11-1 Inventory Management

INVENTORY
MANAGEMENT
CHAPTER 5
week: 11to12
11-2 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)
11-3 Inventory Management

Types of Inventories (Cont’d)

 Replacement parts, tools, & supplies

 Goods-in-transit to warehouses or customers
11-4 Inventory Management

Functions of Inventory

 To meet anticipated demand

 To smooth production requirements
 To decouple operations
 To protect against stock-outs
11-5 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
11-6 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
11-7 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
11-8 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
11-9 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
0

214800 232087768
11-10 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
11-11 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
High
A
C - least important Annual
$ value B
of items

Low C
Few Many
Number of Items
11-12 Inventory Management

Exercise 1.
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

ECONOMIC ORDER QUANTITY

 Identify the optimal order quantity by minimizing

the sum of certain annual costs that vary with the
order size
11-15 Inventory Management

The Inventory Cycle

Figure 11.2

Profile of Inventory Level Over Time

Q Usage
Quantity rate
on hand

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time
11-16 Inventory Management

Total Cost

Annual Annual
Total cost = carrying + ordering
cost cost
Q + DS
TC = H
2 Q
11-17 Inventory Management

Cost Minimization Goal

Figure 11.4C

The Total-Cost Curve is U-Shaped

Q D
TC  H  S
Annual Cost

2 Q

Ordering Costs

Order Quantity
QO (optimal order quantity)
(Q)
11-18 Inventory Management

Deriving the EOQ

Using calculus, we take the derivative of the

total cost function and set the derivative
(slope) equal to zero and solve for Q.

2DS 2( Annual Demand )(Order or Setup Cost )

Q OPT = =
H Annual Holding Cost
11-19 Inventory Management

Minimum Total Cost

The total cost curve reaches its minimum

where the carrying and ordering costs are
equal.

2DS 2( Annual Demand )(Order or Setup Cost )

Q OPT = =
H Annual Holding Cost
11-20 Inventory Management

Example
 A local distributor for a national tire company expects to
sell approximately 9,600 steel-belted tires of a certain size
and tread design next tear. Annual carrying cost is $16 per
tire and ordering cost is $75. The distributor operates 288
days a year.
 A. What is EOQ?
 B. How many times per year does the store reorder?
 C. What is the length of an order cycle?
 D. What is the annual cost if the EOQ quantity is
reordered?
11-21 Inventory Management

When to Reorder with EOQ Ordering

 Reorder Point - When the quantity on hand

of an item drops to this amount, the item is
reordered
 Safety Stock - Stock that is held in excess of
expected demand due to variable demand
rate and/or lead time.
 Service Level - Probability that demand will
not exceed supply during lead time.
11-22 Inventory Management

Determinants of the Reorder Point

 The rate of demand

 The lead time

 Demand and/or lead time variability

 Stockout risk (safety stock)

11-23 Inventory Management

 If demand and lead time are both constant,

 ROP= d*LT

 Where
 d= Demand rate ( units per day or week)
 LT= Lead time in days or weeks
11-24 Inventory Management

Example
 Tingly takes two-a-day vitamins which are
delivered to his home by a routeman seven days
after an order is called in. At what point should
Tingly reorder?
11-25 Inventory Management

 usage= 2 vitamins per day

 Lead time= 7 days

 ROP=usage *lead time

 = 2 vitamins per day * 7 days

 = 14 vitamins
 Therefore, Tingly should reorder when 14 vitamin
tablets are left
11-26 Inventory Management

SAFETY STOCK
 Additional inventory to reduce the risk of running
out of inventory during lead time.
 ROP= expected demand during lead time + safety
stock
 Example
 If expected demand during lead time is 100 units,
and the desired amount of safety stock is 10 units,
the ROP would be 110 units.
11-27 Inventory Management

Safety Stock
Figure 11.12
Quantity

Maximum probable demand

during lead time

Expected demand
during lead time

ROP

Safety stock reduces risk of Safety stock

stockout during lead time LT Time
11-28 Inventory Management

Operations Strategy

 Too much inventory

 Tends to hide problems
 Easier to live with problems than to eliminate
them
 Costly to maintain

 Wise strategy
 Reduce lot sizes
 Reduce safety stock
11-29 Inventory Management

Activity on-line
 Answer the seatwork and submit it to the 2
learning platforms we are utilizing. e.g. LMS and
edmodo
 Wait for my notification on when will you attach
the exercises/seatwork for submission. PBGA!
11-30 Inventory Management

Dr. Maria Nimfa Rivera Diaz