Inventory Management

Role of Inventory

Inventory is a stock of items kept on hand used to meet

customer demand..
A level of inventory is maintained that will meet anticipated
demand.
If demand not known with certainty, safety (buffer) stocks
are kept on hand.
Additional stocks are sometimes built up to meet seasonal
or cyclical demand.
Large amounts of inventory sometimes purchased to take
advantage of discounts.

2
Role of Inventory

In-process inventories maintained to provide independence

between operations.
Raw materials inventory kept to avoid delays in case of
supplier problems.
Stock of finished parts kept to meet customer demand in
event of work stoppage.

3
 Types of Inventory

Inventory comes in many shapes and sizes such as:

– Raw materials – purchased items or extracted materials
transformed into components or products
– Components – parts or subassemblies used in final product
– Work-in-process – items in process throughout the plant
– Finished goods – products sold to customers
– Distribution inventory – finished goods in the distribution
system

4
Types of Inventory

5
Elements of Inventory Management
Demand
Inventory exists to meet the demand of customers.
Customers can be external (purchasers of products) or
internal (workers using material).
Management needs accurate forecast of demand.
Items that are used internally to produce a final product are
referred to as dependent demand items.
Items that are final products demanded by an external
customer are independent demand items.

6
Elements of Inventory Management
Inventory Costs (1 of 3)
Carrying costs - Costs of holding items in storage.
Vary with level of inventory and sometimes with length
of time held.
Include facility operating costs, record keeping,
interest, etc.
Assigned on a per unit basis per time period, or as
percentage of average inventory value (usually
estimated as 10% to 40%).

7
Elements of Inventory Management
Inventory Costs (2 of 3)
Ordering costs - costs of replenishing stock of inventory.
Expressed as dollar amount per order, independent of
order size.
Vary with the number of orders made.
Include purchase orders, shipping, handling,
inspection, etc.

8
Elements of Inventory Management
Inventory Costs (3 of 3)
Shortage, or stockout costs - Costs associated with
insufficient inventory.
Result in permanent loss of sales and profits for items
not on hand.
Sometimes penalties involved; if customer is internal,
work delays could result.

9
Inventory Control Systems

An inventory control system controls the level of inventory

by determining how much (replenishment level) and when
to order.
Two basic types of systems -continuous (fixed-order
quantity) and periodic (fixed-time).
In a continuous system, an order is placed for the same
constant amount when inventory decreases to a specified
level.
In a periodic system, an order is placed for a variable
amount after a specified period of time.

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Inventory Control Systems
Continuous Inventory Systems(Fixed Order)
A continual record of inventory level is maintained.
Whenever inventory decreases to a predetermined level,
the reorder point, an order is placed for a fixed amount to
replenish the stock.
The fixed amount is termed the economic order quantity,
whose magnitude is set at a level that minimizes the total
inventory carrying, ordering, and shortage costs.
Because of continual monitoring, management is always
aware of status of inventory level and critical parts, but
system is relatively expensive to maintain.

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Inventory Control Systems
Periodic Inventory Systems
Inventory on hand is counted at specific time intervals and
an order placed that brings inventory up to a specified level.
Inventory not monitored between counts and system is
therefore less costly to track and keep account of.
Results in less direct control by management and thus
generally higher levels of inventory to guard against
stockouts.
System requires a new order quantity each time an order is
placed.
Used in smaller retail stores, drugstores, grocery stores and
offices.

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Economic Order Quantity Models

Economic order quantity, or economic lot size, is the

quantity ordered when inventory decreases to the reorder
point.
Amount is determined using the economic order quantity
(EOQ) model.
Purpose of the EOQ model is to determine the optimal
order size that will minimize total inventory costs.
Three model versions to be discussed:
Basic EOQ model
EOQ model without instantaneous receipt
EOQ model with shortages

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Economic Order Quantity Models
Basic EOQ Model (1 of 2)
A formula for determining the optimal order size that
minimizes the sum of carrying costs and ordering costs.
Simplifying assumptions and restrictions:
Demand is known with certainty and is relatively
constant over time.
No shortages are allowed.
Lead time for the receipt of orders is constant.
The order quantity is received all at once and
instantaneously.

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 ▪Basic Fixed-Order Quantity Model and Reorder Point Behavior

▪1. You receive an order quantity Q. ▪4. The cycle then repeats.

