Inventory Control

Model
 Inventory as an Important Asset
• Inventory can be the most expensive and
the most important asset for an
organization
Inventory
40%

Other Assets
60%
Inventory as a
percentage of total assets
The Inventory Process

Suppliers Customers

Inventory Storage

Raw Finished
Materials Goods

Fabrication
Work in
and
Process
Assembly

Inventory Processing
Importance of Inventory Control
Five Functions of Inventory
• Decoupling
• Storing resources
• Adapting to irregular supply and demand
• Enabling the company to take advantage
of quantity discounts
• Avoiding stockouts and shortages
 Inventory Decisions
• How much to order
• When to order

wish to minimize total inventory cost

 Inventory Costs

• Cost of the items

• Cost of ordering

• Cost of carrying, or holding inventory

• Cost of safety stock

• Cost of stockouts
 Ordering Costs
• Developing and sending purchase orders
• Processing and inspecting incoming inventory
• Bill paying
• Inventory inquiries
• Utilities, phone bills, etc., - purchasing department.
• Salaries/wages - purchasing department
employees
• Supplies (e.g., forms and paper) - purchasing
department
 Carrying Costs
• Cost of capital
• Taxes
• Insurance
• Spoilage
• Theft
• Obsolescence
• Salaries/wages - warehouse employees
• Utilities/building costs - warehouse
• Supplies (e.g., forms, paper) - warehouse
Inventory Usage Over Time
 Costs as Functions of Order
Quantity
Annual
Cost Total Cost Curve

Minimum
Carrying (holding)
Cost
Cost Curve
Ordering (set-
up)
Cost Curve
Q* Order Quantity
 Costs as Functions of Order
Quantity

Inventory Cost versus Order Quantity

$ Cost

l Cost
Minimum Cost Tota r y Cost
Car
Order Cost
Quantity
Optimal Quantity
 Steps in Finding the Optimum
Inventory
• Develop an expression for the ordering
cost.
• Develop and expression for the
carrying cost.
• Set the ordering cost equal to the
carrying cost.
• Solve this equation for the optimum
desired.
 EOQ : Basic Assumptions
• Demand is known and constant
• Lead time is known and constant
• Receipt of inventory is instantaneous
• Quantity discounts are not possible
• The only variable costs are the cost of setting up or
placing an order, and the cost of holding or storing
inventory over time
• Stockouts can be completely avoided if orders are
placed at the appropriate time
 Developing the EOQ
• Annual ordering cost:
Annual demand

Number of units per order
D
 Co
Q

• Annual holding or carrying cost:

 Average Inventory * Carrying Cost Per Year
Q
 Ch
2

• Material Cost: DC
• Total inventory cost: D Q
TC t  DC  C o  C h
Q 2
 EOQ
Per Unit Carrying Cost:

2DC 0
Q* 
Ch

Percentage Carrying Cost:

*   DC
Q
IP
 Inputs and Outputs of the
EOQ Model
Input Values Output Values
Annual Demand Economic
(D) Order
Ordering Cost Quantity
(Co) (EOQ)
Carrying Cost EOQ
(Ch) Models
Reorder
Lead Time
Point
(L)
(ROP)
Demand Per Day
(d)
The Reorder Point (ROP) Curve
ROP = (Demand per day) x (Lead time for a new order, in days)
=dxL

Q*
Inventory Level (Units)

Slope = Units/Day = d

ROP
(Units)

Lead Time (Days) L

 Inventory Control and the
Production Process
Production
Portion of
Cycle
Inventory Level

Maximum
Inventory
Level
Demand Demand
Portion Portion
of Cycle of Cycle
Time
 Production Quantity EOQ
• Annual Carrying Cost:
Q d
(1  )Ch
2 p
• Annual Ordering Cost:

~ Setup Cost: D
Cs
Q
~ Ordering Costs:
D
Co
Q
Production Quantity EOQ

2DC o
Q 
*
p
 d
C h 1  
 p
Quantity Discount Models
 Quantity Discount Steps
• 1. Calculate Q for each discount

• 2. Adjust Q upward if quantity is too low

for discount
• 3. Compute total cost for each discount

• 4. Select Q with the the lowest total cost

Inventory on The Use of Safety Stock
Hand

Time
Stockout
Inventory on
Hand

Safety Stock Stockout

is avoided
Time
 The Use of Safety Stock

• Known stockout costs:

– Given probability of demand, find total
cost for each safety stock alternative

• Unknown stockout costs:

– Set service level; use normal distribution
Service Level versus Carrying
Costs