CHAPTER 5
INVENTORY
THE PURPOSE OF INVENTORY
1. To create a cushion for uncertainties
• Uncertainty in demand
• Uncertainty in supply
• Uncertainty in yield
2. To hold batch stock
3. To provide for seasonal stock or anticipation stock
4. To provide for strategic stock
THE PURPOSE OF INVENTORY
5. To provide for long-term price changes
• Speculation stock
6. To ensure smooth production processes
7. To meet certain legal requirements
• Guarantee stock
8. To overcome supply-side disappointments
9. To compensate for a shutdown in production
COMMON TYPES OF INVENTORY
1. Cycle stock
2. Safety stock
3. Anticipation stock
4. Seasonal stock
5. Promotional stock
6. Dead stock
7. Non-conformance stock
1. Cycle stock
Portion of inventory that is carried by an organisation
specifically for the purpose of satisfying regular orders.
• Manufacturing
• Production items
• Sales
• Items to satisfy sales orders
2. Safety stock
A portion of inventory items held as a buffer to enable the
organisation to cushion the effects of uncertainties in supply
and demand of those items.
3. Anticipation stock
Stock held by an organisation because of a future event (with
a high likelihood of occurrence) which justifies the stocking of
quantities of the item above regular cycle quantities.
• E.g. price increases
• E.g. strikes
• E.g. upcoming maintenance
4. Seasonal stock
Items that are carried in store simply because of the levels of
demand that are peculiar to particular periods of the year
• Seasonal stock vs. anticipation stock
5. Promotional stock
Stock that is carried by
organisations to enable
them to satisfy high levels
of demand that are due to
a promotional campaign
6. Dead stock
Stock that an organisation may have but cannot utilised as
was intended.
• Kept too long in storage
• Expired
• Outdated
7. Non-conformance stock
• Stock items that are no longer useable by the organisation
that has kept them in storage.
• Could still be utilised by other parties.
INVENTORY HOLDING COSTS
1. Capital cost
2. Cost of obsolescence
3. Handling and storage costs
1. Capital cost
Cost of capital refers to the opportunity cost of making a
specific investment. It is the rate of return that could have
been earned by putting the same money into a different
investment with equal risk.
2. Cost of obsolescence
Incurred when an item in inventory becomes obsolete before
it is sold or used.
3. Handling and storage costs
• Mortgage cost or rent cost
• People and equipment
• Computer hardware and software
• Insurance
• Theft
INVENTORY AND MANAGEMENT
• Many items fall under the category of inventories.
• These items differ from organisation to organisation.
• Stated simply, inventory describes the stock of an item used
in the organisation.
• Inventories are tangible items that are stored for future use.
LEAVE OUT: EQUATION ON PAGE 94 AND TWO
EQUATIONS ON PAGE 95
INVENTORY AND MANAGEMENT
• Raw materials that are stored while
awaiting utilisation in the process of
manufacturing a finished product
• Work-in-progress that are stored
while waiting to be worked on in the
manufacturing process
• Parts/equipment that are stored for
maintenance, repair or operation
tasks
• Finished items that are kept in stock
to satisfy customer's demand when
needed
DEMAND AND INVENTORY
1. Dependent demand and independent demand
2. Random demand and predictive demand
3. Fast demand and slow demand
LEAVE OUT: SECTION 5.7 ANALYSIS OF DEMAND
UNTIL FORECASTING
FORECASTING
• Forecasting: defined as an informed estimate of the level of
the future demand of an item
• Calculated:
• Qualitative techniques
• Panel consensus method
• Delphi method
• Quantitative techniques
• Simple average
• Year-to-date average
• Moving average
• Weighted average
• Exponential smoothing
Qualitative forecasting
1. Panel consensus method
• Five phase process
2. Delphi method
• Interactive forecasting method which
relies on a panel of experts. Delphi is
based on the principle that forecasts
(or decisions) from a structured
group of individuals are more
accurate than those from
unstructured groups.
Quantitative forecasting – Simple average
The summation of the forecast and actual demand figures
from the previous month, and the determination of their
mean.
= is the forecast for the
next period
= is the actual sales figure
for the current period
= is the forecast for the
current period
Calculate the
simple average
forecast for the
month of July?
Quantitative forecasting – Year-to-date
average
The summation of the actual demand figures from the
previous months in the year and the determination of their
mean
Calculate the
year-to-date
forecast for the
month of July?
Quantitative forecasting – moving average
The summation of actual demand figures from only a
predetermined number of previous months in the year
and the determination of the mean.
Using a 4-
month moving
average
determine the
forecast for the
month of July
Quantitative forecasting – weighted average
The application of weights based on a moving average
of a determined amount of months
*Different from the
formula in the book
Forecast the demand
for the month of July
using a three month
moving average
technique. Use a
weighting scheme of
0.5, 0.3 and 0.2.
*Different from the
formula in the book
LEAVE OUT THE REST OF
FORECASTING
VALUE OF INVENTORY ITEMS
Italian economist, Pareto, discovered that 80% of
the property in Italy was owned by 20% of the
people, therefore the 80:20 rule for products exist.
Step 1: Determine the quantities of inventory
items used
Step 2: Calculate the expenditure on each item
Step 3: Rearrange the inventory items in
descending (high to low) order
Step 4: Categorise the items accordingly as A, B or
C
Sort highest to
lowest
TOTAL:
31 2 677 896
Value of item / total Classify based
amount x 100 on given %
75%
20%
5%
32
ORDERING SYSTEMS
1. Ordering dependent demand items
Self study
2. Ordering independent demand items
3. Economic order quantity
4. Re-order point system
5. Variable order quantities
6. Lot-for-lot system
7. Target inventory level system
8. Period order quantity system Self study
9. Periodic ordering
[Link]-phased order point system
[Link] system
[Link] modifiers
ECONOMIC
ORDER QUANTITY
EOQ Method
The aim of the EOQ Method is to keep inventory costs to a
minimum. The two major cost components to be considered
Ordering costs (OC) and the Holding costs (HC).
• Ordering Costs (OC) are all the expenses incurred in the process of
placing an order for items.
FORMULA:
• Ordering cost (OC) = Cost of placing an order
• Holding Costs (HC) are the costs incurred in keeping the inventory
item.
FORMULA:
• Holding cost (HC) = Value of items to be held (V) x Holding percentage (H)
EOQ Method – Different from textbook
FORMULA:
2 D S
2 x annual demand X OC
EOQ
H
HC
EOQ Method Exercise:
ABC Ltd. Is engaged in sale of Soccer balls. Suppose the annual
demand for an inventoried item is 1,200 units. The holding cost for it is
R3 per unit per year. The ordering rate is R50 per order placed.
EOQ =
Calculate the economic order
quantity
22 xannualDdemand
xSOC
EOQ
HHC
2 2 x 1D200 x50 S
EOQ
H3
EOQ = 200 Units