Inventory management
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Inventory Management. Inventory System Defined. Purposes of Inventory. Objective of Inventory Control. To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds Level of customer service Costs of ordering and carrying inventory.

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Inventory Management

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Inventory management


Inventory system defined

Inventory System Defined

Purposes of inventory

Purposes of Inventory

Objective of inventory control

Objective of Inventory Control

  • To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds

    • Level of customer service

    • Costs of ordering and carrying inventory

Independent vs dependent demand

Independent vs. Dependent Demand

Independent Demand (Demand not related to other items or the final end-product)

Dependent Demand

(Derived demand items for component parts,


raw materials, etc.)


Inventory planning

Inventory Planning

  • Finished goods and spare parts typically belong to independent demand items in manufacturing organisations

  • Inventory planning of items must address the following two key questions:

    • How much?

    • When?

Relationship of functional roles

Relationship of Functional Roles



Marketing Goals

Production Goals

Finance Foals

Inventory Goals

Inventory decisions are directly related to production plans and capacity of production

Why inventory is important

Why Inventory is Important

On the balance sheet it represents about 30 to 50 % of the assets.


Inventory Turns is the ratio of the annual sales to the investment in inventory

For ex, if the annual sales is 200 million and the investment in inventory is 40 million then the ratio is 5. It shows how effectively inventory is used.

Days of .supply is the ratio of inventory on hand to the avg daily usage.

Types Of Inventory:

Raw material


Finished goods.

Distribution inventories

MRO items (Maintenance, Repairs and Operational Suppliers

Inventory management

  • Substantial improvement in the productivity of inventory can be achieved by re-engineering supply chain processes.

  • Poor inventory management may lead to stock outs and hence cancellation of customers orders, overstocking leading to insufficient storage space and increase in the number and rupee value of obsolete products.

  • Consequently, inventory management has a large financial impact on the firm.

  • Investments blocked in inventory cannot be used to obtain other goods or assets that could improve the enterprise performance.

Types of inventory

Types of Inventory

  • Cycle Stock/ Lot size

    It is portion of inventory that depleted as customer orders come in

    and replenished as suppliers orders are received. Periodic

    replenishment is required.

    Example hospital ordering 10000 syringes and daily use is 500.

    If Q is the order quantity per cycle then average inventory = Q/2

  • Transportation/Pipeline Inventory:

    Exists because of the time needed to move the goods from one

    location to another such as plant to distribution center called as

    Pipeline or movement inventories.

  • Safety Stock

    is held to cover the unpredictable fluctuations in supply or demand or

    lead time, so that stock out will not happen.

Cyclic pipeline and safety stocks a graphical illustration

Cyclic, Pipeline and Safety StocksA graphical illustration

Cyclic Stock


Pipeline inventory

Safety stock



Cyclic inventory, pipeline inventory and safety stocks are critically linked to “how much” and “when” decisions in inventory planning

Types of inventory1

Types of Inventory

  • Anticipation inventory / Seasonal these are built up in anticipation of a future demand for example, ahead of a peak selling season, promotion etc.

  • Dead stock- It is obsolete stock – that part of the non moving inventory that is unlikely to be of any further use. Example electronics

  • Decoupling Inventory Complexity of production control is reduced by splitting manufacturing into stages and maintaining inventory between these stages

Costs in inventory planning carrying cost

Costs in Inventory PlanningCarrying Cost

  • Interest for short-term borrowals for working capital

  • Cost of stores and warehousing

  • Administrative costs related to maintaining and accounting for inventory

  • Insurance costs, cost of obsolescence, pilferage, damages and wastage

  • All these costs are directly related to the level of inventory

Costs in inventory planning ordering cost

Costs in Inventory PlanningOrdering Cost

  • Search and identification of appropriate sources of supply

  • Price negotiation, contracting and purchase order generation

  • Follow-up and receipt of material

  • Eventual stocking in the stores after necessary accounting and verification

  • A larger order quantity will require less number of orders to meet a known demand and vice versa

Cost of carrying and cost of ordering are fundamentally two opposing cost structures in inventory planning

Costs in inventory planning shortage cost

Costs in Inventory PlanningShortage Cost

  • Costs arising out of rescheduling the production system to accommodate these changes

  • Rush purchases, uneven utilisation of available resources and lower capacity utilisation

  • Missed delivery schedules leading to customer dissatisfaction and loss of good will

  • The effects of shortage are vastly intangible, it is indeed difficult to accurately estimate

Eoq model a graphical representation

EOQ ModelA graphical representation

Sum of the two costs

Total cost of carrying

Cost of Inventory

Minimum Cost

Total cost of ordering

Level of Inventory


Order Qty.

