Inventory Management for Operations & Finance. This guide covers EOQ (Economic Order Quantity)

What is Inventory Management? (Concept & Meaning)

Inventory Management is the systematic approach to sourcing, storing, and selling inventory—both raw materials (inputs) and finished goods (products). In business, inventory is considered a necessary evil: too much ties up capital, but too little leads to lost sales.

Why Hold Inventory? (The 3 Motives):

1. Transaction Motive: To facilitate smooth production and sales operations.

2. Precautionary Motive: To guard against unpredictable changes in demand or supply (e.g., strikes, transport delays).

3. Speculative Motive: To take advantage of price fluctuations (e.g., buying bulk when prices are low).

Key Objectives:

• Operational: Ensure continuous supply and minimize “stockouts” (running out of stock).

• Financial: Minimize the investment in inventory and reduce holding costs.

The Costs of Inventory

To manage inventory, you must balance two opposing costs:

1. Ordering Costs: The cost incurred every time you place an order (transport, inspection, paperwork). This decreases if you order large quantities less often.

2. Carrying (Holding) Costs: The cost of keeping stock in the warehouse (rent, insurance, spoilage, theft). This increases if you hold large quantities.

The Goal: Minimize the Total Inventory Cost (Ordering + Carrying).

Techniques of Inventory Control

Managers use specific mathematical models to find the perfect balance.

1. Economic Order Quantity (EOQ)

Concept: EOQ is the ideal order size that minimizes total inventory costs. It finds the “sweet spot” where Ordering Cost = Carrying Cost.

Formula:

• A = Annual Usage/Demand (units)

• O = Ordering Cost per order

• C = Carrying Cost per unit per year

Example: If Annual Demand = 2000 units, Ordering Cost = ₹50, Carrying Cost = ₹25.

2. Reorder Point (ROP) & Safety Stock

Concept: When should you place the next order? You don’t wait until stock hits zero. You order when stock reaches the Reorder Level.

Formula:

• Lead Time: The time taken by the supplier to deliver goods after receiving the order.

• Safety Stock (Buffer Stock): Extra stock kept to protect against stockouts during emergencies.

3. ABC Analysis (Always Better Control)

Concept: Not all inventory items are equal. This technique classifies items based on their usage value to prioritize control. It follows the Pareto Principle (80/20 rule).

• • A-Items (High Value): 70-80% of total value, but only 10-20% of quantity. Action: Strict control, low safety stock, frequent ordering.

  • B-Items (Moderate Value): 15-20% value, 30% quantity. Action: Moderate control.

  • C-Items (Low Value): 5-10% value, 50% quantity. Action: Loose control, bulk ordering (e.g., nuts and bolts).

Purchasing Methods: Centralized vs. Decentralized

How a company buys materials affects its efficiency.