Inventory Management

• Inventory management is the process of efficiently managing the

flow of goods or materials into and out of a business's inventory.
Effective inventory management involves balancing the costs of
holding inventory with the benefits of having inventory available
for sale or production.
• Some key aspects of inventory management include:
– Inventory tracking: keeping track of the quantity and location
of inventory items in real-time.
– Inventory planning: forecasting demand for products, setting
safety stock levels, and planning replenishment orders.
– Inventory optimization: using data and analytics to optimize
inventory levels, reduce waste and improve efficiency.
– Inventory control: setting policies and procedures for
managing inventory, including cycle counting, inventory
audits, and quality control.
• Effective inventory management can help businesses reduce
costs, improve customer satisfaction, and increase profits.
 Inventory Management
• The objective of inventory management is to strike a balance
between inventory investment and customer service.
• One of the most expensive assets of many companies
representing as much as 50% of total invested capital

Functions of Inventory
• To provide a selection of goods for anticipated demand and to
separate the firm from fluctuations in demand
• To decouple or separate various parts of the production
process
• To take advantage of quantity discounts
• To hedge against inflation
 Types of Inventory Management
• There are several types of inventories that a business may hold.
Here are some of the most common types of inventories:
• Raw materials inventory: This includes the materials that are
used to manufacture a product, such as wood, steel, and plastic.
• Work-in-progress inventory: This includes the partially completed
products that are still being manufactured but are not yet ready
for sale.
• Finished goods inventory: This includes the completed products
that are ready for sale.
• Maintenance, repair, and operating (MRO) inventory: This
includes the items that are needed to support the manufacturing
process, such as tools, spare parts, and cleaning supplies.
 Types of Inventory Management
• Safety stock inventory: This is the extra inventory that is held
to protect against unexpected increases in demand or delays
in the supply chain.
• Consignment inventory: This is inventory that is held by a
retailer but still owned by the supplier until it is sold.
• Cycle inventory: This is the inventory that is ordered in batches
and is used up between orders.
• Seasonal inventory: This includes the inventory that is
specifically ordered to meet seasonal demand, such as holiday
decorations or summer clothing.
Each type of inventory serves a different purpose and requires
different management techniques to ensure that it is effectively
managed and utilized.
 Inventory Classification
• Inventory Classification, as the name says, is classifying the
products in an inventory as per their demands, value, the
revenue they bring in, carrying costs, etc.
• The below-mentioned reasons also help in segregating the
products from an inventory:
• Fast-moving – items that sell at a quick pace; sell as soon as
they are manufactured/produced and moved in the
warehouse
• High-value – items that bring in the highest revenue, but sell
infrequently
• Hybrid – products that remain in between; sell moderately
 VED Analysis
• VED analysis is an inventory management system that
segregates the stock based on its functional importance for a
business. It bifurcates the inventory into three parts, making it
easier for businesses to allocate their resources and budget
accordingly. The three VED heads are:
• Vital Items: Includes those items that are crucial for any
business. The company should always keep an extra stock as
its shortage can hamper the whole production process.
• Essential Items: It includes inventory next to vital for your
business. The difference is that they cause a temporary loss in
case of shortage.
• Desirable Items: This category entails optional goods not
necessary to run business operations.
 FSN Analysis
• Fast Moving – Items which are frequently issued from inventory which
are more than once for a specific time period
• Slow Moving – Items which are less frequently issued which might be
once in a specific time period
• Non-Moving – Items which are not issued from the inventory at all in a
specific time period

• The FSN classification system is extremely helpful in distributing spare

parts which are kept near the dispensing are having items which belong
to the fast-moving category. The items which fall into the non-moving
category can be discontinued if the further scope of use is not expected.
As companies in production for a longer period have a specific
percentage of non-moving spare parts which are usually disposed at
regular intervals. Selling the spare parts or reusing the same can be
again in the capital which can be used for other uses.
 ABC Analysis
• ABC analysis, wherein the products in the inventory are
segregated into three categories: Category A holds the 20% of
the products that bring 80% of revenue to the business,
Category B holds the 30% of the products that bring in 15% of
revenue, and Category C holds the 50% of the products that
bring in the remaining 5% revenue.
• Divides inventory into three classes based on annual dollar
volume
– Class A - high annual dollar volume
– Class B - medium annual dollar volume
– Class C - low annual dollar volume
• Used to establish policies that focus on the few critical parts
and not the many trivial ones
 ABC Analysis
• Policies employed may include
– More emphasis on supplier development for A items
– Tighter physical inventory control for A items
– More care in forecasting A items
 ABC Analysis
ABC Calculation
(1) (2) (3) (4) (5) (6) (7)
PERCENT
OF PERCENT
ITEM NUMBER ANNUAL ANNUAL OF ANNUAL
STOCK OF ITEMS VOLUME UNIT DOLLAR DOLLAR
NUMBER STOCKED (UNITS) x COST = VOLUME VOLUME CLASS
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A
72%
#11526 500 154.00 77,000 33.2% A
#12760 1,550 17.00 26,350 11.3% B
#10867 30% 350 42.86 15,001 6.4% 23% B
#10500 1,000 12.50 12,500 5.4% B
#12572 600 $ 14.17 $ 8,502 3.7% C
#14075 2,000 .60 1,200 .5% C
#01036 50% 100 8.50 850 .4% 5% C
#01307 1,200 .42 504 .2% C
#10572 250 .60 150 .1% C
8,550 $232,057 100.0%
 ABC Analysis
Figure 12.2
A Items
Percentage of annual dollar usage

