Inventory Management

System

Darry Mhei L. Morales, ME-IE

Inventory Management
 Is one of ten operations management
strategic decisions
Functions of Inventory
 To decouple or separate various parts of the
production process.
 To decouple the firm from fluctuation in
demand and provide a stock in goods that will
provide a selection for customers.
 To take advantage of quality discounts
 To hedge against inflation and upward price
changes
Types of Inventory
 Raw material
 Work-in-process
 Maintenance/repair/operating supply (MRO)
 Finished goods
Raw material Inventory
 Materials that usually purchased but have yet
to enter the manufacturing process.
Work-in-process Inventory
 Products or components that are no longer
raw material but have yet to become finished
products
Maintenance/repair/operating
supply (MRO) Inventory
 Maintenance, repair and operating materials
supplies necessary to keep machinery and
processes productive.
Finished goods Inventory
 An end item ready to be sold, but still an
asset on the company’s book.
Inventory Management
 As managers, we examine two ingredients of
such systems:
 How inventory item can be classified (ABC
Analysis)
 How accurate inventory records can be
maintained.
ABC Analysis
 A method for dividing on-hand inventory into
three classification based on annual dollar
volume.
 Class A- items that are those on which the
annual dollar volume is high. This items only
about 15% of the total inventory items and 70-
80% of the total dollar usage
 Class B- this items represents about 30% of
inventory items and 15-25% total value
 Class C- which may represents only 5% of the
annual dollar volume but about 55% of the
total inventory items.
Example
Silicon Chips, Inc. maker of superfast DRAM
chips, has organized its 10 inventory items on
annual dollar-basis. Shown the table are the
items and the percentage of the total
represented by each items.
Item % Annual Unit cost Annual % Class
Stock Number Volume Dollar Annual
No. of item (units) Volume Dollar
Volume
#10286 1000 $ 90.00 $90,000 A
20% 72%
#11526 500 154.00 77,000 A
#12760 1550 17.00 26,350 B
30%
#10867 250 42.86 15,001 B
23%
#10500 1000 12.50 12,500 B
#12572 600 14.17 8,502 C
#14075 2000 .60 1,200 C
50% 5%
#01036 100 8.50 850 C
#01037 1200 .42 504 C
#10572 250 .60 150 C
$232,057 100%
Record Accuracy
 Good inventory policies are meaningless if
management does not know what is on hand.
Accuracy of records is a critical ingredient in
production and inventory systems.
 Records accuracy allow organizations to
focus on those items that are needed, rather
than settling for being sure that “ some of
everything” is in inventory.
Cycle Counting
 A continuing reconciliation of inventory with
inventory records.
Example:2
 Cole’s Truck, Inc. a builder of high-quality refuse
trucks, has about 5,000 items in its inventory.
After hiring Matt Clark, a bright young OM
student, for the summer, the firm determined
that it has 500 A items, 1750 B items, and 2,750
C items. Company policy is to count all A items
every month (20 working days), All B items
every quarter (every 60 working days), and all C
items every 6 months (120 working days). How
many items should be counted each day?
Solution:
Item Class Quantity Cycle Counting Number of Items
Policy Counted per day
A 500 20 working days 500/20=25/day
B 1,750 60 working days 1,750/60=29/day
C 2,750 120 working days 2750/120=23/day
77/day
Advantages of Cycle Counting
1. Eliminates the shutdown and interruption of
production necessary for annual physical
inventories.
2. Eliminates annual inventory adjustments
3. Trained personnel audit the accuracy of
inventory
4. Allow the cause of the errors to be identified
and remedial action to be taken
5. Maintain accurate inventory records.
Control of Service Inventories
 Management of service inventories deserves
special consideration. Although we may think
of services as not having inventory, that is not
the case.
 In retailing, inventory that is unaccounted for
between receipt and time of sales is known
as Shrinkage.
 Pilferage is the inventory theft.
INVENTORY MODELS
 Independent versus Dependent Demand

