity Discount
• A quantity discount is an incentive offered to a supplier that results in a
decreased cost per unit of goods or materials when purchased in greater numbers. A
quantity discount is often offered by supplier to entice manufacturer to purchase in
larger quantities. A typical quantity discount has the following three effects on the
income of a purchaser:
a. A saving in the form of reduced price
b. A saving in the form of reduced ordering costs
c. A loss in the form of increased total holding costs of inventory
A decision to avail the quantity discount should be taken only if the net effect (a+b-
c) of the above components on the income is positive. Or Total Cost from EOQ is greater
than Total Cost from DOQ.
Example 8
Annual demand for a particular item of inventory is 10,000 units.
Inventory carrying cost per unit per year is 20% and ordering cost is
Rs. 40 per order. The price quoted by the supplier is Rs. 4 per unit.
However, the supplier is willing to give discount of 5% for order of
1,500 units or more. Is it worthwhile to avail of the discount offer?
Solution 8
Example 9
PQR Limited produces a product which has a monthly demand of
52,000 units. The product requires a component X which is
purchased at Rs. 15 per unit. For every finished product, 2 units of
component X are required. The ordering cost is Rs. 350 per order and
the carrying cost is 12% p.a.
Solution 9
Example 10
Solution 10
3 ABC Analysis
ABC Analysis is an important plan of Material Control. This technique is also
known as ‘Always Better Control Technique’.
It is a system of inventory control. It exercises discriminating control over
different items of stores classified on the basis of investment involved. Usually
they are divided into three categories according to their importance, namely,
their value and frequency of replenishment during a period.
ABC can be understood as below:
ABC….
‘A’ category of items consists of only a small percentage i.e. about 10% of
total items handles by the stores but require heavy investment about 70% of
inventory value, because of their high price or heavy requirement or both.
‘B’ category of items are relatively less important—20% of the total items of
material handled by stores and % of investment required is about 20% of
total investment in inventories.
‘C’ category—70% of total items handled and 10% of value.
Such an analysis of material is known as ABC analysis.
Classification of Inventory in ABC Analysis
Procedure : ABC Analysis
Salient Features of ABC Analysis
Advantages of ABC Analysis
4 Turnover Analysis
Inventory Turnover Method is also a method of exercising Material Control.
The Stock/Inventory Ratio is calculated as below:
STR= Cost of Material consumed during the period
Cost of Average Stock during the period
Average stock is the average of the opening stock and closing stock.
The stock turnover ratio can also be determined in days as follows:
STR in Days = Days during the period/Inventory Turnover Ratio
STR Continues…
It is essential to compare the turnover of different kinds of material to
find out the items which are slow moving thus helping management
to avoid keeping capital locked up in such items. A low ratio is an
indicator of slow moving stock, accumulation of obsolete stock and
carrying of too much stock. On the other hand, a high turnover ratio
is an indication of fast moving stock and less investment in stock.
This can be understand by following example:
Example 11
Calculate the material turnover ratio for the year 2019 from the
following information and determine which of the two materials is
most fast moving:
Solution 11
5 Just in Time (JIT) Inventory System
➢ Keeping in view the enormous carrying cost of inventory in the stores and god-owns,
manufacturers and merchandisers are asking for more frequent deliveries with
shorter purchase- order lead times from their suppliers. Now-a-days organisations
are becoming more and more interested in getting potential gains from making
smaller and more frequent purchase orders.
➢ In other words, they are becoming interested in just-in-time purchasing system. Just-
in-time (JIT) purchasing is the purchase of material or goods in such a way that
delivery of purchased items is assured before their use or demand.
➢ Just-in-time purchasing recognizes too much carrying costs associated with holding
high inventory levels. Therefore, it advocates developing good relations with suppliers
and making timely purchases from proven suppliers who can make ready delivery of
goods available as and when need arises.
6 Two-Bin System
➢ This system is followed in small organisations which cannot afford expensive techniques
of stores control. The method is also suitable for materials of comparatively less value. The
materials are stored in bins which are divided into two compartments, (there can be two
racks, two shelves or same shelf can be divided into two).
➢ Materials are issued for production from the first compartment and the materials from the
second compartment are not touched in regular course. When the materials in the first
compartment are fully consumed, an order is placed.
➢ The second compartment of materials takes care of the consumption requirement during
the time required to get fresh delivery. The store-keeper has to divide the materials in the
two bins in such a manner that production does not hamper for the want of material. This
system has practical usage and is simple to understand and operate.
7 VED Analysis
➢ VED—vital, essential and desirable—analysis is used primarily for control of spare parts. The spare parts can
be divided into three categories—Vital, Essential or Desirable—keeping in view the criticality to
production. The spares, the stock-out of which even for a short time will stop production for quite some time
and where the cost of stock-out is very high, are known as vital spares.
➢ The spares, the absence of which cannot be tolerated for more than a few hours or a day and the cost of lost
production is high and which are essential for the production to continue, are known as essential spares. The
desirable spares are those spares which are needed but their absence for even a week or so will not lead to
stoppage of production. Some spares, though negligible in monetary value, may be vital for the production to
continue and require constant attention.
➢ Such spares may not receive the attention they deserve if they are maintained according to ABC analysis
because their value of consumption is small. So, in their cases, VED analysis is made to get the effective
results. As VED analysis analyses items based on their criticality to production, it can also be used for those
items of materials which are difficult to procure.
8 FNSD Analysis
➢ FNSD analysis divides the items of stores into four categories in the descending order of importance
of their usage rate. ‘F’ stands for fast moving items that are consumed in a short span of time. ‘N’
stands for normal moving items which are exhausted over a period of a year or so. ‘S’ indicates
slow moving items which are not issued at frequent intervals and are expected to be exhausted over
a period of two years or more.
➢ ‘D’ means dead items and the consumption of such items is almost nil. D items can also be taken as
obsolete items which have become outmoded and have no further use for the purpose they were
purchased. Stocks of fast moving items should be taken care of continuously and replenishment
orders should be placed in time to avoid stock-out of such items.
➢ Normal moving items should be reviewed at a regular span of time and orders for their replenishment
should be given at a regular period of time. Stock of slow moving items of stores should be reviewed
very carefully before any replenishment orders are placed to avoid over stocking of such items.
Alternative uses should be found for dead stock items. Otherwise, they should be disposed of as early
as possible so that their value may not deteriorate further.