Chapter 12: Inventory Management

Importance of inventory: inventory is one of the most expensive assets of many

companies, representing as much as 50% of total invested capital.

Objective of Inventory: strike a balance between inventory investment and

customer service.

Functions of inventory:
1. To provide a selection of goods for anticipated demand and to separate the
firm from fluctuations in that demand (Retail).
2. To decouple various parts of the production process.
3. Take advantage of quantity discounts, because purchases in larger quantities
may reduce the cost of goods or delivery.
4. To hedge against inflation and upward price changes.

Types of Inventory
1. Raw Material Inventory: this has been purchased but not processed. Can be
used to separate suppliers from the production process and eliminate
supplier variability.
2. Work-in-process: components of raw material that have undergone some
change but are not completed.
3. Finished Goods: the completed product awaiting the shipment. Finished
goods may be inventoried because future customer demands are unknown.

Cycle Counting: a continuing reconciliation of inventory with inventory records.

 Advantages:
o Eliminates the shutdown and interruption of production necessary for
annual physical inventories
o Eliminates annual inventory adjustments
o Trained personnel audit the accuracy of inventory
o Maintains accurate inventory needs

Control of Service Inventories

 Inventory that is in transit or idles in a warehouse is lost value.
 Inventory that is unaccounted for between receipt and time of sale is known
as shrinkage
 Inventory theft is known as pilferage

Ways of Controlling Inventory:

1. Good personnel selection, training, and discipline: necessary when employees
have access to inventory
2. Tight control of incoming shipments: Bar codes, RFID. These help identify and
track the inventor.
 3. Effective control of all goods leaving the facility: bar codes, RFID tags,
personnel stationed exits.

Inventory Models

Independent: for example, demand of TV’s is independent of demand of toaster

ovens.
Dependant: Demand for toaster oven components is dependant on demand for
toaster ovens.

Holding, Ordering, and Setup Costs

 Holding Costs: costs associated with holding the inventory over time
(storage, obsolescence, insurance, staffing)
 Ordering Costs: Costs of supplies, forms, order processing, purchasing,
clerical support, etc.
 Setup Cost: the cost to prepare a machine or process for manufacturing an
order. Setup time is the time required to prepare a machine or process
for production.

Independent Demand Models

 Basic economic order quantity model (EOQ)
 Production order quantity model
 Quantity discount model

EOQ Assumptions
 Demand for an item is known, reasonably constant, and independent of
decisions for other items
 Lead time (the time between placement and receipt of order) is known and
consistent
 Receipt of inventory is instantaneous and complete. (One batch of inventory
at a time)
 Quantity discounts are not possible
 The only variable costs are setup costs, and holding costs
 Stockouts (shortages) can be completely avoided if orders are placed at the
right time.