Inventory

Management

What is What is Inventory Inventory

Management?Management?

Inventory

Inventory: A stock or store of goods.

Independent Demand

A

B(4) C(2)

D(2) E(1) D(3) F(2)

Dependent Demand

Independent demand is uncertain. Dependent demand is certain.

Inventory: a stock or store of goods

Inventory

Inventory Models

Independent demand – finished goods, items that are ready to be sold

E.g. a computer

Dependent demand – components of finished products

E.g. parts that make up the computer

Examples

Manufacturing firms carry supplies of raw materials, purchased parts, finished items, spare parts, tools,....

Department stores carry clothing, furniture, stationery, appliances,...

Hospitals stock drugs, surgical supplies, life-monitoring equipment, sheets, pillow cases,...

Supermarkets stock fresh and canned foods, packaged and frozen foods, household supplies,...

The Nature and Importance of Inventories

Inventories are a vital part of business

Necessary for operations

Contribute to customer satisfaction

Inventories represent a significant portion of total assets

Sale of merchandise (inventory) is a major source of revenues for retail and wholesale businesses

Types of Inventories

Raw materials & purchased parts

Partially completed goods called work in progress

Finished-goods inventories (manufacturing firms) or merchandise (retail stores)

Types of Inventories (Cont’d)

Replacement parts, tools, & supplies

Goods-in-transit to warehouses or customers

Functions of Inventory

1. To meet anticipated demand: Anticipation stock – average demand

2. To smooth production requirements: Seasonal inventories

3. To protect against stock-outs: Safety stock – uncertainty

4. To take advantage of quantity discounts

5. To help hedge against price increases

Inadequate Control of Inventories

Inadequate control of inventories can result in both under- and overstocking of items.

UnderstockingUnderstocking (too few) results in missed deliveries, lost sales, dissatisfied customers, and production bottlenecks (idle workers or machines).

Resulting underage cost.

OverstockingOverstocking (too many) ties up funds that might be more productive elsewhere.

Resulting overage cost.Goal: matching supply with demand!

Objective of Inventory Control

To achieve satisfactory levels of customer service

while keeping inventory costs within reasonable

bounds

Two fundamental decisions: When to order (timing) How much to order (size)

Right goods, right place,

right time, right quantity

Performance Measures

Performance measures used to judge the effectiveness of inventory management

1.1. Customer satisfaction:Customer satisfaction: the number and quantity of backorders, customer

complaints.

2.2. 2.2. Inventory turnoverInventory turnover

The higher, the better – more efficient use of inventory

Desirable number of turns depend on industry and profit margin

Indicate how many times a year the inventory is sold

turnover

3. 3. Days of inventory on-handDays of inventory on-hand:: the expected number of days of sales that can be

supplied from existing inventory.

investmentinventory Average

sold goods ofcost Annual

Inventory Counting Systems

Periodic SystemPhysical count of items made at periodic intervals

Perpetual Inventory System System that keeps track of removals from inventory continuously, thus monitoringcurrent levels of each item

Inventory Counting Systems (Cont’d)

Two-Bin System - Two containers of inventory; reorder when the first is emptyUniversal Bar Code - Bar code printed on a label that hasinformation about the item to which it is attached

0

214800 232087768

3. Lead Time Information

Lead TimeLead Time:: Time interval between ordering and receiving the order

- Lead time variability: the greater the potential variability, the greater the need for additional stock to reduce the risk of a shortage between deliveries

4. Inventory Costs

a.a. Ordering cost Ordering cost :: Costs of ordering/producing and receiving inventory.

Eg. RM12 per order

b.b. Unit ordering/production costUnit ordering/production cost:: cost of obtaining one unit of the inventory.

Eg. RM 77 per item

4. Inventory Costs cont.

b. b. Holding (carrying) costHolding (carrying) cost:: Physically holding item in storage.• interest• insurance• taxes• depreciation• obsolescence• warehouse costs (heat, light, rent, security)• opportunity costs

Holding costs are stated in either way:1. a percentage of unit price2. a dollar amount per unit

• deterioration• spoilage• theft• breakage

4. Inventory Costs cont.

c. c. Shortage costsShortage costs:: Costs resulting when demand exceeds supply.• Opportunity cost for not making a sale

• Loss of customer goodwill

• Lateness charges

• Cost of lost production

It is often difficult to quantify shortage costs.

One objective of Inventory Control is to One objective of Inventory Control is to

minimize minimize

the sum of these costs by balancing them.the sum of these costs by balancing them.

Replenishment Replenishment StrategyStrategy

-- EOQ (Basic)-- EOQ (Basic)

Basic Economic Order Quantity Model (EOQ)

Assumptions:

1. Ordering in batch from supplier.

2. Only one product is involved.

3. Constant demand rate. Demand is spread evenly throughout the year.

4. Constant lead time. Lead time does not vary much for a long enough time.

5. Single delivery for each order.

6. A single flat unit price from the supplier.

The Inventory Cycle

Figure 11.2Profile of Inventory Level Over Time

Order/batch size Q

Receiveorder

Placeorder

Receive order

Placeorder

Receive order

Order lead time

Reorderpoint

Demand rate D

Time

Order cycle time

Inventory Level vs. Order Frequency

Large order

Small order

Low average

inventory

High average invento

ry

Long order cycle time

Short order cycle time

Now the Question is…..

Economic order quantity (EOQ): The order

size Q that minimizes total costs per unit time.

Fixed ordering cost S IGD / order

Unit ordering cost P IGD / unit

( P = unit price, assuming no other unit ordering cost component)

Unit carrying cost H= h P IGD / time

( h = carrying cost rate for one IGD value of inventory/time)

NO shortage cost here! Demand is a constant and it is

always met.

Example 2

Demand for a certain radial tires at a tire company is 800 units per month. Each tire costs the company IGD 80. Ordering costs are IGD 75, and the annual carrying costs are 20 percent of the purchase price.

D = 800 * 12 = 9600 /yrS = IGD75 /orderP = IGD80, r = 0.20H = rP = IGD80 * 0.2 = IGD16 /unit · yr

Match!

Solution to Example 2

1. How many tires should the manager order in each lot?

2. What is the company's average inventory of this tire?

3. How often will an order be placed (length of order cycle)?

.units 30016

75)9600(22EOQ

H

DS

.units 1502

300

2

EOQinventoryAverage

.days 9)(days/yr 288)yr( 03125.09600

300EOQ

D

Solution to Example 2 (Cont.)

4. How many times per year will an order be placed?

5. How much does the company spend annually on ordering costs?

6. How much does the company spend annually on holding (carrying) costs?

.yr/ 32300

9600

EOQ

D

400,275300

9600

EOQIGDS

D

400,2162

300

2

EOQIGDH

Solution to Example 2 (Cont.)

7. What is the total annual cost if the EOQ quantity is ordered?

4,800 I 2,400I 400,2

2

EOQ

EOQ

GDGDIGD

HSD

TC

The ordering and carrying costs are equal at the EOQ

800,41675960022 IGDDSHTC

OR