STARTUP COMPANY

Inventory Management
IPE 4111

Afia Ahsan
Lecturer
MPE, AUST
 Inventory Management
Inventory is stock or store of goods
❑ Inventory management is a core operations
management activity.
❑ Good inventory management is important for the
successful operation of most businesses and their
supply chains.
❑ Operations, marketing, and finance have interests
in good inventory management.
❑ Bad inventory management hampers operations,
diminishes customer satisfaction, and increases
operating costs.
 Types of inventories

1. Raw materials & purchased parts

2. Partially completed goods called work-in-process (WIP)
3. Finished-goods inventories
-Completed product awaiting shipment
-(manufacturing firms) or merchandise (retail stores)
 Functions of Inventory

➢ To meet anticipated demand

➢ To keep production running
➢ To protect against stock-outs
➢ To help hedge against price increases
➢ To take advantage of quantity discounts
 Objective of Inventory Control
❖ Inadequate control of inventories can result in both under and
over stocking of items.
❖ Understocking results in missed deliveries, lost sales, dissatisfied
customers and production bottle necks.
❖ Overstocking results in unnecessarily ties up funds that might be
more productive elsewhere.
❖ To achieve satisfactory levels of customer service while keeping
inventory costs within reasonable bounds
-Level of customer service
-Costs of ordering and carrying inventory
 Effective Inventory Management
To be effective, management must have the following:
✓ A system to keep track of inventory on hand and on order
✓ A reliable forecast of demand
✓ Knowledge of lead times and its variability
✓ Reasonable estimates of:
– Inventory Holding (carrying) costs
– Ordering costs
– Shortage costs
✓ A classification system for inventory items
 Inventory Counting Systems
Periodic System
Physical count of items made at periodic intervals

Perpetual (continual) Inventory System

System that keeps track of removals from inventory
continuously, thus monitoring current levels of each item
 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 (shipping cost,
preparing invoices, moving the goods to temporary storage)
❖ Setup costs: cost to prepare a machine or process for manufacturing an
order
❖ Shortage costs: costs when demand exceeds supply (the opportunity cost
of not making a sale, loss of customer goodwill, late charges, the cost of lost
of production or downtime)
 Classification system
ABC Analysis
❑ Classifies inventory items according to some measure of

importance and then allocates control efforts accordingly.

❑ The origin of ABC analysis is “The Pareto Principle” which is
named after an Italian economist Vilfredo Pareto, also called as
80/20 rule. This principle suggests that 80% of the total output is
generated only by 20% of the valuable efforts.
 ABC Analysis
Classifying inventory according to some measure of importance
and allocating control efforts accordingly.
A - very important
B – moderate important
C - least important
ABC Analysis
 ABC Analysis Example 1
A manager has obtained a list of unit costs and estimated annual demands for 12
inventory items and now wants to categorize the items on an A-B-C basis.
Item Number Annual Demand Unit Cost ($)
1 500 200
2 1000 70
3 1900 500
4 1500 100
5 3900 700
6 1000 915
7 200 210
8 1000 4000
9 8000 10
10 9000 2
11 2500 330
12 400 300
 ABC Analysis Example 1
Item Annual Unit Cost ($) Annual Dollar
Number Demand Value
1 500 200 100,000
2 1000 70 70,000
3 1900 500 950,000
4 1500 100 150,000
5 3900 700 2,730,000
6 1000 915 915,000
7 200 210 42,000
8 1000 4000 4,000,000
9 8000 10 80,000
10 9000 2 18,000
11 2500 330 825,000
12 400 300 120,000
=30,900 =10,000,000
 ABC Analysis Example 1
Item Annual Unit Cost ($) Annual Dollar % of Annual % of Annual Classification
Number Demand Value Units Sold Dollar Value
8 1000 4000 4,000,000 3.24 40
A
5 3900 700 2,730,000 12.61 27.3
3 1900 500 950,000 6.15 9.5
6 1000 915 915,000 3.24 9.15 B
11 2500 330 825,000 8.09 8.25
4 1500 100 150,000 4.85 1.5
12 400 300 120,000 1.3 1.2
1 500 2000 100,000 1.62 1
9 8000 10 80,000 25.89 0.8 C
2 1000 70 70,000 3.24 0.7
7 200 210 42,000 0.65 0.42
10 9000 2 18,000 29.12 0.18
=30,900 =10,000,000
ABC Analysis Example 1
ABC Analysis Exercise 1
Annual
Dollar
Value
_____
1500
360
7500

