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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