Inventory

Management

SADORRA, MORIANNE ANGELIQUE

ROSUMAN, ARJOHN
APRIL 27, 2023 OMGT 775
Inventory Concepts
Inventory is created when the receipt of materials, parts, or finished
goods exceeds their disbursement; it is depleted when their
disbursement exceeds their receipts
Pressures for Low Inventory
Inventory Holding (or Carrying) Cost - the variable cost of keeping items on hand,
including interest, storage and handling, taxes, insurance, and shrinkage

Interest or Opportunity Cost whichever is greater, usually is the largest component of

holding cost
Storage and handling Cost may be incurred when a firm rents spacd on either a long-
term or short-term basis
Taxes, Insurance, Shrinkage
More taxes are paid if end-of-year inventories are high
Insurance on assets increases when there's no more to insure
Shrinkage takes three forms:

1. Pilferage - theft of inventory by customers or employees

2. Obsolescence - occurs when inventory cannot be used or sold at full value, owing to
model changes, engineering modifications, or unexpectedly low demand
3. Deterioration - physical spoilage or damage

Pressures for High Inventory

Customer Service - creating inventory can speed delivery and improve on-time-
delivery

Stockout - occurs when an item that is typically stocked isn't available

to satisfy a demand the moment it occurs, resulting in loss of sale
Backorder - a customer order that can't be filled when promised or demanded but is filled
later

Ordering Cost - the cost of preparing a purchase order for a supplier or a production
order for the shop
Setup Cost - the cost involved in changing over a machine to produce a different
component or item
Labor & Equipment Utilization - management can increase work force productivity
and facility utilization by creating more inventory
Transporation Cost - the expenses you make related to transportation operationa
Payment to Suppliers - a firm often can reduce total payment to suppliers if it can
tolerate higher inventory levels
Quantity Discount - price per unit drops when the order is
sufficiently large. It is an incentive to order large quantities
Types of Inventory
Cycle Inventory - the portion of total inventory that varies directly with lot size
Lot sizing - determining how frequent to order, and in what quantity
Safety Stock Inventory - protects against uncertainties in demand, lead time, and supply
Anticipation Inventory - used to absorb uneven rates of demand or supply
Pipeline Inventory - inventory moving from point to point in the materials flow system. It
consists of orders that have been placed or not yet received.

Inventory Reduction Tactics

Primary levers - one that must be activated if inventory is reduced
Secondary levers - reduces the penalty cost of applying the primary lever
ABC Analysis - the process of dividing items into three classes according to their dollar
usage so that the manager can focus on the items that have the highest dollar value

Control of Service Inventories can be a critical component of profitability. Losses may

come from shrinkage or pilferage. Applicable techniques include:
1. Good personnel selection, training, and discipline
2. Tight control on incoming shipments
3. Effective control on all goods leaving facility

Dependent & Independent Demand

Dependent demand - it is derived from the demand for another product or service
Independent demand - it is unrelated to demand for any other product
or service
Inventory Models for Independent Demand
1. Basic Economic Order Quantity (EOQ)
ECONOMIC ORDER QUANTITY (EOQ) is the lot size that minimizes total annual
inventory holding and ordering costs
The approach to determining the EOQ is based on the following assumptions:
The demand rate for the item is constant and known with certainty.
There are no constraints on the size of each lot.
The only two relevant costs are the inventory holding cost and fixed cost per
lot for ordering or setup.
Decisions for one item can be made independently of decisions for other
items.
There is no uncertainty in lead time or supply
Calculating the EOQ

Where: D = annual demand

S = Annual Ordering/Set-up cost
H = Annual Holding Cost
 Annual Holding Cost = (Average cycle inventory)(Unit holding cost)
Annual Ordering Cost = (Number of orders/year)(Ordering or setup cost)
Average Number of Orders Per Year = Annual demand / Lot size
Total Cost = Annual holding cost + Annual ordering or set up cost
or C = Q (H) + D (S)
2 Q