▪Number
▪of units
▪on hand ▪Q ▪Q ▪Q

▪R
▪2. Your start using ▪L ▪L
them up over time. ▪3. When you reach down to a level
▪Time of inventory of R, you place your next
▪R = Reorder point
Q sized order .
▪Q = Economic order quantity
▪L = Lead time
Economic Order Quantity Models
Basic EOQ Model (2 of 2)

Figure 16.1
The Inventory Order Cycle

16
Basic EOQ Model
Carrying Cost (1 of 2)
Carrying cost usually expressed on a per unit basis of time,
traditionally one year.
Annual carrying cost equals carrying cost per unit per year
times average inventory level:
Carrying cost per unit per year = Cc
Average inventory = Q/2
Annual carrying cost = CcQ/2.

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Basic EOQ Model
Ordering Cost
Total annual ordering cost equals cost per order (Co) times
number of orders per year.
Number of orders per year, with known and constant
demand, D, is D/Q, where Q is the order size:
Annual ordering cost = CoD/Q
Only variable is Q, Co and D are constant parameters.
Relative magnitude of the ordering cost is dependent on
order size.

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Basic EOQ Model
Total Inventory Cost (1 of 2)
Total annual inventory cost is sum of ordering and carrying
cost:

D
TC = Co + Cc Q
Q 2

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Basic EOQ Model
Example (1 of 2)
Given following data, determine number of orders to be
made annually and time between orders given store is open
every day except Sunday, Thanksgiving Day, and
Christmas Day.

Model parameters :
Cc = $0.75, Co = $150, D = 10,000yd
Optimal order size :

Qopt = 2CoD = 2(150)(10,000) = 2,000 yd

Cc (0.75)

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Basic EOQ Model
Example (2 of 2)
Total annual inventory cost :

TC min = Co D + Cc Qopt = (150)10,000 + (0.75) (2,000) = $1,500

Qopt 2 2,000 2
Number of orders per year :
D = 10,000 = 5
Qopt 2,000

Order cycle time = 311 days = 311= 62.2 store days

D / Qopt 5

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 Example 2
Alpha industry estimates that it will sell
12000 units of its products for the
forthcoming year. The ordering cost is
Rs.100 per order and the carrying cost per
unit per year is 20 % of the purchase price
per unit. The purchase price per unit is Rs
50.
EOQ Model with Shortages
Description (1 of 2)
In the EOQ model with shortages, the assumption that
shortages cannot exist is relaxed.
Assumed that unmet demand can be backordered with all
demand eventually satisfied.

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EOQ Model with Shortages
Description (2 of 2)

Figure 16.7
The EOQ Model with Shortages

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EOQ Model with Shortages
Model Formulation (1 of 2)

S 2 (Q − S )2
Total shortage costs = Cs Total carrying costs = Cc
2Q 2Q

Total ordering cost = C0 D

Q

S 2 (Q − S )2
Total inventory cost = Cs + Cc + Co D
2Q 2Q Q

2CoD  Cs + Cc 
 
Optimal order quantity = Qopt =
Cc  Cs 

Shortage level = Sopt = Qopt


Cc 

Cc + Cs 




25
EOQ Model with Shortages

Carpet Discount Store allows shortages; shortage cost Cs,

is $2/yard per year.

Co = $150
Cc = $0.75 per yd
Cs = $2 per yd
D = 10,000 yd
Optimal order quantity :

Qopt = 2CoD  Cs + Cc 
  2(150)(10,000)  2 + 0.75 
 
  =   = 2,345.2 yd
Cc  Cs 
  0.75 
 2 

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EOQ Model with Shortages

Shortage level:
Cc  0.75 
   
Sopt = Qopt 
 = 2,345.2

 = 639.6 yd
Cc + Cs 




 2 + 0.75 
 

Total inventory cost :

S 2 (Q − S )2
TC = Cs + Cc + Co D
2Q 2Q Q

(2)(639 .6)2 (0.75)(1,705.6)2 (150)(10,000)

