Basics of Supply Chain Management

Unit 1
UUnit
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BBasics
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Lesson 7
Order Management
 Basics of Supply Chain Management

Unit 1
Preface............................................................................................................3
Course Description................................................................................................................. 3
Lesson 7 – Order Management........................................................................4
Introduction and Objectives.................................................................................................. 4
Inventory Replenishment Objectives ................................................................................... 4
Stock-Keeping Units (SKUs) ................................................................................................. 4
Inventory Levels and Number of Orders ............................................................................. 5
Order Quantities .................................................................................................................... 5
Reduce Costs........................................................................................................................... 8
Ordering for Independent Demand...................................................................................... 9
Order Point Systems .............................................................................................................. 9
Periodic Review.................................................................................................................... 11
Inventory Audits................................................................................................................... 12
Summary ............................................................................................................................... 14
Further Reading ................................................................................................................... 14
Review ................................................................................................................................... 15
What’s Next? ........................................................................................................................ 17
Appendix.......................................................................................................18
Answers to Review Questions .............................................................................................. 19
Glossary ........................................................................................................21

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Preface
Course Description
This document contains the seventh lesson in the Basics of Supply Chain Management unit,
which is one of five units designed to prepare students to take the APICS CPIM examination.
The Basics of Supply Chain Management unit provides the foundation upon which the other four
units build. It is necessary to complete this unit, or gain equivalent knowledge, before
progressing to the other units. The five units, which together cover the CPIM syllabus, are:
Basics of Supply Chain Management
Master Planning of Resources
Detailed Scheduling and Planning
Execution and Control of Operations
Strategic Management of Resources
Please refer to the preface of Lesson 1 for further details about the support available to you
during this course of study.

This publication has been prepared by E-SCP under the guidance of Yvonne Delaney MBA,
CFPIM, CPIM. It has not been reviewed nor endorsed by APICS nor the APICS Curricula and
Certification Council for use as study material for the APICS CPIM certification examination.

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Lesson 7 – Order Management
Introduction and Objectives
Inventory management is concerned with providing the optimum level of customer care while
minimizing costs. A vital part of inventory management is deciding how much to order and
when to order. This lesson examines these issues and explains the economic order quantity
(EOQ) formula and criteria for using it. The lesson also covers periodic review system and cycle
counting.
On completion of this lesson you will be able to:
Identify relevant costs when deciding on order sizes
Describe the criteria for using the EOQ formula
For a given situation, calculate the EOQ
Identify the description of an order point
List reasons for carrying safety stock
Distinguish between the two-bin system and the perpetual inventory system
Explain the periodic review system
Identify the rationale for conducting an inventory audit
Describe the process of cycle counting

Inventory Replenishment Objectives

The main objectives of a company when deciding on inventory replenishment quantities are to:
Minimize the overall costs
Maximize the customer service levels

Effective management of inventory replenishment relies on identifying the most cost effective
and efficient order quantity and frequency of reorder.

Stock-Keeping Units (SKUs)

For most purposes, inventory levels in a company are measured by means
of SKUs An SKU is an individual inventory item at a particular location.
For example, a company that manufactures men’s ties has a box of ties that
has just been produced and passed as finished goods. It also holds a box of
the same type of tie in each of its three distribution centers. Altogether,
there are 4 stock-keeping units.
To further illustrate the concept, two pairs of trousers in the same inventory but of
different sizes or styles would be two different SKUs. The same size and style of
trousers in two different inventories would be two different SKUs.

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Inventory Levels and Number of Orders
Inventory can be managed in many different ways. For example, if a company expected its
requirements for office paper to be 52 boxes per year, it might make one order of 52 boxes at the
beginning of the year. Alternatively, it might order one box a week. The overall amount of
inventory has not changed but the means of procuring and managing it is very different.
In the first example, the company saves time as it does not have to reorder
every week. However, it will require space to store the 52 boxes of paper;
space which could have been used for other purposes. In the second
example, the space is saved but the company must make an order each
week and handle 52 invoices for paper, as opposed to 1 invoice.
Efforts must be made to ensure that the number of orders made and the
costs incurred by carrying inventory are at the most economic levels. The
graph below shows an example relationship between the costs of ordering and the costs of
storing inventory. The balance where overall costs are least occurs when lot sizes fall between
100 and 200 units.

