Corporate Accounting and Financial Management · Working Capital Management

Inventory Management: EOQ, Stock Levels, ABC Analysis and JIT

Updated 11 October 2026 · Fact-checked

Inventory management controls how much stock a firm orders, when it orders and how much it holds, so that ordering cost and carrying cost stay low without stock-outs. To solve problems, find EOQ = √(2AO ÷ C), then reorder level, minimum, maximum and average stock levels from usage and lead time.

Understand Inventory Management

Inventory is the raw material, work-in-progress and finished goods a firm holds. Holding too little stops production and loses sales. Holding too much locks up cash and adds storage, insurance and obsolescence costs. Inventory management finds the balance.

Two costs pull in opposite directions. Ordering cost is the cost of placing and receiving an order. It is fixed per order, so fewer, larger orders reduce it. Carrying cost is the cost of holding stock, such as storage, insurance and interest on money tied up. It rises with the stock held. The Economic Order Quantity (EOQ) is the order size at which the total of these two costs is lowest. At EOQ, total ordering cost equals total carrying cost.

Stock levels set the limits. The reorder level tells you when to place an order, so that stock lasts through the lead time. The minimum level is the safety buffer you should not fall below. The maximum level is the ceiling that avoids overstocking. The danger level is a point below minimum where emergency action is needed.

ABC analysis applies control in proportion to value. A items are few in number but high in value, so they get tight control. C items are many but low in value, so they get simple control. B items sit in between. Just-in-Time (JIT) goes further: materials arrive only when production needs them, keeping stock near zero. It needs reliable suppliers and steady production.

Key rules to remember

Economic Order Quantity: EOQ = √(2 × A × O ÷ C); A = annual consumption in units, O = ordering cost per order, C = carrying cost per unit per year. If carrying cost is given as a percentage, C = percentage × purchase price per unit.
Number of orders per year: Orders = A ÷ EOQ; Time between orders = 12 months (or 365 days) ÷ number of orders.
Total inventory cost: Total cost = Purchase cost + Ordering cost + Carrying cost = (A × P) + (A ÷ Q × O) + (Q ÷ 2 × C); Q = order quantity, P = price per unit. Use this to compare discount offers.
Reorder level: Reorder level = Maximum usage × Maximum lead time; Alternative when only normal usage is given: Normal usage × Lead time + Safety stock.
Minimum stock level: Minimum level = Reorder level − (Normal usage × Normal lead time); Normal usage is the average of maximum and minimum usage unless stated.
Maximum stock level: Maximum level = Reorder level + Reorder quantity − (Minimum usage × Minimum lead time); Reorder quantity is usually the EOQ.
Average stock level: Average level = (Minimum level + Maximum level) ÷ 2, or Minimum level + ½ × Reorder quantity; The two forms can differ slightly in theory; use the one the question implies.
Danger level: Danger level = Normal usage × Emergency lead time; Some texts use average usage; follow the data given.

How to solve Inventory Management questions

Use this order for any question. It keeps units consistent and avoids missing a part.

1Read the data and list it: annual demand, ordering cost, carrying cost or rate, price, usage rates and lead times.
2Make the time units match. Convert weekly usage to annual or annual to weekly, using the same number of weeks or days throughout.
3Find the carrying cost per unit. If given as a percentage, multiply it by the unit price.
4Compute EOQ with √(2AO ÷ C) and round only at the end. State it in units.
5Compute the stock levels in this order: reorder level, minimum, maximum, average, danger.
6If discounts are offered, calculate total cost for each order size and pick the lowest. Do not compare EOQ values alone.
7For ABC analysis, arrange items by annual value in descending order, find cumulative value and cumulative percentage, then classify.
8Write a one-line conclusion with the order size, level or category.

Quickest way: Fast route for EOQ and stock levels

When to use it: Use when time is short and the question gives a single price and plain data.

Write A, O and C on top, with C already in rupees per unit.
Compute 2AO first, divide by C, then take the square root. Check with a quick perfect-square guess.
Write reorder level straight from maximum usage × maximum lead time.
Get minimum level from the reorder level formula, then maximum, directly using the reorder quantity.
For discounts, build a small three-column table: order size, ordering plus carrying cost, purchase cost. Add across.

Common mistakes in Inventory Management

Using carrying cost as a percentage directly in the EOQ formula.
The question says carrying cost is 10% and students put 10 or 0.10 as C.
Fix: Multiply the rate by the unit price. C = 10% × ₹50 = ₹5 per unit per year.
Mixing weekly usage with annual demand.
Data is given in different time units and students do not convert.
Fix: Convert everything to one unit before starting. Note the number of weeks (usually 52) used.
Using normal usage and normal lead time in the reorder level.
Students recall only the word 'normal' from the minimum level formula.
Fix: Reorder level uses maximum usage × maximum lead time. Normal values appear only in the minimum level.
Picking the discount offer with the lowest EOQ cost, ignoring purchase price.
Students focus on ordering and carrying cost only.
Fix: Include the purchase cost. Compare total cost for each price slab at its valid order size.
Applying EOQ at a quantity outside the discount slab.
The EOQ at a lower price may not qualify for that price.
Fix: Check that the order size falls in the slab. If not, use the minimum quantity of that slab.
Classifying ABC items by quantity instead of value.
Students sort by number of units.
Fix: Sort by annual consumption value (units × price) in descending order and use cumulative percentages.

