What is Inventory ?

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Inventory Policy Decisions
Inventory Policy Decisions
Inventory are stocks or items used to
support production (raw materials
and WIP), support activities
(maintenance, repair, and operating
supplies) and customer service
(finishes goods and spare parts).

The fact is inventory is both a

valuable resource and a potential
source of waste

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Why Inventory
There are three basic reasons for keeping an inventory:
 Time
 Uncertainty
 Economies of scale
Reasons To NOT Hold Inventory
Carrying cost

Valuable factory space

Obsolescence

 Damage

 Pilferage
Inventory Hides Problems

Bad
Design
Lengthy Poor
Setups Quality
Machine
Inefficient Unreliable
Breakdown
Layout Supplier

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To Expose Problems:
Reduce Inventory Levels

Bad
Design
Lengthy Poor
Setups Quality
Machine
Inefficient Unreliable
Breakdown
Layout Supplier

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Remove Sources of Problems and
Repeat the Process

Poor
Quality

Lengthy
Setups

Bad
Machine
Design Inefficient Unreliable
Breakdown
Layout Supplier

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Types of Inventory
Cycle stock
Safety stock (buffer inventory)
Anticipation inventory
Others
Hedge inventories
Transportation inventory (pipeline)
Smoothing inventories

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Cycle Stock
Cycle stock refers to components or products that are
received in bulk by a downstream partner, gradually
used up, and then replenished again in bulk by the
upstream partner

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Safety Stock
Extra inventory that
companies hold to
protect themselves
against uncertainties
Demand
replenishment time

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Safety Stocks enable organizations to satisfy customer
demand in the event of these possibilities:
Supplier may deliver their product late or not at all
The warehouse may be on strike
A number of items at the warehouse may be of poor
quality and replacements are still on order
A competitor may be sold out on a product, which is
increasing the demand for your products
Random demand (in reality, random events occur)
Machinery Breakdown
Unexpected increase in demand

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Anticipation Inventory
Inventory that is held in anticipation of customer
demand.
price increase, a seasonal increase in demand, or even
an impending labor strike.
 at Halloween, Christmas, or the back-to-school
season
Hedge Inventory
Inventory buildup to buffer against some event that
may not happen.
Hedge inventory planning involves speculation related
to potential labor strikes, price increases, unsettled
governments, and events that could severely impair
companies strategic initiatives.

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Transportation Inventory
 Inventory that is moving from one link in the supply chain
to the another

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Aggregate Control of Inventories
Inventory Turnover Ratio
ABC Classification
Risk Pooling

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Two “Classic” Systems for Independent
Demand Items

Periodic review systems

Continuous (perpetual) review systems

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 Periodic Review System
(Orders at regular intervals)

Inventory
level

2 4 6 Time

11/04/2021 18
 

 
Determining the restocking level

  average demand during the

reorder period plus the
= replenishment lead time (if there
is a delay getting new products
in).
     
    SS      = safety stock.  This is a “cushion”
of inventory held to mitigate the
uncertainties of forecasts and
lead times.
Higher safety stock levels
increase the likelihood that goods
are available, but also drive up
inventory levels and costs

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 Continuous Review System
(Orders when inventory drops to R)
How is the reorder
Q point ROP established?

Inventory
level

L-T Time
lead time to get
a new order in

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Comparison of Periodic and Continuous
Review Systems
Periodic Review Continuous Review
Fixed order intervals Varying order intervals
Variable order sizes Fixed order sizes (Q)
Convenient to administer Allows individual review
Orders may be combined frequencies
Inventory position only Possible quantity discounts
required at review Lower, less-expensive safety
stocks

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What is the “Best” Order Size Q?
Determined by:
Inventory related costs
Order preparation costs and setup costs
Inventory carrying costs
Shortage and customer service costs
Other considerations
Out of pocket or opportunity cost?
Fixed, variable, or some mix of the two?
EOQ
D = annual demand of the product
S = Fixed cost incurred per order
C = cost per unit
h = Holding cost per year as a fraction of product cost
Holding Cost
$
(Q/2)×H

Holding cost increases

as Q increases . . .

H=h X C
Ordering Costs
$
Ordering costs per year
(Q/2)×H
decrease as Q increases
(why?)

(D/Q)×S

Q
The purchasing manager makes a lot size decision
to minimize the total cost the store incurs….????
Annual material cost Annual material cost = D C

Annual Order cost Annual order cost = (D / Q) S

Annual holding cost
No of orders per year = D / Q
Annual holding cost = ( Q/ 2) h C
Total Annual Cost
Annual material cost = D C

Annual order cost = (D / Q) S

Annual holding cost = ( Q/ 2) h C

Total Annual Costs and EOQ
Holding Cost Ordering Cost Total Cost

2000
Inventory Cost ($)

1500

1000

500

10 50 90 0 0 0 0 0 0 0 0
13 17 21 25 29 33 37 41
Order Quantity Q

EOQ at minimum total cost

Economic Order Quantity (EOQ) Model
Cost Minimizing “Q”
Assumptions:
 Uniform and known demand rate
 Fixed item cost
2DS
EOQ  Q 
 Fixed ordering cost *
 Constant lead time
H
Aggregate Control of Inventories
Inventory Turnover Ratio
ABC Classification
Risk Pooling
 Inventory Turnover Ratio
Measures the number of times, on average, the inventory is
sold during the period. Its purpose is to measure the
liquidity of the inventory.