1000
900
800
700
600 Cost of Carrying
Cost

500 Cost of Ordering

400 Total Cost
300
200
100
0
50 100 150 200 250 300 350 400 450
Lot Size

Figure 1 Example of carrying and ordering costs for an inventory item

Order Quantities
Techniques for inventory replenishment include fixed reorder period, lot-for- lot ordering, fixed
order quantities, and economic order quantities (EOQ).
Order quantities are expressed in terms of stock-keeping units (SKUs). An SKU is a single
inventory item with a specific warehouse location.

Fixed Order Quantity

Material is reordered when inventory drops to a predefined level. A specific amount is ordered
each time an order is placed. The fixed order quantity is often based on reasonable estimations
and does not always lead to the best results. However, it is a quick and simple method.

Fixed Reorder Period

An order for the required amount of the commodity is made regularly, for example, every week.

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Fixed Reorder Point
Orders for the required amount are made when stock reaches a predetermined level.

Lot-for-Lot Order Quantity

When one lot is used, the next lot is drawn down and the original lot is replaced. Only the
amount needed is ordered. With this type of reordering system no unused lot-size inventory is
created. This method is used for:
Dependent demand items
Expensive components
JIT manufacturing processes

EOQ
The underlying objectives of supply chain management are to minimize costs while maintaining
customer service. The EOQ is an amount of inventory where the cost of carrying the inventory
and the cost of ordering are at a minimum. It is the most economic quantity or lot size of a
component or part to order at a given time. It takes a number of factors into consideration.
The factors influencing EOQ are:

Using EOQs results in cost effective procurement but always results in excess inventory and may
not take account of all related costs. It is usually valid for finished goods with independent and
steady demand.
The EOQ can be used in cases where:
Demand is relatively constant and known
Items are produced / purchased in lots or batches
Order preparation costs and inventory carrying costs are both constant and known
Replacement occurs all at one
The unit variable cost does not change with qua ntity (for example, discounts for larger
orders)

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The material or component is ordered in agreed, fixed batch sizes. The complete batch
size is delivered at one time. No partial deliveries are accepted.
There are no economies of scale.
The material or component cost is constant, irrespective of order quantity.
Provided the supply lead time is known, the unit variable cost is not a function of the order
quantity (for example, the product is not discounted when ordered in high volumes), and the
demand rate is constant, the optimum economic order quantity for an inventory item can be
calculated by applying the following formula:

EOQ =
√ 2AS
IC

A = Annual usage in units

S = Ordering cost in dollars per order
I = Annual carrying cost rate as a decimal of a percentage
C = Unit cost in dollars
ABC Beverages have an annual demand of 2,000 units of fresh apple juice. The ordering cost is
$40 per order, the carrying cost is 20% and the unit cost is $30. Therefore:
A = 2,000
S = $40
I = 20%
C = $30

EOQ =
√ 2 x 2000 x 40
0.2 x 30

The EQO in this case is equal to 163 units. This is the optimum amount, which balances out
ordering costs and carrying costs to achieve the minimal overall or total cost.

As the order qua ntity increases the annual cost of ordering decreases but the costs of carrying
inventory increase. The EOQ finds the optimum balance between these two costs. The EOQ can
also be calculated in monetary units rather than physical units by changing the annua l usage from

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physical units to dollars and ignoring the cost per unit. Although safety stock may still be
necessary, it should be minimal and can be determined by considering the minimum acceptable
customer satisfaction level and the frequency of stock-outs.
1. A company uses $5000 of a particular item each year. The order costs for
the item are $20 per order and the carrying cost is 20%. What is the dollar
EOQ?

A. 1000 units
Review Q B. $1000
C. $5000
D. 5000 units

When Not to Use EOQ

In many cases, the EOQ model assumptions are invalid, particularly when demand is
inconsistent and so an EOQ cannot be determined. An EOQ can also become irrelevant if
stocking policies involving a fixed reorder point, fixed quantity, or fixed period are applicable.
The EOQ assumes that demand is fairly uniform and replenishment occurs all it once. If this is
not the case period-order quantities would be better than using an EOQ. In other cases where
demand is not uniform and stock must be built ahead it is better to plan a buildup of inventory
based on capacity and future demand rather than use EOQs.

