Inventory Management

What is inventory?

• Stock or store of goods 

• Typical firm: 30% of current assets and 90% of working capital invested in inventory, leading to ROI 

• Types of inventories:

  • Raw materials and purchased parts

  • Work-in-process (WIP)

  • Finished-goods inventory (manufacturing firms) or merchandise (retail stores

  • Tools and supplies

  • Maintenance and repairs (MRO) inventory

  • Pipeline inventory: Goods-in-transit to warehouse, distributors, or customers

• Independent-demand items: items that are ready to be sold or used

• Dependent-demand items: components used to assemble the product

Objective

• To know when to order and to know how much to order 

• Performance measures

  • Inventory turnover: ratio of annual COGS to average inventory investment; indicates how many times a  year the inventory is sold (COGS/Average inventory)

  • Inventory-on-hand

  • Customer satisfaction: quantity of backorder and customer complaints

Inventory Counting Systems

Inventory Counting Systems

Periodic Inventory System Physical count periodically, at fixed intervals (weekly, monthly)  Manager estimates how much will be demanded prior to the next delivery period and bases the order quantity on that information  Perpetual Inventory System Continuous review system Tracks removal of inventory on a continuous basis, with the system providing information on the current level of inventory for each item   Advantage is the control provided by the continuous monitoring of inventory withdrawals  Disadvantage is cost of record keeping  Two-bin system: two containers of inventory → order when the first container is empty and the second bin is enough to satisfy demand in time for new order arrival  Universal Product Code (UPC) Bar code printed on item tag or packaging Computerized checkout system Supermarkets  Identifier of bar codes Point-of-sale (POS) System Electronically record actual sales  Bill of Materials: list of prices of each material → POS converts it to one price and logs the cost and revenue Stock Keeping Units (SKUs) Alphanumeric codes unique to each business Helpful in retail business and to track inventory items and sales  Used to identify product traits (brand, size, color, price, customer type)  Symbols  Radio Frequency Identification (RFID) tags Track of inventory in certain applications Tech that uses radio waves to identify objects, like goods in supply chain  Risk of inventory records Inventory record inaccuracy (IRI) → difference between the recorded quantity on hand and actual inventory

Inventory Costs

PURCHASE COST (PD)

• Amount paid to a vendor or supplier to buy the inventory

• Shipping cost

HOLDING OR CARRYING COSTS (H)

• Amount to physically have items in storage

• Interest, insurance, taxes, depreciation, deterioration, spoilage, warehousing costs, etc. 

• Also include opportunity cost associated with having funds tied up in inventory 

ORDERING COSTS (S)

• Costs of ordering and receiving inventory 

• Generally expressed as fixed dollar amount per order

• SETUP COSTS

• Preparing equipment for the job by adjusting the machine, changing cutting tools

SHORTAGE COSTS

• When demand exceeds the supply of inventory on hand

• Opportunity loss 

EOQ Model

Used to identify a fixed order size that will minimize the sum of the annual costs of holding and ordering inventory 

Assumptions:

• Only one product

• Annual demand known

• Demand is spread evenly in year

• Lead times does not vary

• Each order is received in a single delivery

• No quantity discounts
  
  TC = ACC + AOC = Q/2 (H) + D/Q (S)
  
  Quantity in Units = [squareroot] 2DS/H 
  
  Length of the optimal order cycle = Q/D

  Number of orders per year = D/Q

EPQ Model

The batch  mode is widely used in production. In certain instances, the capacity to produce a part exceeds its usage. Production continues → buildup of inventory, and vice versa 

Assumptions:

• One item

• Annual demand known

• Usage rate is constant

• Usage occurs continually, but production occurs periodically

• Constant production rate

• Lead time is known and constant
  
  

Quantity Discount Model

Price reduction for larger orders offered to customers to induce buying larger quantities

TC = Q/2 (H) + D/Q (S) + PD

ReOrder Point

REORDER POINT (ROP)

• Quantity on hand of an item drops to predetermined among, the item is reordered

• Determinants:

  • Rate of demand based on forecast

  • Lead time

  • Extend of demand or lead time variability

  • Degree of stockout risk acceptable to management
    
    
    Expeted Demand + Safety Stock