Inventory Management

Binoy Bose
S7 Information Technology
School of Engineering, CUSAT

Inventories in the Supply

Chain

Types of Inventory:
How Inventory is Used

Anticipation or seasonal inventory

Safety stock: buffer demand fluctuations
Lot-size or cycle stock: take advantage of quantity
discounts or purchasing efficiencies
Pipeline or transportation inventory
Speculative or hedge inventory protects against
some future event, e.g. labor strike
Maintenance, repair, and operating (MRO)
inventories
Psychic stock: Retail display inventory carried to
stimulate demand

Objectives of Inventory
Management

Provide acceptable level of

customer service (on-time
delivery)
Allow cost-efficient operations
Minimize inventory investment

Relevant Inventory Costs

Item Cost

Cost per item plus any other direct

costs associated with getting the item
to the plant

Holding
Costs

Capital, storage, and risk cost typically

stated as a % of the unit value,
e.g. 15-25%

Ordering
Cost
(setup
cost)

Fixed, constant dollar amount incurred

for each order placed

Shortage

Loss of customer goodwill, back order

Independent vs.
Dependent Demand

Independent demand items are

finished goods or other items sold
to someone outside the company
Dependent demand items are
materials or component parts used
in the production of another item
(e.g., finished product)

Determining Order Quantity

Economic Order Quantity (EOQ or Q

System)

An optimizing method used for determining

order quantity and reorder points
Part of continuous review system which
tracks on-hand inventory each time a withdrawal
is made

Economic Order Quantity

EOQ Assumptions:

Demand is known & constant

- no safety stock is required
Lead time is known &
constant
No quantity discounts are
available
Ordering (or setup) costs are
constant
All demand is satisfied (no
shortages)
The order quantity arrives in
a single shipment

EOQ Total Costs

Total annual costs = annual ordering costs + annual
holding costs

EOQ: Total Cost Equation

TC EOQ

D Q

S
H
Q 2

Where
TC total annual cost
D annual demand
Q quantity to be ordered
H annual holding cost
S ordering or setup cost

The EOQ Formula

Minimize the TC by ordering the
EOQ:
2 DS
EOQ
H

When to Order:
The Reorder Point

Without safety stock:

R dL

where R reorder point in units

d daily/weekly demand in units
L lead time in days/weeks

EOQ Example

Weekly demand = 240 units

No. of weeks per year = 52
Ordering cost = $50
Unit cost = $15
Annual carrying charge = 20%
Lead time = 2 weeks

EOQ Example Solution

D 52 240 12,480 units / year

H 0.2 15 $3 per unit per year

2 DS
2 12,480 50
Q

644.98 645 units

H
3
D Q 12,480
645
TC
S
H
50
3
2

Q 2 645
967.44 967.5 $1,934.94
R dL 240 2 480 units

ABC Inventory
Classification

ABC classification is a method for determining

level of control and frequency of review of
inventory items
A Pareto analysis can be done to segment items
into value categories depending on annual dollar
volume
A Items typically 20% of the items accounting for
80% of the inventory value
B Items typically an additional 30% of the items
accounting for 15% of the inventory value
C Items Typically the remaining 50% of the items
accounting for only 5% of the inventory value

ABC Analysis

Divides on-hand inventory into 3 classes

Basis is usually annual $ volume

A class, B class, C class

$ volume = Annual demand x Unit cost

Policies based on ABC analysis

Develop class A suppliers more

Give tighter physical control of A items
Forecast A items more carefully

Classifying Items
as ABC
% Annual $ Usage

Class % $ Vol % Items

A
80
15
B
15
30
C
5
55

A
B

% of Inventory Items

ABC Classification
Example
Classify the following items as A, B, or C.
Stock #

Annual Volume (Units)

Unit Cost

206
105
019
144
207

26,000
200
2,000
20,000
7,000

$ 36
600
55
4
10

ABC Classification Solution

Stock #

Vol.

206
105
019
144
207

26,000
200
2,000
20,000
7,000

Total

Cost
$ 36
600
55
4
10

$ Vol.

ABC