Practicalities of Using EOQ

Some suppliers require a minimum order, often based on total order rather than individual items.
This generally applies more to C class inventory items where order quantities should be large.
When shipping costs are a large factor, it is important to consider that fact that a full load costs
less per unit to ship than a partial load.
Sometimes order size is constrained by package size. For example, a bottler may only ship in
1,000 unit pallets. In this case, the unit used for the EOQ should be the minimum package size.

Reduce Costs
The costs associated with inventory items are influenced by annual demand, costs of storage,
unit costs and ordering costs. The following table explains these factors and their influence.
Annual Demand Ordering Cost Unit Cost Carrying Cost
§ Determined by the § The cost of placing an § Production or § Depend on the
market order purchase cost of an product and the cost
item of money
§ Should be as high as § Should be as low as
possible possible § Should be as low as § Should be as low as
possible possible
§ As it increases, EOQ § As this decreases, the
increases EOQ decreases § As this decreases, the § As it decreases, the
EOQ increases EOQ increases

Only the ordering costs can be controlled by the company, as demand and unit cost are dictated
by the market place, and the carrying costs are dependent on the product itself.

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To reduce ordering costs, either the process of placing an order must be modified, or the
changeover costs in production must be modified.

Ordering for Independent Demand

Replenishment of inventory should be carried out in accordance with the overall aim of
minimizing the amount of inventory held where possible. An inventory replenishment schedule
may be based on material requirements, order points, or distribution requirements, depending on
the circumstances.

Material Requirements
A material requirements planning approach, if the demand if dependent and production-related,
is useful in any industry with long BOMs, such as the motor industry for example, where the
demand for tyres is dependent on the number and variety of car produced.

Order Point
If the demand is independent and consumption-related, for example the demand for glass is
dependent on the number and variety of orders received from any source, then an order point
approach may be more suitable.

Distribution Requirements
A distribution requirements planning approach may be used if multiple hierarchical facilities are
involved. For example, if the demand has to be aggregated over several sites, then each site
needs to check its own requirement, by using a mini MRP-based system, and then the total
requirement can be estimated.
Systems used to determine when to order include the following:
Order point
Periodic review
Master scheduling

Order Point Systems

A level of stock on hand is designated the order point. When the quantity of stock falls to this
level, an order for more stock is placed. The order point must be sufficiently high to ensure that
there will be enough stock on hand to satisfy demand while waiting on delivery of the
replenishment stock.

Order Point Formula

The order point is calculated by assessing demand for material and the lead time for that item. It
may also include an extra amount of inventory, or safety stock, to guard against the unexpected,
such as increases in lead time or demand.
Order Po int = Demand during lead time + safety stock
For example, ABC Beverages use 100 boxes of oranges per week. The
lead time for oranges is 2 weeks and they usually carry about 20 boxes of
oranges as safety stock. The order point is calculated as follows:
Order Point = (100 x 2) + 10
Order Point = 210

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The company will order more oranges when the stock on hand falls to 210 boxes.

Safety Stock
Safety stock or buffer stock is carried to protect against stock outs. The amount of safety stock to
carry should be calculated based on :
Length of lead time
Ability to predict and control lead times
Frequency of ordering
Service level objectives
Variability of demand during the lead time, caused by random errors in
the forecast.
If the actual demand varies greatly from the forecast demand, the levels of safety stock must be
quite high. If on the other hand, there is little if any random variation between forecast and actual
demand, safety stocks may not be required.
The amount of safety stock carried should be calculated by determining the minimum costs of
carrying the safety stock weighed against the cost of a stockout.

Cost of Stockout
The costs associated with stockouts are difficult to evaluate. They include the cost of back
orders, the cost of sales lost, and the cost of losing customers. Management should agree on the
number of stockouts per year that is tolerable, the lower the better.
Stockouts adversely affect customer service levels. The underlying objective of a business and of
inventory management is to maintain acceptable levels of customer service level. Increasing the
level of safety stock is one method of increasing the service level as it ensures there is more
likely to be sufficient product to meet demand.