The demand for refrigerators is independent of

the demand for toaster ovens. However, the
demand for toaster components is dependent
on the requirements for toaster ovens.
Holding, Ordering, and Set-up
Costs
 Holding Cost- the cost to keep or carry
inventory in stock
 Ordering Cost- the cost of the ordering
process
 Set-up Cost- the cost to prepare a machine or
process for production
 Set-up time- the time required to prepare a
machine or process for production.
Determining Inventory HC
CATEGORY COST (AND RANGE)
AS A PERCENT OF
INVENTORY VALUE
Housing cost (building rent/depreciation, 6% (3-10%)
operating cost, taxes, insurance)
Material Handling (equipment lease or 3% (1-3.5%)
depreciation, power, operating cost)
Labor Cost 3% (3-5%)
Investment Cost (borrowing costs, taxes and 11% (6-24%)
insurance on inventory)
Pilferage, scrap, and obsolescence 3% (2-5%)
Overall carrying cost 26%
INVENTORY MODELS FOR
INDEPENDENT DEMAND
 Three inventory models that address two
important questions: when to order and how
much to order.
 Independent demand Models
1. Basic economic quantity (EOQ) model
2. Production order quantity model
3. Quantity discount model
EOQ Model Assumption
 Demand is known, constant, and independent
 Lead time- that is, time between placement and
receipt of the orders
 Receipt of inventory is instantaneous and complete.
 Quantity discounts are not possible.
 The only variable costs are the cost of setting up or
placing an order and the cost of holding or storing
inventory over time.
 Stockouts (shortages) can be completely avoided if
orders are placed at the right time.
The Objective inventory models
 Minimizing the total cost.
 In order to minimize the cost it must or might
be the total holding cost is equal to the total
ordering cost.
EOQ Variables
EOQ FORMULA
EOQ
Example problem:
 Sharp, Inc., a company that markets painless
hypodermic needles to hospitals, would like
to reduce its inventory cost by determining
the optimal number of hypodermic needles to
obtain per order. The annual demand is 1,000
units; the setup cost is $10 per order; and
holding cost per unit per year is $0.5.
Determine the optimal number of units per
order.
Solution:
 Expected time between order, T:
T= Number of working days per year /N
T= 250 working days/year
5 orders
= 50 days between orders
 Reordering Points-the inventory level (point)
at which action is taken to replenish the
stocked item.
 Lead time- in purchasing systems, the time
between placing an order and receiving it;
 Safety stock – extra stock to allow for uneven
demand; a buffer
Reordering Points
 ROP = (Demand per day)( Lead time for a
new order in days)

 Demand per day, d = D/ Number of working

days in a year
 Electronic Assembler, Inc. has a demand for
8000 VCRs per year. The firm operates a 250-
day working year. IN average of an order takes
3 working days. Calculate the reordering point.
 Demand per day, d = 8000/ 250 = 32 units

 ROP = 32 units x 3 days = 96 units

When the stocks drops to 96 units, an order
should be placed.
Production Order Quantity Model
An economic order quantity technique applied
to production orders.
Q= Number of pieces per order
H = Holding cost per unit per year
p= Daily production rate
d= Daily demand rate, or usage rate
t=Length of the production run in days
 Annual Inventory Holding Cost :
= ave. inventory level x Holding cost per unit per year
 Average inventory level:
= Maximum inventory level / 2
 Maximum inventory level
= Total produced during prd’n run – Total used
during the prd’n run
Q= total produced= pt, and thus t= Q/p
Therefore:
Formula:
Example 2:
 Nathan Manufacturing, Inc. makes and sells
specialty hubcaps for the retail automobile
aftermarket. Nathan’s forecast for its wire-
wheel hubcap is 1,000 units next year, with
an average daily demand of 4 units. However,
the production process is most efficient at 8
units per day. So the company produces 8
per day but uses only 4 days. Given the
following values, solve for the optimum
number of units per order.
Solution:
Quantity Discount Models
 A reduced price for items purchased in large
quantities.
 Ex.

Discount Discount Discount (%) Discount Price

Number Quantity (P)
1 0 to 999 No discount $5.00
2 1,000 to 1,999 4 $4.80
3 2,000 and over 5 $4.75