CHAPTER FOUR

INVENTORY CONTROL

At the end of this chapter you will be able to:

 Explain inventory management

 Identify Functions and types of inventory
 Understand Independent vs. dependent demand
 Compute Inventory Costs, Economic Order Quantity (EOQ), Economic Production
Quantity (EPQ)
 Inventory classification systems, and Just in time (JIT)

4.1 Introduction

Inventory constitutes one of the most important elements of materials management in any
organization dealing with supply, manufacture and distribution of goods and services.
It is a major type of control system applied in most organizations.
The concept of inventory control is as old as the concept of business itself.
But the practical application of inventory management got emphasis after the Second World
War.
The development of operations research and computer technology paved the way for the
practical application of inventory management.
The choice of which items to include in inventory depends on the organization.
A manufacturing operation can have an inventory of, machines, and working capital, as well as
raw materials and finished goods.
In services, inventory generally refers to the tangible goods that are sold and the supplies
necessary to administer the service.

4.2 The meaning of inventory

The meaning of inventory can be defined in the following two ways (Ahuja; 1992):
 Inventory is an idle resource (physical stock of goods) possessing economic value which is
awaiting (kept) for future use.
Here the responsibility of materials management is to maintain sufficient inventories to
meet demand for goods and at the same time incurring the lowest inventory handling
costs.

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  Inventory is a stock of materials that are used to facilitate production or to satisfy customers’
demand.
 Inventory is the total amount of goods or materials contained in a store or factory at any given
time.
4.3 Importance and types of Inventory
4.3.1 Importance of Inventory
Inventories serve a number of functions. Among the most important are; (Stevenson; 2005)
1. To meet anticipated customer demand - A customer can be a person who walks in off the street
to buy a new stereo system, a mechanic who requests a tool.
2. To smooth production requirements - Firms that experience seasonal patterns in demand often
build up inventories during pre-season periods to meet overly high requirements.
3. To decouple operations - To provide a buffer between successive operations.
4. To protect against stock outs - Delayed deliveries and unexpected increases in demand increase
the risk of shortages.
5. To take advantage of order cycles - To minimize purchasing and inventory costs, a firm often
buys in quantities that exceed immediate requirements.
6. To hedge against price increases - Occasionally a firm will suspect that a substantial price
increase is about to occur and purchase larger-than-normal amounts to beat the increase.
7. To take advantage of quantity discounts - Suppliers may give discounts on large orders.

Motives for Holding Inventories

Organizations may hold inventories with the various motives as stated below.
1. Economies of Scale
This means that it could be economical to produce a relatively large number of items in each
production run and store them for future use. This allows the firm to amortize fixed set up costs
over a large number of units.
2. Uncertainties
Uncertainties often plays major role in motivating and firm to store inventories. Uncertainty of
external demand is the most common.
For example, a retailer stocks different items so that he/she can be responsive to consumer
preferences. If a customer requests an item that is not available immediately, it is likely that the
customer will go elsewhere. What is worse is that, the customer may not return.
Inventory provides a buffer against the uncertainty of demand.

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Uncertainty of the lead-time may also motivate an organization to hold inventories. Lead-time is
defined as the amount of time that elapses from the point that an order is placed until it arrives. In the
production-planning context, the lead-time as the time required to produce the item.
3. Speculation
If the value of an item or natural resource is expected to increase, it may be more economical to
purchase large quantities at current price and store the items for future use than to pay the higher
price at a future date. For example, silver is required for the production of photographic film. So
by correctly anticipating a major price increase in silver, a major producer of photographic film,
such as Kodak, could purchase and store large quantities of silver in advance of the increase and
realize substantial savings.

