Inventory Management McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Inventory Management

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 13: Learning ObjectivesYou should be able to:

1. Define the term inventory, list the major reasons for holding inventories, and list the main requirements for effective inventory management

2. Discuss the nature and importance of service inventories3. Explain periodic and perpetual review systems4. Explain the objectives of inventory management5. Describe the A-B-C approach and explain how it is useful6. Describe the basic EOQ model and its assumptions and solve typical

problems7. Describe the economic production quantity model and solve typical

problems8. Describe the quantity discount model and solve typical problems9. Describe reorder point models and solve typical problems10. Describe situations in which the single-period model would be appropriate,

and solve typical problems

13-2Student Slides

Inventory• Inventory

– A stock or store of goods• Independent demand items

– Items that are ready to be sold or used

Inventories are a vital part of business: (1) necessary for operations and (2) contribute to customer satisfaction

A “typical” firm has roughly 30% of its current assets and as much as 90% of its working capital invested in inventory

13-3Student Slides

Inventory Management

• Management has two basic functions concerning inventory:1. Establish a system for tracking items in inventory2. Make decisions about

• When to order• How much to order

Student Slides13-4

Inventory Counting SystemsPeriodic System

Physical count of items in inventory made at periodic intervals

Perpetual Inventory SystemSystem that keeps track of removals from inventory

continuously, thus monitoring current levels of each itemAn order is placed when inventory drops to a

predetermined minimum level– Two-bin system

» Two containers of inventory; reorder when the first is empty

Student Slides 13-5

Inventory CostsPurchase cost

The amount paid to buy the inventoryHolding (carrying) costs

Cost to carry an item in inventory for a length of time, usually a year

Ordering costsCosts of ordering and receiving inventory

Setup costsThe costs involved in preparing equipment for a jobAnalogous to ordering costs

Shortage costsCosts resulting when demand exceeds the supply of inventory;

often unrealized profit per unit

13-6Student Slides

Deriving EOQ• Using calculus, we take the derivative of the total cost

function and set the derivative (slope) equal to zero and solve for Q.

• The total cost curve reaches its minimum where the carrying and ordering costs are equal.

cost holdingunit per annual

cost)der demand)(or annual(22O

H

DSQ

13-7Student Slides

When to Reorder• Reorder point

– When the quantity on hand of an item drops to this amount, the item is reordered.

– Determinants of the reorder point1. The rate of demand2. The lead time3. The extent of demand and/or lead time variability4. The degree of stockout risk acceptable to management

Student Slides13-8

Reorder Point: Under Certainty

) as units timesame(in timeLeadLT

per week) day,per period,per (units rate Demand

where

LTROP

d

d

d

Student Slides 13-9

Reorder Point: Under Uncertainty

• Demand or lead time uncertainty creates the possibility that demand will be greater than available supply

• To reduce the likelihood of a stockout, it becomes necessary to carry safety stock– Safety stock

• Stock that is held in excess of expected demand due to variable demand and/or lead time

Student Slides

StockSafety timelead during

demand Expected ROP

13-10

How Much Safety Stock?

• The amount of safety stock that is appropriate for a given situation depends upon:1. The average demand rate and average lead time2. Demand and lead time variability3. The desired service level

Student Slides

demand timelead ofdeviation standard The

deviations standard ofNumber

where

timelead duringdemand Expected

ROP

LT

LT

d

d

z

z

13-11

Reorder Point: Demand Uncertainty

) as units time(same timeLead LT

) as units time(same periodper demand of stdev. The

per week) day,(per periodper demand Average

deviations standard ofNumber

where

LT ROP

d

d

d

z

zLTd

d

d

LTLT dd Note: If only demand is variable, then

13-12Student Slides

How Much to Order: FOI

• Fixed-order-interval (FOI) model– Orders are placed at fixed time intervals

• Reasons for using the FOI model– Supplier’s policy may encourage its use– Grouping orders from the same supplier can produce savings in

shipping costs– Some circumstances do not lend themselves to continuously

monitoring inventory position

Student Slides 13-13

FOI Model

mereorder tiat handon Amount

orders)between timeof(length intervalOrder OI

where

LTOILT)OI(

mereorder tiat handon Amount

stockSafety

intervalprotection during

demand Expected

Order toAmount

A

Azd d

Student Slides 13-14

Operations Strategy• Improving inventory processes can offer significant cost

reduction and customer satisfaction benefits– Areas that may lead to improvement:

• Record keeping– Records and data must be accurate and up-to-date

• Variation reduction– Lead variation– Forecast errors

• Lean operations• Supply chain management

Student Slides13-15