Calculating the Order Point

A stock out is most likely to occur when stocks are running low, a situation which exists around
the time an order is placed for replenishment stock up until delivery of the ordered stock. Where
the lead time between order and delivery for stock is long, safety stocks must increase to ensure
demand can be met in the interim period. If lead time is short, safety stocks are lower.
The point at which an order occurs is therefore very important as it affects inventory levels and
therefore inventory costs and service levels. There are two basic systems to help inventory
management teams decide on appropriate order points. These are the two-bin and perpetual
inventory record systems.
Two -Bin System
This is a simple and economical method of remembering when
to order and is useful for less critical inventory items of
relatively low cost.
For example, a company manufacturing children’s bicycles, sell
their product in a box with a few assembly items and tools,
including a small spanner. The spanner is an inexpensive

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inventory item which is less critical to the manufacturing process as, for example, the chain or
tyre.
At the end of the productio n line, two bins of spanners are maintained. When the first bin
empties, an order is placed for a new bin of spanners. In the mean time production continues to
use spanners from the second bin.
Perpetual Inventory Record System
The use of a perpetual inventory record is a more complex but more
accurate method of ensuring sufficient stock on hand. Take for
example, the tyre for the child’s bicycle, which is a more bulky, more
expensive, and more critical item than the spanner. The tyres may be
ordered in lots of 500 from a supplier. When stocks drop to 200 tyres,
a new order is released to the supplier.
This inventory item is managed by an inventory record, which records the amount of stock on
hand, the amount on order, and the amounts received, issued, and allocated. At any point in time
the inventory record provides a complete picture of the number of tyres available. An example of
a perpetual inventory record is displayed below:

34756 Tyre -Children’s Bicycle Order Quantity = 500

Order Point 200
Date On Order Received Issued On Hand Allocated Available
20.08.04 500 500
21.08.04 500 300 200
22.08.04 500 300 200 0 200
23.08.04 200 200
24.08.04 500 700 700
Figure 2 Perpetual Inventory Record

Periodic Review
Order point systems generally use a fixed order quantity. When the order point is reached, a new
order is generated. As production rates may vary, the time period between orders may also vary.
When production levels are high, orders will be more frequent than during quieter production
periods.

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In contrast, the periodic review system maintains a constant interval of time between orders, but
the amount of each order may vary significantly. The amount ordered, along with the inventory
on hand, must be sufficient to last until the next shipment arrives.
In this type of system, the time to order is predetermined but the order quantity must be
calculated each time. First, the target inventory level must be established. This is the quantity of
inventory required to satisfy demand for the period in question while allowing for order lead
time and maintaining safety stock levels. Target time is calculated using the formula:
Target Level = (demand per unit of time) x (review period + lead time) + safety stock
The target level is then used, along with data regarding stock on hand, to establish the order
quantity:
Order quantity = Target level – quantity on hand
For example, a factory that makes decorative bricks relies on
scheduled freight trains to deliver raw material from a nearby
quarry, with deliveries every Wednesday. To receive an order
on Wednesday, the company must send the order to the
quarry on Monday, a lead time of two days. The company
usually requires 1 tonne of material each day and they usually
keep a week’s worth of material as safety stock. The review
period is each week (5 working days). The current inventory
level, as they reach the order point, is 7 tonnes.
Using the formula above:
Target level = 1 x (5 + 2) + 5
Target level = 13 tonnes
Order qua ntity = 13 tonnes (target level) – 7 tonnes (quantity on hand)
Order quantity = 7 tonnes
2. A department store stocks candles and orders them from a local supplier
every 4 weeks (20 working days). The average demand for the candles is 100
per week (5 working days), the lead time is 2 days, and the safety stock is 3
days’ supply. An order must be placed this week and the stock on hand is 87.
What is the target level, and how many candles should be ordered?
Review Q
A. Target Level = 500, Order Quantity= 587
B. Target Level = 413, Order Quantity= 500
C. Target Level = 500 Order Quantity= 413
D. Target Level = 587, Order Quantity= 413

