INVENTORY MANAGEMENT What to Inventory?

Inventory is a stock or store of goods. It includes raw materials or stock incoming suppliers . (A) (B) (C) (D) (E) Raw materials and purchased parts Partially completed goods Finished-goods inventories or merchandise Replacement parts, tools, and suppliers oods-in-transit to warehouses or oods In progress

!ypes of "emand#

$% "ependent "emand !hese are items that are typically su&assem&lies or component parts that will &e used in the production of a final or finished product. 'u&assem&lies and component a part is derived from the num&er of finished units that will &e produced. ()ample# "emand for wheels for new cars. *% Independent "emand !hese are items that are the finished goods or other end items. !hese items are sold or at least shipped out rather than used in making another product.

Functions of Inventory

$. !o meet anticipated customer demand. !hese inventories are referred to as anticipation stocks &ecause they are held to satisfy planned or e)pected demand. *. !o smooth production re+uirements. Firms that e)perience seasonal patterns in demand often &uild up inventories during off-season to meet overly high re+uirements during certain seasonal periods. ,ompanies that process fresh fruits and vegeta&le deal with seasonal inventories -. !o decouple operations. !he &uffers permit other operations to continue temporarily while the pro&lem is resolved. Firms have used &uffers of raw materials to insulate production from disruptions in deliveries from suppliers, and finished goods inventory to &uffer sales operations from manufacturing disruptions. !o protect against stock-outs. "elayed deliveries and une)pected increases in demand increase the risk of shortages. !he risk of shortages can &e reduced &y holding safety stocks, which are stocks in e)cess of anticipated demand. !o take advantage of order cycles. Inventory storage ena&les a firm to &uy and produce in economic lot si.es without having to try to match purchases or production with demand re+uirements in short run. !o hedge against price increase. !he a&ility to store e)tra goods also allows a firm to take advantage of price discounts for large orders. !o permit operations. Production operations take a certain amount of time means that there will generally &e some work-in-process inventory. /. 0. 1. 2.
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0. Inventory .ost of ordering and carrying inventories. 8 system to keep track of the inventory on the hand on order. management must have the following# $. 8 classification system for inventory items. 9nowledge of lead times and lead time varia&ility. and shortage costs.ounting 'ystems $% Periodic 'ystem !his is a physical count of items in inventory is made at periodic intervals :e. 'pecifically "ecision maker tries to achieve a &alance in stocking and Fundamental decision must &e made related to the timing and si. lost sales. and department stores.of $* . 8dvantage 4rders for many items occur at the same time. *. in sufficient +uantities.g. 4verstocking unnecessarily ties up funds that might &e more productive !wo 5ain . 5a7or users# 'upermarkets. in the right place. second .oncerns of Inventory 5anagement 4&7ectives of Inventory 5anagement First . 8 relia&le forecast of demand that includes an indication of possi&le forecast error. monthly% in order to decide how much to order of each item. discounts stores. and at the right time. ordering costs. which can result in economies in processing and shipping orders "isadvantages a% &% c% 6ack of control &etween reviews. dissatisfied customers and production &ottlenecks.e of orders Re+uirements for (ffective Inventory 5anagement !o &e effective.oncern 6evel of customer service to have the right goods. weekly. /. !he need to protect against shortages &etween review periods &y carrying e)tra stock. !he need to make a decision on order +uantities at each review Page . -.Inade+uate control of inventories Inade+uate control of inventories can result into two categories# $% *% 3nder stocking results in missed deliveries. Reasona&le estimates of inventory holding costs. !o achieve satisfactory levels of customer service while keeping inventory costs within reasona&le &ounds.

