FM AD 13Inventory Management

7/31/2019 FM AD 13Inventory Management

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INVENTORY

MANAGEMENT


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Inventory Management

Inventory consists of :

Raw materials

W-I-P Finished goods

Consumable stores, Spare parts, etc.

Objectives: efficient management of

inventory should ultimately result in


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Costs & Benefits of HoldingInventory

The costs of holding inventory are ordering costs andcarrying costs

Ordering Costs are the costs associated with acquisition orordering of inventory. Firms have to place orders with suppliers toreplenish inventory of raw materials. The expenses involved arereferred to as ordering costs.

Carrying costs are involved in carrying and or maintaininginventory. It can be categorized into two viz. i) Costs that arisedue to the Storing of Inventory and ii) The opportunity cost ofFunds.


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Techniques of Inventory /Material Control

Classification Problem :

ABCAnalysis

OrderQuantityProblem

:EOQ(Economic

The major problem areas that comprise the heart of

inventory control are as below and can be resolved byABC Analysis and EOQ Techniques :

i) the classification problem to determine the type ofcontrol

ii) the order quantity problemiii) the order point problemiv) safety stocks. Techniq

ues


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ABC Classification ofInventory Items

Type A items : 10% of the items in theinventory but carrying

70% of the total VALUE of inventory - deservehighest attention.

Type B items : 20% of the items in the

inventory but carrying20% of the total VALUE of inventory -requires less stringent

control

Type C items : Remaining 70% of the inventory


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Illustration

Question :A firm has 7 different items in its inventory. Theaverage number of each of these items held, alongwith their units costs is listed below. The firmwishes to introduce an A B C inventory system.

Suggest a breakdown of the items into A, B & Cclassifications.

Itemnumber

Average number ofunits in inventory

Averagecost perunit (Rs.)

1 20,000 60.82 60,000 3.43 20,000 1.34 30,000 35 32,000 116 28,000 10.287 10,000 102.4


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SolutionItem

number

Average numberof units ininventory

Averagecost perunit (Rs.)

AnnualUsage(Rs.)

Rank

1 20,000 60.8 1216000 12 60,000 3.4 204000 53 20,000 1.3 26000 74 30,000 3 90000 65 32,000 11 352000 3

6 28,000 10.28 287840 47 10,000 102.4 1024000 2

Item number(based on

ranks)

Annual Usage(Rs.)

Annual Usage %(of total inventory

value 3199840) Category Assigned

1 1216000 38% A7 1024000 32% A5 352000 11% B6 287840 9% B2 204000 6% C4 90000 3% C3 26000 1% C


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Order Quantity Problem :Economic Order Quantity

(EOQ) ModelThe economic order quantity may be defined as that level ofinventory order that minimizes the total cost associated withinventory management

The costs associated with inventory are mainly :

1) Ordering costs : Requisitioning, Order placing, Transportation,Receiving, Inspection, etc.

2) Carrying costs : Storage/Warehousing , Handling, Clerical staff,Insurance, Depreciation and Obsolescence.

2EOQ =

AO

c

A = Annual usage of inventory (units)O = Buying costs per orderC = Carrying cost per unit ( CPU xCarrying cost Rate)


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Illustration

Question:1) The following details are available in respect

of a firm : Annual requirement of inventory, 40000 units Cost per unit (other than carrying & ordering

cost), Rs16

Carrying costs are likely to be 15% per year Cost of placing order, Rs 480 per order. Determine the economic order quantity.

Solution:

A = Annual Quantity = 40,000 unitsO = Buying Cost per order = Rs. 480

C = Carrying Cost per unit = ( Rs. 16 x 15%) = Rs. 2.40

EOQ = 2AO = 2 x 40,000 x Rs. 480 = 4,000 unitsC Rs. 2.40


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Order Point Problem :

EOQ provides an answer to the question;How much inventory should be ordered in one lot ?

Another important question in inventory management is;When should the order to procure inventory be placed at whatlevel of inventory?

Reorder point problem

The reorder point = Lead time in days X average daily usage ofinventory

= (delivery time x maximum usage)

Lead time is the time taken in receiving the delivery after placingorders with Suppliers

Fore.g. The avg daily consumption inventory of firm A = 5000 unitsThe lead time for that firm to receive orders is 15days

The reorder point for firm A = 15days X 5,000units = 75,000 unitsHence the firm should lace an order for re lenishin stock as soon


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Exercise

Two components A and B used as follows:

Normal usage 50 units each per week , Minimum usage 25 units each per week

Maximum usage 75 units each per week, Re-order quantity A: 300 units, B:500 units

Re-order period A: 4 to 6 weeks, B: 2 to 4 weeks

Calculate for each component:

i) Re-order level ii) Minimum level iii) Maximum level iv) Average stock level

Solution : For A component:

Re-order level = maximum usage x delivery time

= 75 x 6 weeks = 450 units

Minimum level = Re-order level (normal usage x average delivery time in weeks)


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Practice sums

Q1) G ltd. Produces a product which has a monthly demand of 4000 units.The product requires a component X which is purchased at Rs. 20. For everyfinished product, one unit of component is required. The ordering cost is Rs.120 per order and holding cost is 10% p.a. You are required to calculate theEOQ (Answer = 2400 components)

(CA inter May 1999)

Q2) A company manufactures a product from a raw material, which ispurchased at Rs. 60 per kg. The company incurs a handling cost of Rs. 360plus freight of Rs. 390 per order. The incremental carrying cost of inventoryof raw material is Re. 0.50 per kg per month. In additional, the cost ofworking capital finance on the investment in inventory of raw material is Rs.9 per kg. The annual production of the product is 100,000 units and 2.5 unitsare obtained from 1 kg of raw material. Calculate EOQ for raw materials

(Answer = Sqrt (2 x 40000 x 750) / 15* = 2000 kgs *{(0.50x12) + 9} (CA inter Nov 01)


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Question

A firm has furnished following categorization of its holding of inventory. You arerequired to suggest a break down on the items into A, B and C classification.

Item category Avg. no. of units in inventory Average CPU

1 20000 60

2 10000 100

3 32000 11

4 28000 10

5 60000 3.40 (Ca final Nov 2007)

Solution

Units Rate value %of total Cumm Class

1 20000 60 1200000 0.3953 A

2 10000 100 1000000 0.3294 0.7246 A

3 32000 11 352000 0.1159 B

4 28000 10 280000 0.0922 0.2082 B

5 60000 3.4 204000 0.0672 0.0672 C

3036000 1.0000 1.0000

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FM AD 13Inventory Management

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