Inventory Management

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Inventory Management
Introduction
Inventory definition
The Basic Relationship- Average Inventory
Types of Inventory
Reasons to Hold Inventory
Methods to Supervise Inventory
Visible Costs of Inventory
Hidden Costs of Inventory
What Increases Inventory
Effective Inventory Management
Myths in Inventory Management
Why is Inventory Management Important
Economic Order Quantity (EOQ)
Just-In-Time Management (JIT)
Essential Aspects of JIT
Kanban
JIT is Not Possible Without...
Key Features of JIT Approach
JIT Purchasing
EOQ vs. JIT
Conclusion
Introduction
Introduction
The key decision in manufacturing, retail and some service industry businesses is how much inventory to keep
on hand. Inventory is usually a business’s largest asset. The instant inventory levels are established, they become
an important input to the budgeting system. Inventory decisions involve a delicate balance between three classes
of costs: ordering costs, holding costs, and shortage costs.
Before we venture further, what does inventory mean? According to the Merriam- Webster Dictionary, Inventory
is defined as,“ the quantity of goods or materials on hand”
Inventory is also known as “an itemized list of goods or valuables, with their estimated worth; specifically, the
annual account of stock taken in any business” by the online Dictionary.Com.
References:
https://msu.edu/course/prr/473/oldstuff/Inventory Management.htm#cycle 1/17
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1.) http://www.inventorymanagement.com/ccrecac1.htm
2.) Hilton, Ronald W., Managerial Accounting. McGraw-Hill,Inc (1994). p.13-14, p. 407,p.218
3.) Galloway R, Principles of Operations Management, Routledge
4.) Hill T, Production/Operations Management, Prentice Hall, 1991
5.) Saunders, Strategic Purchasing and Supply Management, Pitman
6.) Slack N, Chambers S, Harland C, Harrison A and Johnston R, Operations Management, Pitman, 1995
Back to Index
Inventory Definitions
a.) Base stock - that portion of inventory that is replenished after it is sold to customers.
b.) Safety stock - the second portion of inventory that is held to protect against the impact of uncertainty.
References:
1.) http://sol.brunel.ac.uk/~jarvis/bola/operations/stock/systems.html
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The Basic Relationship- Average Inventory
Without safety stock:
Average inventory = 1/2 order quantity
With safety stock:
Average inventory = 1/2 order quantity + safety stock
References:
1.) Hill T, Production/Operations Management, Prentice Hall, 1991
2.) Slack N, Chambers S, Harland C, Harrison A and Johnston R, Operations Management, Pitman, 1995
Back to Index
Types of Inventories
There are several types of inventory. Raw materials, purchased parts and supplies work-in process, and
component parts are inventories to many businesses. Businesses also need tools, machinery and equipment as
part of their capital inventory. In most businesses however, finished goods are mainly the consistent inventory,
especially for small businesses.
References:
1.) http://hyperserver.engrg.uwo.ca/es492b/Lectures/Lect12/tsld004.htm
Back to Index

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Reasons to Hold Inventory
Most businesses hold inventory for many reasons. Among them are:
Meeting unexpected demands
The chain of supply and demand really comes into consideration here. Business people know that
consumers expect goods and services when they need them. Thus, businesses usually stock up their
inventories to meet these unexpected demands. These demands may result in overcrowding of inventories
because we never know when the storm strikes and consumers would flock to buy the items.
Smoothing seasonal demands
With the comings and goings of major events and the changing seasons, most businesses have inventories
at hand to smoothen the seasonal demands. For example, Christmas is just round the corner. With the
coming season, retail outlets as well as other businesses are busy meeting and stabilizing the upcoming
Christmas demands of consumers. If they do not have any inventory, how can they meet these demands
Taking advantage of price discounts
When a business purchase goods from the manufacturers and suppliers, they usually get price discounts if
they buy in bigger bulks. Manufacturers and suppliers give these discounts to attract and maintain regular
buyers. Taking advantage of price discounts is helpful at times but one must always remember not to
overstock the inventory because inefficient buying may cause failure of the business.
Hedging against price increase
Businesses usually hold inventory to avoid from the ever fluctuating market price of inventories. Thus, by
having efficient and good inventory system, businesses can control their inventory cost.
Getting quality discounts
When businesses have inventory in store, they can get quality discounts because they know which goods
and services to buy from the suppliers and manufacturers. It helps to learn where to get better deals than
no deal at all.
References:
2.) Hilton, Ronald W., Managerial Accounting. McGraw-Hill,Inc (1994). p.407
3.) http://www.ainet.com/opt/csus/invntory.htm
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Methods to Supervise Inventory
The success of a business depends on how well the owner(s)’s ability to maintain adequate quantities of items
sold. Records provided by an inventory control system should call attention to the need for reorder when
necessary or eliminate “dead wood” inventory when called for. Inventories are controlled and supervised by
three (3) methods:

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(a) Perpetual Inventory Control-

The perpetual method is the most frequently used method. It is more costly than the other two but it is an
efficient way of keeping count. In this system, complete data records are kept on each item of merchandise and
additions or subtractions are made with each transaction. There is an inventory balance plus a receipt of sale,
minus the actual sale to reflect the quantity at
hand.
(b) Actual Counting Piece- This is another method used to control and supervise inventory. It is used to actually
count inventory item-by-item. This is an exhausting task and not many companies or businesses do it.
Salespeople are usually involve in this process and there is a large margin of error to be considered as the
salespeople go through the monotonous and tiring task of counting everything.
(c) “Looking It Over”- The third method is “Looking over” the inventory. It is the easiest and cheapest way of
controlling and supervising inventory, but there is bound to be errors. With this method, it is hard to pinpoint the
inventory levels, the items that need to be ordered, and the items that the store is overstocked with. Almost all
financial statements that include inventory figures based on this method cannot be completed accurately.
References:
2.) Anonymous. Successful Small Business Management. Los Angeles Times, January 20 1980
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Visible Costs of Inventory
As mentioned earlier, inventory decisions involve a delicate balance between three classes of cost. These costs
are:
Ordering Cost- Cost of replenishing Inventory

Carrying Cost- Cost of holding an item in inventory
Shortage Cost- Temporary or permanent loss of sales when demand cannot be met
Examples of costs in each of these categories are given in Exhibit (a)
Exhibit (a). Inventory Ordering, Holding, and Shortage Costs
Clerical costs of preparing purchase orders

Some spent finding suppliers and expediting orders
Ordering Cost Transportation costs
Receiving costs (E.g. unloading and inspection)
Costs of storage space (E.g. warehouse depreciation)

Security
Holding Costs Insurance
Forgone interest on working capital tied up in inventory
Deterioration, theft, spoilage, or obsolescence
Shortage Costs Disrupted production when raw materials are unavailable :

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Idle workers
Extra machinery setups
Lost sales resulting in dissatisfied customers

Loss of quantity discounts on purchases
References:
2.) Hilton, Ronald W., Managerial Accounting. McGraw-Hill,Inc (1994). p.407
Back to Index
Hidden Costs of Inventory

Having inventory constantly at hand is good but sometimes there are hidden costs that would prove to be a
menace for businesses. These costs include could cause:
Longer lead times

Reduce responsiveness
Underlying problems are hidden rather than being exposed and solved
Quality problems are not identified immediately
No incentive for improvement of the process
References:
Back to Index
What Increases Inventory?
Inventories are increased “just in case”...
order deliveries are late

quality problems occur
demand increases unexpectedly
lead times are not accurately forecast
References:
2.) http://www.inventorymanagement.com/news.htm
Back to Index
Business must have methods and procedures that offer ample flexibility to meet unusual and sometimes
unreasonable demands on their resources -- personnel, equipment and facilities and operational. Exceptional
customer service also includes providing top quality products at reasonable costs.
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Businesses must keep a careful rein on their inventories. Having too much inventory and/or not having enough
stock is considered primary direct causes of business failures.
There are several definitions of Inventory Management. Among them are:
Inventory Management is “the practice of planning, directing and controlling inventory so that it contributes
to the business' profitability”. Inventory management can help business be more profitable by lowering their
cost of goods sold and/or by increasing sales.
Inventory Management is “making sure that items are available when customers call for it, but not too much
stock so that inventory turnover goals are met”
- Juhi Gonzales, Inventory Management and Systems
Consulting-
Inventory Management is “the art and science of managing to have the RIGHT PRODUCT, at the RIGHT
TIME and PLACE, in exactly the RIGHT AMOUNT, at the BEST POSSIBLE PRICE”.
References:
2.) http://www.freenet.edmonton.ab.ca/imasc/#IncomeStatement
3.) http://www.cris.com/~kthill/inventry.htm
4.) http://www.execpc.com/~matplan/page2.html
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Effective Inventory Management
"Effective inventory management allows a distributor to meet or exceed his (or her) customers’ expectations of
product availability with the amount of each item that will maximize the distributor’s net profits."
References:
1.) http://www.effectiveinventory.com/whatis.html
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Myths in Inventory Management

