Inventory Management

 Inventory: is the stock on hand of materials at a given time period waiting for
future use
 Inventories represent those items which are either stocked for sale or process
of manufacturing or they are in the form of materials which are yet to be
utilized.
 Is the value of the stock of goods by an organization in a particular time
 Need for inventory management
• In adequate control of inventory can result in over stocking or
under stocking
• Under stocking results in:
– Missed deliveries
– Lost sales
– Dissatisfaction of customers
– Production bottlenecks
• Overstocking
– Unnecessary tied up of funds that might be more productive
elsewhere (Interest costs, etc…)
– Insurance cost, taxes, obsolescence/depreciations, deterioration,
spoilage, breakage and warehousing costs such as heat, light,
rent, security, ……etc.
 Types of Inventory
• Independent demand – finished goods, items that are ready to be sold
– The demand for other items is unrelated to each other
– E.g. a computer
• Dependent demand – components of finished products
– The need for one item is a direct result of the need for other items
– Partially completed goods called, work in progress
– E.g. parts that make up the computer (Replacement parts, tools, &
supplies)
 Functions of Inventory
To achieve satisfactory levels of customer service while keeping
inventory costs within reasonable bounds
• To meet anticipated demand
• To smooth production requirements
• To decouple operations
• To protect against stock-outs

• To take advantage of order cycles

• To help hedge against price increases
• To permit operations
• To take advantage of quantity discounts
 Effective Inventory Management
Effective inventory management requires:
a) A system to keep track of inventory
b) A reliable forecast of demand
c) Knowledge of lead times (time interval between ordering and
receiving the order)
d) Reasonable estimates of
Holding (carrying) costs (cost to carry an item in inventory for a
length of time, usually a year)
Ordering costs (costs of ordering and receiving inventory- i.e.
constant dollar amount incurred for each order placed)
 Item Cost
• Includes price paid for the item plus other direct costs
associated with the purchase
 Capital Costs
•The higher of the cost of capital or the opportunity cost for
the company
 Shortage Costs
•Loss of customer goodwill, back order handling, and lost sales

 Risk costs
•Obsolescence, damage, deterioration, theft, insurance and
taxes
 Storage costs
•Included the variable expenses for space, workers, and equipment
related to the volume of inventory held
 Economic Order Quantity

• EOQ Assumptions:
– Demand is known & constant - no
safety stock is required
– Lead time is known & constant
– No quantity discounts are available
– Ordering (or setup) costs are
constant
– All demand is satisfied (no
shortages)
– The order quantity arrives in a
single shipment
 Functions of EOQ model
Total Cost
Annual Annual
Total cost = carrying + ordering
cost cost

Q + D S
TC = H
2 Q
Q = Order quantity
H = Holding cost
D = Annual demand
S = Ordering cost or Setup cost
 Cost Minimization Goal

The Total-Cost Curve is U-Shaped

Q D
TC  H  S
2 Q
Annual Cost

Holding cost

Ordering Costs

Order Quantity (Q)

QO (optimal order quantity)
 Minimum Total Cost

The total cost curve reaches its minimum where the

carrying and ordering costs are equal.

Q = D S
H
2 Q
 Reorder Points
 EOQ answers the “how much” question
 The reorder point (ROP) tells when to order

Demand Lead time for a new

ROP = per day order in days
=dxL
D
R= Number of working days in a year
Example: A computer company has annual demand of 10,000. They want to
determine EOQ for circuit boards which have an annual holding cost (H) of $6 per
unit, and an ordering cost (S) of $75. They want to calculate TC and the reorder
point (R) if the purchasing lead time is 5 days.

• EOQ (Q)
2DS 2 * 10,000 * $75
Q   500 units
H $6
• Reorder Point (R)
10,000
R  Daily Demand x Lead Time  * 5 days  200 units
250 days

• Total Inventory Cost (TC)

 10,000   500 
TC    $75   $6  $1500  $1500  $3000
 500   2 
Thank You!