4.3.2 Types of Inventories

Although inventories are classified in many ways, the following classification is convenient for use in
further discussion of the topic (Dobler and Burt, 1996):
i. Production inventories - Raw materials, parts, and components which enter firm’s product in
the production process.
ii. MRO inventories ( supplies) - Maintenance, Repair, and Operating supplies which are
consumed in the production process but which do not become part of the product (e.g.,
lubricant, soap).
iii. In-process inventories - Semi finished products found at various stages of the production
iv. Finished goods inventories -completed products ready for shipment, or awaiting for sale.
4.4 Objectives of inventory management
Inventory management has two main concerns.
One is to have the right goods, in sufficient quantities, in the right place, at the right time.
The other is the cost of ordering and carrying inventories.
The overall objective of inventory management is to achieve satisfactory levels of customer
service while keeping inventory costs within reasonable bounds.
Specifically, inventory control has the following objective;
Minimize the investment in inventory.
Minimize warehouse costs.
Minimize losses from damage, obsolescence and perishability.
Make forecasts of inventory requirements.
Establish an inventory system (policies and regulation that monitors inventories).
Maximize customer service.
Materials Management – Inventory Control By: Yabsiel Gashaw Page 3
 Maximize the efficiency of purchasing and production.
Maximize profit.
Ensures availability of materials
Reduce chances of going out of stock.
Offers advantage of price discounts from bulk purchasing.

4.5 Inventory cost

There are four major elements of inventory costs that should be taken for analysis;
(1) Item (Purchased) costs
This is cost of the item whether it is manufactured or purchased.
If it is manufactured, it includes such items direct material and labor, indirect materials and
labor and overhead expenses.
When the item is purchased, the item cost is the purchase price of one unit.
(2) Ordering (setup) costs
These are fixed costs usually associated with the production of a lot internally or the
placing of an order externally with a vendor.
The cost associated with ordering are:
 Salaries of the staffs in the purchasing department.
 Negotiating purchases, placing orders and follow up.
 Rent for the space used by the purchasing department.
 The postage, telegram, telephone bills.
 The stationary and other consumables used by the purchasing department.
 Entertainment charges for vendors.
 Traveling expense.
 Inspecting shipment & moving goods to storage.
(3) Holding (or carrying) costs
If the item is held in stock, the cost involved is the item carrying or holding cost. Carrying
material in inventory is expensive.
(i) Opportunity cost of invested funds. When a firm purchases $50,000 worth of a
production material and keeps it in inventory, it simply has this much less cash to spend
for other purposes. This is the “opportunity cost” associated with inventory investment.
(ii) Insurance costs. Most firms insure their assets against possible loss from fire and other
forms of damage.
(iii) Property taxes. Property taxes are levied on the assessed value of a firm’s assets.

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 (iv) Storage costs. The warehouse in which a firm stores its inventory is depreciated a
certain number of dollars per year over the length of its life.
(v) Obsolescence and deterioration. In most inventory operations, a certain %age of the
stock spoils, damaged, pilfered, or eventually becomes obsolete.
(vi) Cost of maintaining inventory records
(vii) The salaries and wages of storing, receiving and issue of material personnel.
N.B: Carrying cost is directly related to the number of items
Ordering cost is directly related to the number of orders placed or indirectly related to the number of
items. I.e. ordering cost is expressed as cost / order.
When more order placed in a period, the more would be the stationary and postage consumed, more
staff and officers will be required for handling the work, the more will be the space required for
accommodating them and soon. Thus the total expenditure on or ordering would depend on the
number of orders placed. I.e. the expenditure on ordering of material is directly proportional to the
number of orders placed.
(4) Shortage (penalty or Stock-out) costs.
The cost of lost production or downtime due to stock out is considered a shortage/penalty cost.
It is the cost of not having sufficient stock on hand to satisfy demand when it occurs.
Examples of these costs are: Lost profit because of lost sales
Lost goodwill which is a measure of customer satisfaction is another
example
Measuring the above penalty costs can be very difficult in practice

4.6 Nature of demands in inventories

The demand for inventory may be dependent or independent.
Dependent Demand Items: are those items where their demand is related to the demand for
another item. This demand is also known as Derived Demand.
Independent Demand Items: are those items that are not influenced by production/operation
but by the market forces.
For example, if an automobile company plans on producing 500 automobiles per day, then
obviously it will need 2,000 tires (plus spares).
The number of tires needed is dependent on the production level for automobiles and not
derived separately.

