Inventory Management

Definition of Inventory
Inventories are stock of the product a company is
manufacturing for sale and components that make
up the product.
Water Tank Analogy for
Inventory
Inventory Level
Supply Rate

Inventory Level

Demand Rate
 Types of Inventories
1. Raw material
2. Work in process
3. Finished goods
 Types of Inventory

Work in
process

Vendors Raw Work in Finished Customer

Materials process goods
Work in
process
 Reasons To Hold Inventory
 Smooth Production
 To achieve competitive edge
 Meet variations in customer demand:
– Meet unexpected demand
– Smooth seasonal or cyclical demand
 Pricing related:
– Temporary price discounts
– Take advantage of quantity discount
 Reducing ordering costs and time
 Reduce risk of production stoppages
 Costs associated with inventories

 Material costs
 Ordering costs
 Carrying costs
 Shortage costs or stock out costs
Inventory Hides Problems

Bad
Design
Lengthy Poor
Setups Quality
Machine
Inefficient Unreliable
Breakdown
Layout Supplier
 To Expose Problems:
Reduce Inventory Levels

Bad
Design
Lengthy Poor
Setups Quality
Machine
Inefficient Unreliable
Breakdown
Layout Supplier
 Remove Sources of Problems
and Repeat the Process

Poor
Quality

Lengthy
Setups

Bad
Machine
Design Inefficient Unreliable
Breakdown
Layout Supplier
 Inventory Counting Systems
• Periodic System
Physical count of items made at periodic
intervals
• Perpetual Inventory System
System that keeps track
of removals from inventory
continuously, thus
monitoring
current levels of
each item
• Two-Bin System - Two containers of inventory; reorder when
the first is empty
• Universal Bar Code - Bar code
printed on a label that has
information about the item
to which it is attached

214800 232087768
INVENTORY MANAGEMET TECHNIQUES
1) ABC Classification System
Classifying inventory according to some measure of importance
and allocating control efforts accordingly.

A - very important
B - mod. important
C - least important
High
A
Annual
$ value B
of items

Low C
Few Many
Number of Items
 ABC Classification
• Class A
– 5 – 15 % of units
– 70 – 80 % of value
• Class B
– 30 % of units
– 15 % of value
• Class C
– 50 – 60 % of units
– 5 – 10 % of value
ABC Classification: Example
PART UNIT COST ANNUAL USAGE
1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120
 TOTAL % OF TOTAL % OF TOTAL
PART PART
VALUE UNIT
VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
9 1
$30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 40 11.0
2 14,000 16.4 4.0 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 4
4,800 5.680 6.0 60 30.0
3 5
3,900 4.630 10.0 100 40.0
6 6
3,600 4.220 18.0 180 58.0
5 3,000
7 3.510 13.0 170 71.0
10 2,400 2.8 12.0 83.0
8 320 50
7 1,700 2.0 17.0 100.0
9 510 60
$85,400
10 20 120
 % OF TOTAL % OF TOTAL
CLASS ITEMS VALUE QUANTITY

A 9, 8, 2 71.0 15.0
B 1, 4, 3 16.5 25.0
C 6, 5, 10, 7 12.5 60.0
2) ECONOMIC ORDER QUANTITY (E0Q)

 EOQ refers to the optimal order size that will result in the
lowest ordering and carrying costs for an item of inventory
based on its expected usage.
 EOQ is defined as that level of inventory order that
minimizes the total cost associated with the inventory
management.
 It is that level one unit beyond which is additional cost to
the firm and one unit below may hamper production
process.
The model is based on the following assumptions;

• Constant or uniform demand

• Constant unit price
• Constant carrying costs
• Constant ordering costs
EOQ = √2AB
CS

Where,
EOQ = Economic ordering quantity
A= Annual consumption
B=Buying cost per order
C=Cost per unit
S= Storage and carrying cost per annum
EX. From the following particulars calculate
Economic order quantity.
Annual consumption= 16,000 units
Buying cost per order= 18
Cost per unit of material=1
Carrying cost =20% per annum
EX. From the following particulars calculate
Economic order quantity.
Annual consumption= 2,000 units
Buying cost per order= 100
Cost per unit =10
Carrying cost =20% per annum
Determination of stock levels
1.Maximum stock level
=Re-order level + Re-order quantity- (Minimum consumption*
Minimum Re-ordering period)
2. Minimum stock level
= Re-order level- (Normal consumption*Normal Re-order period)
3. Danger level
= Average rate of consumption * Emergency supply time
4. Re—order level
= =Maximum consumption * Maximum Re- order period
5. Average stock level
= Minimum level + Maximum level
2
EX. From the following particulars calculate the
(a) Maximum stock level
(b) Minimum stock level
(c) Re-ordering level
(d) Average stock level

Normal consumption=600 units per week

Maximum consumption=840 units per week
Minimum consumption=480 units per week
Re-order quantity=7200 units
Re-order period=10 to 15 weeks
Normal reorder period=12 weeks