Chapter 7 INVENTORY
MANAGEMENT
Prepared by Miss Saima Qamer
Introduction
Inventory can be one of the most expensive assets of an organization.
Inventory may account for more than 10% of total revenue or 20% of total assets.
Management must reduce inventory levels yet avoid stock outs and other problems.
Matching Supply and Demand
Suppliers must accurately forecast demand so they can produce and deliver the right
quantities at the right time at the right cost.
Suppliers must find ways to better match supply and demand to achieve optimum
levels of cost, quality & customer service to enable them to compete with other
supply chains.
Problems that effect product and delivery will have ramifications throughout the
chain.
Dependent & Independent Demand
Inventory management models are generally classified as dependent demand and
independent demand models.
Dependent Demand
Describes the internal demand for parts based on the demand of final product in
which the parts are used. Subassemblies, components & raw materials are example
of dependent demand items.
Independent Demand
The demand for final products & has a demand pattern affected by trends, seasonal
patterns & general market conditions.
Concepts & Tools of Inventory Management
Functions and basic types of inventory
The primary functions of inventory are to:
~ Buffer uncertainty in the market place &
~ Decouple dependencies in the supply chain (e.g safety stock)
Four broad categories of inventories
~ Raw materials- unprocessed purchased inputs
~ Work in process (WIP)- partially processed materials not yet ready to sale.
~ Finished goods- products ready for shipment.
~ Maintenance, repair & operating (MRO)- materials used in production
Concepts & Tools of Inventory Managemnt
Inventory costs
~ Direct cost- directly traceable to unit produced (e.g labor)
~ Indirect cost- can not be traced directly to the unit produced (e.g
overhead)
~ Fixed cost- independent of output quantity (e.g buildings, equipments, &
plant security)
~ Variable cost- vary with output level (e.g materials)
~ Order Cost- directly variable costs for making an order
~ Holding & Carrying cost- incurred for holding inventory in storage.
Concepts & Tools of Inventory Management
Inventory Investment
~ Firms should diligently measure inventory investment to ensure that it does not
adversely effect competitiveness. Measures include:
Absolute value of inventory (found on balance sheet)
Inventory turnover or turnover ratio – how many times inventory “turns”
in an accounting period. Faster is better!
Inventory turnover ratio= cost of revenue/average inventory
Concepts & Tools of Inventory Management
ABC Inventory Control System
Determines which inventories should be counted & managed more closely than
others.
Groups inventory as A, B & C items
A items are given the highest priority with larger safety stocks. A items, which
account for approximately 20% of total items, are about 80% of total inventory
cost.
B & C account for the other 80% of total items and only 20% of costs. The B
items require closer management since they are relatively more expensive (per
unit), require more effort to purchase /make and may be more prone to
obsolescence.
C items have lowest priority.
Concepts &Tools of Inventory Management
The ABC Inventory Matrix
Inventory Models
The Economic Order Quantity (EOQ) Model
A quantitative decision model based on the trade off between annual inventory
holding costs && annual order costs.
The EOQ model seeks to determine an optimal order quantity, where the sum of
annual order cost and inventory holding cost is minimized.
Order cost is the direct variable cost associated with placing an order.
Holding cost & Carrying cost is the cost incurred for holding inventory in
storage.
Inventory Models
Assumptions of EOQ
Demand must be known and constant
Delivery time is known and constant
Replenishment is instantaneous
Price is constant
Holding cost in known and constant
Ordering cost is known and constant
Stock-outs are not allowed.
Inventory Models
Inventory Models
The Quantity discount model or price break model
Relaxes the constant price assumption by allowing purchase quantity
discounts.
Consider the trade off between purchasing the large quantity to take
advantage of the price discount and issuing fewer order, against holding higher
inventory.
Due to step-wise shape of the total inventory cost curve, the optimal order
quantity lies on either one of the feasible EOQs or at the price break points.
Inventory Models
The Economic manufacturing order quantity model or Production order
quantity model
Relaxes the instantaneous replenishment assumption by allowing usage during
production or partial delivery
The EOQ model is especially appropriate for a manufacturing environment
with simultaneous manufacture and consumption.
Inventory builds up gradually during production period rather than at once as
in the EOQ model.
Inventory Models
The statistical reorder point (ROP)
The lowest inventory level at which a new order must be placed to avoid stock
out.
demand and delivery lead time are never certain and require safety stock