Unit 1: Inventory fundamentals
Inventory Management notes · PTU syllabus (MBA 956-26)
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Unit summary
Inventory is often the largest current asset of a manufacturer or retailer, so managing it well frees cash and protects service. This unit covers the concept, objectives and functions of inventory, its classification, identification, codification and specification, factors affecting inventory, inventory costs, lead time, and MRP and demand forecasting requirements.
After this unit you can
- Explain the concept, objectives and functions of inventory
- Classify, identify, codify and specify inventory items
- Explain factors affecting inventory and inventory costs
- Explain lead time and the role of MRP and forecasting
PTU syllabus topics
- Concept
- objectives and functions of inventory
- classification (raw materials, WIP, finished goods, MRO spares)
- identification
- codification and specification
- factors affecting inventory
- inventory costs
- lead time and MRP/demand forecasting requirements
Raw materials
Work in progress
Finished goods
MRO spares
Maintenance, repair, operating supplies
Topic 1
Concept, classification and objectives of inventory
Inventory types: raw materials, work-in-progress, finished goods and maintenance, repair and operating (MRO) supplies. Objectives: smooth production, meet customer demand, protect against uncertainty, gain quantity discounts — while minimising cost.
| Inventory cost | Example |
|---|---|
| Ordering cost | Placing orders, transport, receiving |
| Carrying (holding) cost | Storage, insurance, interest, obsolescence |
| Shortage (stock-out) cost | Lost sales, idle production |
Factors affecting policy: demand pattern, lead time, cost of capital, storage space and perishability.
Topic 2
Functions of inventory
- Inventory: stock of items held for future use or sale — an asset that ties up capital.
Cycle stock
Ordering in lots for economies
Safety (buffer) stock
Protect against demand and lead-time uncertainty
Anticipation stock
Seasonal demand, promotions, price rises
Pipeline (in-transit) stock
Goods moving through the supply chain
Decoupling stock
Separate stages so each works independently
Hedge stock
Protect against price or supply shocks
Topic 3
Identification, codification and specification
- Identification: recognising each item uniquely by description, part number and characteristics.
- Codification: assigning systematic codes to items so they can be stored, located and recorded easily and duplicates avoided.
Numerical
Digits grouped by class, sub-class and item
Alphabetical
Letters representing item groups
Alphanumeric
Mix of letters and digits
Kodak system
Ten major groups with sub-divisions
Brisch system
Structured multi-digit classification
Bar codes and QR codes
Machine-readable codes (GS1 standards)
Example
In the code 31-04-125: 31 = electrical items, 04 = cables, 125 = 2.5 mm copper wire.
- Specification: precise description of an item's required characteristics — material, dimensions, grade, performance, standards (BIS), packaging; avoids wrong purchases and supports competitive buying.
- Standardisation and variety reduction cut the number of items stocked.
Topic 4
Factors affecting inventory
- Nature of business and production process; demand level and variability; lead time and supplier reliability; ordering and carrying costs; price trends and discounts; perishability and obsolescence; storage capacity; financial resources; service level targets; government policy and seasonality.
Topic 5
Inventory costs
Purchase cost
Price paid; affected by quantity discounts
Ordering cost
Requisition, purchase order, follow-up, receiving, inspection, payment processing
Carrying (holding) cost
Capital cost, storage, insurance, taxes, obsolescence, deterioration, handling — often 15–30% of item value a year
Stock-out (shortage) cost
Lost sales, lost goodwill, idle production, expediting costs
- Trade-off: larger orders lower ordering costs but raise carrying costs — the basis of EOQ.
Topic 6
Lead time
- Lead time: time between recognising a need to order and receiving the goods.
- Components: administrative lead time (requisition, approval, ordering), supplier lead time (production, dispatch), transit time, inspection and receiving.
- Lead time variability increases safety stock requirements; reduce it through supplier partnerships, local sourcing, faster transport and e-procurement.
Topic 7
MRP and demand forecasting requirements
- Independent demand (finished goods, spares) is forecast; dependent demand (components) is calculated from the production schedule through MRP.
- Forecasting requirements: historical data, seasonality and trends, promotions, new product introductions, forecast accuracy tracking.
- MRP requirements: accurate master production schedule, bill of materials and inventory records; lead times for each item.
Key terms
- Codification
- Systematic coding of inventory items
- Specification
- Precise description of an item's requirements
- Carrying cost
- Cost of holding inventory over time
- Lead time
- Time between ordering and receiving goods
- Dependent demand
- Demand derived from the demand for other items
Quick revision
- Inventory types, objectives and functions.
- Identification, codification (numerical, alphanumeric, Kodak, Brisch, bar codes), specification.
- Factors affecting inventory.
- Purchase, ordering, carrying and stock-out costs.
- Lead time components; independent vs dependent demand; MRP and forecasting needs.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.State three functions of inventory.
- Q2.What is codification?
- Q3.Name two codification systems.
- Q4.Name the components of carrying cost.
- Q5.What is lead time?
- Q6.Distinguish independent and dependent demand.
Long-answer questions
- Q1.Explain the concept, objectives, functions and classification of inventory.
- Q2.Explain identification, codification and specification of materials.
- Q3.Discuss factors affecting inventory and the costs of inventory.
- Q4.Explain lead time and the requirements of MRP and demand forecasting.
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