1.
1
Inventory
Management

2.
2
Introduction
 Inventory is any stock or stored resources of any
item that are used by organization to satisfy
current or future needs. They maybe items that
are purchased from others, or those produced
internally.
 The objective of inventory management is to
strike a balance between inventory investment
and customer service.

3.
UiTMK/Chapter 10 3
The Functions of Inventory
• To ”decouple” or separate various parts of
the production process
• To provide a stock of goods that will provide
a “selection” for customers
• To take advantage of quantity discounts
– Supplies usually offer discount to encourage bulk
buying
• To hedge against inflation and upward price
changes
– Buy more and stock up more when price is low

4.
UiTMK/Chapter 10 4
Types of Inventory
 Raw material
 Purchased but not processed
 Work-in-process
 Undergone some change but not completed
 A function of cycle time for a product
 Maintenance/repair/operating (MRO)
 Necessary to keep machinery and processes
productive
 Finished goods
 Completed product awaiting shipment

5.
UiTMK/Chapter 10 5
Techniques of inventory
1. ABC Analysis
2. Record accuracy
3. Cycle Counting
4. Control of Service Inventories

6.
UiTMK/Chapter 10 6
1. ABC Analysis
 Divides inventory into three classes
based on annual dollar volume
 Class A - high annual dollar volume
 Class B - medium annual dollar volume
 Class C - low annual dollar volume
 Used to establish policies that focus on
the few critical parts and not the many
trivial ones

7.
UiTMK/Chapter 10 7
% of Inventory Items
Classifying Items as ABC
0
20
40
60
80
100
0 50 100
% Annual $ Usage
A
B
C
Class % $ Vol % Items
A 80 15
B 15 30
C 5 55

8.
UiTMK/Chapter 10 8
ABC Analysis
 Other criteria than annual dollar
volume may be used
 Anticipated engineering changes
 Delivery problems
 Quality problems
 High unit cost

9.
UiTMK/Chapter 10 9
2. Record Accuracy
 Accurate records are a critical ingredient in
production and inventory systems
 Allows organization to focus on what is needed
 Necessary to make precise decisions about
ordering, scheduling, and shipping
 Incoming and outgoing record keeping must be
accurate
 Stockrooms should be secure

10.
UiTMK/Chapter 10 10
3. Cycle Counting
 Items are counted and records updated on a
periodic basis
 Often used with ABC analysis
to determine cycle
 Has several 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

11.
UiTMK/Chapter 10 11
4. 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 on incoming shipments
3. Effective control on all goods leaving facility

12.
UiTMK/Chapter 10 12
Independent versus
Dependent Demand
• Independent demand - demand for item
is independent of demand for any other
item
• Dependent demand - demand for item is
dependent upon the demand for some
other item

13.
UiTMK/Chapter 10 13
Inventory Costs
• Holding costs - associated with holding
or “carrying” inventory over time
• Ordering costs - associated with costs
of placing order and receiving goods
• Setup costs - cost to prepare a
machine or process for manufacturing
an order

14.
UiTMK/Chapter 10 14
Cont…
• Holding (Carrying)
Costs
– Obsolescence
– Insurance
– Extra staffing
– Interest
– Pilferage
– Damage
– Warehousing
• Ordering Costs
– Supplies
– Forms
– Order processing
– Clerical support
• Setup Costs
– Clean-up costs
– Re-tooling costs
– Adjustment costs

15.
UiTMK/Chapter 10 15
• Fixed order-quantity models
– Economic order quantity
• is the quantity level that results in the least total
annual inventory cost.
– Production order quantity
– Quantity discount
Inventory Models

16.
UiTMK/Chapter 10 16
Assumption of EOQ model
 Demand is known, constant and independent
 Lead time is known and constant
 Receipt of inventory is instantaneous and
complete. Orders are delivered as whole units at
a single point in time.
 Quantity discounts are not possible
 The only variable costs are setup cost and
holding cost
 Shortages can be completely avoided if orders
are placed at the right time