= + +
2(2,345.2) 2(2,345.2) 2,345.2
= $174.44 + 465.16 + 639.60 = $1,279.20

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EOQ Model with Shortages

Number of orders = D = 10,000 = 4.26 orders per year

Q 2,345.2
Maximum inventory level = Q − S = 2,345.2 − 639.6 =1,705.6 yd

Time between orders = t = days per year = 311 = 73.0 days

number of orders 4.26
Time during which inventory is on hand

= t1 = Q − S = 2,345.2-639.6 = 0.171 or 53.2 days

D 10,000
Time during which the re is a shortage

= t 2 = S = 639.6 = 0.064 year or 19.9 days

D 10,000
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 Example 2
The annual demand for an automobile component
is 24000 units. The carrying cost is Rs.
0.40/unit/year, the ordering cost is Rs.20 per order
and the shortage cost is Rs. 10/unit/year. Find the
optimal values of the following:
• Economic order quantity
• Maximum inventory
• Maximum shortage quantity
• Cycle time
• Inventory period(t1)
• Shortage period(t2)
Quantity Discount
Quantity Discounts with Constant Carrying Costs
Example (1 of 2)
University bookstore: For following discount schedule
offered by Comptek, should bookstore buy at the discount
terms or order the basic EOQ order size?
Quantity Price
1- 49 $1,400
50 – 89 1,100
90 + 900

Determine optimal order size and total cost:

Co = $2,500 Cc = $190 per unit D = 200

Qopt = 2CoD = 2(2,500)(200) = 72.5

Cc 190

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Quantity Discounts with Constant Carrying Costs
Example (2 of 2)
Compute total cost at eligible discount price ($1,100):
TC min = CoD + Cc Qopt + PD
Qopt 2

= (2,500)(200) + (190) (72.5) + (1,100)(200) = $233,784

(72.5) 2
Compare with total cost of with order size of $90 and price
of $900:
TC = CoD + Cc Q + PD
Q 2

= (2,500)(200) + (190)(90) + (900)(200) = $194,105

(90) 2
Because $194,105 < $233,784, maximum discount price
should be taken and 90 units ordered.
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 Example 2
Annual demand for an item is 4800 units. Ordering cost is Rs.500 per
order. Inventory carrying cost is 24% of the purchase price per unit per
year. The price breaks are shown

Quantity Price(Rs)
0-1200 10
1200-2000 9
>2000 8

• Find the optimal order size

• If the order cost is changed to Rs.300 per order, find the
optimal order size
 Production Quantity Model(EBQ/EPQ
for lot)
 An inventory system in which an order is received
gradually, as inventory is simultaneously being
depleted
 p - daily rate at which an order is received over
time, production rate
 d - daily rate at which inventory is demanded
Assumptions of Production Quantity Model
▪ Demand is known with certainty and is constant
over time
▪ No safety stock
▪ No shortages are allowed
▪ Lead time for the receipt of orders is constant
▪ Goods are supplied (p)at and consumed (d)at
uniform rate,
▪ Supply rate is greater than usage rate.
▪ Quantity Discount does not exist
Economic Production Quantity (EPQ)

37
 Production Quantity Model
(cont.)
Inventory
level

Maximum
Q(1-d/p) inventory
level

Average
Q inventory
(1-d/p)
2 level

0 (p-d)
Begin End Time
order order
Order
receipt receipt
receipt period
 Production Quantity Model (cont.)

p = supply rate d = consumption rate

Q
Maximum inventory level =( p- d)
p

= Q*1- d
p

Q d
Average inventory level = 1-
2 p

Q d
Annual carrying cost= 1- Cc
2 p
 Production Quantity Model
(cont.)
p = supply rate d = consumption rate

Co D
Annual ordering cost=
Q
Co D CcQ d
TC = + 2 1-
Q p

2CoD
Qopt =
Cc 1 - d
p
ABC Analysis
The ABC model prioritises inventory based on annual consumption
value (ACV) and helps businesses focus resources on their most
critical items.

Categories

•A (20% of items, 80% of value): It is the most critical category and

requires close monitoring and strict controls.

•B (30% of items, 15% of value): It is moderately important and

requires moderate monitoring and controls.

•C (50% of items, 5% of value): Judged at the least critical, this needs

minimal monitoring and controls.
VED (Vital, Essential, Desirable) Analysis
VED analysis categorises inventory items based on their
criticality to the business depending on their usefulness.
Categories
•Vital (V): These are items critical to the core operation.

•Essential (E): These represent items whose shortage

wouldn't be catastrophic. Delays or alternative solutions
might be possible.

•Desirable (D): Their absence wouldn't significantly

impact production.
HML (High, Medium, Low) Analysis
HML (High, Medium, Low) analysis categorises
inventory based on unit cost to prioritise control
efforts.
Categories
•High: Costly items (fewer in number) require strict
controls due to high financial risk.

•Medium: Moderate cost items need moderate

control measures.

•Low: Least expensive items (often the most in

number) require minimal controls but benefit from
bulk ordering and optimised storage.
FSN (Fast, Slow, Non-Moving) analysis
This classifies inventory based on sales velocity (fast,
slow, non-moving) for efficient management.
Categories
•Fast (F): Sell quickly and generate high revenue.
Exercise low control here.

