INVENTORY MANAGEMENT
during certain seasonal periods.
Learning Objectives – After completing
this topic, you should be able to:
1. Define inventory.
2. Identify types of inventory.
3. List some reasons why organizations
have inventory.
4. Discuss the concerns and objective of
inventory management.
5. List the two basic inventory decisions.
6. List the requirements for effective
inventory management.
7. Discuss the relevant inventory costs.
8. Discuss the two general types of
inventory systems and do the
computations related to each type.
INVENTORY – a stock or store of goods.
TYPES OF INVENTORIES
1. Raw materials and purchased parts
2. Work-in-process or partially completed
goods
3. Finished goods (manufacturing firms) or
merchandise (retail stores)
4. Replacement parts, tools, and supplies
5. Goods-in-transit to warehouses or
customers
WHY ORGANIZATIONS HAVE INVENTORY
1. To meet anticipated _______________.
 _________________ stocks are
held to satisfy expected average
demand.
2. To protect against ________________.
 _________________ stocks,
which are stocks in excess of average
demand to compensate for variability
in demand and lead time, can reduce
the risk of shortages.
3. To smooth ____________________
requirements.
 ________________ inventories
are stored during off-season periods
to meet overly high requirements
4. To ___________________ components
of the production-distribution system.
 ________________ inventories
are stocked between successive
operations to maintain continuity of
succeeding operations in case of
disruptions in preceding operations.
 Raw materials and supplies
inventories serve as buffer between
the suppliers and the firm.
 Work-in-process inventories serve as
buffer between successive
workstations.
 Finished goods inventories serve as
buffer between the firm and its
customers.
5. To permit ____________________.
 ________________ inventories
exist throughout the production-
distribution system due to the fact that
production operations take time; i.e.,
they are not instantaneous.
6. As a result of taking advantage of
____________ _____________.
 To minimize purchasing and
transportation costs, a firm may buy in
quantities that exceed immediate
requirements. This necessitates
storing the excess for later use.
 Similarly, it is usually economical to
produce in larger rather than small
quantities. Again, the excess output
must be stored for later use.
7. As a result of hedging against
_____________ _____________ or
taking advantage of _____________
_____________.
 Occasionally, a firm may suspect that
a substantial price increase is about
to occur and, thus, purchase larger-
than-normal amounts to avoid the
increase.
MGMT. 6 HANDOUTS/allareola
THE 2 CONCERNS OF INVENTORY
MANAGEMENT

1. ____________________ of the stock
when needed – to maximize level of
customer service
2. _________________ of ordering and
carrying the inventory – to minimize
inventory costs
THE 4 RELEVANT INVENTORY COSTS
THE OBJECTIVE OF INVENTORY
MANAGEMENT
 To achieve satisfactory levels of
customer service while keeping inventory
costs within reasonable bounds; i.e., try
to achieve a balance between the two
concerns.
THE 2 BASIC INVENTORY DECISIONS
1. _______________ _______________
(size) – How much to order
2. _____________ _____________
(timing) – When to order
REQUIREMENTS FOR EFFECTIVE
INVENTORY MANAGEMENT
1. A system to _____keep track____
___________ of the inventory on hand
and on order
2. A reliable ___demand forecast____
that includes an indication of possible
forecast error.
3. Knowledge of ___LEAD TIME_____
________ and lead time variability.
Lead time. Time interval.betweeen
placing order and receiving item
4. Reasonable estimates of inventory
PROCUREMENT COST.(ORDERING.
SET UP COST) (HOLDING OR
CARRYING COST)
______________
____________,
_____________ ____________,
and ___________ ____________.
5. A _________Cclassification
system______ __________ for
prioritizing inventory items.
1. Cost of the item or _______________
costs
 The sum paid to the supplier for the
item received.
 The direct manufacturing cost.
 Irrelevant if the item unit cost is
constant for all quantities ordered.
 Relevant if item unit cost varies with
quantity ordered, e.g., quantity
discounts.
2. Ordering or setup or______________
costs
 The costs incurred by placing an
order for and receiving the item or
incurred as setup costs when item is
manufactured.
 Include cost of postage, phone calls
to vendors, labor costs in purchasing
and accounting, receiving costs,
record keeping and purchase order
supplies.
3. Carrying or holding or ____________
costs
 The costs associated with having the
inventory on hand.
 Include insurance, warehouse rental,
heating and lighting, taxes, losses
due to pilferage, spoilage, or
breakage.
 Opportunity cost – for having capital
tied up in inventory.
4. Stockout or _______________ costs
 The costs associated with demand
when stocks have been depleted.
 Lost sales
– actual unmade sales
– lost customer goodwill
 Backorder costs
 – money spent to reorder goods
– money spent to notify customers
when goods arrive
– loss of goodwill

MGMT. 6 HANDOUTS/allareola
EOQ
ASSUMPTIONS OF THE BASIC EOQ MODEL

1. There is only one item involved.

2. Annual demand (usage) is known.
3. Demand (usage) rate is uniform.
4. The item unit cost does not vary with the
order size (no quantity discounts).
5. Each order is received in a single delivery.
6. Lead time is known and does not vary.
7. Ordering or setup cost is the same
regardless of the amount ordered.
8. Inventory holding cost is based on average
inventory level.
9. All demands for the item will be satisfied (no
stockout; no backorder).

SYMBOLS USED IN THE BASIC EOQ MODEL

TC = Total annual inventory cost

D = Annual demand, units
C = Cost per unit of the item, P/unit
Q = Quantity to be ordered (the optimum
amount is the economic order quantity,
EOQ)
S = Setup or ordering cost, P/order
H = Annual holding or carrying cost per unit of
average inventory, P /unit;
(Often, holding cost is expressed as
percentage of the item unit cost, such that
H = i C, where i is the percent carrying
cost).
L = Lead time, days
R = Reorder point, units

INVENTORY COSTS vs. ORDER QUANTITY

D Q
T .C.  S  H
Q 2
Q
HoldingCost  H
2
Annual cost