INVENTORY
MANAGEMENT
Week 12
INVENTORY
Is a stock or store of goods.
Firms typically stock hundreds or even thousands of items in inventory,
ranging from small things such as pencils, paper clips, screws, nuts, and bolts to
large items such as machines, trucks, construction equipment, and airplanes.
Thus, manufacturing firms carry supplies of raw materials, purchased parts,
partially finished items, and finished goods, as well as spare parts for machines,
tools, and other supplies.
Department stores carry clothing, furniture, carpeting, stationery, appliances,
gifts, cards, and toys. Some also stock sporting goods, paints, and tools.
Hospitals stock drugs, surgical supplies, life-monitoring equipment, sheets
Functions of Inventory
1. To meet anticipated demand. To provide a selection of goods for anticipated
customer demand such inventories are typical in retail establishments.
2. To smooth production requirements. Firms that experience seasonal
patterns in demand often build up inventories during off-season periods to meet
overly high requirements during certain seasonal periods. These inventories are
aptly named seasonal inventories
Functions of Inventory
3. To decouple operations, manufacturing firms have used inventories as
buffers between successive operations to maintain continuity of production that
would otherwise be disrupted by events such as breakdowns of equipment and
accidents that cause a portion of the operation to shut down temporarily
4. To protect against stockouts Delayed deliveries and unexpected increases in
demand increase the risk of shortages. Delays can occur because of weather
conditions, supplier stockouts, deliveries of wrong materials, quality problems, and
so on.
Functions of Inventory
5. To take advantage of order cycles or quantity discounts , To minimize
purchasing and inventory costs, a firm often buys in quantities that exceed
immediate requirements. This necessitates storing some or all of the purchased
amount for later use
6. To hedge against price increases. Occasionally a firm will suspect that a
substantial price increase is about to be made and purchase larger-than-normal
amounts to avoid the increase.
7. To permit operations. The fact that production operations take a certain
amount of time (i.e., they are not instantaneous) means that there will generally be
some work-in process inventory.
Types of Inventory
Raw material inventory has been purchased but not processed. This inventory
can be used to decouple (i.e., separate) suppliers from the production process.
However, the preferred approach is to eliminate supplier variability in quality,
quantity, or delivery time so that separation is not needed.
Work-in-process (WIP) inventory is components or raw material that have
undergone some change but are not completed. WIP exists because of the time it
takes for a product to be made (called cycle time ). Reducing cycle time reduces
inventory. Often this task is not difficult: during most of the time a product is “being
made,” it is in fact sitting idle.
Types of Inventory
Finished-goods inventory (manufacturing firms) or merchandise (retail
stores). is completed product awaiting shipment. Finished goods may be
inventoried because future customer demands are unknown.
Replacement parts, tools, and supplies. devoted to
maintenance/repair/operating supplies necessary to keep machinery and
processes productive.
Goods-in-transit to warehouses or customers (pipeline inventory).
OBJECTIVES OF INVENTORY CONTROL
Inadequate control of inventories
Understocking results in missed deliveries, lost sales, dissatisfied customers,
and production bottlenecks;
overstocking unnecessarily ties up funds that might be more productive
elsewhere
Inventory management has two main concerns.
1. The level of customer service, that is, to have the right goods, in sufficient
quantities, in the right place, at the right time.
2. The costs of ordering and carrying inventories. The overall objective of inventory
management is to achieve satisfactory levels of customer service while keeping
inventory costs within reasonable bounds
MEASUREMENT PERFORMANCE OF AN EFFECTIVE
INVENTORY MANAGEMENT
Managers have a number of measures of performance they can use to judge the
effectiveness of inventory managem
1.customer satisfaction, which they might measure by the number and quantity of
backorders and/or customer complaints.
2. inventory turnover, which is the ratio of annual cost of goods sold to average
inventory investment. The turnover ratio indicates how many times a year the
inventory is sold. Generally, the higher the ratio, the better, because that implies
more efficient use of inventories
OBJECTIVES OF INVENTORY CONTROL
3. Number of days of inventory on hand, a number that indicates the expected
number of days of sales that can be supplied from existing inventory. Here, a
balance is desirable; a high number of days might imply excess inventory, while a
low number might imply a risk of running out of stock.
Requirements for Effective lnventory Management
Management has two basic functions concerning inventor
One is to establish 'system of keeping track of items in inventory, is to make decisions about how
much and when to order.
To be effective, management must have the following:
1. A system to keep track of the inventory on hand and on order.
2. A reliable forecast of demand that includes an indication of possible forecast error.
3. Knowledge of lead times and lead time variability.
4. Reasonable estimates of inventory holding costs, ordering costs, and shortage costs.
5. A classification system for inventory items
Classification System
ABC Analysis approach classifying inventory according to some measure of
importance and allocating control efforts accordingly.