Inventory Audits
There are numerous ways in which error can be introduced into company systems as a result of
delayed or inaccurate data entry, as explained by the following examples.
A substitution may occur on any given BOM. If the change is not updated, the recorded amount
of both the original component and the substituted component held in inventory will be incorrect.
When a Work Order (WO) is released, the Bill of Material (BOM) for that work order is locked

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at the time of WO release. Subsequent changes to the BOM must also be updated in the WO to
maintain accurate records.
Delays in updating data may affect the ability to cycle count correctly. In
consequence, incorrect stock record adjustments may be performed. For example,
a delay in scrapping material, the system may suggest material is available that
has already been consumed in manufacturing.
Data entry errors occur, particularly with manual data entry. For
example, entering receipt of 1010 units instead of 1100 will introduce
errors into the system that will impact inventory accuracy and
planning.
The two basic methods of checking inventory record accuracy are period counts and cycle
counts.
Periodic Audit
Periodic audits are large scale physical counts of all inventory in a plant. This type of audit
usually takes place annually and is primarily concerned with verifying the financial value of the
inventory. Periodic audits are disruptive to production and are expensive in terms of time and
administration. Accuracy is poor as many of those taking part in the exercise may be
inexperienced and error prone. Some items may be counted twice, others not at all.

Cycle Count
Cycle counting is concerned with a specific set of inventory items and takes place much more
often, often daily or at the start and end of each production run. All items are counted a specified
number of times per year depending on their importance. Cycle counting relies on trained and
dedicated personnel.
The advantages of cycle counting include:
Timely detection and correction of problems
Finding and correcting causes of error
Little impact on production time
The frequency of the cycle count will be determined by the inventory item itself. The frequency
should increase as the value of the item and the number of transactions for that item increases.
Most companies classify their inventory items in some form or another. These classifications can
be useful in determining inventory. For example, if ABC classification is used, there may be a
higher cycle count frequency for A items compared to B items.
3. A company has 550 A items, 825 B items, and 125 C items. It decides that
the A items should be counted once a month, the B items every quarter, and
the C items annually. What are the total number of counts and how many
counts will there be per day, given 250 work days in the year?

Review Q A. Total Counts = 10025, Counts per Day = 40.1

B. Total Counts = 18000, Count s per Day = 49.3
C. Total Counts = 10575 Counts per Day = 42.3
D. Total Counts = 18000, Counts per Day = 40.1

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Summary
This lesson examined order management, the need to calculate order quantities and frequencies.
The lesson also covered periodic review system and cycle counting.
You should be able to:
Identify relevant costs when deciding on order sizes
Describe the criteria for using the EOQ formula
For a given situation, calculate the EOQ
Identify the description of an order point
List reasons for carrying safety stock
Distinguish between the two-bin system and the perpetual inventory system
Explain the periodic review system
Identify the rationale for conducting an inventory audit
Describe the process of cycle counting

Further Reading
Introduction to Materials Management, JR Tony Arnold, CFPIM,
CIRM and Stephen Chapman CFPIM
5th edition 2004, Pearson Education Limited

APICS Dictionary
10th edition, 2002, APICS

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Review
The following questions are designed to test your recall of the material covered in
lesson 7. The answers are available in the appendix of this workbook.

4. Which of the following is an indication that EOQ may not be suitable?

A. Demand is relatively constant and known and replacement occurs all at once
B. Order preparation and inventory carrying costs are both constant and known
C. The unit variable cost does not change with quantity and the material is ordered in
fixed batch sizes
D. Stocking policies involve a fixed reorder point, fixed quantity, or fixed period
5. If the lead time is 3 weeks, the demand per week is 300 units and the safety stock level is
100 units, at what level is the order point?
A. 300
B. 400
C. 900
D. 1000
6. Which of the following are causes of inventory record inaccuracy?
1. Unauthorized withdrawal of inventory
2. Transaction errors in re cording inventory issues
3. Poor training of personnel
4. Secured stockrooms
A. 1, 2, and 3
B. 2, 3, and 4
C. 1, 3, and 4
D. 1, 2, 3, and 4
7. Which is the best description of the periodic review order system?
A. Material is kept in two containers and when the first is emptied it is sent for refilling
while the second bin is used.
B. Material never drops below a fixed level. An inventory record records the amount of
stock on hand, the amount on order, and the amounts received, issued, and allocated.
At any point in time the inventory record provides a complete picture of the number
available.
C. There is a constant interval of time between orders, but the amount of each order may
vary significantly. The amount ordered, along with the inventory on hand, must be
sufficient to last until the next shipment arrives.
D. Large scale physical count of all inventory in a plant that takes place annually and is
primarily concerned with verifying the financial value of the inventory

