INVENTORY

MANAGEMENT
OPERATIONS MANAGEMENT AND TOTAL QUALITY MANAGEMENT
PRESENTATION CREATED BY ROBERT BALUNGAYA, TRISHA CABANTOC, AND AZLINEA GUMABAY OF BSAC 1
NATURE &
IMPORTANCE
an inventory is a stock or store of goods
they contribute to customer satisfaction
inventory decisions are critical in service organizations
inventory sales are the major source of revenues for retail and wholesale
business
FUNCTIONS
01 TO MEET ANTICIPATED CUSTOMER
DEMAND 05 TO TAKE ADVANTAGE OF ORDER CYCLES

02 TO SMOOTH PRODUCTION
REQUIREMENTS 06 TO HEDGE AGAINST PRICE
INCREASES

03 TO DECOUPLE OPERATIONS
07 TO PERMIT OPERATIONS

04 08
TO TAKE ADVANTAGE OF QUANTITY
TO REDUCE THE RISK OF STOCK OUTS
DISCOUNTS
 OBJECTIVES OF
INVENTORY MANAGEMENT

1 2 3 4
TO AVOID UNDERSTOCKING HELPS TO DECIDE ‘WHEN TO SATISFACTORY LEVELS OF DESIRABLE INVENTORY
OR OVERSTOCKING ORDER’ AND ‘HOW MUCH TO CUSTOMER SERVICE WITH TURNOVER AND DAYS OF
ORDER’ REASONABLE INVENTORY INVENTORY ON HAND
COSTS
 PERFORMANCE
MEASURES
TO JUDGE THE EFFECTIVENESS OF INVENTORY MANAGEMENT
COSTS AND CUSTOMER
SATISFACTION
Desirable: Lower costs and
higher customer satisfaction
can be measured by number
and quantity of backorders
and/or customer complaints
INVENTORY TURNOVER
Ratio of annual cost of goods sold
to average inventory investment
Desirable: Higher ratio
High Turnover Rate: lower profit margin
& shorter time to manufacture/sell
Low Turnover Rate: higher profit
margin & longer time to manufacture/sell
DAYS OF INVENTORY
ON HAND
Expected number of days of sales that can
be supplied from existing inventory
Desirable: Balance in expected number of
days
Excess Inventory: high number of days
Risk of Running Out of Stock: low
number of days
REQUIREMENTS FOR EFFECTIVE
INVENTORY MANAGEMENT
KEEPING TRACK OF ITEMS AND DECIDING WHEN AND HOW MUCH TO ORDER
ARE THE 2 BASIC MANAGEMENT FUNCTIONS CONCERNING INVENTORY. TO BE
EFFECTIVE, MANAGEMENT MUST HAVE THE FOLLOWING:

1. A system to keep track of

the inventory on hand and
on order
2. Reliable forecast of
demand with an indication of
possible forecast error
3. Knowledge of lead times and
lead time variability

4. Reasonable estimates of
costs like inventory holding,
ordering and shortage costs
5. A classification system for
inventory items
INVENTORY COUNTING SYSTEMS
1. PERIODIC
INVENTORY SYSTEM
a physical count of items in inventory is
made at periodic, fixed intervals
Advantage: orders for many items occur
at the same time resulting in economies in
processing and shipping orders
Disadvantage: lack of control between
reviews and the need to protect against
shortages between review periods by
carrying extra stock
2. PERPETUAL
INVENTORY SYSTEM
tracks removals from inventory on a
continuous basis so the system can
provide information on the current level of
inventory for each item
Advantage: control provided by the continuous monitoring
of inventory withdrawals and management can determine
an optimal order quantity
Disadvantage: added cost of record keeping and a
physical count of inventories must still be performed
periodically
4 BASIC INVENTORY COSTS
1 PURCHASE COSTS
amount paid to a vendor or supplier to buy the inventory

2
HOLDING/CARRYING COSTS
relate to physically having items in storage (examples: interest,
insurance depreciation, obsolescence, deterioration, spoilage,
pilferage, breakage, tracking, picking, and warehousing costs)