arrying . deterioration. late charges. spoilage. depreciation. ta)es. !he control provided &y the continuous monitoring of inventory withdrawals. management can identify an economic order si. !he advantage of this system is that there is no need to record each withdrawal from inventory.ost is cost resulting when demand e)ceeds the supply of inventory on hand.ost includes interest. -. pilferage. =olding or . loss of customer goodwill. In manufacturing. the disadvantage is that the reorder card may not &e turned in for a variety of reasons. the greater the potential varia&ility.ost is cost of ordering and receiving inventory. !he added cost of record keeping.ode :3P. reorder when the first is empty. 8l-sa>adi . and finished goods greatly facilitate counting and monitoring activities. preparing invoices. . <ar coding represents an important development for other sectors of &usiness &esides retailing. Inventory . 8dvantages $. etc. so the system can provide information on the current level of inventory for each item.ost is the costs to carry an item in inventory for a length of time usually a year. "isadvantage $. "emand Forecast and 6ead time Information 5anagers need to know the e)tent to which demand and lead time might vary. the greater the need for additional stock to reduce the risk of a shortage &etween deliveries. !hese costs can include the opportunity cost of not making a sale. *. insurance.ost :Three Basic Costs) $. o&solescence. !hese include determining how much is needed. &ar codes attached to parts. &reakage. !he fi)ed-order +uantity. 6ead time is time interval &etween ordering and receiving the order. !wo-&in-system method Is two containers of inventory. su&assem&lies.e. 4rdering .i.% &ar code printed on a la&el that has information a&out the item to which it is attached. 'torage . !racking 'ystem 3niversal Product .*% Perpetual Inventory 'ystem :also known as a continual system% !his keeps track of removals from inventory on a continuous &asis. and similar costs Page / of $* 8&dul. and moving the goods to temporary storage. *. inspecting goods upon arrival for +uality and +uantity.

es total cost. 8pproach classifies inventory items according to some measure of importance. coils of wire. usually annual dollar usage. 8l-sa>adi . 5anagement 'cience-* 5idterm @otes Page 0 of $* 8&dul. !he economic order +uantity model with non instantaneous delivery.lasses of Items 3sed# 8 :very important% < :moderately important% . 8pproach 8-<-. (4A models identify the optimal order +uantity in terms of minimi. :least important% !he key +uestions concerning cycle counting for management are# $.Inventory 5anagement . !hree :-% 4rder 'i.ing the sum of certain annual costs that vary with order si. !he economic order +uantity model. which are withdrawn at instant rate over time. ()ample# 8 producer of electrical e+uipment might have electric generators. an order for A units is su&mitted to the supplier. sales or usage volume. !hree . When should cycle counting &e performed? -.i. or stock-out penalties. 4R"(R A38@!I!B 54"(6' (conomic 4rder Auantity :(4A% is the order si.lassification 'ystem 8n important aspect of inventory management is that items held in inventory are not of e+ual importance in terms of dollars invested.e that minimi.4@45I. 8-<-. When the +uantity on the hand is 7ust sufficient to satisfy demand during lead time. Inventory . and miscellaneous nuts and &olts among the items carried in inventory. Who should do it? (. -.ycles &egins with the receipt of an order of A units. =ow much accuracy is needed? *. !he +uantity discount model.e $. .e. *. profit potential. and then allocates control efforts accordingly. It would &e unrealistic to devote e+ual attention to each of these items.ontinue?.

*. deterioration. !hey are the cost that varies with the actual placement of an order such as shipping cost. 4nly one product is involved.ost is ()press in terms of unit. EOQ Model Annual Cost =olding . security and rent. inspecting goods upon arrivals. (ach order is received in a single delivery.ost C =olding .osts are the costs of ordering and receiving inventory. Holdin Cost Order !uantit" In (4A 5odel =olding . -. !otal . !here are +uantity discounts.ost includes interest. Holdin Cost Order (#etu$) Cost Order !uantit" !he ordering . depreciation 4&solesce. EOQ Model Annual Cost Total Cost Cur%e Holdin Cost Order (#etu$) Cost Order !uantit" <y merging the two raphs we can notice that the minimum Inventory . light. spoilage."eveloping (4A 5athematical 5odel 8ssumption of the <asic (4A 5odel $. /.e. preparing invoices. 1.ost e)press as Fi)ed dollars per order regardless of order si. 8nnual demand re+uirements are known. &reakage. insurance.ost O$ti&al Order !uantit" (!') Page 1 of $* .ost is at the intersection point. 0. ta). 6ead time does not vary. 'o# !otal holding .ost D 4rdering . . Warehouse cost :heat.ost C @um&er of unit ) +uantity EOQ Model Annual Cost 4rdering .ost:=% or carrying cost relate to having items in storage. "emand is spread evenly throughout the year so that the demand rate is reasona&ly constant.

