Inventory Control Models

The word 'inventory' means simply a stock of idle resources of any kind having an economic value.

In other words, inventory means a physical stock of goods, which is kept in hand for smooth and efficient running of future affairs of an organization. It may consist of raw materials, work-in-progress, spare parts/consumables, finished goods, human resources such as unutilized labour, financial resources such as working capital, etc.

It is not necessary that an organization has all these inventory classes. But whatever may be the inventory items, they need efficient management as generally, a substantial amount of money is invested in them. The basic inventory decisions include:

  • How much to order?
  • When to order?
  • How much safety stock should be kept?

"Inventories are inevitable for the successful functioning of manufacturing and retailing organizations." -Vinay Chhabra & Manish Dewan

The problems faced by different organizations have necessitated the use of scientific techniques in the management of inventories known as inventory control.

Inventory control is the technique of maintaining stock items at desired levels. In other words, it is concerned with the acquisition, storage, and handling of inventories so that the inventory is available whenever needed.

What are the factors that affect Inventory levels ?

  1. Inventory related costs

    Inventory related costs are classified as

    • Purchase (or production) cost. It is the cost at which an item is purchased, or if an item is produced, it is the direct manufacturing cost. In many practical situations, the unit purchase price depends on the quantity purchased so the purchase price is of special interest when large quantities are bought or when large production runs may result in a decrease in the production cost.
    • Ordering (or replenishment or set up) cost. The cost incurred in replenishing the inventory is known as ordering cost. It includes all the costs relating to administration (such as salaries of the persons working for purchasing, telephone calls, computer costs, postage, etc.), transportation, receiving and inspection of goods, processing payments, etc. If a firm produces its own goods instead of purchasing the same from an outside source, then it is the cost of resetting the equipment for production. This cost is expressed as the cost per order or per set up. It is denoted by Co.
    • Carrying (or holding) cost. The cost associated with maintaining the inventory level is known as holding cost. It is directly proportional to the quantity to be kept in stock and the time for which an item is held in stock. It includes handling cost, maintenance cost, depreciation, insurance, warehouse rent, taxes, etc.
      This cost may be expressed either as per unit of item held per unit of time or as a percentage of average rupee value of inventory held. It is denoted by Ch.

      In several practical situations, the carrying cost might not be directly proportional to the inventory level. For example, the rent of a warehouse will not change day to day by the change in inventory level.

    • Shortage (or stock out) cost. It is the cost, which arises due to running out of stock (i.e., when an item can not be supplied on the customer's demand). It includes the cost of production stoppage, loss of goodwill, loss of profitability, special orders at higher price, overtime/idle time payments, expediting, loss of opportunity to sell, etc. It is denoted by Cs.

  2. Demand
    It is an effective desire which is related with a particular time, price, and quantity. The demand pattern of a commodity may be either deterministic or probabilistic. In case of deterministic, it is assumed that the quantities needed in future are known with certainty. This can be fixed (static) or can vary (dynamic) from time to time. To the contrary, in case of probabilistic, the demand over a certain period of time is uncertain, but its pattern can be described by a known probability distribution.

  3. Ordering cycle
    An ordering cycle is defined as the time period between two successive placement of orders. The order may be placed on the basis of following two types of inventory review systems:
    • Continuous review: In this case, record of the inventory level is updated continuously until a specified point (known as reorder point) is reached, at this point a new order is placed. Sometimes, this is referred to as the two-bin system. The inventory is divided into two parts (two bins). Initially, items are used only from one bin, and when it becomes empty, a new order is placed. Demand is then satisfied from the second bin until the order is received. After receiving the order, the second bin is filled to make up the earlier total. The remaining items are placed in the first bin.
    • Periodic review: In this case, the orders are placed at equally spaced intervals of time. The quantity ordered each time depends on the available inventory level at the time of review.

  4. Time horizon
    This is also known as planning period over which the inventory level is to be controlled. This can be finite or infinite depending on the nature of demand.

  5. Lead time or delivery lag
    The time gap between the moment of placing an order and actually receiving the order is referred to as lead time. The lead time can be deterministic, constant or variable, or probabilistic. If there is no such gap, then we say that lead time is zero. If the lead time exists (i.e., it is not zero), then it is required to place an order in advance by an amount of time equal to the lead time.

  6. Buffer (or safety) stock

    Normally, demand and lead time are uncertain and cannot be predetermined completely. So to absorb the variation in demand and supply, some extra stock is kept. This extra stock is known as buffer stock.

    "In today's dynamic business environment, certainty is an illusion." -Vinay Chhabra & Manish Dewan

  7. Number of items

    Generally, an inventory system involves more than one commodity. The number of items held in inventory affect the situation when these items compete for limited floor space or limited total capital.

8. Government's policy

For items to be imported as well as for other items like explosive, highly inflammable, and other essential items, the Government has laid down some policy norms. All these affect the level of inventories in an organization.

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