Chapter 4

INVENTORY CONTROL

‘Besides gravity, nothing keeps me down.’

Industrial Engineering and Management, BME III/II

 Course outline
 Economic Order Quantity.
 Safety stock, Re-order point, Lead
time.
 ABC analysis

Industrial Engineering and Management, BME III/II

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 Inventory control
Inventory is defined as the list of movable goods which
helps directly or indirectly in the production for sale.
Inventory is a service to production. It is just a sort of
investment in the form of raw materials, tools, gauges,
supplies etc.
Classification of inventories
1. Direct inventories
a. Raw materials.
b. In process inventories (work in progress).
c. Purchased parts.
d. Finished goods.
2. Indirect inventories
a. Tools (standard and hand tools).
b. Supplies (miscellaneous).

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Inventory control
Inventory control may be defined as the scientific
method of finding how much stock should be
maintained in order to meet the production demands
and be able to provide right type of material at right
time in the right quantities and at competitive price.

Industrial Engineering and Management, BME III/II

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 Inventory control

Factors affecting material planning

• Macro factors – Price trends, business cycles,
government import policy, credit policy
• Micro factors – Corporate objectives, plant capacity
(and utilization), rejection rates, inventory levels, lead
time etc.

Objectives of inventory management

• Provide acceptable level of customer service (on-time
delivery)
• Allow cost-efficient operations
• Minimize inventory investment

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 Inventory control

Relevant inventory costs

Purchase cost: It is the actual price paid for procurement of
items. Its unit of measurement is in Rs. Per unit.
Purchase cost = price per unit (Cu) x demand per unit time (S)
Where, Cu = unit cost and S = annual demand.

Ordering cost: It is the cost of placing an order from a vendor.

This includes all costs incurred from calling for quotations to
the point at which the item is taken into stock.
If S = annual requirement then
Annual cost of ordering = S x Co/q

Industrial Engineering and Management, BME III/II

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 Inventory control
Holding (carrying) Costs: The costs incurred in
maintaining the stores in the firm. It includes storage
cost, cost of obsolescence, cost of deterioration and
spoilage, cost of insurance, cost of capital etc.
Annual carrying cost = Cu x i x q/2
Where, i = interest rate and q = order quantity.

Shortage Costs: Loss of customer goodwill, back order

handling, and lost sales

Total inventory cost = Purchase cost + Inventory carrying

cost + Ordering cost + Shortage cost.

Industrial Engineering and Management, BME III/II

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 Inventory control

Order quantity strategies

Lot-for-lot: Order exactly what is needed for the
next period
Fixed-order quantity: Order a predetermined
amount each time an order is placed
Min-max system: When on-hand inventory falls
below a predetermined minimum level, order
enough to refill up to maximum level
Order n periods: Order enough to satisfy demand
for the next n periods

Industrial Engineering and Management, BME III/II

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 1. Economic Order Quantity

Three Mathematical Models for Determining Order

Quantity
• Economic Order Quantity (EOQ or Q System)
– An optimizing method used for determining order quantity
and reorder points
– Part of continuous review system which tracks on-hand
inventory each time a withdrawal is made
• Economic Production Quantity (EPQ)
– A model that allows for incremental product delivery
• Quantity Discount Model
– Modifies the EOQ process to consider cases where
quantity discounts are available

Industrial Engineering and Management, BME III/II

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 1. Economic Order Quantity
Economic Order Quantity
It is the order quantity which will minimize the total variable cost
of managing the inventory.
In determining ‘Economic Order Quantity’ it is assumed that the
cost of managing the inventory costs of two parts i.e.
Total annual costs = annual ordering costs + annual holding costs

EOQ Assumptions:
– Demand is known & constant - no safety stock is required
– Lead time is known & constant
– No quantity discounts are available
– Ordering (or setup) costs are constant
– All demand is satisfied (no shortages)
– The order quantity arrives in a single shipment

Industrial Engineering and Management, BME III/II

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 1. Economic Order Quantity
Determining Inventory Level
Maximum Level

Average Inventory
Inventory Level

Reorder Level

Cycle Time Lead

Time Period Time

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1. Economic Order Quantity

Economic Order Quantity

(EOQ)
2×𝐶𝑜×𝑆
=√
𝐶𝑢×𝑖

Total variable cost of managing

the inventory per year,
𝑆
E = 𝐶𝑜 × + 𝐶𝑢 × 𝑖 × 𝑞/2
𝑞

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1. Economic Order Quantity
A company requires 16000 units of raw material costing Rs. 2 per unit.
The cost of placing an order is Rs. 45 and the carrying costs are 100% per
year per unit of the average inventory. Determine:
i. The economic order of quantity
ii. Cycle time
iii. Total variable cost of managing the inventory.
Solution:
Now, S = 16000, C0 = Rs. 45, Cu = Rs. 2, i = 0.1
2×𝐶𝑜×𝑆 2×45×16000
i) EOQ = √ =√ = 2684 units.
𝐶𝑢×𝑖 2×0.1
ii) Cycle time = 1/(No. of orders/year) = 1/(16000/2684) year = 2
months
iii) Total variable cost of managing the inventory
(E) = Co.S/qo + Cu.i.qo/2 = 45*6 + (2*0.1*2684)/2 = RS. 538.4

Industrial Engineering and Management, BME III/II

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2. Safety stock, Re-order point, Lead time

Industrial Engineering and Management, BME III/II

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 2. Safety stock, Re-order point, Lead time

Safety stock
It refers to the items of inventory kept in stock as an insurance stock to
meet the fluctuations in demand or lead time.

Lead time
The time between placement of the requisition of an item and its
receipt for actual use is called delivery lag or lead time.

Re-order point
It is pre-known that it takes days between initiating the order and
receiving the required quantity. Re-order point indicates that at this
time the purchase order should be initiated and if not done so, the
inventory may exhaust and even the reserve stock utilized before the
new material arrives. It may result in stoppage of production.

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 3. ABC analysis

It is also known as Always Better Control

It divides inventories into three groupings in terms of
percentage of number of items and percentage of total
value.
A – items: constitutes about 10 % of the total number
of items and 70 % of the total money value for all
items.
B – items: constitutes about 20 % of the total number
of items and 20 % of the total money value for all
items.
C – items: constitutes about 70 % of the total number
of items and 10 % of the total money value for all
items.
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 3. ABC analysis

Value
A
(A)

Percentage of Value
Items
10 % 70 %
20% (B) 20 %
B Items

70 % (C) 10 %
C Items

Number
Percentage of Numbers

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 3. ABC analysis

Objectives of ABC analysis

• It enables selective control
• The degree of control related to materials
planning, forecasting, ordering, review,
records, postings, revisions, lead time analysis,
safety stock etc. is rigorous A items, moderate
for B items and minimum for C items.
• It is helpful to rationalize the number of
orders and reduce the overall inventory.

Industrial Engineering and Management, BME III/II

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 3. ABC analysis

Control policies for A Control policies for B Control policies for B

items items items
• Should be ordered • General in between • The safety stock
more often, but in those for A and C. should be liberal
small quantities to • Order for these items (requirement of 3
reduce capital locked must be placed less months or more).
up. frequently. • Annual or six-
• Future requirement • The safety stock monthly orders
must be planned. should be medium (3 should be placed to
• Purchases and stock months or less). reduce paper work
should be looked by and ordering cost
• B items are subjected and to get advantage
top executives. to moderate control of quantity discount
• Ordering quantities, for large orders.
re-order point and
maximum stock • In case of these
should be revised items only routine
more frequently. check is required.

Industrial Engineering and Management, BME III/II

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Industrial Engineering and Management, BME III/II 20