= C $FF units * :<% @um&er of orders C $FFF" .4ptimal Auantity C (4A A .arrying cost is G*F of per unit cost. 'ave5art is open -1F daysIyr.ost C . . 4rdering cost is G$FF per order. 6ead time is 0 days. C $F times. " A" .ycle C A .ostC 6ength 4f order .= D .$ per year C F.$ ) -1F daysIyear C -1 days " $FFF A$FF$FFF" . !he cost of each coffee maker is G2H.% .= * " 8nnual .ost C !otal annual Inventory .ost C Page 2 of $* . C F.C.' A *"' = 8nnual =olding .= D .' C. (A) What is (4A 5odel? (B) =ow many times per year does the store reorder? (C) What is the length of order cycle? (D) What is the total annual cost if the (4A +uantity is ordered? 8nswer :8% (4A *"' = * $FFF $FF $F A .C $FFA :.ycle 6ength C $FFA .' *A "eterminants of Reorder point +uantity :when we have to reorder?% a% &% c% d% Rate of demand !he lead time !he e)tent of demand !he degree of stock out risk accepta&le to management R4P :Reorder Point% C "aily "emand E 6ead !ime R4P C d ) 6 @ote that "emand is on daily &asis ()ample 'ave5art needs $FFF coffee makers per year.) *F)$FF C*FFF **$FFA :"% !otal 8nnual Inventory .arrying .

min I ma) . In the more typical case. If usage production :or delivery% rates are e+ual.arrying cost D setup cost !.' A time &etween &eginning of range .(4A with @on instantaneous Replenishment :(PA% When a firm is &oth a producer and a user or deliveries are spread over time. In the production case. * "' p !he economic Production Auantity C. the production or delivery rate e)ceeds the usage rate.e doesn>t come up.: p u % P is Production or "elivery Rate 3 is usage rate Page H of $* .= * Ap u " . =pu !otal Inventory cost C . production occurs over only a portion of each cycle &ecause the production rate is greater than the usage rate.ycle !ime C Run time C Ap p production phase of the cycle I ma) * 8verage inventory I average !he ma)imum inventory level C Where Ap p . and usage occurs over the entire cycle. there will &e no inventory &uildup since all output will &e used immediately and the issue of lot si. inventories tend to &uild up gradually instead of instantaneously.

!he firm operates */F days per year. 'etup cost of production run of wheels is G/0. "etermine the#a% 4ptimal Run 'i. !he firm makes its own wheels.' C:$%:/0% $HFF A**FF c% .ycle !ime C d% Run time C */FF $* days *FF Ap p */FF HFF .' A so we first must find Ima) !he ma)imum inventory level C Ap p .days 5anagement 'cience-* 5idterm @otes Page J of $* 8&dul. d% Run time. c% .FFF ru&&er wheels per year for its popular dump truck.e. .CC*/FF wheels.= * " .()ample 8 toy manufacturer uses /H.:HFF *FF% $HFF wheel 'o !.i.: p u % C */FF HFF . &% 5inimum total annual cost for carrying and setup. 8l-sa>adi .min I ma) .arrying cost is G $ per wheel a year.ycle time for the optimum run si.min I ma) . 8nswer " C /H.FFF wheel per */F days or *FF wheels per day a% Ap C *:/HFFF%/0HFF* "' p .e.= * Ap u "$HFF/HFF . which it can produce at a rate of HFF per day. !he toy trucks are assem&led uniformly over entire year.FFF wheels per year 'C G /0 =C G $ per wheel per year P C HFF wheels per day 3 C /H. $HFF *FF= p u &% !.

F per case.ost C A"/0$HF .= D . )0) *0 $./ )2F --2. the customer must weigh the potential &enefits of reduced purchase price and fewer orders that will result from &uying in large +uantities against the increase in carrying costs caused &y higher average inventories !. 8l-sa>adi . C A .ost C * $HF *0 0 /. "etermine the optimal order +uantity and total cost.2 and the total annual cost will &e#!otal 8nnual .' C.$0 */-*A If we order /0 unit we may get discount the price will &e reduced from G* to G$.i.ost C A"2F$HF . C carrying cost D 4rdering cost D Purchasing .*H *2F*A We can note that at some range from /0 to 2F units annual cost will &e appropriate even the (4A state other range due to discount effect. 4rdering costs are G*0.' C.ost !. )0) *0 $.' A P". )0) *0 * ) /.= D ./ the annual cost in this case would &e #!otal 8nnual .2 to G$. more than 2F cases will cost G$. Where# P C 3nit price E(AM)*E !he maintenance department of a large hospital uses a&out $HF cases of li+uid cleanser annually.unit A"/-$HF . /0 to 1J will cost G$. carrying costs are G0 per case a year.= D .= * " .' C./ per case. (4A *"' = !otal . and the new schedule indicates that orders of less than /0 cases will cost G*.2 per case.*JH. 5anagement 'cience-* 5idterm @otes Page $F of $* 8&dul.2 ) /0 */0*A *HJ If we order 2F unit we may get further reduction as the price will &e reduced from G$. If +uantity discounts are offered.(4A with Auantity "iscount Auantity "iscounts are price reductions for large orders offered to customers to induce them to &uy in large +uantities.

