Inventory Management
• Inventory Management
• Inventory Models for Independent Demand
Inventory
• Inventories are stocks or stores of goods that are a vital part of a
business. They are necessary for operations and contribute to
customer satisfaction.
• Some very large firms have tremendous amounts of inventory.
Inventory Management
• The overall objective of inventory management is to:
“ Achieve satisfactory levels of customer service while keeping
inventory cost within reasonable bounds”
Inventory Cost
• 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 Cost relates to physically having items in storage.
These include interest, insurance, taxes (in some states), depreciation,
obsolescence, deterioration, spoilage, pilferage, breakage, tracking,
picking, and warehousing costs (e.g., heat, light, rent, workers,
equipment, and security).
Inventory Cost
• Ordering Costs are the costs of ordering and receiving inventory.
These costs occur with the actual placement of an order. They include
determining how much is needed in preparing invoices, inspecting
goods upon arrival for quality and quantity, and moving the goods to
temporary storage. Ordering costs are generally expressed as a fixed
dollar/peso amount per order, regardless of order size.
• Setup Costs are expressed as a fixed charge per production run,
regardless of the size of the run.
Inventory Cost
• Shortage Costs result when demand exceeds the supply of inventory
on hand. These costs can include the opportunity cost of not making a
sale, loss of customer goodwill, late charges, backorder costs, and
similar costs (Stevenson, 2015).
Managing Inventory
ABC Analysis
• ABC analysis classifies inventory items according to some measure of
importance and then allocates control efforts accordingly. Generally,
three (3) classes of items are used: A (very important), B (moderately
important), and C (least important).
Managing Inventory
Cycle Counting
• Even though an organization may have made substantial efforts to
record inventory accurately, these records must be verified through a
continuing audit. Such audits are known as cycle counting.
Historically, many firms performed annual physical inventories. This
practice often meant shutting down the facility and having
inexperienced people count parts and material. Inventory records
should instead be verified via cycle counting (Heizer, Render, &
Munson, 2017).
Managing Inventory
Cycle counting has the following advantages (Heizer, Render, & Munson, 2017):
• It eliminates the shutdown and interruption of production necessary for
annual physical inventories;
• It eliminates annual inventory adjustments;
• It trains personnel audit the accuracy of inventory;
• It allows the cause of the errors to be identified and remedial action to be
taken; and
• It maintains accurate inventory records.
Inventory Models for Independent
Demands
Economic Order Quantity (EOQ) Model
• This model is used to identify a fixed order size that will minimize the
sum of the annual costs of holding
• and ordering inventories. The unit purchase price of items in
inventory is not generally included in the total cost because the unit
cost is unaffected by the order size unless quantity discounts are a
factor. If holding costs are specified as a percentage of unit cost, then
unit cost is indirectly included in the total cost as a part of holding
costs.
Inventory Models for Independent
Demands
Economic Order Quantity (EOQ) Model
This is based on the following assumptions (Stevenson, 2015):
• Only one (1) product is involved;
• 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; and
• There are no quantity discounts.
Economic Order Quantity (EOQ) Model
CASE
The Warren W. Fisher Computer Corporation purchases 8,000 transistors each
year as components in minicomputers. The unit cost of each transistor is P10.00
and the cost of carrying one transistor in inventory for a year is P3.00. Ordering
cost is P30.00 per order. What is the optimal order quantity?
CASE
The Warren W. Fisher Computer Corporation purchases 8,000 transistors each
year as components in minicomputers. The unit cost of each transistor is P10.00
and the cost of carrying one transistor in inventory for a year is P3.00. Ordering
cost is P30.00 per order. Assume that fisher operates on a 200-day working year.
What is the expected time between orders (T)? What is the total annual cost?
Inventory Models for Independent
Demands
Reorder Point
Simple inventory models assume that receipt of an order is instantaneous. In
other words, they assume (1) that a firm will place an order when the
inventory level for that particular item reaches zero and (2) that it will receive
the ordered items immediately. However, the time between placement and
receipt of an order, called lead time, or delivery time, can be as short as a few
hours or as long as months. Thus, the when to- order decision is usually
expressed in terms of a reorder point (ROP), the inventory level at which an
order should be placed (Heizer, Render, & Munson, 2017).
Inventory Models for Independent
Demands
Reorder Point
CASE
Annual demand for notebook binders at Meyer’s Stationery Shop is
10,000 units. Brad Meyer operates his business 300 days per year and
finds that deliveries from his supplier generally take 5 working days.
Calculate the reorder point.
Inventory Models for Independent
Demands
Production Order Quantity
• In the previous inventory model, we assumed that the entire inventory order
was received at one time. There are times, however, when the firm may
receive its inventory over a period of time. Such cases require a different
model--one that does not require the instantaneous-receipt assumption.
• Because this model is especially suitable for the production environment, it is
commonly called the production order quantity model. It is useful when
inventory continuously builds up over time, and traditional economic order
quantity assumptions are valid. We derive this model by setting ordering or
setup costs equal to holding costs and solving for optimal order size, 𝑄𝑄∗
(Heizer, Render, & Munson, 2017).
Inventory Models for Independent
Demands
Production Order Quantity
CASE
Leonard Presby Inc. has an annual demand rate of 1,000 units but can
produce at an average production rate of 2,000 units. Setup cost is
P10.00; carrying cost is P1. What is the optimal number of units to
produced each time?
