INVENTORY MANAGEMENT

THE IMPORTANCE OF
INVENTORY
 INVENTORY is an asset that
includes goods belonging to a
company with the intention to sell in
a normal business period, or
inventory of goods that are still under
construction/production process, or
raw material inventories waiting for
their use in a production process.
THE REASONS OF COMPANIES TO
DO INVENTORY

 Eliminating the risk of late arrival of goods

 Eliminating the risk of the ordered material is not
good so it must be returned
 To stack seasonally produced ingredients
 Maintain the stability of the company's operations and
ensure the smooth production process
 Achieve optimal machine use
 Providing maximum service to customers
 Making procurement or production does not need to
be in accordance with the use or sale
 INVENTORY
FUNCTION
 To decouple or separate various parts of the
production process
 To decouple companies from fluctuations in
demand and provide inventory of goods that
will provide choices for customers
 To take advantage of quantity discounts
 To maintain the influence of inflation and rising
prices.
TYPES OF INVENTORY
(ACCORDING TO THE FUNCTION)

Batch Stock or Lot Inventory

Is inventory held for buying or making materials / goods
in large quantities from the amount needed, for
reasons; get discounts, get production efficiency, save
transportation costs.
Fluctuation Stock
Is inventory held to deal with consumer demand that
cannot be predicted.
Antisipation Stock
Is inventory held to deal with predictable fluctuations in
demand based on seasonal patterns in one year or
face increasing use / demand.
TYPES OF INVENTORY
(ACCORDING TO THE ITEM)

Raw materials stock

Purchased parts/components stock
Supplies stock
Work in process/progress stock
Finished good stock
TYPE OF INVENTORY
COSTS
Ordering cost
such as processing, wages, administration, packing,
inspection, shipping, current debt, etc.
Holding cost/carrying cost
such as capital costs, obsolescence, insurance,
taxes, security, inventory handling, etc.
Setup cost
such as idle machines, direct labor, scheduling,
expediting, etc.
Shortage cost
such as loss of sales / customers, special ordering
costs, price differences, disruption of operations, etc.
 INVENTORY MODEL FOR FREE
DEMAND

This inventory model wants to answer two

important questions:
When to order?
How much must order?

There are three types in the request model:

Economic Order Quantity (EOQ) basis
model
Production order quantity model
Quantity discount model
BASIC EQQ MODEL
(ASSUMPTIONS USED)

Requests are known, fixed and free

Lead time, known and constant
Inventory receipts are instant and complete
Discounts because quantity is not possible
Variable costs are only arrangement or
booking costs (set-up costs) or storage or
warehousing costs
Empty inventory (shortages) can be
completely avoided if the order is done at the
right time
 ORDER QUANTITY CHART

Annual Fee

Total cots curve

Storage cost curve
Mnimum total
cost

Order cost curve

Optimum order Order quantity

quantity
EQUATION DEVELOPMENT
STEPS

Make an equation for set-up fees or

ordering fees
Make an equation for storage costs
Determine set-up costs that are equal
to storage costs
Complete the equation for optimum
order quantity
DESCRIPTION OF SYMBOLS

Q (quantity) = number of items in each

order
EOQ = the optimum number of items
on each order
D (demand) = annual demand in units
for supplies
S (setup) = setup fee or booking fee for
each order
H (holding) = the cost of storing or
storing per unit per year
 STEPS FOR COMPLETING
EQUATION
Annual set-up fee = (number of messages placed per year) x
(setup fee or booking fee per order)

anual request Setup fees or booking

= x
number of units in each order fees per order

D
= x (S )
Q

Annual annual storage costs = (average inventory level) x

(storage costs per unit per year):
= order quantity
( storage cos ts per unit per year )
2
Q
= H
2
STEPS FOR COMPLETING
EQUATION
 Optimal order quantities are obtained when
annual setup costs equal annual storage
costs, namely:
D Q
S  H
Q 2

 Final equation
2 DS  Q 2 H
2 DS
Q 2

H
2 DS
Q 
H
EXAMPLE CASE

 A hospital intended to reduce inventory costs by

determining the optimum number of syringes for
each order. Annual demand is 1000 units, setup or
booking costs are $ 10 per order, and storage
costs per unit per year are $ 0.50. working days
per year 250 days. Calculate the most
economical / optimum order rate, number of orders
(N), estimated time between orders (T) and total
annual inventory costs?
ANSWER CASE
demand 1000
N   5 orders per year
order quantity 200
2 DS
Q 
H
2(1000)(10)
  40.000  200 unit
0,50

demand 1000
N    5 orders per year
order quantity 200
number of working days per year
T 
amount of order required
250 working days per year
  50 days between orders
5 orders
D Q 1000 200
Total cos t  S  H  ($10)  ($0,50)
Q 2 200 2
 $50  $50  $100
REORDER POINT

Reorder Point (ROP) = (request per day) x (lead

time for new orders in units of days) = (d x L)
Safety stock
Is an additional inventory that allows requests
that are not uniform in a reserve

Demand per day (d) =

D
d 
number of working days in one year
EXAMPLE CASE
Electric companies have requests for 8000 VCRs
every year the company operates for 250 working
days per year. On average, shipping an order
takes 3 working days. Calculate the ROP?

