Inventory

Chapter 7
Inventory
Inventory Functionality and Definitions

Inventory Carrying Cost

Planning Inventory

Managing Uncertainty

Inventory Management Policies

Inventory Management Practices

 Inventory Functionality and
Definitions
Inventory management is risky which varies depending upon a
firms position in distribution channel.

For manufacturer
long-term risk

For wholesaler
Assortment of merchandise

For retailer
velocity of buying and selling
Inventory Functionality

Inventory is a current asset that should provide return on the

capital invested. The return on inventory investments is the
marginal profit on sales that would not occur without
inventory.

4 Prime Functions of Inventory

Geographical Specialization
Allows geographically positioning across multiple
manufacturing and distributive units of an enterprise.
Inventory maintained at different locations and stages of the
value-creation process allows specialization.
Decoupling
Allows economy of scale within a single facility and permits each
process to operate at maximum efficiency rather than having the
speed of the entire process constrained by the slowest.

Supply/Demand Balancing
Accommodates elapsed time between inventory availability
(manufacturing, growing, or extraction) and consumption.

Buffering Uncertainty
Accommodates uncertainty related to demand in excess of forecast
or unexpected delays in order receipt and order processing in
delivery and is typically referred to as safety stock.
Inventory Definition

Inventory Policy
Consists of guidelines regarding what to purchase or
manufacture, when to take action, and in what quantity.

Service Level
A performance target specified by management.
Service level is often measured in terms of
performance cycle time, case fill rate, line fill rate,
order fill rate, or any combination of these.
Average inventory
The materials, components, work-in-process, and fnished
product typically stocked in the logistical system is called
inventory and the rolling mean across time is refferred to as
average inventory.

Order quantity - the amount ordered for replenishment

Cycle inventory/base stock - portion of average inventory that

results from replenishment.
 Average cycle inventory or base stock
Equals one-half order quantity

Stock level - at a maximum following stock receipt from the

supplier.

Safety stock -the remainder of inventory in the typical

logistics system.

Ave. Inventory = one-half order quantity plus safety stock

and intransit stock
 Transit inventory -amount typically in transit between
facilities or on order but not received.

Obsolete inventory -stock that is out-of-date or that has not

experienced recent demand.

Speculative inventory - bought prior to need to hedge a

currency exchange or to take advantage of a special discount,
or prepare for a potential work force disruption.
 Inventory Definitions:
Inventory Cycle for Typical
Product
Maximum Inventory Average Inventory
$70,000 order quantity ($40,000/2 or
$20,000) + Safety Stock
($30,000) =
$50,000

$30,000

Transit/Obsolete/Speculative/
Safety stock

1 2
Average inventory across multiple
performance cycles
Reorder point
Defines when a replenishment order is initiated

Inventory turns
Total sales divided by the average inventory

Economic Order Quantity (EOQ)

Provides a specific quantity balancing the cost of ordering and the
cost of maintaining average inventory.
 Inventory Definitions:
Inventory Cycle with No Demand
Uncertainty

Order Placed
for 200
products Order Arrives
200
Average
Inventory on

Inventory (Q/2) =
100
hand

0
10 60
40
Days
Reorder Point

If sales occur at the rate of 10 products/day,

it takes 20 days to sell 200 products
 Inventory Definitions:
Inventory Cycle with No Demand Uncertainty

Order PlacedOrder Arrives Order Placed

200 for 200 for 200
products products

0
10 20 30 60
40
Reorder Point Reorder Point
Assuming a work year of 240 days,12(240/20) purchases
will be req. during the year. Therefore, over a period of 1
year 2400 (200*12) unit will be purchased. Inventory
turnover will be 24 (2400 unit/100 units of ave. inventory)
times.
 Inventory Definitions:
More Frequent Orders, Smaller Order Quantity

Order Placed
Order Arrives
for 100
products Average
Inventory
100
50 products

0
10 20 30 40 50
Reorder Reorder Reorder
Point Reorder Reorder Point
Point Point
Point

Will have 24(240 days/10 days) purchases. Inventory turnover

will be 48( 2400/50)times.
Inventory Carrying Cost

Inventory carrying cost is the expense associated with

maintaining inventory. Inventory expense is calculated by
multiplying annual inventory carrying cost percent by
average inventory value.

Capital
Capital assessments range from the prime interest rate
to a percent determined by upper management.
Taxes
The tax expense is usually a direct levy based on
inventory value on a specific day of the year or average
inventory value over a period of time
Insurance
Insurance cost is an expense based upon estimated risk
or loss over time

Obsolescence
Obsolescence cost results from deterioration of product
during storage. Obsolescence also includes financial
loss when a product no longer has fashion appeal or no
longer has any demand.

Storage
Storage cost facility expense related to product holding
rather than product handling.