Amazingly, there are so many myths about Inventory Management. Some of them sound idiotic but they do
really happen in the “Real World” of business. Sometimes, it’s best to learn from other people’s (business
people?) mistakes or misunderstandings and incorporate our findings in our own business.
Myth: The “SALES” data that we have in our company records, is all we need for inventory management”
WRONG! : Inventory management systems do not use sales data. They must be supported by accurate demand
information-which is totally different!
Myth: The more expensive a software system is, the better it will help us control our inventory.
WRONG! : The BEST inventory forecasting and planning system available today, costs under $1000 and they
work as well as any other system in the market.
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Myth: “Our real problem is our people- they just don’t do their jobs the way they should!”
WRONG! : In working with thousands of inventory managers, no one is that stupid or lazy! The problem is that
most managers have received NO training, and/ or have the wrong tools (systems) to work with, or none at all.
This is rarely their fault!
Myth: We keep all of our sales histories by month, and this data is all we need to make good forecasts for
inventory planning.
WRONG! : Using monthly sales data is one of the major contributors to poor inventory forecasting and
planning. It inevitably leads to inaccurate safety stock calculations and other projections and, thus, not having
the inventories that our companies need when we need them!
Myth: Our company’s accounting system includes an “Inventory Control” module and, therefore, if our people
would only use it right, our inventories should be fine.
WRONG! : The GREATEST MYTH of all! No accounting system- no matter how good it may be at performing
acconting functions, and most are very good- can ever provide the data and/ or analysis required to precisely
manage any company’s inventories! Your company or business needs (No! MUST Have) an inventory
management system.
References:
1.) http://www.execpc.com/~matplan/page3.html
Back to Index
Why is Inventory Management Important?
1.) Inventory management can help business be more profitable by lowering their cost of goods sold
and/or by increasing sales.
Consider a typical company - ABC Company with the following income statement:
Sales $ 2,000,000
Cost of Goods Sold 1,100,000
Gross Profits 900,000
Gen. Administrative Expenses 402,000
Marketing Expenses 350,000
Net Income before taxes $ 148,000
==========
Not bad -- return on sales is over 7%.
Now, suppose that through application of sound inventory management principles, ABC Company was able to
reduce the cost of goods sold by 3%. And because there is less inventory, let's say that carrying costs (warehouse
storage charges, insurance, finance charges, etc) is reduced by 2% of the general administrative expense. Those
minimal cost reductions result in significant increase on net income:
Sales $ 2,000,000
Cost of Goods Sold 1,067,000
Gross Profits 933,000
Gen. Administrative Expenses 394,000
Marketing Expenses 350,000

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Net Income before taxes $ 189,000

