Inventory model

is a mathematical model that helps business in determining the optimum level of inventories
that should be maintained in a production process, managing frequency of ordering, deciding
on quantity of goods or raw materials to be stored, tracking flow of supply of raw materials
and goods to provide . Inventory models deal with the time at which orders for certain goods
are to be placed, and the quantity of the order. The research problem concerns ways of
optimizing these decisions, taking into account the cost of obtaining the goods, the cost of
holding a unit in inventory, and the cost of shortages

Benefits and Importance of Inventory Management/modelling

The importance of inventory management cannot be stressed enough especially for
eCommerce and online retail brands. Accurate inventory tracking allows brands to fulfil
orders timely and accurately. Inventory management in businesses must grow as the company
expands. With a strategic plan in place that optimizes the process of overseeing and managing
inventory, including real-time data of inventory conditions and levels, companies can achieve
inventory management benefits that include:
Accurate Order Fulfilment
With an effective inventory management system, you can easily track the stock in the
warehouse. Bid goodbye to overstocking, stocking of obsolete items, understocking and start
focusing on making your brand become one of the key players in the market space. Develop a
robust plan with the help of an efficient accounting software and avoid inaccurately filled
orders, high return volumes and a loss of customer base.
Better Inventory Planning and Ordering
Striking a balance between the demand and supply is extremely crucial for businesses, thus,
inventory management provides aid in better planning and ordering of stock items. Imagine
having a huge demand for a particular product but not having enough material to supply the
same. Sounds like your worst nightmare, right? A detailed inventory management mitigates
these issues, allowing warehouse managers to refresh inventory only when needed. It’s both
space and cost-effective.
Increased Customer Satisfaction
Since a systematic and robust inventory tracking system will give you a comprehensive view
of your stock at-hand, it yields in an increased customer satisfaction. In retail sector,
customers resent late deliveries or “out of stock” notifications and eventually never return to
the website to fulfil their shopping needs. However, good inventory management leads to
orders being fulfilled more quickly and shipped out to customers faster. The enhanced
processes can help eCommerce and online retail brands build a strong repertoire with
consumers – and keep them coming back for more.
Organised Warehouse
A good inventory management strategy leads to an organized fulfilment centre. An organized
warehouse results in more efficient present and future fulfilment plans. This also includes
cost-savings and improved product fulfilment for businesses utilizing the warehouse for
managing inventory.
Minimise the Blockage of Financial Resources
The importance of inventory control is to minimise the blockage of financial resources. It
reduces the unnecessary tying up of capital in excess inventories and also improves the
liquidity position of the firm. With proper inventory tracking module, business owners can
take quicker decisions about the stock lying in the warehouse more wisely.
inventory management models
Three of the most popular inventory management models are Economic Order Quantity
(EOQ), Inventory Production Quantity and ABC Analysis. 
Each of the inventory management models has an alternate way to deal with assisting you to
know how much stock you ought to have available. Things you choose to utilize relies upon
your business.
1. Economic Order Quantity (EOQ)
Best eCommerce traders and retail operators are driven by a prudent rationale to keep away
from stockouts. Utilizing deterministic inventory management models – like the Economic
Order Quantity (EOQ) model – will assist you with processing an ideal request amount that
limits stock expenses (and keep away from the most dreaded part of eCommerce). The EOQ
is a recipe that figures the most prudent number of things a business should request to limit
costs and boost esteem when reloading stock.
EOQ = 2DS/C
D = Annual Demand
C = Carrying Cost
S = Ordering Cost
In any case, the EOQ model expects a (consistent) request of an item and prompts
accessibility of things to be restocked. It does not represent occasional or economic
fluctuations. It expects fixed expenses of inventory units, requesting charges and holding
charges. No stockouts are allowed. 
This inventory model requires nonstop checking of inventory levels. The viability of the
essential EOQ model is generally restricted by the presumption of a one-item business, and
the recipe does not permit communication between items. Also, EOQ accepts a boundless
arranging skyline and that there is no restriction on capital availability.
Assumptions (Basic EOQ Model).
1. A known constant demand rate of a units per unit time.
2. The order quantity (Q) to replenish inventory arrives all at once just when desired, namely,
when the inventory level drops to 0.
3. Planned shortages are not allowed.
In regard to assumption 2, there usually is a lag between when an order is placed and when it
arrives in inventory. As indicated in Sec. 19.2, the amount of time between the placement of
an order and its receipt is referred to as the lead time. The inventory level at which the order is
placed is called the reorder point. To satisfy assumption 2, this reorder point needs to be set at
the product of the demand rate and the lead time. Thus, assumption 2 is implicitly assuming a
constant lead time

