Inventory Management

LSCM3221
3Cr.hrs
 Course Description and Objectives
 This is a course on inventory management. It describes recent
thinking about inventory/stock and methods for its control.
 Inventories play a crucial role in every economy.
 For example, in the United States total value of business inventories
is about 1.3 trillion dollars, representing 9% of the country’s current
GDP (in, 2010).
 Inventory management is the process of ordering, handling, storing,
and using a company’s non-capitalized assets - AKA its inventory.
 For some businesses, this involves raw materials and components,
while others may only deal with finished stock items ready for sale.
 Either way, inventory management all comes down to balance -
having the right amount of stock, in the right place, at the right time.
 And this course will help you achieve just that.
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 Specifically, after a successful completion of this course students
will be able to:
1. Enunciate key concepts in inventory management.
2. Explain why do organizations hold inventories/stocks.
3. Set inventory management in its overall context, noting its
interactions with other activities, and explicitly recognizing its
strategic importance.
4. Describe the two approaches to inventory management; namely
the independent demand methods and dependent demand
methods.
5. Discuss the information needed to support these methods,
including information from the inventory management
information system, forecasts of demand and planned operations.
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 Brief outline of the course
1 Overview of Inventory
Management

2 Inventory within
an Organizations

3: Forecasting
4. Inventory
Analysis and control
5. Material Requirements
Planning

6. Models for
Independent Demand

7. Just-in-Time
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 Assessment and Evaluation
 Individual Assignment……………………….……10%
 Group assignment (including presentation)……….20%
 Tests……………………………………………..……….20 %
 Final Examination…..………………….…...…….50%

 Total……………….......................................100%

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 Class Policy

1. Question of the Day/Session/Semester

game.
 We will play a game in our Class called the
Question of the Day/Session/Semester game.
 The student who asks the best question during
the day/Session/Semester receives a special prize.
2. Others (as indicated on the course outline)

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Chapter One 8

Overview of
Inventory
Management

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 Aims of the chapter
 After successful completion of this chapter
you should be able to do the following:
 define the main terms used for inventory
management;
 discuss the reasons for holding stock;
 explain the elements of good inventory
management practices; and
 describe different categories of inventories.

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 Chapter Outline

1. Introduction : Defining key concepts.

2. What is Inventory Management
3. Constructs of Good Inventory Management
4. Purposes of inventory: Reasons for holding
inventory
5. Types of Inventories.

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 1.1 Introduction: Defining Key Concepts

1. Inventory Vs Stock
 All organizations hold inventory. These are the stores of materials
they keep until needed.
 Thus, it isn’t just retail stores that must manage inventories.
 In fact, inventories pervade the business world.
 Maintaining inventories is necessary for any company dealing with
physical products, including manufacturers, wholesalers, and
retailers.
 For example,
 Manufacturers need inventories of the materials required to make
their products. They also need inventories of the finished products
awaiting shipment.
 Similarly, both wholesalers and retailers need to maintain inventories
of goods to be available for purchase by customers.
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 A shop buys goods from a wholesaler and keeps
them in stock until it sells them to customers;
 A factory keeps a stock of raw materials for its
products;
 A television company has a stock of recorded
programs;
 A farmer stores hay to feed his animals over the
winter;
 A research company has a stock of information;
 A bank holds cash for its day-to-day transactions.
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 A problem in connection with this practice is that
people use terms such as inventory, stock,
materials, items,… in different ways.
 In recent years it has become more common to use
‘inventory’ for both the list of items and the stock itself,
and the two terms then become interchangeable.
 At the same time, organizations refer to their stock as
stores, provisions, stockpiles, holdings, reserves,
accumulated materials, banks, or a host of other names.
 To add to the confusion some groups put slightly
different interpretations on the terms.
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 Accountants, for example, view ‘inventory’ as the
amount of money tied up in stocks, rather than
the stocks themselves, or it might be the total
value of an organization’s assets.
 To finance people, ‘stocks’ are a way of raising
capital – in the sense of ‘stocks and shares’ – and
have nothing to do with stores of materials.
 Usually, these differences are fairly obvious and
cause few problems, but sometimes you have to
be a bit more careful.
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 In short:
 Stock consists of all the goods and materials that are stored
by an organization. It is a store of items that is kept for
future use or sale.
 An inventory is a list of the items held in stock.
 The Institute of Logistics and Transport defines inventory
as:
 all the goods and materials held by an organization for sale or
use
 a list of items held in stock.
 Inventory is also defined as:
 Materials in a supply chain or in a segment of a supply chain,
expressed in quantities, locations and/or values (synonym stock).
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 2. Item vs Unit
 An item is a distinct product that is kept in stock: it is one entry
in the inventory. Each entry in the inventory is a distinct item
that is held in stock.
 A unit is the standard size or quantity of an item.
 A supermarket, for example, has ‘one- liter bottles of Diet Coke’
as a distinct item.
 Other items in its inventory might be ‘two- liter bottles of Diet
Coke’, ‘half-liter bottles of Diet Coke’, ‘one-liter bottles of Diet
Pepsi’, and every other distinct product that it sells.
 Some people use different terms, with the most common
alternative being stock keeping unit or SKU.
 A typical supermarket, for example, stocks about 30,000
items/ SKU.
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 Each item is sold or consumed in standard
quantities, or units.
 With our one-liter bottles of Diet Coke, the
unit is clearly a bottle.
 Similarly, unleaded petrol is an item in a
filling station, and each liter is a unit.

