Inventory Management

DEFINITION OF INVENTORY
Inventory is the stock of any item or
resource used in an organisation.
Inventory system is the set of policies and
controls that monitor levels of inventory
and determine what level should be
maintained, when stock should be
replenished, and how large orders should
be.
 PURPOSES OF INVENTORY
 To maintain independence of
operations. A supply of materials at a
work center allows that center
flexibility in operations.
 To meet variation in product demand.
If the demand for the product is
known precisely, it may be possible
to produce the product to exactly
meet the demand.
 To allow flexibility in production
scheduling.
 To provide a safe guard for variation
in raw material delivery time.
 To take advantage of economic
purchase order size.
 Types of Inventory
 Raw material
 Work-in-progress
 Maintenance/repair/operating supply
 Finished goods
The Functions of Inventory
 To “decouple” or separate various parts of the
production process
 To provide a stock of goods that will provide a
“selection” for customers
 To balance the seasonal fluctuations in demand
 To take advantage of quantity discounts
 To meet the fluctuation losses during machinery
breakdown, shut down arising out of non-
availability vital inputs
 To hedge against inflation and upward price
changes
 To protect against stock-outs.
 Disadvantages of Inventory
 Higher costs
 Item cost (if purchased)
 Ordering (or setup) cost
• Costs of forms, clerks’ wages etc.
 Holding (or carrying) cost
• Building lease, insurance, taxes etc.
 Difficult to control
 Hides production problems
 INVENTORY MODELS

Independent versus Dependent
Demand

Holding, Ordering, shortage costs and
Setup Costs

INVENTORY MODELS FOR INDEPENDENT

DEMAND
1.Basic Economic Order Quantity (EOQ)
Model
Minimizing Costs
Reorder Points
2.Production Order Quantity Model
3.Quantity Discount Models
 Independent versus
Dependent Demand
 Independent demand - The
demand for various items are
unrelated to each other.
 Dependent demand - demand for
item is dependent upon the demand
for some other item
 INVENTORY COSTS
 Holding or carrying costs
 Ordering costs
 Shortage costs
 Setup or production change costs.
 Holding (Carrying) Costs
 Obsolescence
 Insurance
 Extra staffing
 Interest
 Damage
 Warehousing
 Etc.
 Ordering Costs
 Supplies
 Forms
 Order processing
 Clerical support
 Etc.
 SHORTAGE COSTS
 When the stock of an item is depleted, an
order for that item must either wait until
the stock is replenished or be cancelled.
There is a trade off between carrying stock
to satisfy demand and the costs resulting
from stock out. This balance is sometime
difficult to obtain, because it may not be
possible to estimate lost profits, the effect
of lost customers, or lateness penalties.
 Setup Costs
 Clean-up costs
 Re-tooling costs
 Adjustment costs
 Etc.
 What is Inventory?
 Stock of materials
 Stored capacity
 Examples
 AMAZON.com
 JeffBezos, in 1995, started AMAZON.com
as a “virtual” retailer – no inventory, no
warehouses, no overhead; just a bunch of
computers.
 Growth forced AMAZON.com to excel in
inventory management!
 AMAZON is now a worldwide leader in
warehouse management and automation.
 Order Fulfillment at AMAZON
1. You order items;, computer assigns your
order to distribution center [closest facility
that has the product(s)]
2. Lights indicate products ordered to workers
who retrieve product and reset light.
3. Items placed in crate with items from other
orders, and crate is placed on conveyor. Bar
code on item is scanned 15 times – virtually
eliminating error.
 Order Fulfillment at
AMAZON- Continued
4. Crates arrive at central point where
items are boxed and labeled with new
bar code.
5. Gift wrapping done by hand (30
packages per hour)
6. Box is packed, taped, weighed and
labeled before leaving warehouse in a
truck.
7. Order appears on your doorstep within a
week
The Material Flow Cycle
 Techniques for Controlling
Service Inventory Include:
 Good personnel selection, training,
and discipline
 Tight control of incoming shipments
 Effective control of all goods leaving
the facility
 Inventory Models
Help
Help answer
answer the
the
 Fixed order-quantity models
inventory
inventory
(Q- model) planning
planning

Economic order quantity questions!
questions!

Production order quantity
 Quantity discount

 Probabilistic models
 Fixed order-period models (P-
model)
 EOQ

ASSUMPTIONS:
 Known and constant demand
 Known and constant lead time
 Instantaneous receipt of material
 No quantity discounts
 Only order (setup) cost and holding
cost
 No stockouts
 Deriving an EOQ
1. Develop an expression for setup or
ordering costs
2. Develop an expression for holding
cost
3. Set setup cost equal to holding cost
4. Solve the resulting equation for the
best order quantity
 EOQ Model
When To Order
Inventory Level
Optimal Average
Order Inventory
Quantit (Q*/2)
y
(Q*)
Reorder
Point
(ROP)

Time
Lead Time
 EOQ Model
How Much to Order?
Annual Cost

u r ve
o stC ve
al C u r
Minimu T ot os tC
g C
m total ldin
H o
cost

Order (Setup) Cost Curve

Optimal Order quantity

Order Quantity (Q*)
 Why Holding Costs Increase
 More units must be stored if more are ordered

Purchase Order Purchase Order

Description
Qty. Description Qty.
Microwave 1 Microwave 1000

Order Order
quantity quantity
Why Order Costs Decrease
Cost is spread over more units
Example: You need 1000 microwave ovens

