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,
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 ?
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
- 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,
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.
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.
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
- 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.
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.
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.
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
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.