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 The demand for automobiles, on the other hand, is independent-it comes from many sources
external to the automobile firm and is not a part of other products and so is unrelated to the
demand for other products.
4.7. Inventory Model for Independent Demand
There are a number of mathematical models that can be applied to determine the
optimum (economical) level for independent demand materials.
Some of these models are discussed in this section.
I. Economic Order Quantity (EOQ) Model
The EOQ (Economic Order Quantity) model is one method of determining the adequate
(optimum) inventory level for independent demand materials.
It is used to identify a fixed order size that will minimize the sum of the annual costs of
holding inventory and ordering inventory.
Assumptions of this model are;
- Only one product is involved. - Lead time does not vary.
- Annual demand requirement are known. - Demand is constant.
- Each order is received in a single delivery. - There are no quantity discounts
In constructing any inventory model, the first step is to develop a functional relationship between the
variables of interest and the measure of effectiveness. Thus, total cost obtained by;
Total Annual Annual Annual
Annual = Ordering + Holding + Purchase
cost cost cost cost
To develop an equation for total inventory cost and for the purpose of analyzing inventory models, the
following symbols will be used throughout the chapter.
TC = Total annual cost CO = Set up or Ordering cost
D = Annual demand in units Q = Quantity to be ordered
Cc = Carrying cost per unit P = Purchase price per unit or cost per unit.
NB: D and Cc must be in the same units, e.g., months, years.
i. Annual Ordering Cost
Annual (Number of orders (Ordering cost
Ordering cost = Placed per year) X per order)

NB - The number of orders per year will be D/Q, and hence:

D
Annual Ordering cost = Co
Q

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 ii. Annual Holding Cost
Annual
Holding cost =(average inventory value)x(inventory carrying cost as a % of inventory value)

In order to calculate the annual carrying cost (ACc) let us look at the concept of average inventory.
The concept of average e inventory is based on the following assumption ;Purchase is made at the
beginning, Usage rate is constant and the last item is used on the last date. Then the average inventory
will be Q/2 where Q is the order quantity in units.
Q
Annual holding cost = Cc
2

iii. Annual Purchase Cost

Annual purchase cost = DP

iv. Total Cost Equation.

D Q
TC = Co  Cc  DP
Q 2

So, by equating ACC with that of AOC, EOQ can be determined

At EOQ  ACC = AOC

Q/2 x CC = D/Q x OC

If we multiply both sides by Q, the result will be

(Q/2 x CC = D/Q x OC)Q (Both sides are multiplied by Q)
 Q2 x CC = D x OC
2

 Q2 x CC = D x OC
2 CC
CC
 Q2
= D x OC
2 CC

 2 (Q2 = D x OC)
2 CC

 Q2 = 2 x D x OC

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 CC

2  D  OC
 Q = (Both sides are squared)
CC

Where  Q = economic Order Quantity

D = Annual demand
OC = Ordering Cost/order
CC = Carrying Cost per Unit per Year
The above analysis can be summarized as follow
 Minimum incremental(inventory) Cost = ACC + AOC
 Minimum total Annual Cost = ACC + AOC + Purchase cost

The next step is to find that order quantity, Q, for which total cost is a minimum i.e.

2.D.Co
EOQ 
Cc
NB - Minimum Inventory Cost = ACc + ACo

Example
A local distributor for Addis Tire Company expects to approximately 9,600 steel belted tires of certain
size next year. The annual carrying cost is 16.00 Birr per tier per year and the ordering cost are 75.00
Birr per order. The distributor operates 288 days a year.
Required:
1. Determine EOQ.
2. What is the Ordering Cost per year and annual carrying cost at EOQ?
3. What is the total incremental or minimum inventory cost at EOQ
4. If purchase price per tire is 80.00 Birr. What is the total cost at EOQ?
5. How many times per year the store does reorders.
6. Determine the length of an order cycle.
7. Compute Ordering, Carrying, minimum Inventory costs & overall total costs. If order quantities
are 100, 150, 200, 250, 300, 350 and 400 units. What do you infer from this exercise?
Solution:
Given: D = 9,600Co =75.00 Birr
Cc= 16.00 BirrWorking days per year 288