2. Inventory Production Quantity

Also called Economic Production Quantity, or EPQ, this kind of inventory management
models discloses to you the number of items your business should arrange in a solitary
cluster, in order to diminish holding expenses and arrangement costs. It expects that each
request is conveyed by your provider in parts to your business, instead of in one full item. 
This model is an augmentation of the EOQ model. The distinction between the two models is
the EOQ model expects providers are conveying stock in full to your client or business.
Here is how to calculate your Inventory Production Quantity:
2KDh(1-x)
K = Setup (order) costs
D = Demand Rate
h = Yearly Holding Cost Per Product
P = Yearly Production Rate
x = D/P
* Take the square root of (2SD)/Production Cost (1 – x)
* S is your setup (order) costs
* D is your demand rate (units)
* X is your Demand Rate/Production Rate
This model could be the best choice for your business if:
 Your business will generally request inventory from providers in parts as opposed to
one full request, for example, for an automotive organization. 
 Interest for items is consistent over various periods of time.
3. ABC Analysis
The more cash explicit inventory presents to you, the more significant it is to you. ABC
examination arranges your inventory dependent on degrees of significance. By realizing
which stock is the main, you realize where to concentrate. To be best, ABC Analysis is often
utilized with other inventory management models, like the Just in Time (JIT) technique. 

Stock is sorted into either bunch A, B, or C. So how would you know which class to put
inventory under? It depends on the 80/20 guideline, otherwise called the Pareto Principle: 
Category A: Inventory under this classification gets the most cash and is just a modest
quantity of your all-out stock. It accounts for just 20% of your stock however gets 70% of
complete income. Category A stock is given the most measure of consideration and has tight
requesting controls set up. 
Category B: Unlike Category A stock, this Category B stock is not fundamental for your
business to endure, however, it actually matters. It is 30% of your stock with 25% income. 
Category C: Inventory arranged under Category C is 50% of your items with 5% income.
This stock does not get as much benefit as A and B, however, it is steady. Inventory
management is quite free here since it gets a modest quantity of pay. 
In the event that your organization offers administrations or items that all shift significantly in
cost, for example, an arranging organization, this will be a viable model for you. 
A genuine model is Amazon, whose items cover an enormous scope of costs. Few out of
every odd thing you see recorded on their site is available. That would prompt extraordinarily
high holding costs, making it hard to make money. So all things being equal they request
stock dependent on what they see with their ABC classification rules. 
The drawback to this kind of inventory management models is that you need to classify the
correct stock accurately with the goal for it to work. Or else you will be putting all your
inventory management models consideration into an item that is not presenting to you the
most cash.
EXAMPLE 1
Manufacturing Speakers for TV Sets A television manufacturing company produces its own
speakers, which are used in the production of its television sets. The television sets are
assembled on a continuous production line at a rate of 8,000 per month, with one speaker
needed per set. The speakers are produced in batches because they do not warrant setting up a
continuous production line, and relatively large quantities can be produced in a short time.
Therefore, the speakers are placed into inventory until they are needed for assembly into
television sets on the production line. The company is interested in determining when to
produce
a batch of speakers and how many speakers to produce in each batch. Several costs must be
considered:
1. Each time a batch is produced, a setup cost of $12,000 is incurred. This cost includes the
cost of “tooling up,” administrative costs, record keeping, and so forth. Note that the existence
of this cost argues for producing speakers in large batches.
2. The unit production cost of a single speaker (excluding the setup cost) is $10, independent
of the batch size produced. (In general, however, the unit production cost need not be constant
and may decrease with batch size.)
3. The production of speakers in large batches leads to a large inventory. The estimated
holding cost of keeping a speaker in stock is $0.30 per month. This cost includes the cost of
capital tied up in inventory. Since the money invested in inventory cannot be used in other
productive ways, this cost of capital consists of the lost return (referred to as the opportunity
cost) because alternative uses of the money must be forgone. Other components of the holding
cost include the cost of leasing the storage space, the cost of insurance against loss of
inventory by fire, theft, or vandalism, taxes based on the value of the inventory, and the cost
of personnel who oversee and protect the inventory.
4. Company policy prohibits deliberately planning for shortages of any of its components.
However, a shortage of speakers occasionally crops up, and it has been estimated that each
speaker that is not available when required costs $1.10 per month. This shortage cost includes
the extra cost of installing speakers after the television set is fully assembled otherwise, the
interest lost because of the delay in receiving sales revenue, the cost of extra record keeping,
and so forth