Inventory turnover ratio = Cost of goods sold / Average

inventory
 STOCK/INVENTORY TURNOVER RATIO

 (Average Inventory/Sales) x 365 for days

 (Average Inventory/Sales) x 52 for weeks
 (Average Inventory/Sales) x 12 for months

Average Inventory or Stocks = (Opening Stock + Closing Stock)

-----------------------------------------
2
 This ratio indicates the number of times the inventory is
rotated during the relevant accounting period
ABC Classification Method
IDEA
Companies have thousands of items to track

Methods like EOQ only justifiable for most

important items.
 What is the “Best” Order Size Q?
Determined by:
Inventory related costs
Order preparation costs and setup costs
Inventory carrying costs
Shortage and customer service costs
Other considerations
Out of pocket or opportunity cost?
Fixed, variable, or some mix of the two?

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 ABC Method
1. Determine annual $ usage for each item
2. Rank the items according to their annual $ usage

3. Let:
 Top 20%  “A” items  roughly 80% of total $

 Middle 30%  “B” items  roughly 15% of total $

 Bottom “50%  “C” item  roughly 5% of total $

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 ABC Analysis Example
Item Cost Demand $ Usage
A1 $46 200 $9,200
B2 $40 10 $400
C3 $5 6680 $33,400
D4 $81 100 $8,100 Total $ Usage
E5 $22 50 $1,100 = $98,500
F6 $6 100 $600
G7 $176 250 $44,000
H8 $6 150 $900
I9 $10 10 $100
J10 $14 50 $700

36
11/04/2021
 Ranking by Annual $ Usage
Cumulative $ % of Total $
Item $ Usage Usage Usage Class
G7 $44,000 $44,000 44.67% A
C3 $33,400 $77,400 78.58% A
A1 $9,200 $86,600 87.92% B
D4 $8,100 $94,700 96.14% B
E5 $1,100 $95,800 97.26% B
H8 $900 $96,700 98.17% C
J10 $700 $97,400 98.88% C
F6 $600 $98,000 99.49% C
B2 $400 $98,400 99.90% C
I9 $100 $98,500 100.00% C

37
11/04/2021
Risk Pooling
Consider these two systems:

Warehouse One Market One

Supplier
Warehouse Two Market Two

Market One
Supplier Warehouse

Market Two
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Risk Pooling
For the same service level, which system will
require more inventory? Why?
For the same total inventory level, which system
will have better service? Why?
What are the factors that affect these answers?

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Risk Pooling
Demand variability is reduced if one aggregates
demand across locations.
More likely that high demand from one customer will
be offset by low demand from another.
Reduction in variability allows a decrease in safety
stock and therefore reduces average inventory.

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Virtual Inventory (Cross Filling)
Rarely are planned inventory levels so high to
guarantee that customer demand can be filled
immediately from available stock.

 On average, a planned percentage of orders

cannot be filled from their primary source
without experiencing a backorder or a lost
sale.

 To counter stock outs, companies will

frequently cross fill, or transship, the unfilled
demand from a comparable secondary
inventory location.
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 Types of Pull Systems
1. Top-Up System Simple but poor inventory control
2. Signal Kanban
3. 2-Bin Kanban
4. 3-Bin Kanban
5. Multi-Card Kanban Complex but excellent inventory control

11/04/2021 42
Top-Up Pull System
Material is delivered at a set period, and any material
that was consumed during this period is replenished.

Ideal for small, low-cost parts where high inventory

control is not essential
E.g. Nuts, bolts, washers, etc.

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Top-Up Pull System
Example
Every month, the hardware supplier comes into the
facility and fills up all of the hardware containers (nuts,
bolts, screws, etc.). Each container is marked with a line
to indicate how much to fill it. The inventory is equal to
the average monthly consumption (cycle stock), plus a
buffer to handle peak production periods (buffer stock),
and an allowance for up to 2 days incase the supplier is
late delivering.

11/04/2021 44
2-Bin Kanban Pull System
Material is stored in 2 containers of a set quantity. Every
period, a material handler takes away empty containers and
returns them the next period.
Ideal for processes that consume many parts, especially if
each part has a different rate of consumption
E.g. Assembly processes

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2-Bin Kanban Pull System
Example
The material handler checks the assembly process every
hour. As each container is emptied, it is placed in a
specific location. The material handler retrieves these
empty containers and spends the rest of the hour
replenishing them. They then return the replenished
containers to the assembly process and collect any
containers that are now empty.

11/04/2021 46
Multi-Card Kanban Pull System
Cards are used to signify a set amount of material. When
that material is consumed, the card is returned to the
supplier to indicate that more inventory is required.

The supplier places returned cards on a board and uses

them to determine which product to build next.

Ideal for processes that have an interval

E.g. Machining processes or Suppliers (where the
interval = delivery frequency)

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Multi-Card Kanban Pull System
Example
At the end of each day, the Team leader collects the
kanban sheets from the boxes of material that the
assembly process opened. They fax these sheets to the
supplier and shreds them. The supplier receives the faxed
sheets and places them on a board. When this product is
the highest on the board, the supplier will changeover. As
each box is completed, the sheet is placed on it, and it is
sent to shipping for delivery.

11/04/2021 48
2-Bin Kanban Pull System
Advantages:
Excellent control of inventory
Minimizes the amount of inventory required

Disadvantages:
Requires signals to be sent repeatedly
Is more sensitive to changes in data than the other systems
(needs to be kept up to date)
Requires delivery of material almost every period

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Supermarket Pull Systems

Purpose: Provide production instruction to upstream

processes that cannot be linked in flow.
production withdrawal
kanban kanban

Supplier Customer
Process Process

replenished withdrawn
product product

supermarket
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Thank u …

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