UNIT 2

Inventory Management
What Is Inventory?
⚫ Stock of items kept to meet future demand
⚫ Ex: manufacturing organization, service
organization (Hospitals, banks etc.)
⚫ Purpose of inventory management
⚫ Main purpose: to control Stock out. ex: retail store of
Medicine ( Profit loss, goodwill loss)
⚫ It should not on high level of inventory or low level
⚫ how many units to order
⚫ when to order
 Uses of Inventory

▪To satisfy the

expected ▪To provide buffer ▪De link various process of
customer between successive organization so it is costly
demand operations ▪Easy to repair or
(Anticipation (Decoupling concentrate on less
Inventory) Inventory or breakdown
▪To protect Work-in-process
Inventory)
▪Total price against price
decrease in increases and ▪To satisfy periods of
to take seasonal high ▪Umbrella,
compare to ▪Inventory
advantage of demand (Seasonal crackers,
competitors
Quantity Inventory) AC,
▪Distant place heaters,
order Discounts
woolen
garments
▪To avoid stock ▪To act as a buffer etc
outs (Safety between various
Stock or
▪To minimize elements of the
Buffer Stock) Supply-Chain
the total cost
by ordering (Suppliers-Producers-Di ▪Try to reduce
the Economic stributors-Wholesalers- transit time
Order Retailers-Customers)
Quantity (Pipeline or Transit
(Cycle Stock) Stock)
 Two Forms of Demand
▪ Dependent
▪ Demand for items used to produce final
products
▪ So that will be component, parts or sub
assemblies of finished goods
▪ Tires stored at a Goodyear plant are an
example of a dependent demand item
▪ Independent
▪ Demand for items used by external
customers
▪ Cars, appliances, computers, and houses
are examples of independent demand
inventory
Inventory Costs
▪ Carrying cost
▪ cost of holding an item in inventory
▪ Cost of warehouse, capital tied up,
maintains of warehouse, cost of
damages etc
▪ Ordering cost
▪ cost of replenishing inventory
▪ The purchase department incurs
following cost: employee salary, office
cost (stationary & other bills expanses)
etc.
EOQ Model
Economic Order Quantity
EOQ Assumptions
⚫ The annual demand of item is Known & constant
⚫ Annual demand of the item is uniformly distributed
throughout the year.
⚫ The lead time is zero. Lead time: time between
placing the order & receiving the order.
 EOQ Model

Annual
cost Total Cost
Slope = 0
QC
Minimum Carrying Cost R= 2
total cost

Ao
Ordering Cost P = Q

Optimal order Order Quantity, Q

Qopt
Types of Model
⚫ EOQ
⚫ Discounting Model
⚫ Differential Discounting Model
⚫ Safety stock
Safety Stock
⚫ In actual situation, demand of items may fluctuate any
point of time or supplier may need lead time.
⚫ Lead Time: Time between placing the order and receiving
the order.
⚫ Ex: Supplier need 10 days Lead time and every day
consumption is 50 units.
⚫ So in this case, Reorder Point (R)= d*L = 50 *10= 500
units.
⚫ So we may say, when in stocks there are 500 units, company
needs to order.
▪ There are stock out because of
▪ Excessive consumption in lead time
▪ Lead time has increased

Fig- Excessive consumption in lead time

Fig- Lead time has increased
Fig- Safety stock to avoid stock out
⚫ EOQ
⚫ Total inventory cost /yr and Total inventory cost/working
day with EOQ and with a safety stock decreased to 5000
units.
Optimal level of safety stock
⚫ Higher safety stock—CC increase
⚫ Lower safety stock- -Stock Out cost
⚫ To maintain the same, in firm there is need of optimal level
of safety stock
⚫ safety stock involves two type of cost:
⚫ CC of safety stock
⚫ Stock Out cost
⚫ CC of safety stock ∝ 1
Stock Out cost

⚫ Total cost of safety stock is minimum when CC of safety stock

= Stock Out cost ; corresponds optimal level of safety stock
The production Quantity Model
⚫ In this EOQ model, the assumption that orders are
received all at once is relaxed.
⚫ The order quantity is received gradually over time.
⚫ The inventory level is depleted at the same time it is being
replenished.
⚫ This situation is applicable when the inventory user is also
the producer.
⚫ The length of time to receive an order for this type of
manufacturing operation is commonly called the length of
the production run.
⚫ Production run = Q/P
Summer 22
WINTER 22
Facility Capacity Planning
Capacity planning
⚫ The capacity of a facility is defined as the maximum load
that can be handled by it during given period.
⚫ The load can be expressed in terms of the amount of i/ps
or o/ps.
⚫ Ex: sugar mill capacity is expressed in terms of the no of
tones proceed.
 ▪Need for Facility Capacity Planning