ANSWER:
D 8000
d=   32 unit
number of working days in one year 250

ROP = d x L = 32 unit per day x 3 days = 96 unit

Image of EOQ, ROP, and
Safety Stock Relationships
Inventory Level

EOQ
Order
Made
Economic
d Order
Quantity

ROP R=dL
Safety
Stock
Time
L L
PRODUCTION ORDER QUANTITY
MODEL

Is an economical order quantity technique that is applied to

production orders.
Annual inventory = Average inventory = Storage costs per unit
storage costs level per year

Average inventory = inventory level max imum

level 2
Inventory level = Total production - Total use during
maximum during production production time
time
= Pt - dt Q Q
Inventory level max imum  P ( )  d ( )
P P
d d
 Q  Q  Q (1  )
P P
PRODUCTION ORDER QUANTITY
MODEL

Annual inventory storage costs =

Inventory level max imum Q d 
(H )  1  ( ) H
2 2  P 
Ordering cos ts equal to storage cos ts
D 1  d 
S  HQ 1  ( )
Q 2  P 
2 DS
Q2 
 d 
H 1  ( ) 
 P 
2 DS
Q ( EOQ ) 
 d 
H 1  ( )
 P 
EXAMPLE CASE

Nathan manufactures, manufactures and sells

hubcaps specifically for the retail car market. The
company's forecast for hubs for wire mesh wheels
is 1000 units next year, with an average demand of
4 units per day. However the most efficient
production process is 8 units per day. Therefore the
company produces 8 units per day, but only uses 4
units per day. Assuming 1 year 250 days,
determine the optimum number of units per order
ANSWER CASE
Known: annual request, D = 1000 units
Setup fee = S = $ 10
Storage costs = H = $ 0.50 per unit each year
Daily production rate = P = 8 units per day
Daily demand rate = 4 units per day

2 DS
QP 
H 1  (d / P )
2(1000)(10) 20.000
QP    80.000
0,501  ( 4 / 8) 0,50(1 / 2)
 282,8 dop atau 283 dop
QUANTITY DISCOUNT

That is an approach in EOQ that uses a reduced price

for items purchased in large quantities
The main factor in considering discounts is that quantity
is between reduced product costs and increased storage
costs
Total cost = setup fee + storage fee + product cost

D Q
TC  S H  PD
Q 2
STEPS IN THE QUANTITY
DISCOUNT MODEL
For each discount, calculate a value for the optimum
order size, formula:
2 DS
Q 
IP
 
For any discount, if the order quantity is too low to meet
the discount requirements, the lowest quantity of order
quantity is adjusted to meet the requirements for the
discount.
a) Calculate the total cost for each Q (EOQ) specified in
steps 1 and 2.
b) Select Q (EOQ) which has the lowest total cost, as
calculated in step three.
EXAMPLE CASE 1
Wohl Discount stores have a stock of toy racing cars given a
discount schedule as in the table. In addition, the booking
fee is $ 49 for each message, an annual demand of 5,000
units, warehousing costs as a percentage of the storage fee
of 20%. What is the order quantity that will minimize
inventory costs.

Discount Discount Discount Discount

Amount Quantity (%) Price (P)
1 0 s/d 999 No discount $5,0
2 1.000 s/d 1.999 4 $4,8
3 Above 2.000 5 $4,75
ANSWER CASE 1
The first step count Q for each discount.
(2(5000)(49)
Q1   oder 700 cars
(0,2)(5,0)
2(5.000)(49)
Q2   order 714 cars
(0,2)((4,8)
2(5000)(49)
Q3   order 718 cars
(0,2)(4,75)
Second step. Make adjustments to Q values. Below the
vulnerable discounts allowed.
Q1 = 700
Q2 = 1.000 – adjusted
Q3 = 2.000 – adjusted
The third step, calculates the total cost for each order
quantity.
 Calculation of Total Costs
Discount Unit Order Annual Annual Storage Total Costs
Number Price Quantity Product Booking Costs
Costs Fee

1 $5,0 700 $25.000 $350 $350 $25.000

2 $4,8 1.000 $24.000 $245 $480 $24.000
3 $4,75 2.000 $23.000 $23.750 $950 $24.822,5

The fourth step: Select the order quantity with the lowest
total cost
EXAMPLE CASE 2
An ABC soy sauce company requires raw materials
every 364 quintals. The price of soybean raw
materials per quintal is $ 160. Message costs per
order $ 728, -. The cost of storing raw materials is
40%.