ORDERING COSTS

3
costs of ordering and receiving inventory that occur with the actual
placement of an order (examples: transportation, shipping fees,
inspection fees, preparing invoices, and analogously, machine setup
costs)

3
SHORTAGE COSTS
when demand exceeds the supply of inventory on hand (examples:
opportunity cost of not making a sale, loss of customer goodwill, late
charges, backorder costs)
INVENTORY
CONCEPTS
Inventory is created when the receipt of materials,
parts, or finished goods exceeds their
disbursement.
Inventory is depleted when their disbursement
exceeds their receipt.
 HOLDING/CARRYING COST
PRESSURES Interest, Opportunity Costs
FOR - whichever is greater, usually is the largest component of holding cost

L
Storage and Handling Costs
- may be incurred when a firm rents space on either a long-term or short-
term basis

O
Taxes
- more taxes are paid if end-of-year inventories are high

Insurance

W
- insurance on assets increases when there is more to insure

Shrinkage
Pilferage - theft of inventory by customers or employees
Obsolescence - when inventory cannot be used or sold at full value,
INVENTORIES owing to model changes, engineering modifications, or unexpectedly
low demand
Deterioration - physical spoilage or damage
PRESSURES Customer Service
FOR - creating inventory can speed delivery and improve on-time-delivery

H
Stockout - when an item that is typically stocked isn’t available to satisfy a demand
the moment it occurs, resulting in loss of the sale
Backorder - customer order that can’t be filled when promised or demanded but is
filled later

Ordering Costs

I
- for the same item, the ordering cost is the same regardless of the order size

Setup Costs
- independent of the order size

G
Labor and Equipment Utilization
- by creating more inventory, management can increase work-force productivity and
facility utilization

Transportation Costs

H
- outbound and inbound transportation cost can be reduced by increasing inventory levels

Payment to Suppliers
- a firm often can reduce total payment to suppliers if it can tolerate higher inventory
levels
Quantity Discount - price per unit drops when the order is sufficiently large which is

INVENTORIES
an incentive to order larger quantities
 TYPES OF INVENTORIES

RAW MATERIALS AND FINISHED GOODS

PURCHASED PARTS INVENTORY

WORK-IN-PROCESS MAINTENANCE, REPAIR

INVENTORY AND OPERATIONS (MRO)
INVENTORY
TYPES OF
INVENTORIES (cont’d)
SAFETY STOCK ANTICIPATION
INVENTORY INVENTORY
protects against uncertainties used to absorb uneven rates of
in demand, lead time, demand or supply which
and supply businesses often face
TYPES OF
INVENTORIES (cont’d)
CYCLE INVENTORY
goods, supplies, or raw materials
that a business keeps on hand to
meet its minimum production
requirements
the portion of total inventory that
varies directly with lot size
Lot Sizing is determining how frequent to
order, and in what quantity
2 Principles of Lot Sizing
The lot size, Q, varies directly with the
elapsed time (or cycle) between orders
The longer the time between orders for
a given time, the greater the cycle
inventory must be
TYPES OF
INVENTORIES (cont’d)
CYCLE INVENTORY
Average Cycle Inventory
= Q+0 =Q
2 2
Q = lot size
*Note: This formula is exact only when the demand rate is constant and uniform.
TYPES OF
INVENTORIES (cont’d)
PIPELINE INVENTORY Pipeline Inventory
inventory moving from point to point
= DL = dL
in the materials flow system
DL= average demand during lead time
consists of orders that have been
d = average demand for the item per
placed but not yet received
period
L = number of periods in the item’s lead
time to move between the two points
PROBLEM 1: CYCLE & PIPELINE INVENTORY

XYZ Furniture ships tables on a monthly basis to a

wholesaler in average lot sizes of 460 tables. On average,
the wholesaler demands 95 tables a week, with the lead
time from XYZ being four weeks long. Determine the cycle
inventory and pipeline inventory.
INVENTORY REDUCTION TACTICS
1 LEVERS
basic tactics for reducing inventory