Where C = total cost per year

Q = lot size, in units
H = cost of holding one unit in inventory for a year, often calculated as the
proportion of the item’s value
D = annual demand, in units per year
S = cost of ordering or setting up one lot,
in dollars per lot
 TIME BETWEEN ORDERS (TBO) for a particular lot size is the average elapsed time
between receiving (or placing) replenishment orders of Q units

Formula for determining Formula for determining

TBO in years: TBO in months, weeks, days:
 A museum of natural history opened a gift shop two years ago. Managing inventories has
become a problem. Low inventory turnover is squeezing profit margins and causing cash-flow
problems.
One of the top selling items in the container group at the museum’s gift shop is a
birdfeeder. Sales are 18 units per week, and the supplier charges $60 per unit. The cost of
placing an order with the supplier is $45. Annual holding cost is 25% of a feeder’s value,
and the museum operates 52 weeks per year. Management chose 390-unit lot size so that
new orders could be placed less frequently. What is the annual cost of the current policy of
using 390-unit lot size?
Solution:

For the birdfeeder in the previous example, calculate the EOQ and its total cost.
How frequently will orders be placed if the EOQ is used?
First, compute the EOQ......then the Annual cost which is as follows:

Now, to compute how frequent orders will be made, we first determine the time between
orders which is as follows:
2. Production order quantity
3. Quantity discount model

UNDERSTANDING THE EFFECT OF CHANGES

A change in the Demand Rate. Because D is in the numerator, the EOQ increases in
proportion to the square root of the annual demand.
A change in the Setup Costs. Because S is in the numerator, increasing S increases
the EOQ and, consequently, the average cycle inventory. Conversely, reducing S
reduces the EOQ, allowing smaller lot sizes to be produced economically.
A Change in the Holding Costs. Because H is in the denominator, the EOQ declines
when H Conversely, when H declines, the EOQ increases.
Errors in Estimating D, H, and S. Total cost is fairly insensitive to errors even when
estimates are wrong by a large margin.
Inventory Control Systems
Continuous Review (Q) System
sometimes called a reorder point (ROP) system or fixed order quantity system
tracks the remaining inventory of an item each time a withdrawal is made to
determine whether it is time to reorder.
reviews are done frequently or continuously
INVENTORY POSITION (IP) - measures the item’s ability to satisfy future demand. It includes
scheduled receipts (SR), which are orders that have been placed but not yet received (also
called open orders), plus on-hand inventory (OH) minus backorders (BO).
Inventory Position = On-hand inventory + Scheduled receipts – Backorders
IP = OH + SR - BO
A. Selecting the Reorder Point When Demand is Certain
Reorder point , R
-predetermined minimum level
- R equals demand during lead time, with no added allowance for safety stock

R = Average demand during lead time

Example:

Demand for chicken soup at a supermarket is 25 cases a day and the lead time is four
days. The shelves were just restocked with chicken soup, leaving an on-hand inventory
of only 10 cases. There are no backorders, but there is one open order for 200 cases.
Should a new order be placed?
B. Selecting the Reorder Point When the Demand is Uncertain
This approach will create a safety stock, or stock held in excess of expected
demand to buffer against uncertain demand

R = Average demand during lead time + Safety stock

Finding the Safety Stock
We compute the safety stock by multiplying the number of standard deviations
from the mean needed to implement the cycle-service level, z, by the standard
deviation of demand during lead time probability distribution, σL
Example:

Records show that the demand for dishwasher detergent during the lead time is normally
distributed, with an average of 250 boxes and σL = 22. What safety stock should be
carried for a 99 percent cycle-service level? What is R?

Solution:
Periodic Review (P) System
sometimes called a fixed interval reorder system or periodic reorder system in which
an item’s inventory position is reviewed periodically rather than continuously.
Hybrid System
a. Optional Replenishment System
Sometimes called the optional review, min-max, or (s, S) system
Much like the P system
It is used to review the inventory position at fixed time intervals and, if the position has
dropped to (or below) a predetermined level, to place a variable-sized order to cover expected
needs
b. Base-Stock System
Issues a replenishment order, Q, each time a withdrawal is made, for the same amount as the
withdrawal
Thank you!

SADORRA, MORIANNE ANGELIQUE

ROSUMAN, ARJOHN
APRIL 27, 2023 OMGT 775