INVENTORY MANAGEMENT

Management Science (Lecture)​

(BSA) (1-B) | Ms. Lady Kenneth M. Dizon, MBA | SEM 1 2024

INVENTORY MANAGEMENT REASONS FOR MAINTAINING AN

●​ Involves activities that organize IDEAL LEVEL OF INVENTORY
the availability of supply to the ●​ Protection against fluctuating
customers. demand.
●​ Proper coordination must be ○​ Sufficient inventories must
made with different activities, such be ready at all times to
as purchasing, manufacturing, and meet peak demand.
distribution, to meet the goals of ●​ Protection against delayed
marketing. supply.
○​ Inventories serve as a
PRIMARY ROLE OF INVENTORY buffer that can be used in
MANAGEMENT cases of late deliveries.
●​ Suppress the mismatch between ●​ Protection against inflation.
supply and demand. ○​ There are times when
●​ Minimize the risk of shortage of inventories are built up in
supply anticipation of a price
●​ Minimize the total cost of the increase.
supply chain. ●​ Benefits of large quantities.
○​ Buyers are entitled to a
price discount when
TYPES OF INVENTORY purchasing large quantities
●​ Raw Materials of items.
●​ Components ●​ Primary basis for business.
●​ Work-in-Process ○​ Fully stocked shelves and a
●​ Finished Goods wide selection of products
●​ Distribution Inventory will attract customers to
patronize a store.
RAW MATERIALS ●​ Savings on ordering costs.
●​ Purchased items or extracted ○​ If orders are placed in large
materials transformed into quantities, then placing
components or products orders will be less
frequent.
COMPONENTS
●​ Parts or subassemblies used in STRUCTURE OF ​
final product INVENTORY SYSTEM

WORK-IN-PROCESS ●​ Inventory Level

●​ Items in process throughout the ●​ Demand and Depletion
plant ●​ Reordering
●​ Replenishment, Shortages, and
FINISHED GOODS Surpluses
●​ Safety Stock and Average
●​ Products sold to customers
Inventory
DISTRIBUTION INVENTORY
INVENTORY LEVEL
●​ Finished goods in the distribution
●​ Each item that is stocked in a
system
warehouse has to be monitored.
●​ The inventory level refers to the
size of the inventory on hand.

1
INVENTORY MANAGEMENT
Management Science (Lecture)​
(BSA) (1-B) | Ms. Lady Kenneth M. Dizon, MBA | SEM 1 2024

DEMAND AND DEPLETION SAFETY STOCK AND AVERAGE

●​ The inventory gets depleted to INVENTORY
serve demand. ●​ To avoid shortages, a level of
●​ The rate of demand is equivalent safety stock or buffer must be
to the depletion rate. established.
●​ A higher rate of demand results ●​ To aid managers in
in to faster reduction of inventory. decision-making, an average
inventory has to be calculated.
REORDERING
●​ Every item must be replenished Monday 25
periodically in order to have a
sufficient inventory. Tuesday 22
●​ A replenishment order is made
Wednesday 13
when the inventory is reduced to a
certain level called the reorder Thursday 10
point.
●​ Lead Time Friday 0
○​ The time between an
order is placed and the Total 70
arrival of delivery. Divide by: No. of 5
days
REPLENISHMENT, SHORTAGES, AND
SURPLUSES Average inventory 14 (units)
●​ The reordering is scheduled so
that the replenishment will be
delivered when the inventory is MAJOR DECISIONS IN​
fully depleted. INVENTORY MANAGEMENT
●​ Shortage
●​ The most difficult decision in
○​ Will occur when the
inventory management is the
shipment arrives after
appropriate inventory level since
depletion,
this decision can affect both
●​ Surplus
finance and marketing matters.
○​ Will happen when the
●​ Other related decisions to that are
shipment arrives before
the following:
depletion.
○​ “how much to order”
○​ “when to order”
○​ “size of safety stock”

INVENTORY COSTS
●​ Maintaining inventory entails costs,
and this is one of the major
concerns of management.
●​ The following are the major types
of inventory cost:
○​ Ordering Costs
○​ Holding Costs
○​ Shortage (or Stock out)
Costs
○​ Item Costs

2
INVENTORY MANAGEMENT
Management Science (Lecture)​
(BSA) (1-B) | Ms. Lady Kenneth M. Dizon, MBA | SEM 1 2024

ORDERING COSTS HOLDING COSTS

●​ Cost of obtaining additional ●​ Cost of keeping inventory in
inventories. hand
●​ It includes expenses pertaining to ●​ Its components include:
placing orders, such as: ○​ storage costs
○​ the cost of communicating ○​ interest on capital invested
the order in the inventories
○​ travel expenses ○​ deterioration or spoilage
○​ clerical/paperwork costs
expenses ○​ evaporation
○​ salaries of purchasing ○​ insurance
personnel ○​ rent
○​ inspection and receiving of ○​ overhead of the stores
deliveries ○​ security
○​ data encoding ○​ janitorial services
●​ Also included are costs to
To Compute – maintain date and expenses for
1.​ Get the total expenses in the physical inventory.
preparation of orders. ●​ Are expressed in terms of costs
2.​ Divide the total expense for per item per year or as
placement of orders by the percentage of the value of the
number of times an order was inventory.
made. ●​ They are assumed to be constant
per unit of inventory.
●​ The large the volume of inventory,
the higher the total holding costs
and vice versa.