•Slow (S): You can see these and review them gradually.

•Non-moving (N): No sales, analyse cause, chances for

discounts and write-offs.
SDE (Scarce, Difficult, Easily Available) Analysis
SDE (Scarce, Difficult, Easily available) categorises
inventory based on how easy it is to acquire.
Categories
•Scarce: These are items available in limited
quantities.

•Difficult: These items pose challenges in

procurement and need constant monitoring.

•These are readily available and allow for bulk

ordering and less control.
ABC analysis
From the following data draw an ABC analysis
graph after classifying A, B & C class items.
Item Unit Annual Consumption (units)
Price(Rs.)
1 200.0 3000
2 2.0 60000
3 5000.0 20
4 12.5 200
5 9.0 350
6 25.0 6000
7 1000.0 40
8 70.0 300
 Solution
• Step 1: Determination of annual
consumption value Value Annual Consumption
Item Annual Consumption
(units* unit price) Value (ACV)
1 3000*200 600000
2 60000*2 120000
3 20*5000 100000
4 200*12.5 2500
5 350*9 3150
6 6000*25 150000
7 40*1000 40000
8 300*70 21000
• Step 2: Rearrange the items in the descending
order of annual consumption value and calculate
cumulative ACV
Item Annual Consumption Value Cumulative Annual
(ACV) Consumption Value
1 600000 600000
6 150000 750000
2 120000 870000
3 100000 970000
7 40000 1010000
8 21000 1031000
5 3150 1034000
4 2500 1036650
• Step 3: Since the basis for BC classification is
not given, assume the following

Category % of total ACV

A 70%

B 20%

C 10%
• 70% of total ACV =0.70*1036650 = Rs. 725655
• Since this value is near to cumulative ACV of
Rs.750000, categorise Item 1 and Item 6 under
A category items.
• A and B together account for 90% of ACV.
• 90% of Acv = 0.90 * 1036650 = Rs. 932985
• Since this value is nearer to cum. ACV of Rs.
970000, categorize items 2 and 3 under B
category items.
• Remaining items are categorized as C category
items
• Step 4: Construction of ABC analysis graph
• Exact % of ACV of A category items
750000
= ×100 = 72.34%
1036650
• Exact % of ACV of A+B category items
970000
= ×100 = 93.57%
1036650

% of ACV of B category items = 93.57-72.34 =

21.23%
% of ACV of C category items= 100-93.57 = 6.43 %
 ABC Analysis Graph
Chart Title
120

100
100 93.57
% OF [Link]

80 72.34

60

40

20

% 0F ITEMS
MATERIAL HANDLING
 Material Handling Equipment
1. Between fixed points over a fixed path
1. Belt conveyor
2. Roller conveyor
3. Chute conveyor
4. Slat conveyor
5. Screw conveyor
6. Chain conveyor
7. Overhead monorail conveyor
8. Trolley conveyor
9. Wheel conveyor
[Link] conveyor
[Link] conveyor
[Link]-on-track conveyor
[Link] tube conveyor
 Material Handling Equipment
2. Over limited areas
▪ Hoists
▪ Overhead cranes
▪ Hydraulic scissors lift
3. Over large areas
▪ Handcart/truck
▪ Tier platform truck
▪ Hand lift truck / pallet jack
▪ Power-driven hand truck
▪ Power-driven platform truck
▪ Forklift truck
▪ Narrow aisle truck
▪ Tractor-trailer truck
▪ Material lift
▪ Drum truck
▪ Drum lifter
▪ Dolly
▪ Automated guided vehicle system
Belt conveyor
Belt conveyor
Roller conveyor
Chute conveyor
Chute conveyor
Slat conveyor
Screw conveyor
Screw conveyor
Chain conveyor
Chain conveyor
Overhead monorail conveyor
Overhead monorail conveyor
Trolley conveyor
Wheel conveyor
Wheel conveyor
Tow conveyor
Tow conveyor
Bucket conveyor
Bucket conveyor
Cart-on-track conveyor
Pneumatic tube conveyor
Pneumatic tube conveyor
Hoists
Overhead cranes
Hydraulic scissors lift
Handcart/truck
Tier platform truck
Hand lift truck / pallet jack
Power-driven hand truck
Power-driven platform truck
Forklift truck
Narrow aisle truck
Tractor-trailer truck
Material lift
Drum lifter
Drum lifter
Dolly
Pallet
Tote Pan