MAR 3203 Chapter 12: Inventory Management

Inventory management

The objective is to strike a balance between inventory investment and customer service

Two basic issues are how much to order and when to order

Importance of inventory

• One of the most expensive assets of many companies representing as much as 50% of total invested capital

• Less inventory lowers costs but increases chances of running out

• More inventory raises costs but always keeps customers happy

Functions of inventory

1. To provide a selection of goods for anticipated demand and to separate the firm from fluctuations in demand

2. To decouple or separate various parts of the production process

3. To take advantage of quantity discounts

4. To hedge against inflation

Types of inventory

• Raw material

• Work-in-process (WIP)

• Maintenance/repair/operating (MRO)

• Finished goods

Raw material

Materials that are usually purchased and have yet to enter the manufacturing process

Work-in-process (WIP) inventory

Products or components that are no longer raw materials but have yet to become finished products; a function of cycle time for a product

MRO inventory

Maintenance, repair, and operating materials 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 books

Managing inventory

1. How inventory items can be classified

2. How accurate inventory records can be maintained

ABC analysis

A method for dividing on-hand inventory into three classifications based on annual dollar volume

• Class A - high annual dollar volume

• Class B - medium annual dollar volume

• Class C - low annual dollar volume

Record accuracy

Accurate records are a critical ingredient in production and inventory systems

• Period systems require regular checks of inventory (i.e. two-bin system)

• Perpetual inventory tracks receipts and subtractions on a continuing basis (may be semi-automated)

Cycle counting

A continuing reconciliation of inventory with inventory records that is often used with ABC analysis

Advantages:

1. Eliminates shutdowns and interruptions

2. Eliminates annual inventory adjustment

3. Trained personnel audit inventory accuracy

4. Allows causes of errors to be identified and corrected

5. Maintains accurate inventory records

Control of service inventories

• Can be a critical component of profitability

• Losses may come from shrinkage or pilferage

• Applicable techniques include:

  1. Good personnel selection, training, and discipline

  2. Tight control of incoming shipments

  3. Effective control of all goods leaving facility

Shrinkage

Retail inventory that is unaccounted for between receipt and sale

Pilferage

A small amount of theft

Economic order quantity (EOQ) model

Tells how much to order

An inventory-control technique that minimizes the total of ordering and holding costs

Assumes that:

1. Demand is known, constant, and independent

2. Lead time is known and constant

3. Receipt of inventory is instantaneous and complete

4. Quantity discounts are not possible

5. Only variable costs are setup (or ordering) and holding

6. Stockouts can be completely avoided

Economic order quantity (EOQ) formula

Q = Number of units per order

Q* = Optimal number of units per order (EOQ)

D = Annual demand in units for the inventory item

S = Setup or ordering cost for each order

H = Holding or carrying cost per unit per year

Robust

Giving satisfactory answers even with substantial variation in the parameters

Lead time

In purchasing systems, the time between placing and receiving an order AKA delivery time

Reorder point (ROP)

Tells when to order

The inventory level (point) at which action is taken to replenish the stocked item

Reorder point (ROP) formula

Total annual cost (TC) formula

Single-period model

Only one order is placed for a product

• Units have little or no value at the end of the sales period

C_s = Cost of shortage = Sales price/unit - Cost/unit
C_o = Cost of overage = Cost/unit - Salvage value

Service level = C_s / (C_s + C_o)

Service level

The complement of the probability of a stockout

Example: probability of a stockout is 0.05 (5%), then the service level is .95 (95%)

Probabilistic model

A statistical model applicable when product demand or any other variable is not known but can be specified by means of a probability distribution

Most inventory models attempt to minimize ____.

total inventory costs