Production and Project Management

Course code: ChEg 5104

Credit Hours: 3

Aregawi G/Eyesus (Assistant Professor)

Email: aregawig1974@[Link] Cellphone: +251968925386

March 17, 2025

 Chapter 4: Inventory Management

4.1 Role of Inventory

4.2 Elements of Inventory Management
4.3 Demand Forecasting
4.4 Inventory Control Systems
4.5 Inventory Models
 Chapter four Learning Objectives
• To define inventory and inventory system
• To understand the role of Inventory & the Types
• To describe the different Elements of Inventory
Management
• To know the benefits of Inventory Management
• To express Dependent demand Forecasting
• To perform Inventory Control Systems (ABC inventory
control , etc…)
• To compute the different Inventory Models
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 Definition of Inventory & Inventory System
 Inventory is the stock of any item or resource used in
an organization and can include: raw materials,
finished products, component parts, supplies, and
work-in-process.

 An inventory system is the set of policies and

controls that monitor levels of inventory and
determines what levels should be maintained, when
stock should be replenished, and how large orders
should be.

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 4.1 Role of Inventory

To maintain independence of operations

To meet variation in product demand
To allow flexibility in production scheduling
To provide a safeguard for variation in raw
material delivery time
To take advantage of economic purchase-order
size
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 ………..the Role of Inventory
• To Providing materials for production and
operations.
• To Acting as a buffer between supply chain
stages and customers.
• To Managing uncertainty and fluctuations in
demand and supply.
• To Ensuring enough stock is on hand.
• To Tracking stock levels and location in
warehouses

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 Classification of Inventory
Inventory’s are classified in to three. Namely:-
1. Demand based Inventory
2. Position-based Inventory
3. Function or Purpose -based Inventory

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Types of Inventory (Demand based)

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Types of Inventory (position-based)

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 Types of Inventory (function-based)
• Buffer/Reserve inventory: is also called safety inventory. Its purpose
is to compensate for the unexpected fluctuations in supply and
demand. This is carried as a cushion to protect against possible
demand variation, “just in case” of unexpected demand. It is a
cushion of supply in excess of forecast demand
• Cycle/Lot-size inventory: occurs because one or more stages in the
process cannot supply all the items it produces simultaneously. Cycle
stock Inventory or working stock inventory is the portion of
inventory available to meet normal demand during given period.
– It only results from the need to produce products in batches, and
the amount of it depends on volume decisions.

• De-coupling/Speculative or Hedge inventory: is a buildup to protect

against some future event such as a strike at your supplier, a price
increase, or the scarcity of a product that may or may not happen.
– It creates the opportunity for independent scheduling and
processing speeds between process stages.
– It’s built to ensure a continuous supply of necessary items.
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 Cont’d
Decoupling Inventory involves Separating inventory within a
manufacturing process so that does not slow down other parts of
process.
• Anticipation (Seasonal) inventory: is most commonly used when
demand fluctuations are large but relatively predictable. It might
also be used when supply variations are significant, such as in the
canning or freezing of seasonal foods. Anticipation Inventory is the
stock of components , materials or Goods kept at hand by a
company to meet demand or to meet the shortfall caused by erratic
production
• Pipeline/Transportation/transit inventory: exists because material
cannot be transported instantaneously between the point of supply
and the point of demand. It is in transit between the manufacturing
plant and the distribution warehouse. It is used in need of transport
one item or material from one location to another location.
• MRO Goods Inventory /Maintenance, Repair and Operating
Supplies/ are items that are used to support and maintain the
production process and its infrastructure.
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 Why Manage Inventory?
• 34% in Manufacturing
• 26% in Retail 82% of the total
• 22% in Wholesale
• 8% in Farm
• 10% in Other

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 Why Manage Inventory?
• In 1998, American companies spent $898 billion in logistics-
related activities (or 10.6% of Gross Domestic Product).
– Transportation 58%, Inventory 38% and Management 4%
• By effectively managing inventory:
– Xerox eliminated $700 million inventory from its supply chain
– Wal-Mart became the largest retail company utilizing efficient
inventory management
– GM has reduced parts inventory and transportation costs by
26% annually
• By not managing inventory successfully:
– In 1994, “IBM continues to struggle with shortages in their
ThinkPad line” (WSJ, Oct 7, 1994)(WSJ, July 15, 1993)
– In 1993, “Dell Computers predicts a loss; Stock plunges. Dell
acknowledged that the company was sharply off in its forecast
of demand, resulting in inventory write downs”
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 Inventory management
• Inventory management involves tracking and
managing a company's raw materials, WIP, and
finished goods.

