BUS 309

Handout # 6:

Inventory Management

CLO # 6: Apply inventory management concepts to effectively plan

operations.

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Chapter Outline

 The role of inventory

 Inventory costs
 Inventory control systems
 Economic order quantity models

2
What Is Inventory?
 Stock of items kept to meet future demand

 Purpose of inventory management

◦ how many units to order
◦ when to order

 Types of inventory
◦ Raw materials
◦ Purchased parts and supplies
◦ Work-in-process (partially completed) products
◦ Tools and equipment
Inventory Costs

 Carrying cost
• cost of holding an item in inventory

 Ordering cost
• cost of replenishing inventory

 Shortage cost
• temporary or permanent loss of sales when
demand cannot be met
 Inventory Control Systems

• Continuous system (fixed-order-quantity)

constant amount ordered when inventory
declines to predetermined level

• Periodic system (fixed-time-period)

order placed for variable amount after fixed
passage of time
Economic Order Quantity (EOQ)
Model
 EOQ
◦ optimal order quantity that will minimize total inventory
costs

 Assumptions of Basic EOQ Model

◦ Demand is known with certainty and is constant over
time
◦ No shortages are allowed
◦ Lead time for the receipt of orders is constant
◦ Order quantity is received all at once
Inventory Order Cycle
Order quantity, Q
Demand
rate
Inventory Level

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
placed receipt placed receipt
EOQ Cost Model

Co - cost of placing order D - annual demand

Cc - annual per-unit carrying cost Q - order quantity

Co D
Annual ordering cost =
Q
CcQ
Annual carrying cost =
2
Co D CcQ
Total cost = +
Q 2
EOQ Cost Model

Deriving Qopt Proving equality of

costs at optimal point
Co D CcQ
TC = +
Q 2 C oD CcQ
=
TC Co D C Q 2
= + c
Q Q2 2 2CoD
Q2 =
- C0 D Cc Cc
0= +
Q2 2
2CoD
2CoD Qopt =
Qopt = Cc
Cc
EOQ Cost Model (cont.)
Annual
cost ($) Total Cost

CcQ
Minimum Carrying Cost =
2
total cost

CoD
Ordering Cost =
Q

Optimal order Order Quantity, Q

Qopt
EOQ Example
Cc = $0.75 per yard Co = $150 D = 10,000 yards

2CoD CoD CcQ

Qopt = TCmin = +
Cc Q 2
2(150)(10,000) (150)(10,000) (0.75)(2,000)
Qopt = TCmin = +
(0.75) 2,000 2

Qopt = 2,000 yards TCmin = $750 + $750 = $1,500

Orders per year = D/Qopt Order cycle time = 311 days/(D/Qopt)

= 10,000/2,000 = 311/5
= 5 orders/year = 62.2 store days