Inventory

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Company – DCM Shriram

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 Company – Tata Steel

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 Company – HUL

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 Financial considerations

• Valuation of Inventory – How?

• Current assets – Net Current Assets, Current Ratio,
Quick Ratio
• Business cycles
• Inventory turnover
– COGS/Average Inventory
– An indicator of efficiency of an supply chain
– Influenced by distribution network, degree of vertical
integration, accounting convention etc
– Too much focus can be counter productive

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 Inventory turnover comparison
Source: Janat Shah. ‘Supply Chain Management’ (2009), Data derived from CMIE, Prowess

Worst Average Best

Food and Beverages 1.2 4.0 31.0
Chemical 1.2 8.5 32.5
Textile 1.9 5.3 45.2
Machinery 1.2 5.5 17.1
Metals 2.5 5.5 42.5

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 Reasons for holding inventory

Economies of Scale in production, transportation etc

– Cycle stock
Uncertainty in demand, lead times, replenishment
quantities – Safety stock , Seasonal stock
Distance– Pipeline stock
System boundaries– Decoupling stock
Price instability – Speculation stock
Service Requirements– MRO Inventory

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 Types of Inventory Models
Demand – Independent, Dependent
Demand – Constant, Deterministic,
Stochastic
Lead times – 0, >0, stochastic
Horizon – Single Period, Finite, Infinite
Products – One product, Multiple products
Capacity – Constrained, unconstrained
Service – No shortage, shortages allowed
Discounts – Bulk discounts, No Discounts
Perishability – Perishable, Non- Perishable

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 The Economic Order Quantity (EOQ)
Model

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 Assumptions - EOQ
Demand – Independent, Dependent
Demand – Constant, Deterministic,
Stochastic
Lead times – 0, >0, stochastic
Horizon – Single Period, Finite, Infinite
Products – One product, Multiple products
Capacity – Constrained, Unconstrained
Service – No shortage, shortages allowed
Discounts – Bulk discounts, No Discounts
Perishability – Perishable, Non- Perishable

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 Relevant Costs

Carrying Costs or Holding Costs

Opportunity costs, storage costs, material handling costs,
power, special requirements, obsolescence, pilferage,
spoilage, depreciation etc.
Key point: Depends on average inventory

Ordering Costs
Paperwork, communication, freight, inspection,
transportation, salary in purchasing dept, reject and rework,
delay etc
Key point: Depends on number of orders
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 Key Question
How much to order?

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 Inventory Profile

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 Notations
Lot sizing for a single product (EOQ)
D = Annual demand of the product
S = Ordering Costs (per order)
C = Cost per unit
h = Holding cost per year as a fraction of product cost

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 Cycle inventory, Flow time

Cycle Inventory = Lot Size/2 = Q/2

(How do we get it?)

Average Flow time = Average Inventory/Average Flow rate

= Cycle Inventory/Demand
= Q/2D

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 Cost components and total cost
Lot sizing for a single product (EOQ)
Annual material cost = CD
Number of orders per year = D/Q
Annual ordering Cost = (D/Q) S
Annual Holding Cost = (Q/2)H = (Q/2)hC
Total Annual Cost , TC = (D/Q) S + (Q/2)hC + CD

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 Cost components and total cost

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 Lot Sizing

The economic order quantity (E O Q)

2DS
Optimal lot size, Q* 
hC

The optimal ordering frequency

D DhC
n*  
Q* 2S

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 Some Properties of EOQ

If demand increases by a factor of k, the optimal lot

size increases by a factor of √𝑘
The number of orders placed per year should also
increase by a factor of √𝑘
Flow time attributed to cycle inventory should
decrease by a factor of √𝑘
To reduce the optimal lot size by a factor of k, the
fixed order cost S must be reduced by a factor of 𝑘 2

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 Example

Demand for a computer is 1000 units per month.

Ordering costs of $4000 is incurred each time an order
is placed. Each computer costs $500 and there is an
annual holding cost of 20%. Evaluate the optimal
order quantity, average inventory, flow time, number of
orders per year, annual ordering and holding costs.

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