Inventory Management

Introduction
Importance of Inventory

• Balance the advantages and

disadvantages of small and large
inventories

• Pressures for small inventories

– Inventory holding cost
– Cost of capital
– Storage and handling costs
– Taxes, insurance, and shrinkage
 Importance of Inventory

• Pressures for large inventories

– Customer service
– Ordering cost
– Setup cost
– Labor and equipment utilization
– Transportation cost
– Payments to suppliers
 Reasons for Holding Inventory

• To meet anticipated customer demand

• To protect against stock outs
• To take advantage of economic order cycles
• To maintain independence of operations
• To allow for smooth and flexible production
operations
• To guard against price increases
In Short, Buffer against uncertainty in…..

▪ Supply (Raw material inventories)

▪ Production process ( Work in process
inventories) &
▪ Demand (Finished good inventories)
 Type of Inventory

Process Demand
Purpose Others
stage Type

Raw Materials
WIP Independent Cycle Spares
Finished Goods Dependent Safety Consumable
Seasonal
Pipeline
Independent vs. Dependent Demand
Independent Demand
(demand for item is independent
of demand for any other item)

Dependent Demand
(demand for item is dependent
upon the demand for some
other item)
Independent vs. Dependent Demand..

Materials With Materials With

Item
Independent Demand Dependent Demand

Demand
Company Customers Parent Items
Source
Material
Finished Goods WIP & Raw Materials
Type
Method of
Forecast & Booked Calculated
Estimating
Customer Orders
Demand
Planning
EOQ & ROP MRP
Method
 Inventory Type : Purpose
• Seasonal stocks
– These are accumulated to absorb seasonal fluctuations
in supply or demand.
• Cycle stocks
– Due to fixed transportation and handling charges or set
up requirements, it is economical to order or produce
large quantities at a time.
• Safety stocks
– These are built as a hedge against uncertainties in
supply or demand.
• Pipeline stocks
– Inventories in-transit.
 ABC Analysis

• Stock-keeping units (SKU)

• Identify the classes so management can
control inventory levels
• A Pareto chart
 ABC Analysis
100 — Class C
Class B
90 —
Percentage of dollar value Class A
80 —

70 —

60 —

50 —

40 —

30 —

20 —

10 —

0—
10 20 30 40 50 60 70 80 90 100
Percentage of SKUs
 ABC Problem
Booker’s Book Bindery divides SKUs into three classes, according to their
dollar usage.
Calculate the usage values of the following SKUs and determine which is
most likely to be classified as class A.

Quantity Used Unit Value

SKU Number Description
per Year ($)
1 Boxes 500 3.00
2 Cardboard 18,000 0.02
(square feet)
3 Cover stock 10,000 0.75
4 Glue (gallons) 75 40.00
5 Inside covers 20,000 0.05
6 Reinforcing tape 3,000 0.15
(meters)
7 Signatures 150,000 0.45
 ABC Problem
Quantity
SKU Unit Value Annual Dollar
Description Used per
Number ($) Usage ($)
Year
1 Boxes 500  3.00 = 1,500
2 Cardboard 18,000  0.02 = 360
(square feet)
3 Cover stock 10,000  0.75 = 7,500
4 Glue (gallons) 75  40.00 = 3,000
5 Inside covers 20,000  0.05 = 1,000
6 Reinforcing tape 3,000  0.15 = 450
(meters)
7 Signatures 150,000  0.45 = 67,500
Total 81,310
 ABC Problem

Class C
100 – Class B
90 –Class
Percentage of Dollar Value

A
80 –
70 –
60 –
50 –
40 –
30 –
20 –
10 –
0–
10 20 30 40 50 60 70 80 90 100
Percentage of SKUs
 Inventory Cost
• Holding costs - associated with holding or
“carrying” inventory over time

• Ordering costs - associated with costs of

placing order and receiving goods

• Setup costs - cost to prepare a machine or

process for manufacturing an order

• Shortage cost
 Terms used in Inventory
• Material cost = Ci (Average price paid per unit purchased is a
key cost in the lot-sizing decision )
• Fixed ordering cost = Co (Fixed ordering cost includes all costs
that do not vary with the size of the order but are incurred
each time an order is placed)
• Holding cost = CH = %*Ci (Holding cost is the cost of carrying
one unit in inventory for a specified period of time i.e. $
CH/Unit/Year)
• Quantity in a lot or batch size = Q (Quantity is either produced
or purchased at a time, EOQ* = Q* )
• Demand per unit time = D (i.e. Demand in one 1 year, d =
average demand per week, So, D = d *52 / year)
 Inventory Cost
Holding Costs (CH) Ordering Costs (Co)

• Obsolescence • Supplies
• Insurance • Forms
• Extra staffing • Order processing
• Interest • Clerical support
• Pilferage • etc.
• Damage
• Warehousing Setup Costs (Cs)
• etc. • Clean-up costs
• Re-tooling costs
• Adjustment costs
• etc.
 Inventory Cost
Holding cost (CH)
• Cost of Capital
• Obsolescence cost
• Handling cost
▪ Vary with quantity of product received , ZERO otherwise

• Occupancy cost
▪ Vary with quantity of product stored, ZERO otherwise

• Miscellaneous costs

Theft, security, damage, tax, insurance

 Inventory Cost
Ordering cost (Co)
• Buyer time
▪ Time of buyer for placing extra order, ZERO otherwise
▪ Internet and communication has reduced this cost significantly

• Receiving costs
▪ Administrative work such as purchase order matching with updating inventory
records
▪ Quantity dependent should not be included here

• Transportation costs
▪ Fixed cost should be included here
 Shortage Costs

When occurs, company faces two

possibilities…..

• It can meet the shortage with some type

of rush, special handling or priority
shipment
• It cannot meet the shortage at all

So…. It depends on
How company handles the problem ?
 Shortage Costs

• Permanent
– Lost profits due to unsatisfied demand
– Lost profits of future sales

• Temporary (CB)
– Backordered, so not necessarily lost
– Special clerical & paperwork costs
– Extraordinary transportation cost to customer
 The EOQ Model
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

D Q
S = H
Q 2
Solving for Q* 2DS = Q2H
Q2 = 2DS/H
Q* = 2DS/H
Questions ?
 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year

Expected Demand D
number of =N= =
orders Order quantity Q*

1,000
N= 200= 5 orders per year
THANK YOU