• It means making sure that the right products are

offered in the right amounts, at the right time
and place, and at the right price.

• The goal of inventory management is to keep the

right amount of stock on hand to meet customer
needs, keep prices low, and make as much money
as possible.

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4.2 Elements of Inventory Management
• Tracking inventory
• Forecasting demand
• Placing orders
• Receiving and storing goods
• Monitoring stock levels
• Demand forecasting
• Inventory Planning
• Reorder points and safety stock
• Inventory turnover
• Managing or optimizing Inventory
• Procurement of Raw material,
• Warehousing and processing
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 The five basic elements of inventory management
• Demand forecasting: Demand forecasting is the practice of estimating
future consumer product demand, which aids a business in setting its
inventory levels.
• Inventory planning: Inventory planning is the process of deciding how
much inventory to order or manufacture, taking into account lead
times, safety stocks, and order cycles, as well as demand projections.
• Inventory tracking and control: Inventory tracking and control is the
process of keeping track of stock levels and ensuring that they are
properly handled. It entails monitoring inventory movements, spotting
irregularities, and modifying inventory levels as required.
• Procurement: The process of acquiring the inventory of products
required to satisfy consumer demand is known as procurement. It
covers ordering from suppliers as well as delivery.
• Inventory optimization: Efficiency and profit maximization are known
as inventory optimization. It is figuring out how to lower the expenses
associated with keeping inventory on hand, for example, by
implementing just-in-time (JIT) inventory management or cutting lead
times. Additionally, it entails figuring out how to raise inventory
turnover, such as by implementing promotions or streamlining the
manufacturing procedure.
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Inventory Management Objectives

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 Cont’d
• Minimize Inventory Investment
 Inventory turn over

 Weeks of supply

 Days of supply

• Hence, the objective of inventory management is

to strike a balance between inventory investment
and customer service.
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 Benefit of Inventory Management
• Improved cash flow: One of the primary advantages of inventory management is the
enhancement of cash flow. Effective inventory management helps to free up money that
is used to fund other aspects of the company's operations by lowering inventory carrying
costs and avoiding overstocking.
• Enhanced efficiency: Managing inventory well improves productivity in more than one
way. It leads to faster order handling times, shorter lead times, and better on-time
delivery performance. More efficient inventory management helps companies save
money, provide better customer service, and make more money.
• Cost savings: Effective inventory management helps cut costs by avoiding overstocking,
stock-outs, and inventory obsolescence. Cost: Implementing an inventory management
system incurs substantial costs, including ongoing expenses for maintenance and training.
• Increased customer satisfaction: It helps ensure that products are accessible when clients
need them, enhancing client satisfaction and loyalty.
• Better decision-making: It gives firms helpful information and insights about purchase,
production, and sales choices.
• Reduced waste: Efficient inventory management assists in reducing waste by ensuring
that things are used up before they expire or become obsolete.
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 ………Benefit of Inventory Management
• Increased competitiveness: It helps organizations become more competitive by enhancing
productivity, cutting expenses, and enhancing customer satisfaction.
• Complexity: Inventory management presents a considerable level of intricacy, particularly for
enterprises that possess extensive and varied product portfolios or intricate supply networks.
• Inaccurate forecasting: The effectiveness of inventory management is contingent upon precise
demand forecasting, a task that proves to be challenging. It is due to the capability for
inaccuracies in the forecasting process. Inaccurate predictions of demand lead to either an
excess or a shortage of inventory, resulting in elevated expenses and reduced levels of
customer contentment.
• Obsolete inventory: It poses difficulties when handling items with a restricted shelf life or is
susceptible to becoming obsolete.
• Limited storage space: The management of inventory poses a challenge for businesses that
have restricted storage capacity, as surplus inventory has the capability to occupy the available
space rapidly.
• Supplier reliability: The dependability of suppliers and vendors affects inventory management,
as any disruptions in the supply chain caused by delays or issues with quality impact inventory
levels.
• Unexpected events: Inventory management encounters disruptions due to unforeseen
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circumstances, such as natural calamities, economic recessions, or disturbances.
 4.3 Demand Forecasting
Demand forecasting is the process of estimating
future demand for a product or service.
• It involves analyzing historical sales data to
predict the number of goods or services
expected to be demanded by customers within
a given period in the future

