Meaning of Inventory
Inventory generally refers to the materials in stock. It is also called the idle resource of an enterprise. Inventories represent those items which are either stocked for sale or they are in the process of manufacturing or they are in the form of materials, which are yet to be utilized. The interval between receiving the purchased parts and transforming them into final products varies from industries to industries depending upon the cycle time of manufacture. It is, therefore, necessary to hold inventories of various kinds to act as a buffer between supply and demand for efficient operation of the system. Thus, an effective control on inventory is a must for smooth and efficient running of the production cycle with least interruptions.
Reasons for Keeping Inventories
Meaning of Inventory Control
Inventory control is a planned approach of determining what to order, when to order and how much to order and how much to stock so that costs associated with buying and storing are optimal without interrupting production and sales. Inventory control basically deals with two problems:
These questions are answered by the use of inventory models. The scientific inventory control system strikes the balance between the loss due to non-availability of an item and cost of carrying the stock of an item. Scientific inventory control aims at maintaining optimum level of stock of goods required by the company at minimum cost to the company.
Objectives of Inventory Control
Benefits of Inventory Control
It is an established fact that through the practice of scientific inventory control, following are the benefits of inventory control:
Techniques of Inventory Control
In any organization, depending on the type of business, inventory is maintained. When the number of items in inventory is large and then large amount of money is needed to create such inventory, it becomes the concern of the management to have a proper control over its ordering, procurement, maintenance and consumption. The control can be for order quality and order frequency. The different techniques of inventory control are: (1) ABC analysis, (2) HML analysis, (3) VED analysis, (4) FSN analysis, (5) SDE analysis, (6) GOLF analysis and (7) SOS analysis. The most widely used method of inventory control is known as ABC analysis. In this technique, the total inventory is categorized into three sub-heads and then proper exercise is exercised for each sub-heads.
The classification of ABC analysis is shown by the graph given as follows.
Once ABC classification has been achieved, the policy control can be formulated as follows:
Very tight control, the items being of high value. The control need be exercised at higher level of authority.
Moderate control, the items being of moderate value. The control need be exercised at middle level of authority.
The items being of low value, the control can be exercised at gross root level of authority, i.e., by respective user department managers.
ECONOMIC ORDER QUANTITY (EOQ)
Inventory models deal with idle resources like men, machines, money and materials. These models are concerned with two decisions: how much to order (purchase or produce) and when to order so as to minimize the total cost.
For the first decision how much to order, there are two basic costs are considered namely, inventory carrying costs and the ordering or acquisition costs. As the quantity ordered is increased, the inventory carrying cost increases while the ordering cost decreases. The ‘order quantity’ means the quantity produced or procured during one production cycle. Economic order quantity is calculated by balancing the two costs. Economic Order Quantity (EOQ) is that size of order which minimizes total costs of carrying and cost of ordering.
i.e., Minimum Total Cost occurs when Inventory Carrying Cost = Ordering Cost
Economic order quantity can be determined by two methods:
Inventory cost curve
The data calculated in a tabular column can plotted showing the nature of total cost, inventory cost and ordering cost curve against the quantity ordered .
The XYZ Ltd. carries a wide assortment of items for its customers. One of its popular items has annual demand of 8000 units. Ordering cost per order is found to be Rs. 12.5. The carrying cost of average inventory is 20% per year and the cost per unit is Re. 1.00. Determine the optimal economic quantity and make your recommendations.
The table and the graph indicates that an order size of 1000 units will gives the lowest total cost among the different alternatives. It also shows that minimum total cost occurs when carrying cost is equal to ordering cost.
This fundamental situation can be shown on an inventory-time diagram, with Q on the vertical axis and the time on the horizontal axis. The total time period (one year) is divided into n parts.
The most economic point in terms of total inventory cost exists where,
Inventory carrying cost = Annual ordering cost (set-up cost)
Average inventory = 1/2 (maximum level + minimum level)
= (Q + 0)/2 = Q/2
Total inventory carrying cost = Average inventory × Inventory carrying cost per unit
i.e., Total inventory carrying cost = Q/2 × C1= QC1/2… (1)
Total annual ordering costs = Number of orders per year × Ordering cost per order
i.e.,Total annual ordering costs = (D/Q) × C3= (D/Q) C3 … (2)
Now, summing up the total inventory cost and the total ordering cost, we get the total inventory cost C(Q).
i.e., Total cost of production run = Total inventory carrying cost
+ Total annual ordering costs
C(Q) = QC1/2 + (D/Q)C3(cost equation) …(3)
But, the total cost is minimum when the inventory carrying costs becomes equal to the total
annual ordering costs. Therefore,
QC1/2 = (D/Q)C3
or QC1= (2D/Q)C3or Q2= 2C3D/C1
Then, optimal quantity (EOQ), Q0=
√2 ×16× 1800
=82.8 or 83 lubricants (approx)
A manufacturing company purchase 9000 parts of a machine for its annual requirements ordering for month usage at a time, each part costs Rs. 20. The ordering cost per order is Rs. 15 and carrying charges are 15% of the average inventory per year. You have been assigned to suggest a more economical purchase policy for the company. What advice you offer and how much would it save the company per year?
Given data are:
Number of lubricants to be purchased, D = 9000 parts per year
Cost of part, Cs= Rs. 20
Procurement cost, C3= Rs. 15 per order
Inventory carrying cost, CI = C1= 15% of average inventory per year
= Rs. 20 × 0.15 = Rs. 3 per each part per year
Then, optimal quantity (EOQ), Q0=
√2 ×15× 300
= 300 units
and Optimum order interval, (t0) =
1 × 365
Minimum average cost=
=√2 ×3 ×15 ×9000
= Rs. 900
If the company follows the policy of ordering every month, then the annual ordering cost is = Rs 12 × 15 = Rs. 180
Lot size of inventory each month = 9000/12 = 750
Average inventory at any time = Q/2 = 750/2 = 375
Therefore, storage cost at any time = 375 × C1 = 375 × 3 = Rs. 1125
Total annual cost = 1125 + 180 = Rs. 1305
Hence, the company should purchase 300 parts at time interval of 1/30 year instead of ordering 750 parts each month. The net saving of the company will be = Rs. 1305 – Rs. 900 = Rs. 405 per year.
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