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8. If the annual usage of an item is 1000 units, the cost per order is $20, the carrying cost is
20% and the unit cost in dollars is $5, what is the EOQ?
A. 141
B. 200 units
C. 2,000 units
D. 4,000 units
9. Many companies perform inventory audits. What is the usual reason for performing a
periodic review of inventory?
A. To ensure accuracy of inventory records for a specific set of inventory items
B. To calculate the financial value of inventory
C. To verify inventory records
D. To eliminate waste
10. Which of the following statements about cycle counting are correct?
1. All items are counted a specified number of times per year.
2. The advantages of cycle counting include timely detection and correction
of problems, finding and correcting causes of error, and minimal impact
on production time
3. The frequency of the cycle count is determined by the importance of the
inventory item.
4. if ABC classification is used, there may be a lower cycle count frequency
for A items compared to B items.
A. 1, 2, and 3
B. 2, 3, and 4
C. 1, 3, and 4
D. 1, 2, 3, and 4

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What’s Next?
Lesson 7 covered a variety of techniques and tools used in the management of inventory orders.
You should review your work before progressing to the next lesson which is:
Basics of Supply Chain Management – Lesson 8 Distribution

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Appendix

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Answers to Review Questions

1. B
The monetary EOQ is the square root of (2 x annual dollar usage x order cost) divided by the
carrying cost.
2. C
The total number of counts = (550 x 12) + (825 x 4) + 125. The number of counts per day is
equal to the total number of counts (10025) divided by the number of work days in the year
(250).
3. D
The total number of counts = (550 x 12) + (825 x 4) + 125. The number of counts per day is
4. D
The EOQ may not be suitable when demand is inconsistent or if stocking policies involving a
fixed reorder point, fixed quantity, or fixed perio d are applicable. The EOQ calculation assumes
that demand is fairly uniform and replenishment occurs all it once. Order costs, carrying costs
and demand should be fairly constant and known.
5. D
The order point is equal to the demand during the lead time (3 x 300) plus the safety stock (100).
6. A
Many factors may affect the accuracy of inventory records. Unsecured stockrooms can lead to
inventory inaccuracies as can withdrawal of inventory without authorization, transaction errors
in inventory records and errors made in the inventory record system by untrained personnel.
7. C
In the two-bin replenishment system two bins are filled. When the first container empties it is
sent for refilling and the second bin is used. In the perpetual inventory system an inventory
record maintains the amount of stock on hand, the amount on order, and the amounts received,
issued, and allocated. At any point in time the inventory record provides a complete picture of
the number available. Using a periodic review replenishment system, the reorder time is known
but the amount must be calculated to last until the next shipment. A periodic inventory audit
involves large scale physical counts of all inventory in a plant that takes place annually and is
primarily concerned with verifying the financial value of the inventory. This is not a reorder
system.
8. B
The EOQ is equal to the square root of (2 x annual usage x ordering cost) divided by (carrying
cost times the cost per item).
9. B
The usual reason for performing a periodic inve ntory audit is to satisfy financial auditors about
the value of inventory. It can provide an opportunity to correct inventory record inaccuracies but
this is not the main purpose of the exercise. The success of such inventory audits depends on
good housekeeping, clear identification, and properly trained auditors.

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10. A
A cycle count is a system of counting inventory throughout the year. The inventory items of
greater value and with higher transaction rates are counted most often. In many organizations
cycle counts of selected items occur every day. Cycle counting helps in the detection and
correction of problems and the causes of those problems. It requires trained personnel but has
less impact on production than a full physical inventory review. Using ABC classification, A
items will be counted more often than B or C items as they are of greater value.

