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Inventory Management
Inventory – a stock or store of goods. Inventories are a vital part of business. Not only are they
necessary for operations, but they also contribute to customers satisfaction.
Functions of Inventory
Little’s Law – the average amount of inventory in a system is equal to the product of the average
demanad rate and the average time a unit is in the system.
Inventory management has two main concerns. One is the level of the customer service,
that is, to have the right goods, in sufficient quantities, in the right place, at the right time. The
other is the costs of ordering and carrying inventories.
Inventory turnover – ratio of average cost of goods sold to average inventory investment
Requirements for Effective Inventory Management
Periodic system – physical count of items in inventory made at periodic intervals (weekly,
monthly).
Perpetual Inventory System – system that keeps track of removals from inventory
continuously, thus monitoring current levels of each items.
Two-bin System – two containers of inventory; reorder when the first is empty
Universal Product Code (UPC) – bar code printed on a label that has information about the
item to which it is attached.
Lead time – time interval between ordering and receiving the order
Inventory Costs
1. Holding (carrying) – cost to carry an item in inventory for a length of time, usually a
year.
2. Ordering costs – costs of ordering and receiving an inventory
3. Shortage costs – costs resulting when demand exceeds the supply of inventory; often
unrealized profit per unit
Classification System
Cycle counting – a physical count of items in inventory. The purpose of cycle counting is to
reduce discrepancies between the amounts indicated by inventory records and the actual
quantities of inventory on hand.
Economic Order Quantity (EOQ) – the order size that minimizes total annual cost
Basic Economic Order Quantity (EOQ) Model – is the simplest of the three models. It is used
to identify fixed order size that will minimize the sum of the annual cost of holding inventory
and orrdering inventory.
Annual carrying cost – is computed by multiplying the average amount of inventory on hand by
the cost to carry one unit for one year, even though any given unit would not necessarily be held
for a year.
Q H
Annual carrying cost = 2
Annual ordering cost – is a function of the number of orders per year and the ordering cost per
order
D S
Annual ordering cost = Q
S – ordering cost
Total Annual Cost (TC) associated with carrying and ordering inventory when Q units are
ordered each time
Quantity Discounts – are price reductions for large orders offered to customers to induce them
to buy in large quantities.
Reorder Point (ROP) – when the quantity on hand of an item drops to this amount, the item is
reordered.
Safety Stock – stock that is held in excess of expected demand due to variable demand and/or
lead time.
Service Level – probability that demand will not exceed supply during lead time.
The Amount of Safety Stocks Factors
Fixed-order-interval (FOI) Model – orders are placed at fixed time intervals (weekly, twice a
month, etc,)
Single-period Model – model for ordering of perishables and other items with limited useful
lives.
Excess cost – difference between purchase cost and salvage claue of items left over at the end of
a period.
Uniform – the concept of identifying an optimal stocking level is perhaps easier to visualizes in
demand