INVENTORY CONTROL

Definition of Inventory
Inventory is an idle resource of any kind, which has some economic value
or
Inventory is the material held in an idle or incomplete state awaiting future sale, use, or
transformation
Types of Inventory
• Production Inventories
• MRO Inventories
• In-process Inventories
• Finished Goods Inventories
Functions of Inventory
Ø Inventory exists because supply and demand are difficult to synchronize perfectly
and it takes time to perform material-related operations
Ø Supply and demand frequently differ in the rates at which they respectively
provide and require stock
Ø These reasons can be best explained by four functional factors of inventory
- time, discontinuity (decoupling), uncertainty and economy
Time factor
q Enables an organisation to reduce the lead time in meeting demand
Discontinuity Factor
q Allows the treatment of various dependent operations in independent an
economical manner
Uncertainty Factor
q Concerns unforeseen events that modify the original plans of the organisation
Economy Factor
q Enables the organisation to purchase or produce items in economic quantities
Note
v Inventory is a necessary part of doing business
v The functional factors explain the existence of inventory; this does not mean that
attempts at its reduction should not be pursued
v Inventory can hide operational problems or make problems easier to live with
v It is more desirable to eliminate problems than to cover them up with excess
inventory
INVENTORY PROBLEM CLASSIFICATION
1) Repetitiveness
a) Single order
b) Repeat order
2) Supply Source
a) Outside supply
b) Inside supply
3) Knowledge of Demand
a) 1) Constant demand
2) Variable demand
b) 1) Independent demand
2) Dependent demand
(See fig. 1 which shows the distinction between Independent and dependent
demand)
4) Knowledge of Lead Time
 a) Constant lead time
b) Variable lead time
5) Inventory System
a) Perpetual
b) Periodic
c) Material requirements planning
d) Distribution requirement planning
e) Single order quantity

Fig. 1 Independent versus Dependent Demand

PROPERTIES OF INVENTORY
Common Properties
- Demand, Replenishments, Constraints and costs
Demand
• Categorized according to size, rate and pattern
• Size refers to magnitude and has the dimension of quantity
• Size is same from period to period - constant otherwise - variable
• Size – known- deterministic
- not known- probabilistic-discrete or continuous
• Rate is the demand size per unit of time
• Pattern refers to how units are withdrawn from inventory
Replenishments
• Categorised according to size, pattern and lead time
• Size – quantity to be received into inventory
- constant or variable
• Pattern – how units are added to inventory
- instantaneous, uniform or batch
• Lead time – length of time between the decision to replenish an item and its actual
addition to stock
- constant or variable
Constraints
• Limitation placed on the inventory system
 Space constraints, capital constraints
INVENTORY COSTS
1. Purchase cost
2. Order/setup cost
3. Holding Cost
4. Stockout cost
In the inventory analysis relevant costs are considered
Purchase Cost
• Unit purchase price - from an external source
• Unit production cost – produced internally
• Unit production cost includes direct labour, direct material and factory overhead
Order/Setup Cost
• Expense of issuing a purchase order to an outside supplier or from internal
production setup costs
• Vary directly with number of orders or setups
• Order cost includes transportation cost, and cost for requisition, analysing
vendors, writing purchase orders, transportation cost to transport the order
quantity, receiving materials, inspecting materials, following up orders and doing
the process necessary to complete the transaction
Holding Cost or Carrying Cost
• Cost associated with investing in inventory and maintaining the physical
investment in storage
• Contains capital costs, taxes, insurance, handling, storage, shrinkage,
obsolescence, and deterioration
Stockout Costs
• Economic consequence of an external or an internal shortage
• External shortage – when customer’s order is not filled
• Internal Shortage – When an order of a group or department is not filled
• External shortages can incur backorder cost, present profit loss and future profit
loss
• Internal shortage can result in lost production and delay in completion date

GOALS OF MATERIALS MANAGEMENT

Major goals
• Minimise inventory investment
• Maximise customer service
• Assure efficient plant operation
Common Subgoals
• Low unit cost
• High inventory turnover
• Consistency of quality
• Favourable supplier relation
• Continuity of supply
Inventory turnover
• A performance measure for inventory control
• It is the velocity with which materials move through the organisation
• It is the ratio of the annual cost of goods sold to the average or current inventory
investment
• For a company these values can be obtained from financial statement
o Cost of good sold from income statement
o Inventory investment from balance sheet – average of opening balance and
closing balance
• This ratio computes the number of times the inventory has turned over during a
year