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 1.2 What is Inventory Management?

 The American Production And Inventory Society (APICS)

defines inventory management as the branch of business
management concerned with planning and controlling
inventories.
 Inventory management is the function responsible for all
decisions about stock in an organization. It makes
decisions for policies, activities and procedures to make
sure the right amount of each item is held in stock at any
time.
 Inventory management is the process of ordering,
handling, storing, and using a company’s non-capitalized
assets (i.e., inventory).
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 Inventory management is the practice overseeing and
controlling of the ordering, storage and use of
components that a company uses in the production of
the items it sells.
 A component of supply chain management,
inventory management supervises the flow of goods
from manufacturers to warehouses and from these
facilities to point of sale.
 Inventory management is the process of monitoring
and controlling inventory level and ensuring adequate
replenishment in order to meet customer demand.
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 The bottom line:
 We’ve covered the broad definition of inventory
management.
 But what’s actually​ involved when it comes to making
good inventory management happen?
 It enables you to:
1. Balance inventory levels - having the right amount
of stock, in the right place, at the right time; so that
having too much or too little of each product in
stock is avoided.
2. Efficiently utilize the capital invested in raw materials
and supplies, work- in – progress and finished goods.
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 1.3 Constructs of Good
Inventory Management
 The key aspects in achieving good inventory management are:
1) Types of inventory.
2) Forecasting.
3) Purchasing.
4) Storage.
5) Analysis.
6) Techniques.
7) Tracking.
8) Accounting.
9) Systems and tools.
 These are the basic ingredients of quality inventory management.
 And you’ll need to take a systematic approach to them in order to
best equip your business for long term growth.
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 Types of inventory. So you know what type of
inventory is where and can have full visibility over
it.
 Forecasting. So you know how much stock is
needed to satisfy demand over an upcoming time
period.
 Purchasing. So you know when​ and how​to create
purchase orders to re-order new stock.
 Storage. So you know how much of each inventory
item can be suitably housed, and where to send it.
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 Analysis. So you can use metrics to make more informed
decisions about your inventory as time goes on.
 Techniques. So you can quickly and efficiently book-in, put
away, pick, pack and ship inventory as and when needed at
your various locations.
 Tracking. So you have visibility on where exactly your
inventory is as well as additions (purchases) and subtractions
(sales), to give as close to a live stock figure as possible.
 Accounting. So you can properly record your inventory on
financial documents.
 Systems & tools. So you know which software is right for your
business, and when the right time is to implement it.
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 1.4. Purposes of Inventory

 Why inventories exist in your organization?

 Although some argue against the necessity of holding inventory
( inventory is “the root of evil,”), and still others state that
inventory is a necessary evil, we advocate that inventory is
necessary to satisfy the customer.
 Inventory exists because supply and demand are difficult to
synchronize perfectly and it takes time to perform material-
related operations.
 For several reasons, supply and demand frequently differ in the
rates at which they respectively provide and require stock.
 Organizations cannot function without it.
 It would be ideal if demand and supply could be so coordinated
that no inventories would be needed.
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 Because, it is either impractical or impossible to
know future demand with full certainty and, the
availability of supplies cannot be guaranteed at a
given moment.
 Inventories are accumulated to ensure an
availability of goods and to minimize the overall
costs of producing and distributing the goods.
 Thus, every organization stores materials of one
kind or another for the following purposes.

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a) To protect against uncertainties
b) To achieve economies of scale in
purchasing, transportation and production
c) To hedge against contingencies
d) To cover anticipated changes in demand
and supply
e) Provide and maintain good customer
service
f) To decouple manufacturing process.
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 a) To protect against uncertainties

 In inventory systems, there are uncertainties in supply, demand, price,

and lead-time of materials.
 Safety stocks are maintained in inventory to protect against those
uncertainties.
 Safety stocks of raw materials are maintained to absorb uncertainties in
supply, price and delivery of vendors.
 Safety stocks of in-process inventories are maintained to allow for fast
schedule changes.
 In a similar way, a firm also stocks finished goods inventories to absorb
changes in demand without immediately changing production.
 In most cases, the level of demand on a materials management system
and the time required for resupply cannot be known for sure.
 To assure product availability at a reasonable price, safety stocks are
maintained to provide this protection.
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b) To achieve economies of scale in purchasing,
transportation and production

 Due to ordering costs and quantity discounts, it is often

economical to purchase in large lots because more can
be purchased at one time than is immediately needed.
 Likewise many purchases on small quantities can mean
that the highest transportation rates are paid; one
purpose for establishing an inventory would be to allow
shipping to or form the inventory under the lower per
unit rates of full vehicle load quantities.
 In a similar way, the lowest per unit cost for producing
products generally occurs with long or continuous
production runs at constant quantities.
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 c) To hedge against contingencies

 Labor strikes, fires, floods, and earthquake,

price inflation are just a few of the
contingencies that can be fall an organization.
 Maintaining backup inventories is one way in
which normal supplies can be maintained for
a period of time.