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Glossary

Term Definition
Carrying cost Cost or carrying inventory. This is defined usually as a percentage of the
monetary value of the inventory per unit of time (usually a year). Carrying cost
depends on the cost of capital invested and on costs of maintaining the
inventory, paying tax on it, insuring it, spoilage, storage space, and
obsolescence.
Cycle counting An inventory accuracy audit technique. Each inventory item is allocated a
cycle count frequency, usually more frequent for high value or fast moving
items. Each item is counted in isolation at regular intervals throughout the year
as often as specified for each item. Many items may be counted very working
day. Cycle counting is used to identify items in error. This may lead to
research, identification, and elimination of the causes of the errors.
Demand A need for a particular product or component which could come from a
customer order, forecast of market requirements, interplant requirement, or a
request from a branch warehouse for a service part
Distribution The activities associated with the movement of material, usually finished
goods or service parts from production plant to the customer. Distribution
incorporates functions such as transportation, warehousing, inventory control,
material handling, order administration, location analysis, packaging, data
processing and communications networks.
Economic order Reducing setup time and inventory to the point where it is economical to
quantity (EOQ) produce in batches of one.
Fixed order À lot sizing technique in MRP or inventory management that will always
quantity cause an order to be generated for a fixed quantity or multiples of that fixed
quantity, if net requirements for the period are higher than the fixed order
quantity.
Independent Demand for an item that does not depend on the order of other items. Demand
demand for finished goods, parts required for destructive testing, and service parts are
examples of independent demand.
Inventory Stocks or items used to support production (raw materials and work- in-process
items), activities that support production (operating supplies, maintenance and
repair), and customer service (finished goods and spare parts).
Inventory turns The number of times that an inventory turns over during a year. This is
calculated by dividing the average inventory level into the annual cost of sales.
For example, an average inventory of $600,000 divided into an average cost of
sales of 1,800,000 means that inventory turned over 3 times during the year.
Lot-for-lot A lot sizing technique that generates planned orders in quantities equal to the
net requirements in each period.
Order point A predefined inventory level, which if it is higher than the stock on hand and

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 Basics of Supply Chain Management

Unit 1
stock on order combined, will trigger an action to replenish the stock.

Order Quantity or The amount of an item that is ordered from a supplier or from the plant or is
Lot size issued as a standard quantity to the production process.
Periodic review This is also called fixed reorder cycle inventory model. It is a form of
system independent demand item management in which an order has a fixed quantity.
The reorder point will be large enough to cover the maximum expected
demand during the replenishment lead time.
Perpetual An inventory recordkeeping system where each transaction in and out is
inventory recorded and a new balance is computed.
Productivity An overall measure of the ability to produce a product, either goods or
services. It is the actual output of production compared to the actual input of
resources. Productivity is a relative measure across time or against common
entities. Some ratios available to measure productivity involve adding the
standard hours of labor produced plus the standard machine hours actually
produced in a given time period and dividing these by the actual hours
available for both labor and machines during that time.
Safety stock This is a quantity of stock that is planned for inventory to protect against
fluctuations in demand or supply. In the context of master production
scheduling, the additional inventory and capacity planned as protection against
forecast errors and short term changes in the backlog. Overplanning can be
used to create safety stock. Safety stock is also known as buffer or reserve
stock.
Service level A desired measure (usually a percentage) of satisfying demand through
inventory or by the current production schedule in time to satisfy the
customers’ requested delivery dates and quantities. In a make-to-stock
environment, level of service is sometimes the percentage of orders picked
complete from stock upon receipt of customer order.
Stockout A lack of required materials components or finished goods.
Two-bin system A type of fixed order system in which inventory is carried in tow bins. A
replenishment quantity is ordered when the first bin is empty. During the
replenishment lead time, material is used from the second bin. When the
material is received, the second bin, which contains a quantity to cover
demand during the lead time plus some safety stock, is refilled and the excess
is put into the working bin. AT this time, stock is drawn from the first bin until
it is empty again. The bins may be metaphorical only.
Unit cost Total labor, material, and overhead cost for one unit of production.
Work-in-process Also known as work in progress, this refers to products that are in a partial
(WIP) stage of completion throughout the plant. This includes all material from raw
material that has been released for initial processing up to completely
processed material awaiting final inspection and acceptance as finished
product.

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