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Types of demand forecasting include:
• Short-term demand forecasting: It predicts the demand for the next
three to twelve months based on current trends and market
conditions.
• Long-term demand forecasting: It predicts the demand for the next
one to four years based on strategic plans and future scenarios.
• Passive demand forecasting: It assumes that the current situation
will continue and does not account for any changes or interventions
• Active demand forecasting: It considers the effects of planned
actions and policies on the demand.
• Macro demand forecasting: It estimates the total demand for a
product or service in a given market or industry.
• Internal demand forecasting: It estimates the demand within the
organization or a specific department.
• Qualitative demand forecasting: It relies on expert opinions and
judgments to make predictions.
• Quantitative demand forecasting: It uses statistical methods and
historical data to make predictions.
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• Try to predict the future based on the past data
• To select forecasting model: Time horizon, Data availability, Accuracy
required, size of forecasting, budget and qualified personnel.
• Components of time-series data:
– Trend—general direction (up or down)
– Seasonality—short term recurring cycles
– Cycle—long term business cycle
– Error (random or irregular component)
• “Decomposition” of time-series. Data are broken into the four components
Simple Average
Moving Averages
Exponential Smoothing
Regression Analysis
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 4.4 Inventory Control Systems
• Inventory control systems are a set of technologies,
processes, and procedures used to monitor and
manage the ordering, storage, and use of materials
within an organization or business.
• They help companies keep track of their inventory in
real-time, make sure it is available when needed, and
also help monitor inventory cost and quality control.
• An inventory control system is a software solution that
tracks and manages the inventory of a company across
the entire supply chain.
• Inventory control involves various techniques for
monitoring how stocks move in a warehouse, including
ABC analysis, Last In, First Out (LIFO) and First In, First
Out (FIFO), batch tracking, and safety stock
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Inventory Control Systems

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Inventory control and Inventory management

There are slight differences between inventory

control and inventory management.
• Inventory control handles existing stock in a
warehouse. Where as
• Inventory management involves the overall
movement of goods across supply chains.

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Demand in Inventory Models

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Inventory Review Systems

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 4.5 Inventory Models
• ABC Analysis
• Economic Order Quantity (EOQ)
• Inventory Production Quantity
• Materials Requirement Planning (MRP)
• Just-In-Time management (JIT)
• Days Sales of Inventory (DSI)

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 Different types of Inventory models
• Inventory classification models, which group
inventory items based on various criteria, such as
Transit inventory, Buffer inventory, Anticipation inventory,
Decoupling inventory, Cycle inventory, and MRO goods
inventory
• Inventory optimization models, which determine
the optimal quantity and timing of inventory
orders, such as Economic Order Quantity (EOQ), Inventory
Production Quantity, and Materials Requirement Planning
(MRP)
• Inventory management models, which control
the flow and storage of inventory items, such as
Just-in-Time (JIT), Flexible-Stock, and Days Sales of Inventory
(DSI).

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• Inventory models are mathematical frameworks
used by businesses to determine the optimal
quantity and timing for stock reordering to
minimize costs and meet demand.
• The most popular inventory management
models are three namely:-
[Link] Order Quantity (EOQ),
[Link] Production Quantity, and
[Link] Analysis.