1.1 PRIMARY LEVER

is one that must be activated if inventory is reduced

SECONDARY LEVER
1.2 reduces the penalty cost of applying the primary lever and the need for
having inventory in the first place

2
ABC ANALYSIS
the process of dividing items into three classes according to their
dollar usage so that the manager can focus on the items that have the
highest dollar value
TYPES OF DEMAND
IN TERMS OF DEPENDENCE ON OTHER ITEMS

INDEPENDENT DEMAND DEPENDENT DEMAND

the demand for an item is the demand for an item is

independent of the demand for dependent upon the demand for
any other item in inventory some other item in the inventory
 INVENTORY MODELS FOR
INDEPENDENT DEMAND

1 2 3
BASIC ECONOMIC ORDER PRODUCTION ORDER QUANTITY DISCOUNT
QUANTITY (EOQ) QUANTITY MODEL
BASIC ECONOMIC
ORDER QUANTITY (EOQ)
ECONOMIC ORDER The approach to determining the EOQ is

QUANTITY (EOQ)
lot size that minimizes total annual
inventory holding and ordering costs
EOQ = √2DS/H
D = annual demand
S = annual ordering/set-up cost
H = annual holding cost
based on the following assumptions:
1.) demand rate for the item is constant and
known with certainty
2.) no constraints on the size of each lot
3.) two relevant costs: holding cost and fixed cost
per lot for ordering/setup
4.) decisions for one item can be made
independently of decisions for other items
5.) no uncertainty in lead time or supply
RELEVANT FORMULAS IN EOQ
ANNUAL ANNUAL AVERAGE C = QH/2 + DS/Q
NUMBER OF TOTAL
HOLDING ORDERING ORDERS PER COST Where:
COST COST YEAR C = total cost per year
Q = lot size, in units
H = cost of holding one
Average cycle Number of Annual holding
Annual unit in inventory for a
inventory orders per year cost year, often calculated as
demand
x x the proportion of
+
Lot size the item’s value
Unit holding Ordering or Annual D = annual demand, in
cost setup cost ordering or units per year
S = cost of ordering or
setup cost
setting up one lot, in
dollars per lot
RELEVANT FORMULAS IN EOQ
TBO TBO TBO TBO TIME BETWEEN
IN IN IN IN ORDERS (TBO)
YEARS MONTHS WEEKS DAYS
for a particular lot size
is the average elapsed
time between
EOQ EOQ EOQ receiving (or placing)
EOQ
x 12 mos. a yr. x 52 wks. a yr. x 365 days a yr. replenishment orders of
D Q units
D D D
PROBLEM 2.1: EOQ

Ms. Mho Quo is the purchasing manager for the headquarters of a large
insurance company chain with a central inventory operation. Mho has 2
buyers of its fastest-moving inventory item each demanding 6,000 units
per year. The cost of each unit is 150 and the inventory carrying cost per
unit is 1/15 of the unit cost. The average ordering cost is 40 per order.
There are 250 working days per year. Mho would also like to use EOQ in
computing for costs and other related computations.
REQUIREMENT:
Find the EOQ
PROBLEM 2.2: EOQ

Ms. Mho Quo is the purchasing manager for the headquarters of a large
insurance company chain with a central inventory operation. Mho has 2
buyers of its fastest-moving inventory item each demanding 6,000 units
per year. The cost of each unit is 150 and the inventory carrying cost per
unit is 1/15 of the unit cost. The average ordering cost is 40 per order.
There are 250 working days per year. Mho would also like to use EOQ in
computing for costs and other related computations.
REQUIREMENT:
Find the Average Cycle Inventory
PROBLEM 2.3: EOQ

