Inventory Management

Inventory management refers to the process of

ordering, storing, using, and selling a company's
inventory. This includes the management of raw
materials, components, and finished products, as well
as warehousing and processing of such items.
Inventory is accounted for using one of three
methods: first-in-first-out (FIFO) costing;
last-in-first-out (LIFO) costing; or
weighted-average costing. An inventory account
typically consists of four separate categories:
 Inventory Management
Raw materials — represent various materials a company
purchases for its production process. These materials
must undergo significant work before a company can
transform them into a finished good ready for sale.
Work in process (also known as goods-in-process) —
represents raw materials in the process of being
transformed into a finished product.
Finished goods — are completed products readily
available for sale to a company's customers.
Merchandise — represents finished goods a company
buys from a supplier for future resale.
 Inventory Management
Depending on the type of business or product being
analyzed, a company will use various inventory
management methods. Some of these management
methods include just-in-time (JIT) manufacturing,
materials requirement planning (MRP),
economic order quantity (EOQ), and
days sales of inventory (DSI).
Just-in-Time Management (JIT) — This manufacturing
model originated in Japan in the 1960s and 1970s. Toyota
Motor (TM) contributed the most to its development. 1 The
method allows companies to save significant amounts of
money and reduce waste by keeping only the inventory
they need to produce and sell products.
 Inventory Management
This approach reduces storage and insurance costs, as
well as the cost of liquidating or discarding excess
inventory. JIT inventory management can be risky. If
demand unexpectedly spikes, the manufacturer may
not be able to source the inventory it needs to meet that
demand, damaging its reputation with customers and
driving business toward competitors.
Even the smallest delays can be problematic; if a key
input does not arrive "just in time," a bottleneck can
result.
 Inventory Management
Materials requirement planning (MRP) —
This inventory management method is sales-forecast
dependent, meaning that manufacturers must have
accurate sales records to enable accurate planning of
inventory needs and to communicate those needs with
materials suppliers in a timely manner.
For example, a ski manufacturer using an MRP
inventory system might ensure that materials such as
plastic, fiberglass, wood, and aluminum are in stock
based on forecasted orders. Inability to accurately
forecast sales and plan inventory acquisitions results in a
manufacturer's inability to fulfill orders.
 Inventory Management
Economic Order Quantity (EOQ) — This model is used
in inventory management by calculating the number of
units a company should add to its inventory with each
batch order to reduce the total costs of its inventory while
assuming constant consumer demand.
 The costs of inventory in the model include holding and
setup costs. The EOQ model seeks to ensure that the right
amount of inventory is ordered per batch so a company
does not have to make orders too frequently and there is
not an excess of inventory sitting on hand. It assumes
that there is a trade-off between inventory holding costs
and inventory setup costs, and total inventory costs are
minimized when both setup costs and holding costs are
minimized.
 Inventory Management
Days sales of inventory (DSI) — is a financial ratio
that indicates the average time in days that a company
takes to turn its inventory, including goods that are a
work in progress, into sales. DSI is also known as the
average age of inventory, days inventory outstanding
(DIO), days in inventory (DII), days sales in inventory
or days inventory and is interpreted in multiple ways.
 Indicating the liquidity of the inventory, the figure
represents how many days a company’s current stock
of inventory will last. Generally, a lower DSI is
preferred as it indicates a shorter duration to clear off
the inventory, though the average DSI varies from one
industry to another.
 Inventory Management
Economic Order Quantity (EOQ), also known
as Economic Purchase Quantity (EPQ), is the order
quantity that minimizes the total holding costs and
ordering costs in inventory management. It is one of the
oldest classical production scheduling models. The
model was developed by Ford W. Harris in 1913, but R.
H. Wilson, a consultant who applied it extensively, and
K. Andler are given credit for their in-depth analysis.
EOQ applies only when demand for a product is
constant over the year and each new order is delivered in
full when inventory reaches zero. There is a fixed cost
for each order placed, regardless of the number of units
ordered; an order is assumed to contain only 1 unit.
 Inventory Management
There is also a cost for each unit held in storage, commonly
known as holding cost, sometimes expressed as a
percentage of the purchase cost of the item. While the EOQ
formulation is straightforward there are factors such as
transportation rates and quantity discounts to consider in
actual application.
We want to determine the optimal number of units to order
so that we minimize the total cost associated with the
purchase, delivery, and storage of the product.
The required parameters to the solution are the total demand
for the year, the purchase cost for each item, the fixed cost
to place the order for a single item and the storage cost for
each item per year. Note that the number of times an order
is placed will also affect the total cost, though this number
can be determined from the other parameters.
 Inventory Management