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 2  D  OC
1. Q0 = Where Q0 is optimum Quantity.
CC
2  9600 75
=
16
= 300 tires per order.
2. ACc = Q/2 x Cc ACo = D/Q x Co
= 300/2 x 16 = 9,600/300 x75
= 2,400 Birr = 2,400 Birr

3. Minimum Inventory Cost = 2,400 +2,400

= 4,800 Birr
4. Total Cost = ACo + ACc+ DP
= 2,400 +2,400 +80(9600) = 772,800 Birr
5. Number of Order per year = Annual Demand = 9,600= 32 Order
Order Size 300
6. Length of Order Cycle = Annual Working Days x Q0OrAnnual Working Days
D No. of orders per year
=288 = 9 Working Days
32
7. It means the optimum quantity will be used within working days

Order ACC = AOC = Minimum Overall Total

Quantity (Q/2 x CC) (D/Q x OC) Inventory Cost Cost
100 800 7200 8000 Birr 776,000
150 1200 4800 6000 774,000
200 1600 3600 5200 773,200
250 2000 2880 4880 772,880
300 2400 2400 4800 772,800
350 2800 2057 4857 772,857
400 3200 1800 5000 773,000
450 3600 1600 5200 773,200

From this we can infer that that at EOQ, minimum inventory as well as the overall total cost
will be minimum. When the order size is large, the ACC will be high & AOC will be low.

Reorder Point (ROP)

The reorder point occurs when the quantity on hand drops to a predetermined amount.
That amount generally includes expected demand during lead time and perhaps an extra
cushion of stock.

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 Lead-time:- is defined as the time interval between the placing of the orders and the actual
receipt.
i. ROP when demand and lead time are both constant.
If demand and lead time are both constant, the reorder point is simply

ROP = d x LT

Where: d = Demand rate (units per day or week)

LT = Lead time in days or weeks.
Note: Demand and lead time must be expressed in the same time units.
Example1:
Mr. X takes two vitamins tabletsa Day, which are delivered to his home by a route man seven days
after an order is called in. At what point should Mr. X reorder?
Solution:
Usage = 2 vitamins a day
Lead time = 7 days
ROP = Usage x Lead time
= 2 vitamins per day x 7 days
= 14 vitamins
Thus, Mr. X should reorder when 14 vitamin tablets are left.
ii. Reorder point when variability is present in demand or lead time.
Variability in demand or lead time creates the possibility that actual demand will exceed
expected demand.
Consequently, it becomes necessary to carry additional inventory, called safety stock.
The reorder point then increases by the amount of the safety stock:

ROP = Expected demand + Safety stock

during lead time

Safety Stock and Service Level

Safety stock: is used in order to prevent a stock out occurring.
Service level: can be defined as the probability that demand will not exceed supply during lead
time.
Hence, a service level of 95% implies a probability of 95% that demand will not exceed supply
during lead time and 5% of stock out risk.

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 Service level = 100 % – stock out risk
The models used in this case, generally assume that any variability in demand rate or lead
time can be adequately described by a normal distribution.
The value of z used in a particular instance depends on the stock out risk that the manager is
willing to accept.
The first model can be used if an estimate of expected demand during lead time and its
standard deviation are available. The formula is:
ROP = Expected demand + zdLT
during lead time

Where: z = Number of standard deviations.

dLT = The standard deviation of lead time demand.
Example
Suppose that the manager of a construction supply house determined from historical records that
demand for sand during lead time averages 50 tons. In addition, suppose the manager determined that
demand during lead time could be described by a normal distribution that has a mean of 50 tons and a
standard deviation of 5 tons. Answer these questions, assuming that the manager is willing to accept a
stock out risk of no more than 4%:
a. What value of z is appropriate?
b. How much safety stock should be held?
c. What reorder point should be used?
Solution:
Given: Expected lead time demand = 50 tons
dLT = 5 tons
Risk = 4%
a. Service level = 100 % – stock out risk
= 1-0.04 = 0.9600
= 0.9600- 0.5000 = 0.4600
Look for the table closest to 0.4600. If you look at the table associated with a z value of 1.75, you
should see 0.4599, which is as close to 0.4600 as we can get. Therefore, the appropriate z value is 1.75.
To determine the appropriate amount of safety stock, do the following calculation:

b. Safety stock = zdLT = 1.75(5) = 8.75 tons

c.ROP = Expected lead time demand + Safety stock

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 = 50 + 8.75= 58.75 tons, round up to 59 tones.