===========
Small costs reductions due to application of sound inventory management principles resulted in very significant
increase (28%) in net income!
Lower cost of goods sold is achieved by making the inventory smaller and therefore turn more often; while
making sure that stocks are large enough will result in increased sales because products are available when
Customers call for it. Inventory management is balancing those two opposing factors for optimum profitability.
2.) Conduct an inventory audit that answers the following questions:
What is your inventory turnover performance? Are you carrying too much inventory and paying more for
interest and/or storage charges?
If you can improve your inventory turnover performance, how much will your gross profits increase?
What is your service level performance? Are you losing potential or current Customers (and revenues)
because you are out-of-stock of the products they want?
If you can improve your service level, how much will be the increase in your sales revenues?
How accurate are your records?
Are you losing Customers (and sales revenues) because your inventory records are not accurate enough –
they show you have some in stock but actually, none?
Or are you overstocked on some products because your records showed that you didn't have any and you
ordered some, when in fact you have lots? (Please note: Quality of answers to these questions will
depend on available records or information maintained by your organization.)
Set up either a manual or computer-based inventory control system to better manage inventory.
Where required, provide contractual project leadership from installation into conversion and start-up of
new system.Where also required, develop a procedure manual and train staff in using new system.
If an inventory system is in place, review current processes to make it better. Where required, provide
contractual inventory management to carry out recommendations and resolve unsatisfactory conditions.
3.) Improve Customer Service
4.) Reduce Inventory Investment
5.) Increase Productivity
6.) Prevent Poor Inventory Record Accuracy

Inventory record errors are costly. No computer system, be it old or new, will work properly if the
transactions are not entered correctly. The costs of poor inventory record accuracy are not always apparent to
management. Consider the following results, all of which increase production costs and reduce profits:
Unanticipated stock-outs
Decreased production efficiency
Higher investment in safety stocks
Requirement for staging of items to determine availability or shortages
Invalid data for inventory replenishment system
More obsolete and excess inventory
Some of these costs can be quantified. Others are intangible, but nevertheless do exist and can be substantial. It
is important to have inventory records, which are accurate. Most experts agree that this accuracy must be at least
95% and even higher for critical or high unit value items. The key to accurate records is the implementation of a
sound cycle counting system.

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References:
2.) http://www.freenet.edmonton.ab.ca/imasc/#InvMgmt
3.) http://sol.brunel.ac.uk/~jarvis/bola/operations/stock/systems.html
Back to Index
Economic Order Quantity

Economic Order Quantity, better known as EOQ, is a mathematical tool for determining the order quantity that
minimizes the costs of ordering and holding inventory. It attempts to minimize total inventory cost by answering
the following two questions.
1) How much should I order? ( Economic Order Quantity )
2) How often should I place each order? ( Cycle Time )
This model assumes that the demand equation faced by the firm is linear. In other words, the rate of demand is
constant or at least nearly constant.
The goal is to minimize total inventory cost. Inventory costs are made up of Holding and Ordering cost. Holding
cost include the cost of financing the inventory along with the cost of physically maintaining the inventory.
These costs are usually expressed as a percentage of the value of the inventory. Ordering cost include the cost
associated with actually placing the order. These include a labor cost as well as a material and overhead cost.
The equation for total inventory cost is developed as follows:
Total Inventory Cost (TIC) = Holding Cost + Ordering Cost
TIC = (Average Inventory)(Holding cost per unit) + (Number of orders per year)(Ordering cost per order)
Assumptions of Basic EOQ Model:
Demand is known with certainty

Demand is relatively constant over time
No shortages are allowed
Lead time for the receipt of orders is constant
The order quantity is received all at once

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Simple Economic Order Quantity Example:
A truck manufacturer uses 120,000 headlight assemblies a year in the production of a certain model truck. Daily
production of this truck is reasonably stable through out the year. The cost of each headlight assembly is
$150.00. The company's incremental order (acquisition) cost is $40.00 per order. Its incremental inventory
carrying cost is 33% of the average inventory value per year.
What is the optimum order quantity?

How many orders will be placed in a year?
Development of EOQ Model

The development of the EOQ (Economic Order Quantity) inventory model consists of five steps:
(a.) List ASSUMPTIONS concerning the inventory situation

