What is Inventory?

 Definition--The stock of any item or

resource used in an organization
 Raw materials
 Finished products
 Component parts
 Supplies
 Work in process
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 Inventory System Purpose

 The set of policies and controls that

determine what inventory levels should
be maintained, when stock should be
replenished, and how large orders
should be

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 Purposes of Inventory
1. To maintain independence of operations
2. To meet variation in product demand
3. To allow flexibility in production scheduling
4. To provide a safeguard for variation in raw
material delivery time
5. To take advantage of economic purchase-
order size

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 Inventory Costs
 Holding (or carrying) costs

 Setup (or production change) costs

 Ordering costs

 Shortage (or backlog) costs

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 Independent vs. Dependent Demand
Independent Demand
(Demand not related to other items)

Dependent Demand
(Derived/Calculated)

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 Classifying Inventory Models
 Fixed-Order Quantity Models
 Event triggered
 Make exactly the same amount
 Use re-order point to determine timing

 Fixed-Time Period Models

 Time triggered
 Count the number needed to re-order

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 Inventory Control

Inventory Inventory Models

Fixed Order Fixed Time Single

Quantity Models Period Models Period Models

Constant Uncertainty
Demand in Demand

EOQ w/
Simple EOQ
Quantity
EOQ w/usage
Discounts

Find the Determine Calculate

EOQ and R p and d Total costs

Find the Select Q

EOQ and R and find R
 Fixed-Order Quantity Models
Assumptions
 Demand for the product is constant and uniform
throughout the period
 Lead time (time from ordering to receipt) is constant
 Price per unit of product is constant
 Inventory holding cost is based on average inventory
 Ordering or setup costs are constant
 All demands for the product will be satisfied (No
back orders are allowed)

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 EOQ Model--Basic
Fixed-Order Quantity Model

Inventory
Level
Q Q Q

R
L L

Time
R = Reorder point
Q = Economic order quantity
L = Lead time
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 Basic Fixed-Order Quantity Model
Annual Annual Annual
Total Annual Cost = Purchase + Ordering + Holding
Cost Cost Cost

Derive the Total annual Cost Equation, where:

TC - Total annual cost
D - Annual demand (and d-bar = average daily demand = D/365)
C - Cost per unit
Q - Order quantity
S - Cost of placing an order or setup cost
R - Reorder point
L - Lead time
H - Annual holding and storage cost per unit of inventory

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 Cost Minimization Goal

C
O Total Cost
S
T Holding
Costs
Annual Cost of
Items (DC)

Ordering Costs

QOPT
Order Quantity (Q)
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 Deriving the EOQ
 Using calculus, we take the derivative of the total cost
function and set the derivative (slope) equal to zero

2DS 2(Annual Demand)(Order or Setup Cost)

Q OPT = =
H Annual Holding Cost

Reorder Point, R = dL
_
d = average demand per time unit
L = Lead time (constant)
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 EOQ Example
Annual Demand (D) = 1,000 units
Days per year considered in average daily demand = 365
Cost to place an order (S) = $10
Holding cost per unit per year (H) = $2.40
Lead time (L) = 7 days
Cost per unit (C) = $15

Determine the economic order quantity and the reorder point.

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 Solution
2DS 2(1,000 )(10)
Q OPT = = = 91.287 units
H 2.40
91 or 92 units???
1,000 units / year
d = = 2.74 units / day
365 days / year
Why do we round up?
_
Reorder point, R = d L = 2.74units / day (7days) = 19.18 or 20 units

When the inventory level reaches 20, order 91 units.

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 Problem
 Retailer of Satellite Dishes
D = 1000 units
S = $ 25
H = $ 100
How much should we order?

What are the Total Annual Stocking Costs?

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 ABC Classification System
 Items kept in inventory are not of equal importance in
terms of:
60
 dollars invested % of
$ Value 30 A
 profit potential 0 B
% of 30 C
 sales or usage volume
Use 60
 stock-out penalties

So, identify inventory items based on percentage of total dollar

value, where “A” items are roughly top 15 %, “B” items as next
35 %, and the lower 50% are the “C” items.
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 Inventory Accuracy and
Cycle Counting
 Inventory accuracy
 Do inventory records agree with physical
count?

 Cycle Counting
 Frequent counts
 When? (zero balance, backorder, specified
level of activity, level of important item,
etc.)

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