Ms. Mho Quo is the purchasing manager for the headquarters of a large
insurance company chain with a central inventory operation. Mho has 2
buyers of its fastest-moving inventory item each demanding 6,000 units
per year. The cost of each unit is 150 and the inventory carrying cost per
unit is 1/15 of the unit cost. The average ordering cost is 40 per order.
There are 250 working days per year. Mho would also like to use EOQ in
computing for costs and other related computations.
REQUIREMENT:
Find the Annual Holding Cost
PROBLEM 2.4: EOQ

Ms. Mho Quo is the purchasing manager for the headquarters of a large
insurance company chain with a central inventory operation. Mho has 2
buyers of its fastest-moving inventory item each demanding 6,000 units
per year. The cost of each unit is 150 and the inventory carrying cost per
unit is 1/15 of the unit cost. The average ordering cost is 40 per order.
There are 250 working days per year. Mho would also like to use EOQ in
computing for costs and other related computations.
REQUIREMENT:
Find the Average Number of Orders Per Year
PROBLEM 2.5: EOQ

Ms. Mho Quo is the purchasing manager for the headquarters of a large
insurance company chain with a central inventory operation. Mho has 2
buyers of its fastest-moving inventory item each demanding 6,000 units
per year. The cost of each unit is 150 and the inventory carrying cost per
unit is 1/15 of the unit cost. The average ordering cost is 40 per order.
There are 250 working days per year. Mho would also like to use EOQ in
computing for costs and other related computations.
REQUIREMENT:
Find the Annual Ordering Cost
PROBLEM 2.6: EOQ

Ms. Mho Quo is the purchasing manager for the headquarters of a large
insurance company chain with a central inventory operation. Mho has 2
buyers of its fastest-moving inventory item each demanding 6,000 units
per year. The cost of each unit is 150 and the inventory carrying cost per
unit is 1/15 of the unit cost. The average ordering cost is 40 per order.
There are 250 working days per year. Mho would also like to use EOQ in
computing for costs and other related computations.
REQUIREMENT:
Find the Total Annual Inventory Cost
PROBLEM 2.7: EOQ

Ms. Mho Quo is the purchasing manager for the headquarters of a large
insurance company chain with a central inventory operation. Mho has 2
buyers of its fastest-moving inventory item each demanding 6,000 units
per year. The cost of each unit is 150 and the inventory carrying cost per
unit is 1/15 of the unit cost. The average ordering cost is 40 per order.
There are 250 working days per year. Mho would also like to use EOQ in
computing for costs and other related computations.
REQUIREMENT:
Find the TBO
 INVENTORY CONTROL
SYSTEMS

1 2 3
CONTINUOUS REVIEW (Q) PERIODIC REVIEW (P) HYBRID
SYSTEM SYSTEM SYSTEM
INVENTORY
CONTROL SYSTEMS
CONTINUOUS REVIEW SYSTEM
other names: reorder point (ROP) system, fixed order quantity
system, Q system
tracks the remaining inventory of an item each time a withdrawal is
made to determine whether it is time to reorder
order quantity is fixed, when to order is not fixed
reviews are done frequently or continuously
INVENTORY
CONTROL SYSTEMS
Q SYSTEM SCENARIOS
Demand
is certain
Q system σLis directly
available
Demand
is uncertain σLis not
directly
available
INVENTORY
CONTROL SYSTEMS
Q SYSTEM SCENARIO: DEMAND IS CERTAIN
we’re going to compare inventory position (IP) and reorder point (R)
don’t reorder if IP>R, reorder if IP<R, under company’s discretion to reorder or not if IP=R

IP = OH + SR - BO
*IP measures the
R = average demand *R is a specific
Where:
item’s ability to OH = on-hand inventory x lead time level at which your
satisfy future SR = scheduled receipts/open orders stock needs to be
demand BO = backorders replenished
PROBLEM 3: Q SYSTEM SCENARIO:
DEMAND IS CERTAIN