Typically, three classes of items are locating control efforts used:
A (very important or fast moving), ( Very expensive)
B (moderately important), ( Less Expensive)
C (least important). ( Least Expensive)
ABC Analysis
To determine annual dollar volume for ABC analysis, we measure the annual
demand of each inventory item times the cost per unit . Class A items are those
on which the annual dollar volume is high. Although such items may represent
only about 15% of the total inventory items, they represent 70% to 80% of the
total dollar usage. Class B items are those inventory items of medium annual
dollar volume. These items may represent about 30% of inventory items and
15% to 25% of the total value. Those with low annual dollar volume are Class C
, which may represent only 5% of the annual dollar volume but about 55% of the
total inventory items
Inventory Counting System
Periodic systems a physical count of items in inventory is made at periodic
intervals (e.g., weekly, monthly) in order to decide how much to order of each
item.. An advantage of this type of system is that orders for many items occur at
the same time, which can result in economies in processing and shipping orders.
There are also several disadvantages of periodic reviews. One is a lack of control
between reviews. Another is the need to protect against shortages between
review periods by carrying extra stock
Inventory Counting System
Perpetual inventory (also known as a continual system) keeps track of removals
from inventory on a continuous basis, so the system can provide information on
the current level of inventory for each item.
One disadvantage of this approach is the added cost of record keeping. Moreover,
a physical count of inventories must still be performed periodically to verify records
Inventory Counting System
A two-bin system,uses two containers for inventory. Items are withdrawn from
the the first is empty. first bin until its contents are exhausted. It is then time to
reorder. Sometimes an order card is placed at the bottom of the first bin. The
second bin contains enough stock to satisfy expected demand until the order is
filled, plus an extra cushion of stock that will reduce the chance of a stockout if the
order is late or if usage is greater than expected. The advantage of this system is
that there is no need to record each withdrawal from inventory; the disadvantage
is that the reorder card may not be turned in for a variety of reasons (e.g.,
misplaced, the person responsible forgets to turn it in).
Inventory Counting System
Batch. -inventory records are collected periodically and entered into the system.n
batch systems, a sudden surge in demand could result in reducing the amount of
inventory below the reorder point between the periodic read-ins. Frequent batch
collections can minimize that problem.
On-line systems, the transactions are recorded immediately. The advantage of
on-line systems is that they are always up-todate. I
Inventory Counting System
Supermarkets, discount stores, and department stores have always been major
users of periodic counting systems.
Today, most have switched to computerized checkout systems universal product
code Bar using a laser scanning device that reads a universal product code
(UPC), or bar code, code printed on a label that has printed on an item tag or on
packaging. A typical grocery product code is illustrated here.
Record Accuracy
● Record accuracy requires good incoming and outgoing record keeping as well
as good security.
● Stockrooms will have limited access, good housekeeping, and storage areas
that hold fixed amounts of inventory.
● In both manufacturing and retail facilities, bins, shelf space, and individual
items must be stored and labeled accurately.
● Meaningful decisions about ordering, scheduling, and shipping, are made
only when the firm knows what it has on hand.
Cycle Count or Cycle COunting
A continuing audit to thoroughly ensure and verify record inventories are accurate
Cycle counting uses inventory classifications developed through ABC
analysis. With cycle counting procedures, items are counted, records are verified,
and inaccuracies are periodically documented. The cause of inaccuracies is then
traced and appropriate remedial action taken to ensure integrity of the inventory
system
A items will be counted frequently, perhaps once a month;
B items will be counted less frequently, perhaps once a quarter; and
C items will be counted perhaps once every 6 months.
Cycle Counting
Another option is to cycle count items when they are reordered. also ha
Advantages
1. Eliminates the shutdown and interruption of production necessary for annual
physical inventories.
2. Eliminates annual inventory adjustments.
3. Trained personnel audit the accuracy of inventory.
4. Allows the cause of the errors to be identified and remedial action to be taken.
5. Maintains accurate inventory records.
Service Inventories
Although we may think of the service sector of our economy as not having
inventory, that is seldom the case.
Extensive inventory is held in wholesale and retail businesses, making inventory
management crucial.
In the food-service business, control of inventory is often the difference between
success and failure. Moreover, inventory that is in transit or idle in a warehouse is
lost value. Similarly, inventory damaged or stolen prior to sale is a loss.
In retailing, inventory that is unaccounted for between receipt and time of sale is
known as shrinkage .Shrinkage occurs from damage and theft as well as from
sloppy paperwork.Pilferage is theft.
Control of Service Inventories
1.Good personnel selection, training, and discipline: These are never easy but
very necessary in food-service, wholesale, and retail operations, where employees
have access to directly consumable merchandise.