3000

1000

450
67500
 Independent Vs Dependent Demand

❑ Independent demand - the demand for item is independent

of the demand for any other item in inventory

❑ Dependent demand - the demand for item is dependent

upon the demand for some other item in the inventory
 Inventory Models for Independent Demand

Need to determine when and how much to order

✓ Basic economic order quantity
✓ Production order quantity
✓ Quantity discount model
Inventory ordering & Usage Cycle
 Basic EOQ Model
EOQ is the order size that minimizes total cost
Economic
Important assumptions
I. Demand is known, constant, and independent
II. Lead time is known and constant
III. Receipt of inventory is instantaneous and complete
IV. Quantity discounts are not possible
V. Only variable costs are setup and holding
VI. Stockouts can be completely avoided
Cost Curves
 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

Annual setup cost = (Number of orders placed per year) x (Setup or order cost per order)
𝐷
= 𝑆
𝑄

Annual holding cost = (Average inventory level) x (Holding cost per unit per year)
𝑄
= 𝐻
2
 The EOQ Model
The total annual cost associated with carrying and ordering inventory
when Q units are ordered each time is:

Total cost = Annual Setup cost + Annual Holding cost

𝐷 𝑄
𝑇𝐶 = S+ H
𝑄 2
Optimal order quantity is found when annual setup cost equals annual
holding cost
𝐹𝑜𝑟 𝑆𝑜𝑙𝑣𝑖𝑛𝑔 𝑄∗ ,
𝐷 𝑄
S= H
𝑄 2
2𝐷𝑆 = 𝑄 2 𝐻
∗ 2𝐷𝑆
𝑄 =
𝐻
 An EOQ Example 1
D = 1,000 units
S = $10 per order
H = $.50 per unit per year
1. Determine optimal number of needles to order
2. Determine number of orders in a year to fulfill the demand
3. Determine Expected time between orders (Working Day 300
days/year)
4. Determine Total Cost
∗ 2𝐷𝑆 2×1000×10
1. 𝑄 =
𝐻
=
.50
= 40,000 = 200 𝑢𝑛𝑖𝑡𝑠
𝐷 1000
2. 𝑁= ∗=
𝑄 200
= 5 𝑜𝑟𝑑𝑒𝑟 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑓 𝑑𝑎𝑦𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟 300
3. 𝑇=
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑟𝑑𝑒𝑟𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
=
5
= 60 𝑑𝑎𝑦𝑠 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑜𝑟𝑑𝑒𝑟𝑠
𝐷 𝑄 1000 200
4. 𝑇𝐶 = S+ H= × 10 + . 50 = $100
𝑄 2 200 2
 EOQ Exercise 1
A local distributor for a national tire company expects to sell
approximately 9600 steel-belted radial tires of a certain size and
tread design next year. Annual carrying cost is $ 16 per tire, and
ordering cost is $ 75. The distributor operates 288 days a year.
(a) What is the EOQ?
(b) How many times per year does the store reorder?
(c) What is the length of an order cycle?
(d) What is the total annual cost if the EOQ quantity is ordered?
 EOQ Exercise 2
Piddling manufacturing assembles security monitors. It purchases
3600 black and white cathode ray tubes a year at $ 65 each.
Ordering costs are $ 31, and annual carrying costs are 20 percent of
the purchase price.
(a) Compute the optimal quantity
(b) What is the carrying cost?
(c) What is the ordering cost?
(d) Calculate the total annual cost ?
 Reorder point (ROP)

Reorder point occurs When the quantity on hand of an item drops to

a predetermined amount, the item is reordered.

If demand and lead time are both constant, the reorder point is
simply defined as
ROP = Expected demand in (LT) = (d) x (LT)

Where,
d = Demand rate units per day or week)
LT = Lead time in days or weeks
 Reorder Point (ROP) Example 1
Tingly takes two a day vitamins which are delivered to his home by
routeman seven days after an order is called in. At what point should
Tingly reorder?

Usage is 2 vitamins per day

Lead time (LT) is 7 days
ROP=d x LT=(2) x (7)= 14 vitamins

Thus, Tingly should reorder when 14 vitamin tables are left.

THANK
YOU