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Inventory Models

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Types of Costs in Inventory Models

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Holding Costs

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Categorized Holding Cost Components

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Material Costs (Item Costs)

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Ordering/ Set-up Costs

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Ordering Cost Categorization

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Systems Cost

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Shortage Costs

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Cost effect of an Impending Shortage

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Inventory Control Decisions

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 ABC Analysis
 Divides inventory into three classes
based on annual dollar volume
 Class A - high annual dollar volume
 Class B - medium annual dollar volume
 Class C - low annual dollar volume
 Used to establish policies that focus on
the few critical parts and not the many
trivial ones

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 ABC Analysis
Percent of Percent of
Item Number of Annual Annual Annual
Stock Items Volume Unit Dollar Dollar
Number Stocked (units) x Cost = Volume Volume Class
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A
72%
#11526 500 154.00 77,000 33.2% A

#12760 1,550 17.00 26,350 11.3% B

#10867 30% 350 42.86 15,001 6.4% 23% B

#10500 1,000 12.50 12,500 5.4% B

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 ABC Analysis
Percent of Percent of
Item Number of Annual Annual Annual
Stock Items Volume Unit Dollar Dollar
Number Stocked (units) x Cost = Volume Volume Class
#12572 600 $ 14.17 $ 8,502 3.7% C

#14075 2,000 .60 1,200 .5% C

#01036 50% 100 8.50 850 .4% 5% C

#01307 1,200 .42 504 .2% C

#10572 250 .60 150 .1% C

8,550 $232,057 100.0%

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 ABC Analysis
A Items
80 –
Percent of annual dollar usage

70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
0 – | | | | | | | | | |

10 20 30 40 50 60 70 80 90 100
Percent of inventory items Figure 12.2
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 ABC Analysis
 Other criteria than annual dollar
volume may be used
 Anticipated engineering changes
 Delivery problems
 Quality problems
 High unit cost

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 ABC Analysis
 Policies employed may include
 More emphasis on supplier development
for A items
 Tighter physical inventory control for A
items
 More care in forecasting A items

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 Record Accuracy
 Accurate records are a critical ingredient
in production and inventory systems
 Allows organization to focus on what is
needed
 Necessary to make precise decisions
about ordering, scheduling, and shipping
 Incoming and outgoing record keeping
must be accurate
 Stockrooms should be secure

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 Cycle Counting
 Items are counted and records updated on
a periodic basis
 Often used with ABC analysis
to determine cycle
 Has several advantages
 Eliminates shutdowns and interruptions
 Eliminates annual inventory adjustment
 Trained personnel audit inventory accuracy
 Allows causes of errors to be identified and
corrected
 Maintains accurate inventory records
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 Cycle Counting Example
5,000 items in inventory, 500 A items, 1,750 B items, 2,750 C
items
Policy is to count A items every month (20 working days), B items
every quarter (60 days), and C items every six months (120 days)

Item Number of Items

Class Quantity Cycle Counting Policy Counted per Day
A 500 Each month 500/20 = 25/day
B 1,750 Each quarter 1,750/60 = 29/day
C 2,750 Every 6 months 2,750/120 = 23/day
77/day

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Deterministic Single-Item Inventory Models

Four deterministic Models are Considered

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Model II Model IV 53
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Con’t…… Model I: Economic Order Quantity, EOQ
Infinite Input Rate, No Backlogging

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Con’t…… Model I: Economic Order Quantity, EOQ
Infinite Input Rate, No Backlogging

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Con’t…… Model I: Economic Order Quantity, EOQ
Infinite Input Rate, No Backlogging

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Con’t…… Model I: Economic Order Quantity, EOQ
Infinite Input Rate, No Backlogging

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Given Required Solution
D=10,000 A) Total Cost (TC)? TC= HQ/2 + SD/Q
H=6 B) Reorder point (R)? TC=6 x500/2 +75 x10,000/500
S=75 TC=$3,000
L=5 R=d x L =
Q= 2𝑠𝐷 R= 40 x 5=200
𝑛
−
2 ∗ 75 ∗ 10000
Q= Q= 500
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The Value of TC Will be

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 Then, TC will increase by:

Then, TC will increase by:

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Model II: Production Order Quantity POQ(EPQ)
Finite Input Rate, No Backlogging

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 Cycle Length
1
𝑇𝐼
2 𝑚𝑎𝑥 𝐼 𝑄 𝐷
Average Inventory= = 𝑚𝑎𝑥 = 1−
𝑇 2 2 𝑃
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Example 6

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𝜕𝐺1 (𝑄) 5+𝑆 𝐷 0.29ℎ
=- 2 + =0
𝜕𝑄 𝑄 2
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End of Chapter Three 96