1 Order (Postage $ 1000 Orders (Postage

0.33) $330)
Purchase Order PurchaseOrder
Purchase Order
Description Qty. Purchase
Purchase Order
Descriptio Qty.
Order
Descriptio
Descriptio Qty.
Qty.1
Microwave 1000 nn
Microwave
Description Qty.
Microwave
n
Microwave 11
Microwave 1
Order
quantity
 EOQ Model Equations
Optimal Order Quantity=Q = 2×D×S
H
D
=N =
Expected Number of Orders
Q
Working Days /Year
xpected Time Between Orders =T =
N
D D = Demand per year
d=
Working Days /Year S = Setup (order) cost
per order
ROP = d × L H = Holding (carrying)
cost
d = Demand per day
L = Lead time in days
 EXAMPLE
 A HOSPITAL PROCURES ITS SUPPLIES OF A
MATERIAL ONCE A YEAR. THE TOTAL NUMBER
PROCURED IS 2400 PACKAGES (IN A YEAR). THIS
POLICY OF PROCURING MATERIAL ONCE A YEAR IS
BEING QUESTIONED. THE ACCOUNTANTS
CALCULATE THE COSTS OF INVENTORY HOLDING
AT Rs. 36/ PACKAGE/ YEAR. IT IS ALSO FGURED
OUT THAT THE COST OF PROCUREMENT AD UPTO
Rs. 1200 PER ORDER.
WHAT INVENTORY POLICY WOULD YOU ADVISE TO
THIS HOSPITAL?
 SOLUTION:
EOQ = 2 x D x S
H
2 x 1200 x 2400
=
36

= 400 units

Therefore, it is best to place 2400 = 6 order in a year

400
The Reorder Point (ROP) Curve
Q

Slope = units/day
=d
Inventory level

ROP
(Unit
(units)

s)

Time
Lead time (days)
=L
Production Order Quantity
Model
 Answers how much to order and when to
order
 Allows partial receipt of material

Other EOQ assumptions apply
 Suited for production environment

Material produced, used immediately

Provides production lot size
 Lower holding cost than EOQ model
 Reasons for Variability in
Production
Most variability is caused by waste or by poor
management. Specific causes include:
❑ employees, machines, and suppliers produce

units that do not conform to standards, are

late or are not the proper quantity
❑ inaccurate engineering drawings or

specifications
❑ production personnel try to produce before

drawings or specifications are complete

❑ customer demands are unknown
 Quantity Discount Model
 Answers how much to order &
when to order
 Allows quantity discounts
 Reduced price when item is
purchased in larger quantities

Other EOQ assumptions apply
 Trade-off is between lower price &
increased holding cost
Quantity Discount Schedule
Discou Discount Discount Discount
nt Quantity (%) Price (P)
Numbe
r
1 0 to 999 No $5.00
discount
2 1,000 to 4 $4.80
1,999
3 2,000 and 5 $4.75
over
 Probabilistic Models
 Answer how much & when to order
 Allow demand to vary

Follows normal distribution
 Other EOQ assumptions apply

 Consider service level & safety stock

 Service level = Probability of stockout

 Higher service level means more safety

stock
 Fixed Period Model
 Answers how much to order
 Orders placed at fixed intervals
 Inventory brought up to target amount

 Amount ordered varies

 No continuous inventory count

(counted at particular times such as every week
or every month)
 Possibility of stockout between intervals
 Useful when vendors visit routinely
 Useful when buyers want to combine orders
to save transportation costs.
 FIXED PERIOD MODEL
CONTD.
 Fixed- time period models generate order
quantities that vary from period to period,
depending upon the usage rates. These
generally require a higher level of safety
stock than a fixed order quantity system.
 Fixed time period model with safety stock-

Order quantity = average demand over the

period + safety stock – inventory currently
on hand
 REVIEW PERIOD FOR P-
MODEL
The optimal review period is approximately
given by;

P= 1
N (opt)
 DIFFERENCE BETWEEN
Q-MODEL AND P-MODEL
Features Q-model P-model
Q- constant (Same amt. Q- variable (varies each
Order time order is placed)
Ordered each time)
Quantity

When to when inventory position When the review period

place drops to the reorder arrives
order level

Record Each time a withdrawal Counted only at review

keeping or addition is made period

Size of Less than fixed time Larger than fixed order

inventory period model quantity model
 ABC Analysis
 ABC classification scheme divides inventory items into three
grouping:
high rupee volume (A)
moderate rupee volume (B)
low rupee volume (C)
 Rupee volume is a measure of importance; an item low in cost but
high in volume can be more important than a high cost item with
low volume.
 Basis is usually annual volume
 volume = Annual demand x Unit cost
 Policies based on ABC analysis
 Develop class A suppliers more

Give tighter physical control of A items
 Forecast A items more carefully
 Classifying Items as ABC
% Annual Usage Class % Vol % Items
100 A 80 15
B 15 30
80
C 5 55
60
40
A
B
20 C
0
0 50 100
% of Inventory Items
 CYCLE COUNTING
 Cycle counting is a physical inventory
taking technique in which inventory is
counted frequently rather than once or
twice a year.
 The key to effective cycle counting is in
deciding;
which items are to be counted,
when to be counted,
by whom to be counted.
 CYCLE COUNTING CONTD.
 The easiest time for stock to be counted is when
there is no activity in the stock room or on the
production floor. This means on the week-ends or
during the second or third shift, when the facility is
less busy.
 The level of accuracy between physical inventory
and records has been much debated. The
recommended accuracy level by experts is:
• + 0.2 % for A items,

• + 1 % for B items,

• + 5% for C items.