Inventory Management

Nature of Inventory
Stocks

of manufactured
products and the material that
make up the product.
Components:
raw materials
work-in-process
finished goods

Financial Management, Ninth Edition

I M Pandey
Vikas Publishing House Pvt. Ltd.

Need for Inventories

Transaction

motive
Precautionary motive
Speculative motive

Financial Management, Ninth Edition

I M Pandey
Vikas Publishing House Pvt. Ltd.

Objectives of Inventory
Management
Ensure

a continuous supply of raw

materials to facilitate uninterrupted
production
Maintain sufficient stock of raw materials
in periods of short supply and anticipate
price changes
Maintain sufficient finished goods
inventory for smooth sales operations
and efficient customer service
Minimise the inventory costs
Control inventory investment by
maintaining optimum inventory
Financial Management, Ninth Edition
I M Pandey
Vikas Publishing House Pvt. Ltd.

Key Inventory Terms

Lead

time: time interval between

ordering and receiving the order
Holding (carrying) costs: cost to
carry an item in inventory for a
length of time, usually a year
Ordering costs: costs of ordering
and receiving inventory
Shortage costs: costs when
demand exceeds supply
125

Effective Inventory Management

A

system to keep track of

inventory

reliable forecast of demand

Knowledge

of lead times

Reasonable

estimates of

Holding costs
Ordering costs
Shortage costs
A

classification system
126

Economic Order Quantity Models

Economic

order quantity (EOQ)

model
The order size that minimizes total
annual cost
Economic
Quantity

production model

discount model

127

Assumptions of EOQ Model

Only

one product is involved

Annual

demand requirements

known
Demand

is even throughout the

year
Lead

time does not vary

Each

order is received in a single

delivery

128

EOQ

Annual Cost

The Total-Cost Curve is U-Shaped

Ordering Costs
Q
(optimal
order quantity)
O

Order
Quantity (Q)
129

Deriving the EOQ

Using calculus, we take the
derivative of the total cost function
and set the derivative (slope) equal
to zero and solve for Q.
Q OPT =

2AO
2(Annual Demand)(Order or Setup Cost)
=
C
Annual Holding Cost

1210

Inventory Management
Techniques
Reorder

point under
certainty: is the inventory
level at which an order
should be placed to
replenish the inventory.
lead time
average usage
Reorder point = Lead time x average usage

11

Financial Management, Ninth Edition

I M Pandey
Vikas Publishing House Pvt. Ltd.

For

eg if the lead time is three

weeks and average usage is 50
units per week
Reorder point = 50 X 3 = 150
If there is no lead time the new
order will be place at the end of
tenth week
But if lead time is 3 weeks, the
new order will be placed at the
end of seventh week, when there

If delivery is not instantaneous, but there

is a lead time L:
When to order? How much to order?

Inventory

Order
Quantity
Q

Lead Time
Place
order

Receive
order

Time

Reorder point under

uncertainty
safety stock
Reorder point = (Lead time x average
usage) + safety stock

ABC Inventory Control

system
ABC

analysis

classify inventory into three categories according to

value
In this technique the inventories are classified on the
basis of their values
The high value items are classified as A items and
would be under the tightest control.
C items represent relatively least value and would be
under simple control.
B items falls between these two categories and
requires reasonable attention of management
control by importance and exception: maximum
attention to A items
15

Financial Management, Ninth Edition

I M Pandey
Vikas Publishing House Pvt. Ltd.

Classify the following items using the A, B and C method of

inventory classification:
Item Serial No. Annual Usage units)

1
2
3
4
5
6
7
8
9
10

12000
2000
4000
7000
200
1200
600
1200
300
70

0.5
100
80
1.5
1.2
0.8
50
0.4
0.6
500

Price per unit (in Rs)