2. Tight control of incoming shipments: This task is being addressed by many firms
through the use of Universal Product Code (or bar code) and radio frequency ID
(RFID) systems that read every incoming shipment and automatically check tallies
against purchase orders. When properly designed, these systems—where each stock
keeping unit (SKU; pronounced “skew”) has its own identifier—can be very hard to
defeat.
3. Effective control of all goods leaving the facility: This job is accomplished with
bar codes, RFID tags, or magnetic strips on merchandise, and via direct observation.
Direct observation can be personnel stationed at exits (as at Costco and Sam’s Club
wholesale stores)
Inventory Models
Independent vs. Dependent Demand
Inventory control models assume that demand for an item is either independent of
or dependent on the demand for other items.
For example, the demand for refrigerators is independent of the demand for
toaster ovens. However, the demand for toaster oven components is dependent
on the requirements of toaster ovens.
Independent Demand
Holding cost The cost to keep or carry inventory in stock.
costs associated with holding or “carrying” inventory over time. Therefore,
holding costs also include obsolescence and costs related to storage, such as
insurance, extra staffing, and interest payments.
Ordering cost . The cost of the ordering process
includes costs of supplies, forms, order processing, purchasing, clerical
support, and so forth. When orders are being manufactured, ordering costs also
exist, but they are a part of what is called setup costs.
Independent Demand
Setup cost is the cost to prepare a machine or process for manufacturing an order.
This includes time and labor to clean and change tools or holders. Operations
managers can lower ordering costs by reducing setup costs and by using such efficient
procedures as electronic ordering and payment.
In manufacturing environments, setup cost is highly correlated with setup time .
Setups usually require a substantial amount of work even before a setup is actually
performed at the work center. With proper planning, much of the preparation required
by a setup can be done prior to shutting down the machine or process. Setup times
can thus be reduced substantially. Machines and processes that traditionally have
taken hours to set up are now being set up in less than a minute by the more
imaginative world-class manufacturers. Reducing setup times is an excellent way to
reduce inventory investment and to improve productivity
Inventory Models for Independent Demand
1. Basic economic order quantity (EOQ) model
2. Production order quantity model
3. Quantity discount model
Economic Order Quantity (EOQ) Model
An inventory-control technique that minimizes the total of ordering and holding costs
The economic order quantity (EOQ) model is one of the most commonly used inventorycontrol techniques.
This technique is relatively easy to use but is based on several assumptions:
1. Demand for an item is known, reasonably constant, and independent of decisions for
other items.
2. Lead time—that is, the time between placement and receipt of the order—is known and
consistent.
Economic Order Quantity (EOQ) Model
3. Receipt of inventory is instantaneous and complete. In other words, the inventory from an order arrives
in one batch at one time.
4. Quantity discounts are not possible.
5. The only variable costs are the cost of setting up or placing an order (setup or ordering cost) and the
cost of holding or storing inventory over time (holding or carrying cost). These costs were discussed in the
previous section. 6. Stockouts (shortages) can be completely avoided if orders are placed at the right time.
The objective of most inventory models is to minimize total costs.
EOQ
Assumptions
1. Only one product is involved
2. Annual Demand Requirement is
known
3. Demand is spread evenly throughout
the year so that the demand rate is
reasonably constant
4. Lead Time does not vary
5. Each order is received in single
delivery
6. There are no quantity discounts
Re Order Points (ROP)
When to order.
Assumes (1) that a firm will place an order when the inventory level for that
particular item reaches zero and
(2) that it will receive the ordered items immediately.
Lead time (delivery time)- time between placement and receipt of an order, ,, can
be as short as a few hours or as long as months.
Thus, the when to-order decision is usually expressed in terms of a reorder point
(ROP)
Re Order Points (ROP)
Economic Production Quantity Model ( EPQ)
Deliveries are received incrementally during production
This model is applicable under two situations:
(1) when inventory continuously flows or builds up over a period of time after an order has been
placed or
(2) when units are produced and sold simultaneously.
Under these circumstances, we take into account daily production (or inventory-flow) rate and daily
demand rate.
Because this model is especially suitable for the production environment, it is commonly called the
production order quantity model . It is useful when inventory continuously builds up over time, and
traditional economic order quantity assumptions are valid. We derive this model by setting ordering
or setup costs equal to holding costs and solving for optimal order size,
Production Order Quantity Model
Quantity Discount Models
Are price reductions for large orders offered to customers to induce them to buy in
large quantities
Remember placing an order for that quantity, however, even with the greatest
discount price, may not minimize total inventory cost. This is because holding
cost increases.
Thus, the major tradeoff when considering quantity discounts is between reduced
product cost and increased holding cost .
Quantity Discount Models
Safety Stock
A method of reducing stockouts is to hold extra units in inventory by adding a
number of units as a buffer to the reorder point.
ROP