Assumptions are:
Demand rate is constant, recurring and known

No stockout are allowed
Orders are delivered at once
All costs are assumed to be known and constant
All orders are placed independently (no joint orders)
(b.) Develop a COST EQUATION (MODEL) QUALITATIVELY
(c.) Develop a COST EQUATION (MODEL) QUANTITIVELY
MODEL QUANTITIVELY:
TC = K(D/Q) + HC(Q/2) + DC
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(d.) Minimize the total cost equation (model)
(e.) Find REORDER QUANTITY & REORDER POINT
OPTIMAL RE-ORDER QUANTITY
Q* = square root [(2 x D x K)/(H x C)]
Where: D = annual demand in units
K = ordering cost per order
H = carrying cost per unit expressed as a fraction of cost of an individual unit
Q = reorder quantity
Q* = optimal reorder quantity
C = cost of an individual item
TC = total annual inventory cost
References:
1.) http://www.wvsc.edu/academics/dept/business/lewis/eoq.html
3.) Hilton, Ronald W., Managerial Accounting. McGraw-Hill,Inc (1994). p. 407
5.) http://garnet.acns.fsu.edu/~dwilson/4700/Notes/invntor1.html
6.) http://mscmga.ms.ic.ac.uk/jeb/or/invent.html
7.) http://server.nich.edu/~wshell/mgt368/368-l9a.html#basiceoq
Back to Index
Just-In-Time Management (JIT)
In traditional settings, inventories of raw materials and parts, finished goods and all, were kept as a buffer
against the possibility of running out of needed item. In recent years, however, managers have come to realize
that large buffer inventories are costly. Consequently, many companies have completely changed their approach
to production and inventory management. These manufacturers have adapted a new strategy for controlling the
flow of manufacturing in a multistage production process.
In a just-in-time (or JIT) production system, raw materials and parts are purchased or produced just in time to be
used at each stage of the production process. This approach to inventory and production management brings
considerable cost savings from reduced inventory levels.
The key system to the JIT System is the “pull” approach to controlling manufacturing. To visualize this
approach, look at Exhibit (c), which displays a simple diagram of a multistage production process. The flow of
manufacturing activity is depicted by the solid arrows running down the page from one stage of production to
the next. However, the signal that triggers more production activity in each stage comes from the next stage of
production. These signals, depicted by the dashed- line arrows, run up the page. We begin with sales at the

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bottom of the exhibit. When sales activity warrants more production of finished goods, the goods are “pulled”
from the production stage III by sending a signal that more goods are needed. Similarly, when production
employees in stage III need more input, they send a signal back to stage II. This triggers production activity in
stage II. Working our way back up to the beginning of the process, purchases of raw materials and parts are
triggered by a signal that they are needed in stage I. This pull system of production management, which
characterizes the JIT approach, results in a smooth flow of production and significantly reduced inventory levels.
The result is considerable cost savings for the manufacturer.
References:
1.) http://www.inventorymanagement.com/imijita2.htm
2.) Hilton, Ronald W., Managerial Accounting. McGraw-Hill,Inc (1994). p.13, p.14, p.218, p. 407
4.) http://server.nich.edu/~wshell/mgt368/368-l9a.html#imc
( CHART )
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Essential Aspects to JIT
1.reduction/minimisation of inventory in supply chains. Lessons have been learnt from Japanese methods where
substantial efficiencies are gained from frequent deliveries of small quantities to meet immediate demands. This
compares with methods of stock control such as the calculation of economic order quantities.
2.the application of Kanban - a "pull" system of production/materials control
3.an employee participation and involvement strategy involving the securing of commitment and changed work
practices leading to elimination of waste
References:
1.) http://www.inventorymanagement.com/imijita2.htm
4.) http://sol.brunel.ac.uk/~jarvis/bola/jit/jit.html
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Kanban
At Toyota, the production system used tickets/cards to control immediate material flows between a work station
and another down-stream . The up-stream station (the server) receives tickets calls for small, fixed quantities
from a down-stream user (the client). On sending the supplies, a production "kanban" is generated requesting the
previous upstream server to make/supply a replacement quantity. Thus:
users "pull" off supplies as required

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direct shop-floor communication between client and supplier replaces instructions issued by a remote
center control point.
materials requirements planning and other systems get rapid feedback on progress or delays. Kanban
involves fine-tuning and quick response to changes.
planning (medium and longer-term planning) is still needed for capacity along the supply chain. Kanban
allows fine tuning.
fixed quantity bins or containers or pallets are used to signal replenishment needs (reminiscent of a
traditional two-bin system of stock control). When the first bin is empty, a new full bin can be moved in
within the usage time from the second bin). With well-designed floor layouts this system adds
considerably to the efficiency of the operational environment.
With the integration of computer systems internally and externally with suppliers systems - Kanban data and
instructions can flow between the linked systems.
References:
Back to Index
JIT is Not Possible Without....
reliable delivery
short distances between client and server
consistent quality so that server performance and throughput is unaffected
stable, predictable production schedules and ability to respond quickly to small fluctuations in demand. If
the production system itself is flexible with quick set up times for product changes - then the data flowing
in the JIT system and the ability of servers to respond are critical.
References:
1.) Hilton, Ronald W., Managerial Accounting. McGraw-Hill,Inc (1994). p.13, p.14, p. 407
Back to Index
Key Features to JIT Approach