Thus, the manager of Construction Company should reorder when 59 tons of sands are left.
II. Economic Production Quantity (Economic Run Lengths)
When the company is the producer and user of its items, the run size is the economic
production quantity (EPQ).
In other words the company is the supplier for itself.
In the determination of the EPQ the carrying cost remains the same but the ordering cost is
replaced by set-up-cost which is the cost of preparing production for operations.
Let us now derive the formula of EPQ;

Let d = Daily demand rate for the products.

P = Daily production rate for the product
T = Number of days for a production run (Inorder to produce the
Specified quantity).

When p>d;

 Daily rate of inventory build-up = p-d

 Level of inventory by the end of t-day = (p-d) x t 
Maximum inventory.
Run size  Q = pt
Run time =Q  Stated as days.
p

The maximum inventory is given above as = (p-d) x t

Since t is = Q it can also be stated as = (p-d) x Q/p
p
= (1 –d/p)x Q

And the average inventory will be = Maximum inventory

2
= Q/2 (1-d/p)
Consequently, the annual carrying cost is = Q/2 (1-d/p) x CC

The annual set-up cost (ASC) can be obtained as follows:

ASC = (No. of production run /year) x (set –up cost /year)

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 = ( D ) x Sc Where :
Q0 Q0 = run Size  EPQ
Sc = Set-up cost/year.

Q d  D 
 The Total Annual = 1    CC     Sc
2 p  Q0 

The Optimum production size will also be determined as follows;

2  D  Sc
EP Q  Q0 =
(1  d / p)  cc
Where D = Annual demand
Sc = Set-up cost /run
CC = Annual carrying cost/unit
d/p = Part of production that is not inventoried
1 - d/p = Part of production that is carried in inventory

Example 1
A toy manufacturer uses 48,000 rubber wheels per year for its popular dump- truck series. The firm
makes its own wheel, which it can produce at a rate of 800 per day. The toy trucks are assembled
uniformly over the entire year. Carrying cost is Br 1.00 per wheel a year. Set up cost for a
production and change over from the previous production is Br. 45.00. The firm operates 240 days per
year. Determine each of the following.

A) The optimum Size (EPQ)

B) The minimum total inventory cost.
C) The cycle time for the optimal size.
D) The run time.
E) The number of production runs in a year.
F) Maximum level of inventory.
G) Depict the above situations graphically.
Solution:
Given: D = 48,000
P = 800/day
CC = Br. 1/unit /year
Sc = Br. 45/production
Run
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 Working Days = 240 days

Daily demand = 48000 = 200/day

240
A) The optimum Size

2  D  Sc
= EOQ =
(1  d / p)  cc
2  48,000  45
= = 2400 Wheels
(1  200 / 800)  1

Here one run will last for 3 days = 2400 and form this quantity level 600
800

wheels will be consumed (3 x 200) and the remaining 1,800 units will be kept in the sore.

B) The minimum Total inventory cost is = ASC + ACC

 D  Q d 
 The Total Annual =    Sc 1    CC
 Q0  2 p

 48,000  2,400  200 

=   45  1   1
 2400  2  800 
= 900 + 900
= Birr 1,800
A) The cycle time for the optimal run size:

Optimum Quantity = 2,400 =12 Working days

Daily Demand 200

The optimal run size covers 12 working days.

i.e. 3 days for production & usage time & 9 days will be idle time.

B) The Run time:

t = Q0 = 2,400 = 3 days
p 800
C) The number of production runs in a year:

= Annual demand = 4,800 = 20 runs.

Optimal Quantity 2,400

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 The 20 runs cover 60 production days. i.e. 20 x 3 = 60 days and in this period there is production
and consumption simultaneously. The remaining 180 days are idle time between runs & during
these periods there is only consumption.

D) Maximum inventory level:

= Q0 x (1 – d/p)
= 2,400( 1- 200/800) = 1800

E) Graphically representation of EPQ with non- instant replenishment.