Components of the EOQ Formula:

D: Annual Quantity Demanded
Q: Volume per Order
S: Ordering Cost (Fixed Cost)
C: Unit Cost (Variable Cost)
H: Holding Cost (Variable Cost)
i: Carrying Cost (Interest Rate)
Inventory Management
Inventory Management
Inventory Management
Inventory Management
Inventory Management
 Inventory Management

In materials management, ABC analysis is

an inventory categorization technique. ABC analysis
divides an inventory into three categories—"A items"
with very tight control and accurate records, "B items"
with less tightly controlled and good records, and "C
items" with the simplest controls possible and minimal
records.
The ABC analysis provides a mechanism for identifying
items that will have a significant impact on overall
inventory cost, while also providing a mechanism for
identifying different categories of stock that will require
different management and controls.
 Inventory Management
The ABC analysis suggests that inventories of an
organization are not of equal value.Thus, the inventory
is grouped into three categories (A, B, and C) in order
of their estimated importance.
'A' items are very important for an organization.
Because of the high value of these 'A' items, frequent
value analysis is required. In addition to that, an
organization needs to choose an appropriate order
pattern (e.g. 'just-in-time') to avoid excess capacity. 'B'
items are important, but of course less important than
'A' items and more important than 'C' items. Therefore,
'B' items are intergroup items. 'C' items are marginally
important.
 Inventory Management
There are no fixed thresholds for each class, and
different proportions can be applied based on objectives
and criteria. ABC Analysis is similar to the Pareto
principle in that the 'A' items will typically account for a
large proportion of the overall value, but a small
percentage of the number of items.
Examples of ABC class are
'A' items – 20% of the items accounts for 70% of the
annual consumption value of the items
'B' items – 30% of the items accounts for 25% of the
annual consumption value of the items
'C' items – 50% of the items accounts for 5% of the
annual consumption value of the items
 Inventory Management
Item A:
a) These are subjected to strict inventory control and
are given highly secured areas in terms of storage
b) These goods have a better forecast for sales
c) These are also the items that require frequent
reorders on a daily or a weekly basis
d) They are kept as a priority item and efforts are made
to avoid unavailability or stock-out of these items
 Inventory Management
Item B:
a) These items are not as important as items under
section A or as trivial as items categorized under C
b) The important thing to note is that since these items
lie in between A and C, they are monitored for
potential inclusion towards category A or in a contrary
situation towards category C
 Inventory Management
Item C:
a) These items are manufactured less often and follow
the policy of having only one of its item on hand or in
some cases they are reordered when a purchase is
actually made
b) Since these are low demand goods with a
comparatively higher risk of cost in terms of excessive
inventory, it is an ideal situation for these items to stock-
out after each purchase
c) The questions managers find themselves dealing with
when it comes to items in category C is not how many
units to keep in stock but rather whether it is even
needed to have to these items in store at all.
 Inventory Management
 Quantity discount is a reduction in price offered by seller
on orders of large quantities. Quantity discounts exist in
different forms and in certain scenarios they may not be
obvious. The well-known buy-1-get-1-free sale is actually a
50% quantity discount since you effectively purchase a unit
at half the normal price.
 Different forms of quantity discounts provide different
purchase incentives to buyers. For example, the one
discussed above has a tendency to compel the buyer to
purchase more than they need at the moment i.e. the seller
will not allow you to purchase just one unit at 50% of the
full price. Another form of quantity discount which is
based on the cumulative quantity purchased during a
specific time period actually induces the buyer to continue
purchasing from the current supplier and restricts switching
to other suppliers.
 Inventory Management
 When purchasers following Economic Order Quantity
(EOQ) model for ordering inventory have the opportunity
to avail a quantity discount on order sizes greaters than
their EOQ, they need to base their decision, apart from
qualitative factors, on the net effect of the decision on the
their income. A typical quantity discount has the following
three effects on the income of a purchaser:
 A saving in the form of reduced price
 A saving in the form of reduced ordering costs
 A loss in the form of increased total holding costs of
inventory
 A decision to avail the quantity discount should be taken
only if the net effect of the above components on the
income is positive.
 The following problem tries to clarify decision making
when there is an opportunity to obtain quantity discounts:
 Inventory Management
A retail store dealing in computer hardware imports an
enterprise model solid-state drive (SSD) at a fixed
price of $1000 per unit from the sole distributer of the
SSD.
 On January 1, 2014, the store received an offer of
15% discount on orders of 300 or more units. Provided
further that the estimated sales for the year are 600
units, the cost incurred per order is $1000 and the
average holding cost per unit per annum is estimated to
be $120 per unit. The full price is likely to remain
$1000 during the year. Please ignore opening and
closing inventories, safety stock etc.
Inventory Management
 Inventory Management