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How does a JIT system achieve its vast reductions in inventory and associated cost savings? A production-
systems expert lists the following key features of the JIT approach.
1) A smooth, uniform production rate. An important goal of a JIT system is to establish a smooth production
flow, beginning with the arrival of materials from suppliers and ending with the delivery of goods to customers.
Widely fluctuating production rates result in delays and excess work-in-process inventories. These non-value-
added costs are to be eliminated.
2) A pull method of coordinating steps in the production process. Most manufacturing processes occur in
multiple stages. Under the pull method, goods are produced in each manufacturing stage only as they are needed
at the next stage. This approach reduces or eliminates work-in-process inventory between production steps. The
result is a reduction in waiting time and its associated non-value-added cost.
The pull method of production begins at the last stage of the manufacturing process. When additional materials
and parts are needed for final assembly, a message is sent to the immediate preceding work center to send the
amount of materials and parts that will be needed over the nexrt few hours. Often this message is in the form of a
withdrawal Kanban, a card indicating the number and type of parts requested from the preceding work center.
The receipt of withdrawal Kanban in the preceding work center triggers the release of a production Kanban,
which is another card specifying the number of parts to be manufactured in that work center. Thus, the parts are
“pulled” from a particular work center by a need for parts in the subsequent work center. This pull approach to
production is repeated all the way up the manufacturing sequence toward the beginning. Nothing is
manufactured at any stage until its need is signaled from the subsequent process via a Kanban. As a result, no
parts are produced until they are needed, no inventories build up, and the manufacturing process exhibits a
smooth, uniform flow of production.
3) Purchase of materials and manufacture of subassemblies and products in small lot sizes. This is an outgrowth
of the pull method of production planning. Materials are purchased and goods are produced only as required,
rather than for the sake of building up stocks. The result is a reduction in storage and waiting time, and the
related non-value-added costs.
4) Quick and inexpensive setups of production machinery. In order to produce in small lot sizes, a manufacturer
must be able to set up production runs quickly. Advanced manufacturing technology aids in this process, as more
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and more machines are computer-controlled.
5) High quality levels for raw material and finished products.
6) Effective preventive maintenance of equipment. If goods are to be manufactured just in time to meet customer
orders, a manufacturer cannot afford significant production delays. By strictly adhering to routine maintenance
schedules, the firm can avoid costly down time from machine breakdowns.
7) An atmosphere of teamwork to improve the production system. A company can maintain a competitive edge
in today’s worldwide market only if it is constantly seeking ways to improve its product or service, achieve more
efficient operations, and eliminate non-value-added costs.
8) Multiskilled workers and flexible facilities.
References:
Back to Index
JIT Purchasing
In addition to a JIT production approach, an effective business should implement JIT purchasing. Under this
approach, materials and parts are purchased from outside vendors only as they are needed. This avoids the costly
and wasteful buildup of raw material inventories. The following are five (5) key features of JIT purchasing.
1. Only a few suppliers. This results in less time spent on vendor relations. Only highly reliabled vendors are
used, who can deliver high quality goods on time.
2. Long- term contracts negotiated with suppliers.
3. Materials and parts delivered in small lot sizes immediately before they are needed.
4. Only minimal inspection of delivered materials and parts.
5. Grouped payments to each vendor. Instead of paying for each delivery, payments are made for batches of
deliveries according to the terms of the contract. This reduces costly paperwork for both the vendor and the
purchaser.
JIT is an important operational system for manufacturing and supplying companies to adopt and implement.
Technically, procedurally and managerially it requires attention to:
data, information and communication.