Cayapaba Office Needs’s customers demand, on average, 18 file cabinets

per day and the lead time is 5 days. There are currently 16 file cabinets
on-hand in Cayapaba’s storage room received just now. There is a
backorder of 9 file cabinets, and there is one open order for 55 more.
Solve for R, IP, and determine if Cayapaba should reorder.
INVENTORY
CONTROL SYSTEMS
Q SYSTEM SCENARIO: DEMAND IS UNCERTAIN
AND σL IS DIRECTLY AVAILABLE
creates safety stock which can be determined by a cycle-service level: the probability that there is
no stock-out between when you receive a replenishment, and the next replenishment arrives
R = average demand Safety Stock = zσL
during lead time Where:
z = z-score corresponding the z-value closest to the
+ safety stock percentage of the cycle-service level
σL = standard deviation of demand during lead time
PROBLEM 4.1: Q SYSTEM SCENARIO:
DEMAND IS UNCERTAIN

Demand for scientific calculators in Pondoyon Notebookshop during the

lead time, normally distributed, is, on average, 185 units a week with a
standard deviation of demand during lead time of 17. If the cycle-service
level is 85%, how many scientific calculators should Pondoyon hold as
safety stock? Also, what is R?
INVENTORY
CONTROL SYSTEMS
Q SYSTEM SCENARIO: DEMAND IS UNCERTAIN
AND σL IS NOT DIRECTLY AVAILABLE
R = average demand Safety Stock = zσL σL = σ√L
t

Where: Where:
during lead time
z = z-score corresponding the z- L = lead time
+ safety stock value closest to the percentage of σt = standard deviation of demand
the cycle-service level
σL = standard deviation of demand
during lead time
PROBLEM 4.2: Q SYSTEM SCENARIO:
DEMAND IS UNCERTAIN

Separate scenario: demand for scientific calculators in Pondoyon

Notebookshop is, on average of 150 units a week with a standard
deviation of 19. The lead time is 2 weeks. If the cycle-service level is
92%, how many scientific calculators should Pondoyon hold as safety
stock? Also, what is R?
 VISUALIZING CONTINUOUS REVIEW SYSTEM

TWO-BIN SYSTEM
1

1
1

1 3 2 2
2

4 3 17
4 18
3 2 4 17
4 18
3
5 16
5 16
5 16
5
7 8 14
7 13
8 14
7 13
8 14
7 13
8
9 12
9 9
12 12
9
6 10 15
6 10
11 15
6 11
10 15
6 11
10
12 13 14 12
8 13
9 14
10 12
8 13
9 10
14 12
8 13
9 10
14
11 11
7 11
7 11
7
17 16 15 17
6 16
5 15
4 17
6 16
5 15
4 17
6 16
5 15
4