Question :
a. Calculate the Economic Order Quantity?
b. Prove that the order results based on EOQ are
the cheapest?
c. If the raw material supplier gives a discount of
10% if every order is 182 quintals. Is the offer
accepted or rejected?
ANSWER CASE 2
a. Economic Order Quantity
2 DS 2 x364 x728
EOQ    8,281  91 qu int als
PI 160 x 40%

b. Proof.
364 quintals of raw material can be ordered:
364/91 = 4 times order
364/182= 2 times order
364/52 = 7 times order
 ANSWER CASE 2 (CONT.)

1) 2 orders
Average inventory value =
182 quintals x $ 160 /2 = $ 14.650,-
Annual booking fee = 2 x $728 = $ 1.456,-
Storage costs = 40%x$14.650 = $ 5.824,-
Raw material costs a year = 364 x $160 = $ 58.240,-+
Total annual fee = $ 65.520,-
ANSWER CASE 2 (CONT.)

2) 4 orders
Average inventory value =
91 quintals x $ 160 /2 = $ 7.280,-
Annual booking fee = 4 x $728 = $ 2.912,-
Storage costs = 40% x $7.280 = $ 2.912. ,-
Raw material costs a year = 364 x $160 = $ 58.240,-+
Total annual fee = $ 64.064,-
ANSWER CASE 2 (CONT.)

3) 7 orders
Average inventory value =
52 quintals x $ 160 /2 = $ 4.160,-
Annual booking fee = 7 x $728 = $ 5.096,-
Storage costs = 40% x $4.160 = $ 1.664. ,-
Raw material costs a year = 364 x $160 = $ 58.240,-+
Total annual fee = $ 65.000,-

So the cheapest fees are booked 4 times a year

with a total cost of $ 62,244, per year
 ANSWER CASE 2 (CONT.)

c. Given a 10% discount if one message 182

quintals or 1 year is ordered 2 times.
Average inventory value =
182 quintals x $ 160 x 90% /2 = $ 13.104,-
Annual booking fee = 2 x $728 = $ 1.456,-
Storgae costs = 40% x $13.104 = $ 5.242,-
Raw material costs a year = 364 x $ 160 x 90% = $ 52 .
416,-+
Total annual fee = $ 59.114,-

So the discount offer is accepted because it's cheaper.

EXAMPLE CASE 3

A company needs 364 quintals of raw material in

a year and 7 quintals of raw material every week
(1 year 57 weeks), 4 weeks lead time. The price
of raw materials is $ 160 per quintal. Message fee
of $ 728 per order. The supply of raw materials is
40 quintals. Storage costs are 40% warehouse.
Safety stock 50% of the use of lead time
questions: Calculate EOQ, Calculate ROP,
Calculate maximum inventory, calculate inventory
average, and calculate inventory turnover rate?
ANSWER CASE 3
a. Economic Order Quantity (EOQ)
2 DS 2 x364 x 728
EOQ    91 kw int al
PI 160 x 40%
b. Reorder Point (ROP)
Usage for leed time = 4 weeks x 7 quintals = 28
quintals
Safety stock = 50% x 28 quintals = 14 quintals
ROP = 28 quintals + 14 quintals = 42 quintals
This means that the order of 91 quintals is done
when the remaining 42 quintals are available.
 ANSWER CASE 3 (CONT.)
c. Maximum inventory
• Safety stock + EOQ = 14 quintals + 91 quintals =
105 quintals
• Average inventory includes safety stock EOQ / 2
+ safety stock = 91/2 +14 quintals 59.4 quintals
• Average inventory which is current assets 59.5
quintals - 14 quintals = 45.5 quintals
• If the inventory is 40 kw, it means that the initial
raw material inventory which is current assets =
40 quintals - 14 quintals = 26 quintals
• The final raw material inventory plan which is
current assets = EOQ - initial inventory = 91
quintals - 26 quintals = 65 quintals
ANSWER CASE 3 (CONT.)

d. Inventory turnover rate

raw materials needed during the period

TPP of raw materials 
average raw material inventory
364
TPP   8 times
(26  65) x 2
EOQ EXERCISE

PT. MEGAH is a company engaged in electronics,

the raw materials used are supplied by suppliers.
In one year requires 400,000 units of raw
materials at a price per unit of Rp. 10,000, - and
the cost to pay once is Rp. 750,000. 20% storage
cost of average inventory. If the company buys
every quarter, a 3.5% discount will be given.
From the data above you are asked to:
EOQ EXERCISE (CONT.)

 Calculate the economical amount of purchase

(EOQ)?
 Calculate Reorder Points (ROP) if the waiting time
is 15 days (assuming 1 year 300 days) and savety
stock 2% of the raw material requirements for one
year?
 Determine the optimum order per year and the
optimum order per day?
 Calculate whether the 3.5% discount offer should
be taken or rejected?
 Draw a graph of EOQ, ROP, Savety stock and
lead time relationships?