Chapter 9 :

Inventory
Management
Nur Khairunisa Binti Nazarudin
Nurul Atiqah Binti NoorAzman
Nabila Binti Azmi
19.5.93

Function of Inventory
The four (4) main functions of inventories :
1. To provide a selection of goods for anticipated demand and separate the firm
fluctuations in demand
.

A sufficient level of inventory is required to avoid unnecessary loss of sales.

Enough inventories will ease the production process and provide better
product selection as well as prompt deliveries to customers.

2. To separate (decouple) various parts of the production process

.

A sufficient inventory may prevent work stoppage and smoothen the running
of the manufacturing cycle.

3. To take advantage of discounts

.

Suppliers offer discount for large orders. Thus, firms may buy more and
increase inventory to take advantage of the discounts.

4. To hedge against future price increase

. Firms will buy more and increase their inventory when the price of raw
materials is low and expected to increase in the future.

Types of Inventory
The four (4) types of inventories :
i. Raw materials - consist of the basic materials or
components that are purchased by a firm to be
used in producing or manufacturing products.
ii. Work in progress - consist of partially finished
goods that require additional work, before they
become finished goods.
iii. Maintenance/repair/operating - consist of items that
are necessary to keep machinery and processes
productive.
iv. Finished goods - consist of completed products
which are yet to be sold or are awaiting shipment.

Managing Inventory

- two main ingredients of such a system

- for example, how inventory items can be classified (called ABC
analysis) and how accurately inventory records can be
Themaintained
four (4) techniques of inventory management that can be used by
the operation manager are :

i. ABC Analysis - a method that divides on-hand inventory into three

classifications, based on annual dollar volume. Based on this
method, inventory into Class A, Class B and Class C.
Dividing items into classes allows different policies and controls to be
established for each class. Policies that are based on the ABC analysis
may include :
1. Supplier development strategy should focus on suppliers of items
A.
2. Tighter control should be placed on items A compared to items B
and C.
3. Forecasting for items A requires more care than foresting for items

ii. Record Accuracy

- Accurate records are a critical ingredient in
production and inventory systems.
- Accurate records are necessary to assist
the operations manager in making precise
decisions about ordering, scheduling and
shipping.
- A well-organized stockroom will allow
limited access and have good housekeeping.

iii. Cycle Counting

-.

Items are counted and records are updated on a periodic

basis.

-.

Five advantages of cycle counting are :

1. It eliminates shutdowns and interruptions of

productions, as a result of the annual physical
inventories checking.
2. It eliminates annual inventory adjustment.
3. It uses trained personnel to audit inventory accuracy.
4. It allows causes of errors to be identified and corrected.
5. It maintains accurate inventory records.

iv. Control of Service Inventories - deserves

special consideration and can be a critical
component of profitability.
Applicable technique that can be used to
control service inventories include :
1. Good personnel selection, training and
discipline
2. Tight control on incoming shipments
3. Effective control on all goods leaving the
facility

Inventory Models
There are four (4) cost elements that are
associated with inventory are :
i. Carrying or holding costs - the costs of holding
or carrying inventory over time. Eg; insurance,
extra staffing and the opportunity cost of
funds tied up in inventory, pilferage, damage,
handling costs and storage space.
ii. Ordering costs - the costs of placing an order
and receiving goods. Eg; include the cost of
processing an order (clerical costs and
documents)

iii. Setup costs - the costs of preparing a

machine and facilities, so that they can be
used to produce a particular product or
component. Eg; clean-up costs, re-tooling
costs, adjustment costs and test run
costs.
iv. Stock-out costs - the costs of not having a
product available when demanded by a
customer. Eg; lost sales (both current and
future) the costs of expediting (increased
transportation charges, overtime) and the
costs of interrupted production.

When the demand for a product or material is

known with certainty for given period, two major
costs are associated with inventory
a. If the material or good is
purchased from an outside
source, then the inventoryrelated costs are known as
ordering costs and carrying
costs.
b. If the material or good is
produced internally, then the
costs are called setup costs
and carrying costs.
c. If the demand is not known
with certainty, a third
category of inventory costs
called stock-out costs exists.

Inventory Models for

Independent Demand
Three independent demand models will be
discussed in this section, namely :
1. Basic Economic Order Quantity (EOQ) Model

2. Production Order Quantity Model

3. Quantity Discount Model

Basic Economic Order

Quantity (EOQ) Model

Determining the EOQ

- To minimize the total

inventory costs
- Is the sum of total
ordering cost and
carrying or holding
cost.
- For example, optimal
order quantity (Q*)

Reorder point

ROP determines when to order inventory

Lead time

The length of time between the moment

orders are placed and the time the
inventory or stock arrives or are received.

Safety stock

To buffer stocks or additional stocks that the

firm carries in excess of the economic order
size.

Reorder point (without

safety stock) = d x L

Reorder point (with safety

stock) = (d x L) + SS

*Daily usage (d) =

Annual Demand (D)

Number of working days in a

year

D = Amount demand per year

d = Daily / weekly / monthly demand
S = Ordering cost (RM per order)
H = Carrying @ holding cost per unit per year
L = Lead time in days
SS = Safety stock
P = Price
N = No of order per year
T = Time between the order

September 2013 P(B)

Q5
(A) Define inventory.
Inventory can be defined as goods on hand or any
stock of economic resources at a given point of time,
in anticipation of satisfying a future demand for
them.
(B) Explain three (3) types of inventory.
- Raw material
- Work in progress
- Maintenance/repair/operating

October 2012 P(B)

Q4

September 2011 P(B)

Q2
(A) Define inventory.
Inventory can be defined as goods on hand or any
stock of economic resources at a given point of time,
in anticipation of satisfying a future demand for
them.
(B) Explain any three (3) reasons why companies
keep inventory.
i. Meet variation in production demand - production
plan changes in response to the sales, estimates,
orders and stocking patterns.

ii. Cater to cyclical and seasonal demand market demand and supplies are seasonal
depending upon various factors like
seasons; festivals etc and past sales data
help companies to anticipate a huge
surge of demand in the market well in
advance.
iii. Long lead and high demand items need to
be held in inventory - often raw material
supplies from vendors have long lead
running into several months.