Inventory control for deterministic demand eoq model

Inventory Control for deterministic demand: EOQ Model

Demand during the planning period = D

Order quantity = Q

The cost of ordering per order =

Inventory carrying cost per unit per unit time =

The average inventory carried by an organisation=

The cost associated with carrying inventory =

The total ordering cost is given by

Total cost of the plan =

Total cost of carrying inventory + Total cost of ordering

TC(Q)= +

Inventory control for deterministic demand eoq model1

Inventory Control for deterministic demand: EOQ Model…

Denoting EOQ by Q*, we obtain the expression of Q*as:

The optimal number of orders =

Time between orders =

Issues in using eoq model model assumptions

Issues in using EOQ ModelModel assumptions

  • The demand is known with certainty

  • Demand is continuous over time

  • There is an instantaneous replenishment of items

  • The items are sourced from an outside supplier

  • Assumptions about order quantity

    • There are no restrictions in the quantity that we can order

    • There are no preferred order quantities for the items

    • No price discount is offered when the order size is large

  • Despite this, the EOQ model could be applied with suitable modifications because it is robust

  • Q can be a minimum order quantity if EOQ value is lesser

  • Have a preferred quantity based on truckload quantity, economies of scale, quantity discounts etc

Continuous review q system an illustration

Inventory Position

Physical Inventory


Inventory Level


Mean Demand during LT


Safety Stock



Continuous Review (Q) SystemAn illustration

Periodic review p system an illustration

Inventory Position

Physical Inventory




Order Up to Level


Inventory Level


Safety Stock






Periodic Review (P) SystemAn illustration

Basic fixed order quantity model and reorder point behavior


of units

on hand








R = Reorder Point

Q = Economic Order Quantity

L = Lead Time

Basic Fixed-Order Quantity Model and Reorder Point Behavior

Inventory management

  • Use of Q and P systems

  • Q system is based on perpetual monitoring

  • Q system is less responsive to demand changes when demand declines, the ROP moves to the right and system will continue to order even if demand is less, so carrying cost may rise

  • If demand increases, ROP will happen frequently and ordering cost will increase

  • Another issue is ordering of multiple items A, B,C from the same supplier.

  • P system overcomes limitation of Q system.

  • Greater chances of linkage between MRP and planning system.

  • For high value/ A class use P system

Miscellaneous systems bin systems

Order One Bin of




Miscellaneous Systems:Bin Systems

Two-Bin System

Inventory analysis

Inventory Analysis

Product classification analysis abc

Product Classification Analysis (ABC)

Selective control of inventories alternative classification schemes

Selective Control of InventoriesAlternative Classification Schemes

  • ABC Classification (on the basis of consumption value)

  • XYZ Classification (on the basis of unit cost of the item)

    • High Unit cost (X Class item)

    • Medium Unit cost (Y Class item)

    • Low unit cost (Z Class item)

  • FSN Classification (on the basis of movement of inventory)

    • Fast Moving

    • Slow Moving

    • Non-moving

  • VED Classification (on the basis of criticality of items)

    • Vital

    • Essential

    • Desirable

  • On the basis of sources of supply

    • Imported

    • Indigenous (National Suppliers)

    • Indigenous (Local Suppliers)

Abc classification a graphical illustration

ABC ClassificationA graphical illustration

Inventory planning control chapter highlights

Inventory Planning & ControlChapter Highlights…

  • A fixed order quantity (Q system) or continuous review system of inventory planning and control is useful for B class and C class items of inventory.

    • A popular application of the continuous review system in organisations is the two-bin system.

  • A fixed order interval or a periodic review system (P system) is useful for planning and control of high value and A class items.

    • The P system is more responsive to changes in demand patterns than the Q system.

  • Selective control of inventories is achieved through alternative classification methodologies. The ABC, VED and XYZ classifications are often used by organisations.

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