Inventory Management

© 2009 Cengage Learning/South-Western

 INVENTORY MANAGEMENT

Inventory Management
– refers to the process of formulation and
administration of plans and policies to efficiently and
satisfactorily meet production and merchandising
requirements and minimize cost relative to inventories.

Objective: To maintain inventory at a level that best

balances the estimates of actual savings, the cost of
carrying additional inventory, and the efficiency of
inventory control.

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 INVENTORY MANAGEMENT
TECHNIQUES
Inventory Planning
Involves the determination of the quality
and quantity and location of inventory, as well
as the time of ordering, in order to minimize
cost and meet future business requirements.
Examples: Economic Order Quantity; Reorder
point; Just-in-Time(JIT) System

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 INVENTORY MANAGEMENT
TECHNIQUES
Inventory Control
Involves regulation of inventory within
predetermined level; adequate stocks should
be able to meet business requirements, but
the investment in inventory should be at the
minimum.

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 SYSTEMS OF INVENTORY CONTROL
JUST-IN-TIME PRODUCTION SYSTEM – a “demand pull” (driven by
demand) system in which each component of a finished good is
produced when needed by the next production stage.
FIXED ORDER QUANTITY SYSTEM – an order for a fixed quantity is
placed when the inventory level reached the reorder point. This is
consistent with EOQ concept.
PERIODIC REVIEW OR REPLACEMENT SYSTEM – orders are made
after a review of inventory level has been done at regular intervals.

OPTIONAL REPLENISHMENT SYSTEM - combination of fixed order

and replacement systems.

MATERIALS REQUIREMENT PLANNING (MRP) – MRP is a push

through system that is designed to plan and control materials used in
production based on a computerized system that the manufactures
finished goods based on demand forecasts.
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 SYSTEMS OF INVENTORY CONTROL
MATERIALS REQUIREMENT PLANNING (MRP - II) – A closed loop
system that integrates various functional areas of a manufacturing
company (e.g., inventories, production, sales and cash flows). It is
developed as an extension of MRP.

ENTERPRISE RESOURCE PLANNING (ERP) – ERP integrates

information systems of all functional areas in a company. Every aspect
of operations is interconnected as the company is connected with its
customers and suppliers.

ABC Classification System – inventories are classified for selective

control
A items – high value requiring highest possible control
B items – medium cost items requiring normal control
C items – low cost items requiring the simplest possible control
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 INVENTORY MODELS

A basic INVENTORY MODEL exists to

assist in two inventory questions:
1. How many units should be ordered?
2. When should the units be ordered?

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 ECONOMIC ORDER QUANTITY
Economic Order Quantity – the quantity to be ordered, which minimizes the
sum of the ordering and carrying costs.
where: a – cost of placing one order(ordering cost)
EOQ = 2aD D – annual demand in units
k k – annual cost of carrying one unit in
inventory for one year
Assumptions of the EOQ Model
1. Demand occurs at a constant rate throughout the year.
2. Lead time on the receipt of the orders is constant
3. The entire quantity ordered is received at one time.
4. The unit costs of the items ordered are constant; thus, there can be no
quantity discounts.
5. There are no limitations on the size of the inventory.

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 ECONOMIC ORDER QUANTITY
Ordering costs – include those spent in placing and
order, waiting for an order to be delivered, inspection
and receiving costs, setup costs, and quantity
discounts lost.

Carrying costs - are those spent in transferring the

goods from the receiving department to the
warehouse, holding, maintaining, or warehousing
inventories such as warehousing and storage costs,
handling and clerical costs, property taxes and
insurance, deterioration and shrinkage of stocks,
obsolescence of stocks, interest, and return on
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investment.
 ECONOMIC LOT SIZE (ELS)
Economic Lot Size – when applied to manufacturing operations, the EOQ
formula may be used to compute the Economic Lot Size (ELS)
where: a – set-up cost
ELS = 2aD D – annual production requirement
k k – annual cost of carrying one unit in
inventory for one year

When the EOQ figure is available, the average inventory is computed as follows:

Average Inventory = EOQ

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 EOQ

1. AGI Company carries an inventory of shaving cream bottles that

cost P25 each. The firm’s inventory carrying cost is 18% of the
value of the inventory. It costs P38 to place, process, and
receive an order. The firm uses 20,000 valves a year.
Required:
a. What ordering quantity minimizes the inventoSry costs
associated with the shaving cream bottles? (Round to the
nearest unit)
b. How many orders will be placed each year if the EOQ is used?
c. What are the bottles’ carrying and ordering costs if the EOQ is
used?

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 EOQ

2. SUN publishes a book about nature. Set-up cost is P10.

SUN prints 675 copies of the book evenly throughout the
year. If the optimal production run (economic lot size) is
30, how much is the unit carrying cost per year?

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 EOQ

3. Based on an EOQ analysis (assuming a constant

demand), the optimal order quantity is 4,000 units. Annual
inventory carrying cost equal 30% of the average
inventory level. The company pays P5 per unit to buy the
product, which sells for P12. The company pays P200 to
place an order, and monthly demand for the product is
5,000 units.
Required: a. Annual inventory carrying cost
b. Total inventory order cost per year

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 THE REORDER POINT

When to Reorder:
When to reorder is a stock-out problem. i.e., the objective is
to order at a point in time so as not to run out of stock before
receiving the inventory ordered but to so early that an excessive
quantity of safety stock is maintained.
Lead time – period between the time the order is placed and
received
Normal Time usage = Normal lead time x Average Usage
Safety stock = (Maximum LT – Normal LT) x Average Usage
Reorder point if there is NO SS required = Normal lead time usage
Reorder point if there is safety stock required = SS + NTU or MLT
x
Average usage
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 REORDER POINT

4. The AGI Company purchases 25,600 units of bleaching

soap per year. The average purchase lead time is 7
working days. Maximum lead-time is 10 working days. The
company works 320 days per year.

Required: a. Units of safety stock that the company

should carry
b. The reorder point for bleaching soap
c. Assume that the lead time is always 7 days
and no delay in delivery has been experienced by the
company. What is the reorder point? How many units of
safety stock must be kept by the company in this case?
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