Page 284 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 12: Inventory Management

These distributions are independent Notes
Daily usage Probability Lead time in days Probability
rate in tonnes

4 0.3 5 .6
6 0.5 10 .2
8 0.2 15 .2
The stockout cost is estimated to be 4,000 per tonne. The carrying cost is 1,000 per tonne
per year.
Required: (a) What is the optimal level of safety stock?
(b) What is the probability of stockout?

Source: Nitin Balwani, Accounting and Finance for Managers, Excel Books, New Delhi.

12.4 Summary

 Inventory is composed of assets that will be sold in the future in the normal course of
business operations.

 Inventories provide a ‘buffer’ between purchasing, producing and marketing goods.
 Four types of inventories may be identified which are Raw material inventory, Stores and
spares, Work-in-process inventory and Finished goods inventory.

 The main objective of inventory management is to achieve maximum efficiency in
production and sales with the minimum investment in inventory.

 Minimum level indicates the lowest figure of inventory balance which must be maintained
in hand at all times, so that there is no stoppage of production.
 In ABC Analysis (called Always Better Control) ABC Analysis (called Always Better Control)
the items are divided into three categories according to their importance, value and
frequency of replenishment during a period.

 Economic Order Quantity (EOQ) is the order size for some particular inventory item that
results in lowest total inventory cost for the period.
 The Just-in-Time (JIT) system philosophy is that materials should arrive exactly the time
they are needed for production.
 Many companies used a Material Requirement Planning (MRP) system to determine what
materials to order and when to order.

 The methods used for moving the inventory is first in first out (FIFO), last in, first out
(LIFO) system.

12.5 Keywords

Economic Order Quantity (EOQ): It refers to that level of inventory at which the total cost of
inventory is minimum
Inventory: The stockpile of the products a firm is offering for sales and the components that
make up the product.

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