Page 175 - DMGT409Basic Financial Management

Basic Financial Management

Notes 10.3 Tools and Techniques of Inventory Management

Some of the inventory control techniques are as follows:

ABC Analysis

This is the one of the widely used technique to identify various items of inventory for the purpose
of inventory control. In other words, it is very effective and useful tool for classifying, monitoring
and control of inventories. The fi rm should not keep same degree of control on all the items of
inventory. It is based on Pareto’s Law. It is also known as Selective Inventory Control. The fi rm
should put maximum control on those items whose value is the highest, with the comparison of
the other two items.
The technique concentrates on important items and is also known as Control by Importance and
Exception [CIE]. Usually a fi rm has to maintain several types of inventories, for proper control
of they, firm should have to classify inventories in the instance of their relative value. Hence it is

also known as Proportional Value Analysis (PVA). The higher value items are classified ‘A items’

and would be under tight control. At the other end of the classifi cation, we find category ‘C
items’, on this type of inventory, we cannot afford expenses of rigid controls, frequent ordering
and expending, because of the low value or low amounts in this area. Thus with the ‘C items’, we
may maintain somewhat higher safety stocks, order more months of supply, expect lower levels
of customer service, or all the three. ‘B items’ fall in between ‘A item’ and ‘C item’ and require
reasonable attention of management.

According to this technique the task of inventory management is proper classification of all
inventory items in to three categories namely A, B and C category. The ideal categorization of
inventory items is show in Table.

Category No. of Items(%) Item value (%)
A 15 70
B 30 20
C 55 10
Total 100 100
The above table indicates that only 15 per cent of the items may account for 70 percent of the
value [A category items], on which greater attention is required, where as 55 per cent of items
may account for 10 per cent of the table value of inventory (C category items), will be paid a
reasonless attention. The remaining 30 per cent of inventory account for 20 per cent of total value
of inventory (B category items will be paid a reasonable attention as this, category value lies
between the two other categories.

Economic Order Quantity (EOQ)

Economic order quantity refers to that level of inventory at which the total cost of inventory is
minimum. The total inventory cost comprising ordering and carrying costs. Shortage costs are

excluded in adding total cost of inventory due to the difficulty in computation of shortage cost.
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Did u know? EOQ also known as Economic Lot Size (ELS)
The following assumptions are implied in the calculation of EOQ:
Demand for the product is constant and uniform throughout the period.
Lead time (time from ordering to receipt) is constant.

Price per unit of product is constant.

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