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 d) To cover anticipated changes in demand and
supply

 There are several types of situations where changes

in demand and supply may be anticipated.
 One case is where the price or availability of raw
materials is expected to change.
 Another source of anticipation is planned market
promotion where a large amount of finished goods
may be stocked prior to sale.
 Finally, companies in seasonal businesses often
anticipate demand in order to smooth
employment.
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 e) Provide and maintain good customer
service

 Inventories are carried in order to:

 Ensure an adequate and prompt supply of items to the
customer to avoid the reputation for constantly being out of
stock and avoid the shortage at a minimum cost.
 Provide service to customers with varying demands and in
various locations by maintaining an adequate supply to meet
their immediate and seasonal needs.
 Stock outs (lack of inventories) may occur when there are raw
material shortages, or sole-source supplier with production
problems that increase the risk of inadequate supply.
 As a result of stock out, lack of a particular product could shut
down operations or cause customers to go to competitors.
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 f) To decouple manufacturing process

 One major purpose of inventory is to decouple

manufacturing processes within the organization. It
acts as a buffer.
 For example, when one manufacturing activity has to
be completed before a second active can be started.
 If there is no inventory, the activity of second process
can be stopped.
 But if there is inventory, it can be used as buffer.
 Thus, the decoupling function of inventory implies
inventory avoids many delays and inefficiency.
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 1.5 Types of inventory
 An understanding of the purpose of inventory
reveals that there
are various types of inventories.
 These can be classified in terms of different basis.
 Most commonly, inventories can be categorized
based on:
1. The source of demand.
2. The position of the inventory in the process.
3. The function or use of inventory in the process.
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 i. The source of demand
 The first categorical division of inventory is based on the
source of demand.
 There are essentially two ways to categorize inventory
based on the source of demand:
1) Independent demand inventory.
 The source of demand for this type of inventory is
typically from sources outside the company itself, usually
emanating from an external customer.
 It is called independent since the demand for it is
essentially independent of any internal actions of the
firm. In many cases these items are the end items of
production, often a “sellable” finished good.
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 2) Dependent demand inventory.
 The source of dependent demand inventory is directly
dependent on internal decisions primarily on the
inventory is directly dependent on internal decisions,
primarily on the decision of how many of which product
to produce at what time.
 It should be noticed that some may think this is still
dependent on customers, but in fact many firms can
decide to produce at far different times and at different
rates than what represents the external customer demand.
 This goes back to the concept of inventory as stored
capacity.
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 ii. The position of the inventory
in the supply chain
 The second classification of inventory is
based on its position in the supply chain.
 The more it moves downstream from the factory
towards the final consumer, the higher the value of
the inventory.
 The four general categories include:
 Raw materials
 Work in process (WIP)
 Finished goods
 Maintenance repair and operations (MRO).
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1) Raw materials represent inventory that has been purchased for use
in the production process, but have had no value added by the
company’s production process.
2) Work in process (WIP) represent inventory that has had some value
added, but still has additional processing to be completed before it
can be used to meet customer demand.
3) Finished goods represent inventory that has completed all the
processing from the firm. It is generally ready to be used to meet
customer demand, with the possible exception of packaging.
4) Maintenance repair and operations (MRO) inventory is material
used to support the company’s business and production processes,
but typically will never be directly sold to a customer. It is made up
of spare parts, machine oil, cleaning supplies, office supplies, and so
forth.
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 iii. The function or use of
inventory in the process.
 The third and final categorical division is the function
or use of inventory in the process.
 The most common categories in this area include:
1) Transit inventory is inventory in motion from one
activity to another.
 Inventory in the transportation system is the most
common form.
2) Cycle inventory is inventory that exists because for
any time period the rate of replenishment exceeds the
demand — a situation often caused because of order
costs, setup costs, or packaging considerations.
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3) Buffer inventory is also called safety stock, and exists
just in case.
 There are many situations that can occur in a firm that can
disrupt the normal flow of work in the operation.
 Workers can fail to come to work, suppliers can be late
with shipments or ship the wrong product quality
suppliers can be late with shipments or ship the wrong
product, quality problems can occur, machines can break
down, and so forth.
 Inventory that is maintained explicitly to protect the
organization just in case one or more of these problems
occur is called buffer inventory or safety stock.
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4) Anticipation inventory is inventory built up on
purpose in anticipation of some demand in excess of
the usual production output.
 The two most common uses for this are to accommodate
seasonal demand or marketing promotions.
5) Decoupling inventory is inventory that is purposely
placed between operations to allow them to operate
independently of one another.
 Any inventory in the system, regardless of the
reason for its existence, can serve as decoupling
inventory, even if that is not the intention.
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