80 –
70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
0 – | | | | | | | | | |

10 20 30 40 50 60 70 80 90 100
Percentage of inventory items
 ABC Analysis
• .
Inventory Ordering/ Setup Costs
▶ It is the costs of placing an order and receiving goods
• Ordering costs include payroll taxes, benefits and the wages of
the procurement department, labor costs etc. These costs are
typically included in an overhead cost pool and allocated to the
number of units produced in each period.
– Transportation costs
– Cost of finding suppliers and expediting orders
– Receiving costs
– Clerical costs of preparing purchase orders
– Cost of electronic data interchange
▶ Setup costs - cost to prepare a machine or process for
manufacturing an order. May be highly correlated with
setup time.
 Inventory Holding/ Carrying Costs
▶ The costs of holding or “carrying” inventory over time
• This is simply the amount of rent a business pays for
the storage area where they hold the inventory. This
can be either the direct rent the company pays for all
the warehouses put together or a percentage of the
total rent of the office area utilized for storing inventory.
– Inventory services costs
– Inventory risk costs
– Opportunity cost - money invested in inventory
– Storage space costs
– Inventory financing costs
 Inventory Costs
• Shortage Costs: Shortage costs, also known as stock-out
costs, occurs when businesses become out of stock for
various reasons. Some of the reasons might be as below :
– Emergency shipments costs
– Disrupted production costs
– Customer loyalty and reputation

• Spoilage Costs: Perishable inventory stock can rot or spoil

if not sold in time, so controlling inventory to prevent
spoilage is essential. Products that expire are a concern for
many industries. Industries such as the food and beverage,
pharmaceutical, healthcare and cosmetic industries, are
affected by the expiration and use-by dates of their products.
Inventory Models for Independent Demand

Need to determine when and

how much to order

1. Basic economic order quantity

(EOQ) model
2. Production order quantity model
3. Quantity discount model
 Basic EOQ Model
Important assumptions
1. Demand is known, constant, and independent
2. Lead time is known and constant
3. Receipt of inventory is instantaneous and
complete
4. Quantity discounts are not possible
5. Only variable costs are setup (or ordering) and
holding
6. Stockouts can be completely avoided
 Inventory Usage Over Time
Figure 12.3

Total order received

Average
Order quantity Usage rate inventory on
= Q (maximum hand
Inventory level

inventory level) Q
2

Minimum
inventory 0
Time
 Minimizing Costs
Objective is to minimize total costs
Table 12.4(c)

Total cost of
holding and setup
(order)

Minimum
total cost
Annual cost

Holding cost

Setup (order) cost

Optimal order Order quantity

quantity (Q*)
 Minimizing Costs
▶ By minimizing the sum of setup (or
ordering) and holding costs, total costs are
minimized
▶ Optimal order size Q* will minimize total
cost
▶ A reduction in either cost reduces the total
cost
▶ Optimal order quantity occurs when holding
cost and setup cost are equal
 Minimizing Costs
Q = Number of pieces per order
Q* = Optimal number of pieces per order
(EOQ)
D = Annual demand in units for the
inventory item
S
Annual = Setup
setup cost = or(Number
ordering cost for
of orders each
placed per order
year)
x (Setup or order cost per order)
H = Holding or carrying cost per unit per
year Annual demand Setup or order
=
Number of units in each order cost per order
 Minimizing Costs
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
Annual holding cost = (Average inventory level)
x (Holding cost per unit per year)

Order quantity
= (Holding cost per unit per year)
2
 Minimizing Costs
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year

Optimal order quantity is found when annual setup

cost equals annual holding cost
Solving for Q*
 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units
S = $10 per order
H = $.50 per unit per year
 An EOQ Example
Determine expected number of orders
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year

Expected Demand
number of =N= =
orders Order quantity

1,000
N= = 5 orders per year
200
 An EOQ Example
Determine optimal time between orders
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders/year
H = $.50 per unit per year

Expected time Number of working days per year

between =T =
orders Expected number of orders

250
T= = 50 days between orders
5
 An EOQ Example
Determine the total annual cost
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders/year
H = $.50 per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost

 The EOQ Model
When including actual cost of material P

Total annual cost = Setup cost + Holding cost + Product cost

 Reorder Points
• EOQ answers the “how much” question
• The reorder point (ROP) tells “when” to order
• Lead time (L) is the time between placing and
receiving an order
Demand per Lead time for a new
ROP = day order in days

=dxL

d= D
Number of working days in a year
 Reorder Point Curve
Figure 12.5

Q*
Resupply takes place as order arrives
Inventory level (units)

Slope = units/day = d

ROP
(units)

Time (days)
Lead time = L
 Reorder Point Example
Demand = 8,000 iPods per year
250 working day year
Lead time for orders is 3 working days, may take 4

D
d=
Number of working days in a year
= 8,000/250 = 32 units

ROP = d x L
= 32 units per day x 3 days = 96 units
= 32 units per day x 4 days = 128 units
Thank You