Production & Usage Time

Usage Time
SIZE

2400 Run Size

Maximum Size
1800

1200

600

0 Time
0 3 12 15 24
(Working
Production Time Consumption Days)
only

Usage Time

Example 2
A merchandising business enterprise has a forecasted demand of 10,000 units per year. Holding costs
are Br. 0.4 per unit per year. Acquisition cost is Br. 5.5/order. Daily demand is 40 units. The
enterprise agreed with a supplier for a gradual delivery of 120 units/day.

Based on the above information;

F) Determine the optimum order quantity and annual inventory costs.

Materials Management – Inventory Control By: Yabsiel Gashaw Page 15
 G) What will be the effect of using this policy?

Solution:

2  D  Sc
A) The optimum quantity = Q0 =
(1  d / p)  cc

2  10,000  5.5
=
(1  40 / 120)  0.4
= 642 units

 The total number of orders will be approximately 16 = D/Q = 10000/642  16

 The number of deliveries are = 642/120 = 5.35 deliveries.
 Number of days of one delivery = 120/40 = 3 days

Finally the total inventory cost is = ACC + AOC

642/2(1-40/120) x 0.40 + (10000/642)x 5.5
= 171.20 Birr

B.) In order to learn the effect of the policy lets consider the EOQ with instancous
Supply (receipt) of orders.
Optimum quantity

2  D  OC
Q0 =
CC

2  10,000  5.5
= = 524.40 units
0.40

Total Inventory Cost = (524/2) x 0.40 + (10,000/524) x 5.5 = 209.60 Birr

Decision:

Since the total cost in non-instant supply (under A) is less than the instant receipt (under B), the
enterprise should use the gradual delivery system.

4.8 Inventory analysis system (classification)

Items that are in the inventory are not of equal importance in terms of the amount invested,
profit potential, sock-out penalties…etc.
Therefore, all items do not deserve the same degree of attention.

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 Inventories can be classified in to various groups on the basis of the selective inventory
management approach as follows.

1. ABC Inventory Analysis (Always, Bette, Control) Analysis.

2. VED Inventory Analysis (Vital, Essential, Desirable) Analysis.
3. SDE Inventory Analysis (Scarce, Difficulty, Easy) Analysis.
4. HML Inventory Analysis (High, Medium, Low) Analysis.
5. FNSD Inventory Analysis (Fast moving, Normal, Slow Dead) Analysis.
6. XYZ Inventory Analysis (High, Moderate & Low closing inventory items) Analysis.
1. ABC Inventory Analysis
The technique tries to analyze the distribution of any characteristic by money value of
importance in order to determine its priority.
In materials management, this technique has been applied in areas needing selective
control, such as inventory, criticality of items, obsolete stocks, and purchasing orders,
receipt of materials, inspection, store keeping and verification of bills.
Even though there is lack of clear-cut principle to classify items in to A, B and C for all
organizations, the normal items in most organizations show the following pattern:
1- A items constitute about 5-10% of the total number of items purchased (in inventory) that would
account for about 70–80% of the total dollar value (usage value).
2- B items constitute about 10-20% of the total number of items purchased (in inventory) that would
account for about 10–15% of the total dollar value.
3- C items constitute about 65-80% of the total number of items purchased (in inventory) that would
account for about 5 to 10% of the total dollar value.
Classification of Inventories No. of Items Value of Expenditure
A 5-10% 70 – 80%
B 10-20% 10 – 15%
C 65-80% 5 – 10%

ABC procedure
The mechanics of classifying the items into ‘A’, ‘B’ and ‘C’ categories is described in the following
steps.
1. Calculate the annual usage in birr for each item by multiplying the annual usage with unit price.
2. Rank the items from highest birr usage annually to the lowest annual usage in birr.

