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Inventory Control Introduction

The term inventory may be defined as stock on hand on a given time. Inventories of physical goods are maintained to meet up demands from commercial, governmental and military sectors. As the inventory of an item gets depleted to fulfill demands, it needs to be replenished through procurement actions. Different organizations have different inventory problems. Let us discuss the basic terms related to inventories.


Demand. It can be categorized according to their size, rate and pattern. Demand size refers to the magnitude of demand and has the dimension of quantity. Demand may be constant from period to period or may be variable. When the demand size is known, then it is called deterministic demand.


When the demand size is not known, it is possible in some cases to ascertain its probability distribution and the demand is called probabilistic demand. The demand rate is simply the demand size per unit of time.


Replenishments. The replenishments are usually instantaneous, uniform or batch. Its size refers to the quantity or size of the order to be received into inventory which may be constant or variable.


Lead Time. This is the period between the time an order is placed (administrative lead time) and the time when it is received (delivery lead time). When the lead time is known, it is called deterministic. When it is not known, it can govern by a random variable.


The level of inventory of an item depends upon the length of its lead time.


Costs. The main costs involved in inventory problems are described .below :


(a) Manufacturing or Purchase Cost. The purchase cost of an item is the unit purchase price if it is obtained from an external source. The price breaks (quantity discounts) wherever allowed due to bulk purchasing must be taken into account. Manufacturing cost is the unit production cost when the item is produced internally.


(b) Setup Cost. This cost is incurred due to setting up of machinery before production.


(c) Ordering Cost. This cost originates from the expense of issuing a purchase order to the outside supplier.


(d) Holding Cost/Inventory Carrying Cost/Storage Cost. This cost is associated with investing in inventory and in general, it is directly proportional to the level of inventory and to the time the inventory is maintained.


(e) Shortage Cost/Stockout Cost. The shortage cost is the economic consequence of an external or internal shortage. An external shortage occurs when a consumer's order is not filled. An internal shortage occurs when an order of a group or department within the organization is not filled. Actually shortage cost is the penalty costs that are incurred as a result of running out of stock. It costs money, less business and goodwill loss.


(j) Selling Price/Revenue Cost/Salvage Cost. Actually the price and demand are not control of a company. When the company unable to meet the demand and the sale is lost then the revenue cost is included in the company's inventory policies.


Time Horizon. This is the period over which the inventory is controlled. It can be finite or infinite.


Constraints. These are the limitations placed on the inventory system such as space constraint, capital constraint etc.


Economic Order Quantity. This is also known as 'economic lot size' or EOQ which is the optimum quantity to be purchased or produced such that the total cost of the inventory is minimized.


Re-order Level. The level between the maximum and minimum stock at which purchasing (or manufacturing) activities must start for replenishment is known as re-order level.


Order Cycle. The time period between placement of two successive orders is referred to as order cycle.


The above basic terms highlight the various activities in inventory. Now the basic needs of an inventory are given below :


(a)    It helps to run the business-smooth and efficiently.

(b)   It gives the advantage of price discounts by bulk purchasing.

(c)    It takes the advantage of hatching and longer runs.

(d)   It economizes the transportation, clearing and forwarding charges.


In inventory control attempts are made to answer the following two basic problems :

(i)     When should an order to be placed or the production to be run ?

(ii)   How much quantity to be produced or to be ordered for each time interval ?