Worked examples

Example 1

A company uses 18,000 units of a component a year. Ordering cost is ₹200 per order. Carrying cost is 10% of the purchase price of ₹40 per unit. Lead time is 5 to 15 days, usage is 40 to 80 units a day (normal 60). Taking 300 working days a year, find EOQ, orders per year, reorder level, minimum level and maximum level.

Show the solution

A = 18,000, O = ₹200, C = 10% × ₹40 = ₹4 per unit.
EOQ = √(2 × 18,000 × 200 ÷ 4) = √1,800,000 = 1,341.6, say 1,342 units.
Orders per year = 18,000 ÷ 1,342 ≈ 13.4, say about 13 orders.
Reorder level = maximum usage × maximum lead time = 80 × 15 = 1,200 units.
Normal lead time = (5 + 15) ÷ 2 = 10 days. Normal usage = 60 units.
Minimum level = 1,200 − (60 × 10) = 600 units.
Maximum level = 1,200 + 1,342 − (40 × 5) = 2,542 − 200 = 2,342 units.

Answer: EOQ ≈ 1,342 units; about 13 orders a year; reorder level 1,200 units; minimum level 600 units; maximum level 2,342 units.

Example 2

Annual demand is 2,400 units. Ordering cost is ₹100 per order. Carrying cost is 20% of price. The supplier offers ₹50 per unit for orders below 600 units and ₹48 per unit for orders of 600 units or more. Which order size should the firm choose?

Show the solution

At ₹50: C = 20% × 50 = ₹10. EOQ = √(2 × 2,400 × 100 ÷ 10) = √48,000 = 219.1, say 219 units. This is valid for the ₹50 slab.
Total cost at 219 units, using 219.09: purchase = 2,400 × 50 = ₹1,20,000. Ordering = (2,400 ÷ 219.09) × 100 = ₹1,095.4. Carrying = (219.09 ÷ 2) × 10 = ₹1,095.4. Total ≈ ₹1,22,190.9.
At ₹48: C = 20% × 48 = ₹9.60. EOQ = √(2 × 2,400 × 100 ÷ 9.6) = √50,000 = 223.6, which is below 600, so it does not qualify. Use 600 units.
Total cost at 600 units: purchase = 2,400 × 48 = ₹1,15,200. Ordering = (2,400 ÷ 600) × 100 = ₹400. Carrying = (600 ÷ 2) × 9.60 = ₹2,880. Total = ₹1,18,480.
Compare: ₹1,22,190.9 against ₹1,18,480. The second is lower.

Answer: Order 600 units at a time at ₹48 per unit. Its total cost of ₹1,18,480 is about ₹3,711 lower than ordering about 219 units at ₹50.

Exam tips

Show the formula, the substitution and the unit in every answer. ICSI marks method, so a small arithmetic slip costs little if the steps are clear.
Write the data table first. Most lost marks come from picking the wrong number for usage or lead time.
In discount questions, always show total cost for each option and finish with a clear recommendation.
For ABC analysis, show the cumulative percentage column and state the classes with the usual rough guide of high-value few items as A. Mention that cut-offs are indicative.
Be ready for short theory: advantages and limits of JIT, and why EOQ assumes constant demand and lead time.

Practice questions from Working Capital Management

Inventory Management in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Inventory Management: frequently asked questions

What is the EOQ formula for CS Executive?

EOQ = √(2AO ÷ C), where A is annual demand, O is ordering cost per order and C is carrying cost per unit per year. It gives the order size at which ordering cost and carrying cost are equal and total cost is lowest.

How do I find the reorder level and minimum and maximum stock levels?

Reorder level = maximum usage × maximum lead time. Minimum level = reorder level − (normal usage × normal lead time). Maximum level = reorder level + reorder quantity − (minimum usage × minimum lead time).

How do I calculate EOQ when there are quantity discounts?

Calculate EOQ for each price, check it falls in that price slab, and if not use the slab's minimum quantity. Then compute total cost including purchase cost for each option. Choose the lowest total cost.

How does ABC analysis work?

You rank items by annual consumption value, highest first, and work out cumulative percentages. A items are few but account for most of the value and get tight control. C items are many but low in value and get simple control. B items sit between them.

What is JIT in inventory management?

Just-in-Time means materials are received only as production needs them, so stock stays very low. It cuts carrying cost but depends on dependable suppliers and stable production.