assessment of requirements
programmes to change the structure of production, materials handling, manufacturing processes and
distribution facilities
improved methods of controlling unit supply costs
consideration of the buyer-supplier partnership and the possibility of strategic collaboration.
If change is piecemeal and management attention wanes then JIT may fail. An integrated perspective is needed
with coherent strategic direction and increases in productivity/effectiveness at each operational level so that the
whole supply chain has a competitive edge

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References:
Back to Index
EOQ vs. JIT
The EOQ model minimizes the total cost of ordering and holding purchased inventory. Thus, this inventory
management approach seeks to balance the cost of ordering against the cost of storing inventory. Under the JIT
philosophy, the goal is to keep all inventories as low as possible. Any inventory holding costs are seen as
inefficient and wasteful. Moreover, under JIT purchasing, ordering costs are minimized by reducing the number
of vendors, negotiating long- term supply agreements, making less frequent payments, and eliminating
inspections. The implication of the JIT philosophy is that inventories should be minimized by more frequent
deliveries in smaller quantities.
References:
1.) Hilton, Ronald W., Managerial Accounting. McGraw-Hill,Inc (1994). p. 407
Back to Index
Conclusion
In any business, make it big or small, we must understand that taking good care of our inventory is very
important. If we as managers do not understand the concept of good inventory management, we must learn to be
familiar with it and its applications. One of the reasons for the failure of a business is its inventory management.
There are many ways to fight failure, and we can start from here. There are new technology that can help us
maintain and supervise our inventory. What we can do is learn, implement and evaluate our business. And you
can start with your INVENTORY!!!!!
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The Basic Relationship- Average Inventory

Without safety stock:

Average inventory = 1/2 order quantity

With safety stock:

Average inventory = 1/2 order quantity + safety stock

https://msu.edu/course/prr/473/oldstuff/Inventory Management.htm#cycle 2/17

Reasons to Hold Inventory

Meeting unexpected demands

Smoothing seasonal demands

Taking advantage of price discounts

Hedging against price increase

Getting quality discounts

Methods to Supervise Inventory

https://msu.edu/course/prr/473/oldstuff/Inventory Management.htm#cycle 3/17

(a) Perpetual Inventory Control-

Visible Costs of Inventory

Ordering Cost- Cost of replenishing Inventory

Examples of costs in each of these categories are given in Exhibit (a)

Exhibit (a). Inventory Ordering, Holding, and Shortage Costs

Clerical costs of preparing purchase orders

Costs of storage space (E.g. warehouse depreciation)

Shortage Costs Disrupted production when raw materials are unavailable :

https://msu.edu/course/prr/473/oldstuff/Inventory Management.htm#cycle 4/17

Lost sales resulting in dissatisfied customers

Hidden Costs of Inventory

Longer lead times

What Increases Inventory?

Inventories are increased “just in case”...

order deliveries are late

There are several definitions of Inventory Management. Among them are:

Effective Inventory Management

Myths in Inventory Management

Why is Inventory Management Important?

Not bad -- return on sales is over 7%.

https://msu.edu/course/prr/473/oldstuff/Inventory Management.htm#cycle 7/17

Net Income before taxes $ 189,000

2.) Conduct an inventory audit that answers the following questions:

3.) Improve Customer Service

4.) Reduce Inventory Investment

5.) Increase Productivity

6.) Prevent Poor Inventory Record Accuracy

https://msu.edu/course/prr/473/oldstuff/Inventory Management.htm#cycle 8/17

Economic Order Quantity

1) How much should I order? ( Economic Order Quantity )

2) How often should I place each order? ( Cycle Time )

Total Inventory Cost (TIC) = Holding Cost + Ordering Cost

Assumptions of Basic EOQ Model:

Demand is known with certainty

https://msu.edu/course/prr/473/oldstuff/Inventory Management.htm#cycle 9/17

Simple Economic Order Quantity Example:

What is the optimum order quantity?

Development of EOQ Model

(a.) List ASSUMPTIONS concerning the inventory situation

Demand rate is constant, recurring and known

(b.) Develop a COST EQUATION (MODEL) QUALITATIVELY

(c.) Develop a COST EQUATION (MODEL) QUANTITIVELY

(d.) Minimize the total cost equation (model)