C O N T I N U O U S R E V I E W S
18 19 20 18
1 19
2 20
3 18
1 19
2 20
3 18
1 19
2 20
3

4 3 2 17
4 18
3 19
2 1 17
4 18
3 19
2 17
4 18
3 19
2 17
4 18
3 19
2
5 1 16
5 20
1 3 16
5 20
1 20
1 16
5 20
1 1
20 16
5 20
1
7 8 14
7 13
8 14
7 13
8 19
3 14
7 13
8 3
19 14
7 13
8
9 12
9 4 2 12
9 12
9 12
9
6 10 15
6 11
10 5 9 15
6 11
10 18
4 16
2 15
6 11
10 4
18 2
16 15
6 11
10
12 13 14 12
8 13
9 10
14 8 12
8 13
9 10
14 17
5 14
9 12
8 13
9 10
14 5
17 9
14 12
8 13
9 10
14
7 13
8 8
13
11 11
7 14 10 11
7 12
7 11
7 7
12 11
7
17 16 15 17
6 16
5 15
4 6 17
6 16
5 15
4 14
7 15
10 17
6 16
5 15
4 14
7 10
15 17
6 16
5 15
4
13 11
6 6
11
12 15 13
8 13
8
18 19 20 18
1 19
2 20
3 16 18
1 19
2 20
3 12
9 18
1 19
2 20
3 12
9 18
1 19
2 20
3
11 16
5 15
6 16
5 15
6
17 10
11 11
10
19 17
4 17
4
18 19
3 19
3
There are two bins Eventually, the 20 Eventually, the 18
2
20
1
And the cycle goes 18
2
20
1
And on...
of stock. Stock is first bin will be second bin will be on...
taken from the empty. empty and the first So, the first bin And on...
So, the second
more accessible bin will be full. replaces the
bin replaces the
first bin. *Notice how the time it takes for a bin to get empty is
first bin while the second bin while
not constant? That’s because in a continuous review
first bin gets the second bin
system, the time you will restock a bin is only when it
restocked with a gets restocked with
goes to or below a certain threshold (in this case, when
fixed order a fixed order
the bin is empty). What is constant, however, is the
quantity. quantity.
quantity of units it takes to restock a bin.
INVENTORY
CONTROL SYSTEMS
PERIODIC REVIEW SYSTEM
other names: periodic reorder system, fixed interval reorder system,
P system
order quantity is not fixed, when to order is fixed
an item’s inventory position is reviewed periodically
INVENTORY
CONTROL SYSTEMS
PERIODIC REVIEW SYSTEM
selecting the time between reviews can be on any convenient interval, such as
each Friday or every other Friday
a protection interval is needed or the time interval for which inventory must be
planned when each new order is placed
target inventory level must equal the expected demand for time periods plus
enough safety stock to protect against demand and lead time uncertainty over
this same protection interval
 VISUALIZING PERIODIC REVIEW SYSTEM

SINGLE-BIN SYSTEM
1

TIME
1

TIME TIME
3

INTERVAL 1 INTERVAL 2 INTERVAL 3

4 2
1

1 2
1 3
3 1
2 5 2
3 6 2 4
3 4
2
5 6
17
4 4
16 4 3 4 3
16
5 5
15 5 5 5
14
7 13
8 7
17 18
8 7 7 8 7 8 7 8 7 8
12
9 19
9 8 9 9 9 9 9
6
15 11
10 14
6 20
10 10 6 10 6 10 6
12
8 13
12 12
13 10 12 13 12 10
13
9 14
10 14
11 12 13 14 12 13 14 13 14 12 13 14
14
11
7 10
11 11 11 11 11 11
17
6 16
5 15
4 17
9 16
8 15
7 17 16 17 16 15 17 16 15 17 16 15 17 16 15
15
18
1 19
2 20
3 18
4 19
5 20
6 18 19 20 18 19 20 18 19 20 18 19 20 18 19 20

P E R I O D I C R E V I E W S
There is a stock in The depleted units The replenished The depleted units And the cycle goes And on... And on...
a bin. Its maximum get replenished, bin gets depleted get replenished on...
level is 20 units. It bringing the bin to again by 6 units. again, bringing the *Notice how the number of units used to replenish the
is depleted by 3 maximum level. bin to maximum bin is not constant? That’s because in a periodic
units. level. review system, whatever amount depleted must be
replenished to reach the maximum level. What is
constant, however, is the time interval, the only time
the bin could be replenished.
INVENTORY
CONTROL SYSTEMS
HYBRID SYSTEM
Optional
Replenishment
Hybrid System
system
Base-Stock
System
INVENTORY
CONTROL SYSTEMS
HYBRID SYSTEM:
OPTIONAL REPLENISHMENT SYSTEM
other names: optional review, min-max, (s, S) system
order quantity is not fixed, when to order is not fixed, though the reviews
are periodically fixed
used to review the inventory position at fixed time intervals and, if the position
has dropped to (or below) a predetermined level, variable-sized order is placed
to cover expected needs
INVENTORY
CONTROL SYSTEMS
HYBRID SYSTEM:
BASE-STOCK SYSTEM
issues a replenishment order, Q, each time a withdrawal is made, for the same
amount as the withdrawal
order quantity depends on withdrawn amount, when to order depends
when inventory is withdrawn
a base stock/minimum level of inventory is maintained