Inventory Management

Presented by: Apple Magpantay

Inventory Definition

 A stock of items held to meet future

demand
 Inventory is a list of goods and materials,
or those goods and materials themselves,
held available in stock by a business
Functions of Inventory
 To meet anticipated customer demand.
 To smooth production requirements.
 To decouple operations.
 To reduce the risk of stock outs.
 To take advantage of order cycles.
 To hedge against price increase.
 To permit operations.
 To take advantage of quality discounts.
Objective of Inventory
Management
 To maintain a optimum size of inventory
for efficient and smooth production and
sales operation
 To maintain a minimum investment in
inventories to maximize the profitability
 Effort should be made to place an order at
the right time with the right source to
acquire the right quantity at the right price
and right quality
Requirements for Effective
Inventory Management
 A system to keep track of the inventory
on hand and on order
 A reliable forecast of demand that
includes and indication of possible
forecast error
 Knowledge of lead times and lead time
variability
Requirements for Effective
Inventory Management
 Reasonable estimates of inventory
holding costs, ordering costs and
shortage costs
 A classification system for inventory
items
Inventory Counting Systems
Periodic system – physical count of items
in inventory made at periodic intervals
(weekly, monthly).
A perpetual inventory system (also known
as a continuous review system) keeps track
of removals from inventory on a continuous
basis, so the system can provide information
on the current level of inventory for each
item.
Inventory Counting Systems
A two–bin system, a very elementary system,
uses two containers for inventory. Items are
withdrawn from the first bin until its contents are
exhausted. It is then time to reorder.
Universal product code (UPC) Bar code
printed on a label that has information about the
item to which it is attached.  
Point-of-sale (POS) systems electronically
record actual sales. Record items at time of
sale.
Demand Forecasts and Lead–
Time Information
Lead time-Time interval between ordering
and receiving the order might vary; the
greater the potential variability, the greater
the need for additional stock to reduce the
risk of a shortage between deliveries. Thus,
there is a crucial link between forecasting
and inventory management.
Inventory Costs
Purchase cost is the amount paid to a
vendor or supplier to buy the inventory. It is
typically the largest of all inventory costs.
Holding, or carrying, costs relate to
physically having items in storage. Costs
include interest, insurance, taxes (in some
states), depreciation, obsolescence,
deterioration, spoilage, pilferage, breakage,
tracking, picking, and warehousing costs
Inventory Costs

Ordering costs - costs of Ordering costs.

Costs of inventory.
Setup costs - The costs involved in
preparing equipment for a job.
Shortage costs- Costs resulting when
demand exceeds the supply of inventory;
often unrealized profit per unit.
Classification System
The A-B-C approach classifies inventory
items according to some measure of
importance, usually annual dollar value (i.e.,
dollar value per unit multiplied by annual
usage rate), and then allocates control efforts
accordingly.
To conduct an A-B-C analysis, follow these
steps:
1. For each item, multiply annual volume by
unit price to get the annual dollar value.
Classification System

2. Arrange annual dollar values in

descending order.
3. The few (10 to 15 percent) with the
highest annual dollar value are A items. The
most (about 50 percent) with the lowest
annual dollar value are C items. Those in
between (about 35 percent) are B items.
Classification System
Cycle counting A physical count of items in
inventory.
The key questions concerning cycle
counting for management are
1. How much accuracy is needed?
2. When should cycle counting be
performed?  
3. Who should do it?  
Inventory Ordering Policies
Inventory ordering policies address the two
basic issues of inventory management, which
are how much to order and when to order. In
the following sections, a number of models
are described that are used for these issues.
Cycle stock The amount of inventory needed
to meet expected demand.
Safety stock Extra inventory carried to
reduce the probability of a stockout due to
demand and/or lead time variability
How much to order:

Economic Order Quantity models identify

the optimal order quantity by minimizing the
sum of certain annual costs that vary with
order size and order frequency. Three order
size models are described here:  
1. The basic economic order quantity model
2. The economic production quantity model  
3. The quantity discount model  
Basic Economic Order
Quantity (EOQ) Model
The basic model involves a number of
assumptions.
Only one product is involve.
Annual demand requirements are known.
Demand is spread evenly throughout the
year so that the demand rate is reasonably
constant.
Lead time is known and constant.
Each order is received in a single delivery.
There are no quantity discounts.
Basic Economic Order
Quantity (EOQ) Model
Annual carrying cost is computed by
multiplying the average amount of inventory
on hand by the cost to carry one unit for one
year, even though any given unit would not
necessarily be held for a year.
Annual carrying cost =Q/2 H where
Q = Order quantity in units
H = Holding (carrying) cost per unit per year
Basic Economic Order
Quantity (EOQ) Model
Annual ordering cost is a function of the
number of orders per year and the ordering
cost per order:  
Annual ordering cost = S D/Q where
D = Demand, usually in units per year
S = Ordering cost per order
Basic Economic Order
Quantity (EOQ) Model
The total annual cost (TC) associated with
carrying and ordering inventory when Q units are
ordered each time is
TC = Annual Carrying Cost + Annual ordering
cost= Q/2 H + D/Q S
•(Note that D and H must be in the same units,
e.g., months, years.) An expression for theoptimal
order quantity, Q0, can be obtained using
calculus. The result is the formula
•Q0 = 2DS/H
Basic Economic Order
Quantity (EOQ) Model
Q0 = 2DS/H
The ordering cost per order, and the annual
carrying cost per unit, one can compute the
optimal (economic) order quantity. The
minimum total cost is then found by
substituting Q0 for Q in Formula.
The length of an order cycle (i.e., the time
between orders) is Length of order cycle
= Q/D
 Economic Production
Quantity (EPQ)  
The assumptions of the EPQ model are similar
to those of the EOQ model, except that instead
of orders received in a single delivery, units are
received incrementally during production. The
assumptions are:
1. Only one product is involved
2. Annual demand is known  
3. The usage rate is constant  
4. Usage occurs continually, but production
occurs periodically  
 Economic Production
Quantity (EPQ)  
5. The production rate is constant when
production is occurring  
6. Lead time is known and constant  
7. There are no quantity discounts  
The number of runs or batches per year is D/Q,
and the annual setup cost is equal to the
number of runs per year times the setup cost,
S, per run: (D/Q)S.  
 Economic Production
Quantity (EPQ)  
TCmin = Carrying cost + Setup cost =
(Imax/2) H + (D/Q) S where
Imax = Maximum inventory
Unlike the EOQ case, where the entire
quantity, Q, goes into inventory, in this case
usage continually draws off some of the output,
and what’s left goes into inventory. So the
inventory level will never be at the run size, Q0.
 
 Economic Production
Quantity (EPQ)  
The economic run quantity is
Qp = √2DS/H p/p-u where
p = Production or delivery rate u = Usage rate
Note: p and u must be in the same units (e.g.,
both in units per day, or units per week). The
cycle time (the time between setups of
consecutive runs) for the economic run size
model is a function of the run size and usage
(demand) rate:
 Economic Production
Quantity (EPQ)  
Cycle time = Qp/u
Similarly, the run time (the production phase
of the cycle) is a function of the run (lot) size
and the production rate:
Run time = Qp/p The maximum and
average inventory levels are
Imax = Qp/p (p-u) or Qp-(Qp/p)u and
1average=1max/2
 Quantity Discounts
Quantity discounts are price reductions for
larger orders offered to customers to induce
them to buy in large quantities. When quantity
discounts are available, there are a number of
questions that must be addressed to decide
whether to take advantage of a discount.
These include:  
1. Will storage space be available for the
additional items?  
2. Will obsolescence or deterioration be an
issue?
 Quantity Discounts

3. Can we afford to tie up extra funds in

inventory?
If the decision is made to take advantage of
a quantity discount, the goal is to select the
order quantity that will minimize total cost,
where total cost is the sum of carrying cost,
ordering cost, and purchasing (i.e., product)
cost:
 Quantity Discounts

TC = Carrying cost + Ordering cost +

Purchasing cost
= (Q/2) H + (D/Q) S+ PD
Where
Q = Order quantity
H = Holding cost per unit (usually annual)
D = Demand (usually annual)
S = Ordering cost
P = Unit price or cost  
Thank you