11-1 Inventory Management

Inventory
Management
Module 5
11-2 Inventory Management

An inventory is a stock of
goods that is held for the
purpose of future production
or sales

Inventory Management
-refers to the process of
ordering, storing and using a
company’s inventory
-this includes the
management of raw
materials, components and
finished products, as well as
warehousing and processing
of such items
11-3 Inventory Management

Types of Inventories
 Raw materials & purchased parts
 Partially completed goods called
work in progress
 Finished-goods inventories
 (manufacturing firms)
or merchandise
(retail stores)
11-4 Inventory Management

Types of Inventories (Cont’d)

 Replacement parts, tools, & supplies
 Goods-in-transit to warehouses or customers
11-5 Inventory Management

Functions of Inventory
 To meet anticipated demand

 To smooth production requirement

 To protect against stock-outs

11-6 Inventory Management

Functions of Inventory (Cont’d)

 To take advantage of order cycles
 To help hedge against price increases
 To permit operations
 To take advantage of quantity discounts
11-7 Inventory Management
Objective of Inventory Control

 To achieve satisfactory levels of customer service while

keeping inventory costs within reasonable bounds
 Level of customer service
 Costs of ordering and carrying inventory
11-8 Inventory Management

Effective Inventory Management

 A system to keep track of inventory
 A reliable forecast of demand
 Knowledge of lead times
 Reasonable estimates of
 Holding costs
 Ordering costs
 Shortage costs
 A classification system
11-9 Inventory Management

Inventory Counting Systems

 Periodic System
Physical count of items made at periodic intervals
 Perpetual Inventory System
System that keeps track
of removals from inventory
continuously, thus
monitoring
current levels of
each item
11-10 Inventory Management

Inventory Counting Systems (Cont’d)

 Two-Bin System - Two containers of inventory; reorder when
the first is empty
 Universal Bar Code - Bar code
printed on a label that has
information about the item
to which it is attached

214800 232087768
11-11 Inventory Management

Key Inventory Terms

 Lead time: time interval between ordering and receiving the
order
 Holding (carrying) costs: cost to carry an item in inventory for
a length of time, usually a year
 Ordering costs: costs of ordering and receiving inventory
 Shortage costs: costs when demand exceeds supply
11-12 Inventory Management

ABC Classification System

Figure 11.1
Classifying inventory according to some measure of importance
and allocating control efforts accordingly.

A- very important

B- mod. important

C- least important

High
A
Annual
$ value B
of items

Low C
Fe Many
w Number of Items
11-13 Inventory Management

Cycle Counting
 A physical count of items in inventory
 Cycle counting management
 How much accuracy is needed?
 When should cycle counting be performed?
 Who should do it?
11-14 Inventory Management

Inventory and Purchasing Manager are charged

with making the following basic decisions which
will affect inventory service level and the cost
of inventory

 When to order?
 Where to order from?
 How much to order?
 What are the proper logistics?
11-15 Inventory Management

Economic Order Quantity

(EOQ)
 Two basic Inventory Cost
 Carrying Cost
 Cost incurred by a business for holding items in
inventory
 Ex. Product obsolescence, deferred profit on
investment, depreciation taxes, insurance, interest,
direct storage costs
 Ordering Cost
 Cost a business incurs when it makes an order to
replenish its inventory.
 Ex. Transportation cost, salaries, cost of unloading &
placing it in inventory, cost of processing an order, all
supplies used
11-16 Inventory Management

Computing the Average

Inventory Level
 The amount of inventory is Q, the
size of the order, for an infinite
small period of time, since Q is
always depleted by demand,
likewise, the amount of inventory is
zero for an infinitely small period of
time, since the only time there is no
inventory is at the specific time t,
thus the amount of inventory
available is somewhere between
theses two extremes.

Average Inventory=Q/2
11-17 Inventory Management

Computing the orders per

year
 The total ordering cost is derived from the
number of orders that will be made during the
year. Since the decision maker will not order more
unit than the amount demanded and since we
know demand with certainty, the number of
orders per year is defined as
 Orders per year=D/Q, where D=demand per year
11-18 Inventory Management

Computing for the total

annual ordering cost
 The total ordering cost per year can be computed
as the number of orders per year multiplied by
the cost per order
 Total Annual Ordering Cost= Co D/Q

TOTAL INVENTORY COST

Total Annual Inventory Cost= CcQ/2+CoD/Q
11-19 Inventory Management

Inventory Cost Model

11-20 Inventory Management

Computing for the

Optimal Q (EOQ)
 The optimal value for q corresponding to the
minimum total inventory cost occurs not only
where the total cost curve is lowest, but also
where the total ordering cost equals total carrying
cost. The relationship is expressed
mathematically as:
 Q= 2CoD
Cc
11-21 Inventory Management

Computing the reorder

point
 The reorder point is computed by multiplying the
lead time, L, by the demand per day. If we
assume that the year consist of 365 days, then
the demand per day is D/365, thus the formula for
reorder point is,
 R=L D/365
 Computing the average inventory
 It is necessary to reflect the rate of replenishment
in the model. To do so, we will define the ff.
variable
 r= daily rate of replenishment of inventory
 Number of days to receive an order= Q/r
11-22 Inventory Management

 Compute the daily demand rate

d=annual demand/365 days

 Compute the demand during the order receipt period

Demand during the order receipt= Q/r (d)