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 3. Determine the cumulative annual usage value and total number of items.
4. Convert the annual usage value and total number of items in to percentage.
5. Categorize the items in A, B, and C categories
Example1:
XYZ factory adopts the ABC method of classifying inventories. Currently, the factory has 10 items.
The following is the data related to the items.
Item No Annual usage, Q Unit cost (birr)
22 1100 2
68 600 40
27 100 4
03 1300 1
82 100 60
54 10 25
36 100 2
19 1500 2
23 200 2
41 500 2
Classify the items into ABC with A items taking 80%, B items taking about 15% and C taking 5% of
the total birr value.
Solution:
Step 1: Calculate the annual usage in birr.
Item No Quantity Unit cost Total cost
22 1100 2 2,200 (4)
68 600 40 24,000 (1)
27 100 4 400 (8)
03 1300 1 1,300 (5)
82 100 60 6,000 (2)
54 10 25 250 (9)
36 100 2 200 (10)
19 1500 2 3,000 (3)
23 200 2 400 (7)
41 500 2 1,000 (6)

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Step 2: Rank the items from highest to lowest annual usage in birr. (Shown next to the total cost
column of step 2 above, in bracket)
Step 3: Determine the cumulative annual usage value and total number of items.

Step4: Convert the annual usage value and total number of items in to percentage.
Item No Annual Expenditure % of total value Com. % of total value
68 24,000 61.93 20% A
77.41
82 6,000 15.48
19 3,000 7.74
22 2,200 5.68 16.77 30% B
03 1,300 3.35
41 1,000 2.58
23 400 1.03
27 400 1.03
5.8 50% C
54 250 0.645
36 200 0.516
38,750
Implementing ABC analysis

Factor Item A Item B Item C

1-Degree of Control High Moderate Low
2-Ordring procedure High Moderate Low
3-Priority Treatment High Moderate Low
4-Safety Stock Low Moderate High
5- Price Discount Low Moderate High
6-Physical Stock Taking High Moderate Low
7-Value analysis Heavy emphasis Moderate Less emphasis
8-Nature of purchasing Centralized Combined Decentralized

2. VED (Vital, Essential, Desirable) Analysis

The analysis if based on the criticality of inventory.

 V-item – are items when go out of stock or when not readily available, completely bring the
production to a halt. So, they should be stored adequately to insure continuous production.

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  E-item – are items without which temporary losses of production or dislocation of production
work occurs.
 D-item – are all other items which are necessary but do not cause any immediate effect on
production.
3. SDE (Scarce, Difficult, Easily) Analysis
This analysis is based on availability of items
• Scarce-items- are items which are in small supply and are usually imported items.
• Difficult-items - Stands for difficult items which are available in the market but not easily
available. For example, items which have to come from far off cities.
• Easy-items - are easily available items; mostly local items.
4. HML (High, Medium, Low) Analysis
The cost per item (Unit price) is considered for this analysis,
High cost item (H) – are items with high unit cost.
Medium cost items (M) – are items with average unit price
Low cost items (L) – are items with low per unit acquisition cost.
N.B: What is high for an organization might be low for the other
5. FNSD (Fast, Normal, Slow Dead) Analysis
Here the quantity and rate of consumption is analyzed.
Fast Moving – are items that are purchased and used frequently.
Normal Moving – are items that are consumed at a moderate rate.
Slow Moving – are items with low consumption rate.
Dead Moving – are items whose consumption is once in a long time period
This classification helps in arranging stocks in the stores according to the frequency that the items are
used or consumed.
6. XYZ Analysis
The analysis is based on the value of closing inventory (It is used in relation to customers’ demand)
X-items Items with high closing inventory (Low Demand)
Y-items Items with moderate closing inventory (Medium Demand)
Z-items Items with low closing inventory (High Demand)
1.1. Inventory Control Systems
Inventory Control / Management
 Inventory control may be defined as the planning, ordering and scheduling of materials used in
the manufacturing process.

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  Supervision of the supply, the storage and accessibility of items in order to ensure an
adequate supply with excessive and over supply.
 The monitoring of the supplies, raw materials, work in process, and finished goods by various
accounting and reporting methods.
 The management of inventories, including decisions about which items to stock at each
location, how much stock to keep on hand at various levels of operation, when and how much
to buy; controlling pilferage and damage.
Buying the right quantity is one of the most important as well as the most complicated task of
purchasing. A company’s ability determines the right quantity and is influenced by basic managerial
planning, organizing, coordination, and control. An effective inventory control system must be
integrated with other company wide planning & control activities such as cash flow planning, capital
budgeting, sales forecasting & production planning scheduling and control.