Example 2: Inventory is replenished at every regular interval of 5 days. The maximum

allowable inventory is 800 Units. The inventory reviewed on Day-5, Day-10, Day -15 and
Day -20 were 387 Units, 201 Units, 498 Units and 127 Units respectively.
 Regular Intervals (R) = 5 Days
 Maximum Level (M) = 800 Units
 Inventory on Hand: I5 = 387 Units, I10 = 201 Units, I15 = 498 Units and I20 = 127
Units
 Order Quantity (O) = (M) – (It)
 Order Quantity (O5) = 800 – 387 = 413 Units
 Order Quantity (O10) = 800 – 201 = 599 Units
 Order Quantity (O15) = 800 – 498 = 302 Units
 Order Quantity (O15) = 800 – 127 = 673 Units
COMPONENTS OF INVENTORY MODELS

Because inventory policies affect profitability, the choice among policies depends upon their
relative profitability. As already seen in Examples 1 and 2, some of the costs that determine
this profitability are (1) the ordering costs, (2) holding costs, and (3) shortage costs. Other
relevant factors include (4) revenues, (5) salvage costs, and (6) discount rates. These six
factors are described in turn below.

The cost of ordering an amount z (either through purchasing or producing this amount) can
be represented by a function c(z). The simplest form of this function is one that is directly
proportional to the amount ordered, that is, c z, where c represents the unit price paid. Another
common assumption is that c(z) is composed of two parts: a term that is directly proportional
to the amount ordered and a term that is a constant K for z positive and is 0 for z 0.

The holding cost (sometimes called the storage cost) represents all the costs associated with
the storage of the inventory until it is sold or used. Included are the cost of capital tied up,
space, insurance, protection, and taxes attributed to storage. The holding cost can be assessed
either continuously or on a period-by-period basis. In the latter case, the cost may be a
function of the maximum quantity held during a period, the average amount held, or the
quantity in inventory at the end of the period.

The shortage cost (sometimes called the unsatisfied demand cost) is incurred when the
amount of the commodity required (demand) exceeds the available stock.
Revenue may or may not be included in the model. If both the price and the demand for the
product are established by the market and so are outside the control of the company, the
revenue from sales (assuming demand is met) is independent of the firm’s inventory policy
and may be neglected. However, if revenue is neglected in the model, the loss in revenue must
then be included in the shortage cost whenever the firm cannot meet the demand and the sale
is lost. Furthermore, even in the case where demand is backlogged, the cost of the delay in
revenue must also be included in the shortage cost

The salvage value of an item is the value of a leftover item when no further inventory is
desired. The salvage value represents the disposal value of the item to the firm, perhaps
through a discounted sale. The negative of the salvage value is called the salvage cost. If there
is a cost associated with the disposal of an item, the salvage cost may be positive.

Finally, the discount rate takes into account the time value of money. When a firm ties up
capital in inventory, the firm is prevented from using this money for alternative purposes. For
example, it could invest this money in secure investments, say, government bonds, and have a
return on investment 1 year hence of, say, 7 percent. Thus, $1 invested today would be worth
$1.07 in year 1, or alternatively, a $1 profit 1 year hence is equivalent to $1/$1.07 today. The
quantity is known as the discount factor. Thus, in adding up the total profit from an inventory
policy, the profit or costs 1 year hence should be multiplied by ; in 2 years hence by 2 ; and so
on. (Units of time other than 1 year also can be used.)
Cc