Discounted Order Quantity (DOQ) = 300 units

Annual Orders under EOQ = Demand ÷ EOQ = 600 ÷
100 = 6 orders
Annual Orders under DOQ = Demand ÷ DOQ = 600 ÷
300 = 2 orders
Average Inventory under EOQ = EOQ ÷ 2 = 100 ÷ 2 =
50 units
Average Inventory under DOQ = DOQ ÷ 2 = 300 ÷ 2
= 150 units
Saving from reduction in Price (A)
= Demand × Full Price × Discount Rate
= 600 × 1000 × 0.15 = 90,000
 Inventory Management

Saving from reduction in orders (B)

= Orders reduced × Order Cost
= (6 − 2) × 1000 = 4000
Increase in holding cost (C)
= Increase in average inventory × holding cost per unit
per annum
= (150 − 50) ×120 = 12000
Net Effect on Income
=A+B−C
= 90000 + 4000 − 12000
= 82000
 Materials Requirement Planning
Material requirements planning (MRP) is a computer-
based inventory management system designed to
improve productivity for businesses.
Companies use material requirements-
planning systems to estimate quantities of raw
materials and schedule their deliveries.
Material requirements planning (MRP) is the earliest
computer-based inventory management system.
Businesses use MRP to improve their productivity.
MRP works backward from a production plan for
finished goods to develop inventory requirements for
components and raw materials.
 Materials Requirement Planning
Advantages of the MRP process include the assurance
that materials and components will be available when
needed, minimized inventory levels, reduced customer
lead times, optimized inventory management, and
improved overall customer satisfaction.
Disadvantages to the MRP process include a heavy
reliance on input data accuracy , the high cost to
implement, and a lack of flexibility when it comes to
the production schedule.
 Materials Requirement Planning
MRP works backward from a production plan for
finished goods, which is converted into a list of
requirements for the subassemblies, component parts,
and raw materials needed to produce the final product
within the established schedule.
In other words, it's basically a system for trying to
figure out the materials and items needed to
manufacture a given product. MRP helps
manufacturers get a grasp of inventory requirements
while balancing both supply and demand.
 Materials Requirement Planning
The MRP process can be broken down into four basic
steps:
Estimating demand and the materials required to
meet it. The initial step of the MRP process is
determining customer demand and the requirements to
meet it. Utilizing the bill of materials—which is simply a
list of raw materials, assemblies, and components needed
to manufacture an end product—MRP breaks down
demand into specific raw materials and components.
Check demand against inventory and allocate
resources. This step involves checking demand against
what you already have in inventory. The MRP then
distributes resources accordingly. In other words, the
MRP allocates inventory into the exact areas it is needed.
 Materials Requirement Planning
Production scheduling. The next step in the process
is simply to calculate the amount of time and labor
required to complete manufacturing. A deadline is also
provided.
Monitor the process. The final step of the process is
simply to monitor it for any issues. The MRP can
automatically alert managers for any delays and even
suggest contingency plans in order to meet build
deadlines.
 Materials Requirement Planning
A critical input for material requirements planning is
a bill of materials (BOM)—an extensive list of raw
materials, components, and assemblies required to
construct, manufacture or repair a product or service.
BOM specifies the relationship between the end
product (independent demand) and the components
(dependent demand). Independent demand originates
outside the plant or production system, and dependent
demand refers to components.
 Materials Requirement Planning
Companies need to manage the types and quantities of
materials they purchase strategically; plan which
products to manufacture and in what quantities; and
ensure that they are able to meet current and future
customer demand—all at the lowest possible cost.
MRP helps companies maintain low inventory levels.
Making a bad decision in any area of the production
cycle will cause the company to lose money. By
maintaining appropriate levels of inventory,
manufacturers can better align their production with
rising and falling demand.
 Materials Requirement Planning
 The data that must be considered in an MRP scheme include:
 Name of the final product that's being created: This is
sometimes called independent demand or Level "0" on BOM.
 What and when info: How much quantity is required to
meet demand? When is it needed?
 The shelf life of stored materials.
 Inventory status records: Records
of net materials available for use that are already in stock (on
hand) and materials on order from suppliers.
 Bills of materials: Details of the materials, components, and