Total holding costs are computed by

multiplying the number of units kept in
the inventory (or average inventory on
hand) by the holding cost.
Let us assume that the ordering cost (K) is For example, if the holding cost is equal to
at ₱100 per order and the annual demand ₱48. then the total holding cost of:
will be 2,400 units. The proposed ●​ 200 units is ₱4,800
purchasing policy of the company is ○​ (200/2 x ₱48),
annual, quarterly, and monthly. ●​ 600 units is ₱14,400
○​ (600/2 x ₱48),
The total annual ordering cost formula is: ●​ 2,400 units is ₱57,600
​ ​ Tₒ = NK ○​ (2,400/2 x ₱48)
Where:
N = number of items an order is place
SHORTAGE (OR STOCK OUT) COSTS
K = ordering cost
●​ Shortage costs would depend on
the item under consideration.
●​ For example, a shortage of raw
materials would result in
production stoppage and spoilage
of other materials.
●​ A finished product that is out of
stock will result in unsatisfied
demand to loss of customers.

3
INVENTORY MANAGEMENT
Management Science (Lecture)​
(BSA) (1-B) | Ms. Lady Kenneth M. Dizon, MBA | SEM 1 2024

ITEM COSTS
●​ Also called unit cost
●​ Is the price paid for one unit of
product under consideration.
●​ This cost can also influence the
inventory decisions because
large orders are usually given
quantity discounts.

ECONOMIC ORDER QUANTITY

MODEL (EOQ)
●​ Finding an optimal order size is of
utmost importance
●​ EOQ is an approach to build an
Formula for The BEST Number of
idealized inventory system and
Orders to be placed in a year
calculate a fixed order quantity
that minimizes total quantity.
●​ The overall goal that should be
achieved is to lower the total
inventory costs (TC).

Formula for the Total Inventory Cost ●​ The maximum inventory on hand
should be equal to Q, which is 100
TC = Tₒ + T units in the example.
●​ The average inventory is half of Q,
Where: which is equivalent to 50 units.
Tₒ = total annual ordering cost
T = total annual holding cost The number of days’ supply is the length
of the inventory cycle.

Formula for EOQ Note: If the company operates less than

365 days in a year, the actual number of
Q = √2KD days should be used instead.

Where: ASSUMPTIONS OF THE EOQ MODEL

K = ordering cost ●​ The company knows with certainty
D = annual demand how much a specific item in the
H = holding cost inventory will be used or
demanded over time.
Sample Problem: ●​ The demand or use of inventories
Let us assume that the ordering cost (K) is is constant throughout the period.
at ₱100 per order and the annual demand ●​ Shortages are not allowed.
will be 2,400 units. The proposed ●​ A single delivery is made for
purchasing policy of the company is each order.
annual, quarterly, and monthly.

4
INVENTORY MANAGEMENT
Management Science (Lecture)​
(BSA) (1-B) | Ms. Lady Kenneth M. Dizon, MBA | SEM 1 2024

●​ There is no time interval between but the consumption value is

placing an order and receiving the comparably higher
items. ●​ Analysis and control should be
●​ The ordering cost changes more intense in these items
depending on the number of because it can result to much
orders. lower inventory costs and losses
●​ The holding cost changes
depending on the size of the B ITEMS
average inventory. ●​ Items belonging to this category
●​ No quantity discount is given. are referred to as “interclass” items
●​ This means that their values are
LIMITATIONS OF THE EOQ MODEL lower than Category A items but
●​ Lead time is a schedule of higher than Category C items
deliveries that has to be ●​ Adding A and B groups may
considered which changes from possibly account for 90% of the
time to time. value of the inventory
●​ An EOQ assumption states that
the demand should be constant
throughout the year, which does C ITEMS
not always happen. ●​ Such items have the lowest
●​ The ordering cost fluctuates consumption value that is not
because the transport cost is effective to deploy tight inventory
included. controls as the value at risk of
significant loss is relatively low
●​ ABC analysis or the value of
volume analysis is very useful
ABC CLASSIFICATION SYSTEM
particularly to some organizations
●​ ABC analysis is an approach for that carry large numbers of items
classifying inventory items based in the inventory, such as
on the items’ consumption values supermarkets and department
●​ Consumption values is the total stores
value of an item consumed over a
specified time period
●​ It is based on the Pareto principle ADVANTAGES OF USING ABC
to be able to manage more ANALYSIS
important issues 1.​ Approach better monitoring on
high-value inventory. This will
Applying this principle means that the improve its availability while
inventory has to be grouped as: reducing costs and losses. So,
●​ A items during the physical counting of
●​ B items stocks, more resources are
●​ C items dedicated to A than B and C items.
This approach saves a lot of time
and money.
A ITEMS 2.​ Relatively lower value on B and C
●​ Categorized as the “highest inventories will allow better
consumption value” goods allocation of funds for buffer
●​ Pareto principle (80/20 rule stocks. These will enable fewer
wherein the 80% of output is the stock out situations.
result of the 20% input) applies to 3.​ Fewer stock outs can improve
this group because it comprises a customer satisfaction
relatively small number of items

5
INVENTORY MANAGEMENT
Management Science (Lecture)​
(BSA) (1-B) | Ms. Lady Kenneth M. Dizon, MBA | SEM 1 2024

FIXED QUANTITY SYSTEM OR

PERPETUAL SYSTEM
●​ The fixed quantity system is a
system in which whenever the
stock on hand reaches the re-order
point, it is an indicator that a fixed
quantity of materials should be
ordered
●​ The fixed quantity that is ordered
must be based on the EOQ
●​ A “safety stock” is usually added to
the order, as determined by
experience and some form of
computations
●​ This system is every ideal for type
A items