Type of Inventory control system

There are three basic types of Inventory Control Systems
1. Cyclical / Fixed Order Interval System
2. Order point / Fixed Order Quantity System
3. Just-In-Time (JIT) Approach)
1. Cyclical / Fixed Order Interval System
It is a time-based system which involves scheduled periodic reviews of the stock level of all
inventories. When the stock level of a given time is not sufficient to sustain the production operation
until the next scheduled review, an order is placed replenishing the supply. That is, the required level
of inventories will be replenished (added) in the meantime. The frequency of reviews/control depends
on types of organizations and types of items. Stock level con be monitored by physical inspection.
In operations where a small quantity of material is involved, the simplest method is a periodic
physical count of stock.

1. Order point / Fixed Order Quantity system

It is based on the order quantity factor rather than on the time factor. The major advantages claimed by
this system are: -each material can be procured in most economical quantity.
-Purchasing of items/materials is when required.
The inventory policy, in this system, is drawn defining the following:
 Fixed Order Point / Reorder Level for each item.
 Fixed Maximum, minimum levels for each item
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  Fixed quantity to be ordered
N.B: The order quantity is constant and the time between orders is variable.
Perpetual inventory records are required.
Example: 300 →50 →300 →50 →
2. Just-In-Time (JIT) Approach)
It is a philosophy that helps in eliminating or at least minimizing the various wasteful activities while
loading, unloading, carrying, etc.
As the name suggests, just-in-time refers to producing and then delivering the products after finishing,
just-in-time for selling and also making sub-assemblies at just the right time to be assembled in to the
finished goods.
JIT Purchasing refers to the technique of eliminating waste during the purchasing phase with the help
of the mutual understanding with good suppliers.
JIT is a philosophy which came in to existence in the early 1970’s in Toyota Manufacturing plant.
So, it can be said that JIT is a Japanese philosophy.
“a philosophy of manufacturing based on planned elimination of all waste and on continuous
improvement of productivity. It is also known as lean Production or Stockless production. (No
buffer/safety Stock)
JIT approach is a comprehensive production scheduling inventory system. It attempts to reduce costs
and improve work flow by scheduling materials and parts to arrive at a work station exactly when they
are needed. It minimizes in process inventories, waste and saves storage space.
Just in time (JIT) operation

The JIT approach was developed at the Toyota Motor Company of Japan by TaiichiOhno (who
eventually became vice president of manufacturing) and several of his colleagues.
The development of JIT in Japan was probably influenced by Japan being a crowded country
with few natural resources.
Not surprisingly, the Japanese are very sensitive to waste and inefficiency.
They regard scrap and rework as waste and excess inventory as an evil because it takes up
space and ties up resources.
According to Voss, JIT is viewed as a “Production methodology which aims to improve overall
productivity through elimination of waste and which leads to improved quality”.
JITprovides an efficient production in an organization and delivery of only the necessary parts
in the right quantity, at the right time and place while using the minimum facilities”.

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 The term just-in-time (JIT) is used to refer to an operations system in which materials are
moved through the system, and services are delivered with precise timing so that they are
delivered at each step of the process just as they are needed-hence the name just-in-time.
Initially, the term JIT referred to the movement of materials, parts, and semi-finished goods
within a production system.
The ultimate goal of JIT is a balanced system, that is, one that achieves a smooth, rapid flow of
materials and/or work through the system. .
Those goals are eliminate disruptions, make the system flexible, eliminate waste, especially
excess inventory.
Benefits of JIT
The most significant benefit of JIT is to improve the responsiveness of the firm to the changes
in the market place thus providing an advantage in competition.
Following are the benefits of JIT:
 Product cost- is greatly reduced due to reduction of manufacturing cycle time, reduction of
waste and inventories and elimination of non-value added operation.
 Quality- is improved because of continuous quality improvement programs.
 Design- Due to fast response to engineering change, alternative designs can be quickly
brought on the shop floor.
 Productivity improvement.
 Higher production system flexibility.
 Administrative and ease and simplicity.

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