 Computing for the maximum inventory level

Maximum Inventory level= Q-(Q/r)d

 Computing the average inventory level

Average inventory Level= Q/2 (1-d/r)

 Computing the total annual carrying cost

 Total Annual Carrying Cost= CcQ/2 (1-d/r)
11-23 Inventory Management

 Computing the total annual inventory cost

Total annual inventory cost= C0 D/Q+CcQ/2(1-d/r)

 Computing Optimal Q

Q*= 2CoD
Cc(1-d/r)
11-24 Inventory Management

The EOQ Model with

Shortage and Back
Ordering
It is often economical to
allow shortages and
back order demand and
incur cost associated
with not being able to
meet demand than to
keep an excessive
amount of on hand to
avoid shortages
11-25 Inventory Management

Adding shortage cost to

the EOQ Model
 In order to develop an EOQ model that includes
shortages, a shortage cost must be added to our
total cost equation
 Total Shortage Cost = Cs S2/2Q
 The total carrying cost= Cc(Q-S)2/2Q
 The total ordering cost is the same as our previous
EOQ Model
 Total Ordering Cost= Co D/Q
 Total Annual Inventory Cost=
 Cs S2/2Q + Cc(Q-S)2/2Q + Co D/Q
11-26 Inventory Management

The total annual cost

equation
11-27 Inventory Management

Example 1

 The Alpha Company uses 12,000 valves per year.

Each valve costs P50. The Materials Department
estimates that it costs P 1,700 to order a
shipment at valves and the Accounting
Department estimates the carrying cost is 15% of
the value of inventory. Determine the EOQ, total
annual inventory costs of the policy, optimal
number of orders per year and the time between
each order.
11-28 Inventory Management

Solution
11-29 Inventory Management
11-30 Inventory Management

Example 2

 Using the previous example with slight change in

the replenish rate from infinite to a uniform 500
valves per day to restate, the Alpha Company
uses 12,000 valves per year. Each valve costs
P50. The Product Engineering Department
estimates set up cost at P1,700, and the
Accounting Department estimates the carrying
cost is 15 of the value of the inventory. Determine
the ordering cost and the minimum total
inventory cost
11-31 Inventory Management

Answer

 Identify the given

 D=12,000 valves
 Cc= P7.50
 Co= P1,700
 r= daily rate of replenishment =500
 d=daily rate of demand
 d= 12,000/365 = 32.88
 Q= 2CoD
 Cc ( 1- d/r)
11-32 Inventory Management

 2 (1,700)(12,000)
 7.50 (1-32.88/500)

 = 40,800,000/7.0068

 =2.413.07
 The company should order 2,413 valves every
time inventory reaches zero
11-33 Inventory Management

 Total inventory cost

 C= 2CcCoD 1-(d/r)

 = 2(7.50) (1,700)(12,000) 1-(32.88/500)

 =17,492.86 (0.97)
 =P16,968.07
11-34 Inventory Management

Activity

 Falcon Computer Village stocks and sells a

particular brand of personal computer. It cost the
store P25,000 each time it places an order with
the manufacturer for the personal computers. The
annual cost of carrying the PC’s in inventory is
P9,000. The store manager estimates that annual
demand for the PC’s will be 1,500.
 A. Determine the optimal order quantity
 B. The total minimum inventory cost
 C. Orders per year
 D. Optimal time between orders
11-35 Inventory Management

Solution

 A. identify the given in the problem

 D=1,500 Cc=P9,000 Co=P25,000
 Determine the optimal order quantity
 Q= 2CoD
Cc
 = 2(25,000)(1,500)
9,000
=91.29 personal computers
11-36 Inventory Management

 B. Solve for the total minimum inventory cost

 Total Cost = Cc Q/2+ Co D/Q
 = 9,000( 91.29/2)+ 25,000(1,500/91.29)
 =9,000(45.65)+25,000(16.43)
 = 410,850 + 410,750
 =P821,600
 C. Orders per year
 =D/Q
 =1,500/91.29
 = 16.43 optimal orders per year
 D.t=optimal time between orders
 t=planning period/optimal number of
orders
 =365/16.43
 =22.22 days
11-37 Inventory Management

PRACTICE EXERCISES to
be submitted on BB
 1. Given the following annual demand, annual
carrying cost and cost per order, compute the
economic order quantity and total minimum cost
 D=10,000 units per year C0=P5,000 per order
 Cc=P25 per unit per year

 2. Given the following annual demand, annual

carrying cost, and cost per order, compute the
economic order quantity and total minimum cost
 D=38,000 units per year Co=P2,200 per order
 Cc=P8 per unit per year
11-38 Inventory Management

Problem Solving
 3. An inventory system has an annual ordering cost of P12,000
per order, an annual per unit carrying cost of P35, and an annual
demand of 3,000 units ( assuming a 365-day year. Compute the
following
 A. Economic Order Quantity
 B. Minimum total annual inventory cost
 C. Optimal number of orders per year
 D. Optimal time between orders
4. The Alpha Shoe Company purchases leather from Beta Textile
Mills. The Alpha Company uses 15,000 yard of the leather per
year (365 days) to make shoes. The cost of ordering leather from
textile company is P100,000 per order. It cost Alpha P30 per
yard annually to hold a yard of leather in inventory. Determine
the optimal number of yards of leather the Alpha Company
should order, the minimum total annual inventory cost, the
optimal number of orders per year and the optimal time between
orders.