sub-assemblies required to make each product.
 Planning data: This includes all the restraints and directions
to produce such items as routing, labor and machine
standards, quality and testing standards, lot sizing techniques,
and other inputs.
 Materials Requirement Planning
There are several advantages to the MRP process:
Assurance that materials and components will be
available when needed
Minimized inventory levels and costs associated
Optimized inventory management
Reduced customer lead times
Increased manufacturing efficiency
Increased labor productivity
Increased overall customer satisfaction
 Materials Requirement Planning
Of course, there are also disadvantages to the MRP
process:
Heavy reliance on input data accuracy
MRP systems can often be difficult and expensive to
implement
Lack of flexibility when it comes to the production
schedule
 Materials Requirement Planning
Material requirements planning was the earliest of the
integrated information technology (IT) systems that
aimed to improve productivity for businesses by using
computers and software technology.
The first MRP systems of inventory management
evolved in the 1940s and 1950s. They used mainframe
computers to extrapolate information from a bill of
materials for a specific finished product into a
production and purchasing plan. Soon, MRP systems
expanded to include information feedback loops so
that production managers could change and update the
system inputs as needed.
 Materials Requirement Planning
The next generation of MRP, manufacturing resources
planning (MRP II), also incorporated marketing,
finance, accounting, engineering, and human resources
aspects into the planning process.
 A related concept that expands on MRP is enterprise
resources planning (ERP), which uses computer
technology to link the various functional areas across
an entire business enterprise. As data analysis and
technology became more sophisticated, more
comprehensive systems were developed to integrate
MRP with other aspects of the manufacturing process.
 MRP 2
MRP II is not a proprietary software system and can
thus take many forms. It is almost impossible to
visualize an MRP II system that does not use a
computer, but an MRP II system can be based on
either purchased–licensed or in-house software.
Almost every MRP II system is modular in
construction. Characteristic basic modules in an MRP
II system are:
Master production schedule (MPS)
Item master data (technical data)
Bill of materials (BOM) (technical data)
Production resources data (manufacturing technical
data)
Inventories and orders (inventory control)
 MRP 2
Purchasing management
Shop floor control (SFC)
Capacity planning or capacity requirements planning
(CRP)
Standard costing (cost control) and frequently also
Actual or FIFO costing, and Weighted Average
costing.
Cost reporting / management (cost control)
 ERP
ERP can cover many core functions across your
organization—helping break down the barriers
between the front office and back office while offering
the ability to adapt your solution to new business
priorities. Some of the key business functions include:
Commerce
Today’s retailers face many challenges and an ERP
system can deliver a complete, omnichannel solution
that unifies back-office, in-store, and digital
experiences. Customers will get a more personalized
and seamless shopping experience , while retailers are
able to increase employee productivity, help reduce
fraud, and grow their business.
 ERP
Finance
Modern ERP will help you increase profitability while
driving compliance. It offers dashboards and AI-driven
insights that give you an overview of your finances to
help you tap into the real-time information anytime
and anywhere. It should also help you cut down on
entering information manually by automating daily
tasks and include tracking abilities that help with your
business’s regulatory compliance.
 ERP
Human resources
Modern solutions offer ways to manage company data
and streamline employee management tasks like
payroll, hiring, and other duties. You’ll be in a better
position to help retain, recruit, and empower employees
while also tracking employee performance and
identifying HR problems before they happen.
Manufacturing
This function improves business communication,
automates daily processes through robotic process
automation, and offers manufacturers the ability to
fulfill customer needs and manage resources by
accessing real-time data. This solution also optimizes
project and cost management as well as production
planning.
 ERP
Supply chain
If your company is still entering information by hand
and trying to track down inventory in your warehouse,
you can easily save time and money by automating
these processes with ERP. Modern solutions also offer
dashboards, business intelligence, and even Internet of
Things (IoT) technology to help you get a handle on
your inventory management.