10/16/2021

Inventory Management and Control

LOGS313
Chapter 2:
Stocks within an Organization

Introduction:
• Logistics is responsible for the movement of materials into, through,
and out of an organization. Stocks are formed whenever there is a
delay in this movement, so inventory management is often
considered a part of logistics.
• A benefit of this view of inventory management as a part of logistics is
that it clearly shows the interactions with all the other activities that
move materials along the supply chain.
• The best results come when logistics is considered as a single
integrated function that includes a range of related activities.

logs315_Inventory Management 2

1
 10/16/2021

logs315_Inventory Management 3

Integrating logistics within an organization:

• Decisions within an organization can be described as strategic, tactical
or operational.
• Essentially, inventory managers aim at contributing to the logistics
strategy, and hence to the overall aims of the organization.
• There are many generic strategies – such as lean and agile – but
organizations have to tailor the details to fit their own circumstances.
• The resulting strategy might focus on a specific aspect of
performance.
• Each strategy puts different demands and constraints on inventory
management.

logs315_Inventory Management 4

2
 10/16/2021

Setting the aims of inventory management:

• Organizations need a clear understanding of inventory costs. These
are affected by the accounting conventions used, so that even a basic
measure, like the value of stock, is open to some discussion.
• It is convenient to classify the costs associated with stocks as unit,
reorder, holding or shortage costs.
• A reasonable aim of inventory managers is to achieve an acceptable
level of customer service while minimizing the associated costs.
• Decisions about the precise aim, definition of an ‘acceptable’ service,
and the balance between costs and service, depend on specific
circumstances.
logs315_Inventory Management 5

Setting the aims of inventory management:

•The broad decisions about inventory policy lead
to more detailed decisions about stock:
what items to keep in stock,
when to place orders, and
how much to order.

logs315_Inventory Management 6

3
 10/16/2021

Types of cost:
• The usual approach describes four types of cost – unit, reorder,
holding and shortage costs:
Unit cost. This is the price charged by suppliers for one unit of the item, or the
cost to the organization of acquiring one unit.
Reorder cost. This is the cost of placing a repeat order for the item and might
include allowances for drawing-up an order (with checking, getting
authorization, clearance and distribution), correspondence and telephone
costs, receiving (with unloading, checking and testing), supervision, use of
equipment and follow-up. Sometimes costs such as quality control, transport,
delivery, sorting and movement of received goods are included in the reorder
cost.

logs315_Inventory Management 7

Types of cost:
Holding cost. This is the cost of holding one unit of an item in
stock for one period of time. As the usual period for calculating
stock costs is a year, a holding cost might be expressed as, say, $10
a unit a year. The most obvious cost of holding stock is money tied
up – which is either borrowed (in which case there is interest to
pay), or could be put to other use (in which case there are
opportunity costs). Other holding costs are due to storage space
(supplying a warehouse, rent, rates, heat, light, etc.), loss (due to
damage, obsolescence and pilferage), handling (including all
movement, special packaging, refrigeration, putting on pallets,
etc.), administration (stock checks, computer updates, etc.) and
insurance.

logs315_Inventory Management 8

4
 10/16/2021

Types of cost:
Shortage cost. If an organization runs out of stock for an item and
there is demand from a customer, then there is a shortage that has
an associated cost. In the simplest case a retailer might lose the
profit from a lost sale. Usually, though, the effects of shortages are
wider than this and include loss of goodwill, loss of future sales,
loss of reputation, and so on.

logs315_Inventory Management 9

Stock turnover:
• It might be difficult to use costs to monitor inventory performance
over time, so we can use some more direct measures.
• Perhaps the most common measure Inventory Control and
Management is the stock turnover, which is the ratio of the number
of units sold to the average stock:

logs315_Inventory Management 10

5
 10/16/2021

Stock turnover:
• Organizations often find their stock turnover indirectly from accounts
rather than directly from actual counts. Then we can define a cost of
units sold as the total cost of buying or acquiring the units that are
later sold to customers, and the turnover is:

logs315_Inventory Management 11

Worked example:
• Emergent Technologies Wholesale (Scandinavia) buys an item for
$100 a unit and sells it for $150. Annual sales of the item are around
1,000 units, with average stock of 150 units. Each unit held in stock
costs approximately 25 percent of cost a year.
1. Describe the stock holdings.
2. What are the benefits if average stocks of the item are reduced
to 100 units without affecting customer service?

logs315_Inventory Management 12

6
 10/16/2021

Solution:
1. We can calculate a number of measures for the stock.
Stock turnover is: (cost of units sold) / (average value stock) = (1000 × 100) /
(150 × 100) = 6.67
Annual gross profit on the item: sales × (selling price − unit cost) = 1,000 ×
(150 − 100) = $50,000 a year
Average investment in stock: (number of units held) × (unit cost) = 150 ×
100 = $15,000
Annual stock holding cost: (average number of units in stock) × (cost of
holding each unit) = 150 × (100 × 0.25) = $3,750 a year
Stock holding cost per unit sold: (stock holding cost) / (number of units sold)
= 3750 / 1000 = $3.75

logs315_Inventory Management 13

Solution:
• If the average stock is reduced to 100 units, the company would be operating
more efficiently with:
stock turnover = (1, 000 × 100)/(100 × 100) = 10
average investment in stock = 100 × 100 = $10,000
annual stock holding cost = 100 × (100 × 0.25) = $2,500
stock holding cost per unit sold = 2,500/1,000 = $2.50
additional profit = reduced stock holding cost = 3,750 − 2,500 = $1,250 a
year

logs315_Inventory Management 14

7
 10/16/2021

Approaches to inventory control:

• Basic questions:
1. What items should we keep in stock?
Holding any stock is expensive, so organizations have to make
sure that their stocks remain at the lowest level that allows
acceptable service. This means:
i. keeping stock of existing items at reasonable levels;
ii. not adding unnecessary items to the inventory;
iii. removing all items which are no longer used from the
inventory.
Unless tightly controlled, there is a tendency for stock holdings
to drift upwards.
logs315_Inventory Management 15

Approaches to inventory control:

• Basic questions:
2. When should we place an order?
There are basically three different approaches to this question:
i. The first uses a periodic review to place orders of variable size at
regular intervals of time. Any variation in demand is allowed for
by the changing order size.
ii. The second approach uses a fixed order quantity. Stock levels are
continuously monitored and when they fall to a specified level a
fixed amount is ordered. Any variation in demand is allowed for by
changing the time between orders.
iii. The third approach relates the supply more directly to the
demand and orders enough stock to meet known demand over a
specified period. Then both the time and quantity ordered
depend directly on demand.

logs315_Inventory Management 16

8
 10/16/2021

Approaches to inventory control:

• Basic questions:
3. How much should we order?
Every time we place an order, there are associated costs for
administration, delivery, and so on.
i. If we place large, infrequent orders, the costs of ordering
and delivery are kept low, but stock levels and average
inventory value are high.
ii. If we place small frequent orders, costs of ordering and
delivery are high, but average stock level is low.
iii. In general, we will look for a compromise between these
two extremes that minimizes overall cost.
logs315_Inventory Management 17

Approaches to inventory control:

• Answering the basic questions:
There are basically two different methods, which are based on the
ways of assessing demand.
i. Independent demand methods assume that the demand for an
item is independent of the demand for any other item.
ii. Dependent demand methods. In practice, the demands for
different items are often related. In a factory the demand for all
components of a product are related through the production
plans.

logs315_Inventory Management 18

9
 10/16/2021

logs315_Inventory Management 19

10