o. . how much that would affect the minimum total annual cost? Pro&lemK- 8 large law firm uses an average of /F &o)es of copier paper a day. (A) "etermine the economic order +uantity. Pro&lemK/ =ighland (lectric .H1F &ags a year.o.e from part a? (C) ()cept for rounding.ycle time and run time for the optimum run si.M Would you recommend that the office manages use the optimal order si. 'torage and handling costs for the paper are G-F a year per &o). !he firm operates *1F days a year. !he partners of the firm e)pect the office to &e managed Min a cost-efficient manner. (E) If ordering costs were to increase &y G$ per order.FFF. =(.i. to generate electricity. =(. and the ordering cost is G0.. (B) What is the average num&er of &ags on hand? (C) =ow many orders per year will there &e? (D) .e. 5anagement 'cience-* 5idterm @otes Page $$ of $* 8&dul. are annual ordering and carrying costs always e+ual at (4A? (D) !he office manager is currently using an order si.e instead of *FF &o)es? Nustify your answer.0FF tons per day for G$F. (A) What order si.e of *FF &o)es. Preparing an order and receiving a shipment of flour involves a cost of G$F per order. can supply coal at the rate of -.e the sum of annual ordering and carrying costs? (B) .e? &% What is =(.Pro&lemK$ 8 local distri&utor for a national tires company e)pects to sells appro)imately J1FF steel &elted radial tires of certain si.edar . and its costs appro)imate G 1F to order and receive a shipment of paper. !he &akery uses an average ofL /. 8nnual carrying costs are G20 per &ag.0F per ton... 8nnual carrying cost is G$1 per tire and ordering cost is G 20. &uys coal from .e and treated design ne)t year.ompute the total cost of ordering and carrying flour.e would minimi. a% What is the economical production lot si.ompute the total annual cost using your order si.reek .>s ma)imum inventory level for coal? c% What is . (A) What is (4A 5odel? (B) =ow many times per year does the store reorder? (C) What is the length of order cycle? (D) What is the total annual cost if the (4A +uantity is ordered? Pro&lemK* 8 large &akery &uys flour in *0-pound &ags. 8l-sa>adi .>s annual carrying cost for coal is G* per ton. uses the coal at a rate of HFF tons per day and operates -10 days per year. !he distri&utor operates *HH days a year.oal .

!he following price schedule applied.FFF ne)t year. It costs 8-$ G$FF to place an order for the tires. and the annual carrying cost is G-F per unit. c% !he length :in days% of a run.$0 G$. "etermine#a% !he optimal order +uantity? &% !he num&er of orders per year? @um&er of &o)es $FFF to $JFF *FFF to /JJJ 0FFF to JJJJ $FFFF or more Price per &o) G $. !he firm operates *FF days a year. &% !he num&er of runs per year. Find a% !he optimal run si.JF Pro&lemKH 8 mail order house uses $H. 'etup cost G$FF and storage and handling cost are G0 per ton a year. 8l-sa>adi . Pro&lemK1 8 chemical firm produces sodium &isulphate in $FF-pound &ags. . "emand for this product is *F tons per day.i.e.J0 G *F.e? c% "etermine the appro)imate length of a production run in days? d% 8&out how many runs per year would there &e? e% =ow much could the company save annually if the setup cost reduced to G*0 per run? Pro&lemK2 8-$ 8uto Parts has a regional tire warehouse in 8tlanta. !he cost to prepare e+uipment for producing hot dog is G11. !he supplier +uotes these prices for the tire# @um&er of &o)es $ to /JF 0FF to JJJ 5ore than $FFF Price per &o) G *$.FFF &o)es a year. 4ne popular tire. !he factory operates -FF days a year.$F 5anagement 'cience-* 5idterm @otes Page $* of $* 8&dul.1F G *F. F'F supplied hot dogs to local restaurant at a steady state rate of *0F per day. has estimated demand of *0.arrying cost are 1F percent of a &o) cost price and ordering cost are GJ1 per order. the ERE20.*0 G $. 8nnual holding cost is /0 cents per hot dog. :@ote $ ton C *FFF pounds% a% =ow many &ags per run are optimal? &% What would the average inventory &e for this lot si.FFF units per day.Pro&lemK0 !he friendly 'ausage factory :F'F% can produce hot dogs at a rate of 0.*F G $. !he capacity for producing the product is 0F tons per day.