▪To find the optimal

capacity of the facility
so that the total of costs
of under-capacity and
over-capacity is the
minimum

▪To keep the initial

▪To satisfy the ▪Need for investment in the
future demand of Facility facility as low as
products without Capacity possible to achieve
any shortages Planning lesser break-even
volume

▪Investments in
facility capacity are
long-term and
cannot be reversed
easily over the
period of time
Types of Capacity

⚫ Design capacity represents the maximum rate of output that can be

achieved under ideal conditions.max no of labors but what is o/p
from machines and equipments.
⚫ Effective capacity is the maximum rate of output which can be
practically achieved under the constraints of time consumed in
set-ups, oiling & cleaning, defective items, etc. this is used when
different products are produced with batches. Effective capacity is
always lesser than the design capacity.
⚫ Actual capacity is the maximum output rate which is actually
achieved under the constraints of machine breakdowns, labor
inefficiencies & absenteeism, defective products, late deliveries of
materials by the supplier, and so on. Actual capacity can be equal to
or less than the effective capacity.
▪Ways of Increasing Effective Capacity

▪Proper process quality control

so that there are less
defective items requiring
rework

▪Proper facility ▪Good training, high

location, layout, motivation, less absenteeism
and internal & high turnover on part of
working conditions ▪Ways of workers
Increasing
Effective
▪By making products Capacity
& services as uniform ▪Good coordination with suppliers
as possible in design for timely & defect-free supplies
so that number of and proper scheduling of products
set-ups required are on machines
less (batch sizes will
▪By properly following the
be large)
environmental and pollution norms,
which results in lesser inspections by
government enforcement agencies
and, thus, lesser disruption of
production activities
 ▪Trends in Demand Forecasts

▪Capacity
expansion ▪Decline
▪Demand
forecast ▪Growth ▪Demand trend
trend forecast ▪Processing new
products in existing
facility
▪Time ▪Time

▪Demand
forecast ▪Demand
▪Cyclical forecast ▪Stable
trend trend

▪Time
▪Time

▪Products A & B

▪Demand ▪Product B
forecast

▪Product A

▪Time
▪Optimal Capacity Determination

▪Average cost
per unit of the
product

▪0 ▪Optimal output rate ▪Output rate

▪Part a
▪Small-sized
▪Average cost Plant
per unit of the
product
▪Medium-size
d Plant

▪Large-sized
Plant

▪0 ▪Output rate

▪Part b
Role of Other Functional Departments in inventory Management
▪Finance Department

▪Information
regarding the
▪Formulation ▪Information ordering cost
▪Demand ▪Salaries & of annual regarding and carrying
forecast of wages of budget for payments to cost figures to ▪Performance
finished goods employees materials be made to be used in appraisal of
so that raw in the suppliers order size employees in
materials can be materials calculations the materials
procured department department
accordingly
▪Recruitment
▪Feedback
of
regarding quality ▪Materials ▪Human
▪Marketing employees
requirements of Department resources
department in the
finished goods department
Materials
and thus the
Department
▪Information materials used ▪Training of
regarding changes employees in ▪Training &
made in the the materials development of
materials quality to department employees in
enhance the quality regarding use of the materials
of finished goods ERP and other department
software
▪Installation ▪Requirement
of ERP or of suitable
other software in
software in the materials
▪Information department
the materials systems
department department
Types of Inventory Management Systems
▪Inventory Management
Systems

▪Independent Demand Inventory ▪Dependent Demand

Management Systems Inventory Management
Systems

▪For Retailers ▪For Manufacturers

▪Material ▪Just-In-Time
▪ABC Requirements (JIT)
▪EOQ Model for
Classification Planning (MRP) Systems
Manufacturers
of Items Systems

▪Hybrid MRP-JIT
Systems
▪Category ▪Category ▪Category
A Items B Items C Items

▪Periodic
▪Basic Economic Review
Order Quantity System
(EOQ) Model

▪EOQ Model ▪EOQ Model with ▪EOQ Model ▪EOQ Model

with Quantity Differential with Safety with Intentional
Discounts Discounting Stock Shortages
Types of Inventory