17.
17
Economic Order Quantity
Number of Orders
Time Between Orders
(Reorder cycle)
Working Days Per Year
Working Days Per Year
= =
× ×
= =
= =
=
Q*
D S
H
N
D
Q*
T
N
d
D
2
D = Demand per year
S = Setup/Ordering Cost (RM per order)
H = Carrying/Holding cost (annual basis)
d = Demand per day
L = Lead time in days
ss = Safety Stock
EOQ Model Equations
UiTMK/Chapter 10

18.
Reorder Point (without safety stock) = d x L
Reorder Point (with safety stock) = (d x L) + ss
Total ordering cost = (D/Q) x S
Total Carrying Cost = (Q/2) x H
Total annual cost = D x S + Q x H
(without ss) Q 2
Total annual cost = D x S + Q +ss x H
(with ss) Q 2 18
UiTMK/Chapter 10

19.
UiTMK/Chapter 10 19
Cont…
• Lead time – the length of time between the time
order is placed and the time the inventory or
stock arrived or received
• Reorder point – the level that signals the need to
reorder inventory. It indicates the time for the
form to place new order.
• Safety stock – a buffer stock or additional stocks
maintain by the firm to meet the unexpected
increase in demand or uncertainties in delivery
time

20.
UiTMK/Chapter 10 20
Production Order Quantity
Model
 Used when inventory builds up over
a period of time after an order is
placed
 Used when units are produced and
sold simultaneously

21.
UiTMK/Chapter 10 21
Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days
= (Average inventory level) x
Annual inventory
holding cost
Holding cost
per unit per year
= (Maximum inventory level)/2
Annual inventory
level
= –
Maximum
inventory level
Total produced during
the production run
Total used during
the production run
= pt – dt

22.
22
Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days
= –
Maximum
inventory level
Total produced during
the production run
Total used during
the production run
= pt – dt
However, Q = total produced = pt ; thus t = Q/p
Maximum
inventory level = p – d = Q 1 –
Q
p
Q
p
d
p
Holding cost = (H) = 1 – H
d
p
Q
2
Maximum inventory level
2
UiTMK/Chapter 10

23.
UiTMK/Chapter 10 23
Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
D = Annual demand
Q2 =
2DS
H[1 - (d/p)]
Q* =
2DS
H[1 - (d/p)]
p
Setup cost = (D/Q)S
Holding cost = HQ[1 - (d/p)]
1
2
(D/Q)S = HQ[1 - (d/p)]
1
2

24.
UiTMK/Chapter 10 24
 Reduced prices are often available when
larger quantities are purchased.
 The concern – to determine the best order
size/to select the order quantity that would
minimized the total annual inventory costs
 Answers how much to order &
when to order
Quantity Discount Model

25.
UiTMK/Chapter 10 25
Total annual cost – without ss
= (D/Q x S) +(Q/2 x H) + (P x D)
Total annual cost – with ss
= (D/Q x S)+ (Q/2+ss) x H + (P x D)
Total Purchase Cost = P x D
P = cost of item/price
D = demand per year

26.
UiTMK/Chapter 10 26
Steps involve for discount model
 Compute EOQ for each price,until a
feasible EOQ is found
 Compute TAIC for feasible EOQ
 Then calculate the TAIC for the next lower
price breaks
 Repeat procedure in step 3 until you found
the quantity that result in lowest TAIC

27.
UiTMK/Chapter 10 27
Exercise 1:
• The owner of a bakery received a price list from a vendor
who supplies flour. The bakery uses approximately 5000
bags of flour every year. The annual holding cost for each
bag of flour is 30% of purchase cost and the ordering cost
is RM10 per order.
Determine an order quantity that will minimize the total cost
Quantity (bag) Purchase Cost per
bag(RM)
1 - 499 3.30
500 – 999 3.10
> 1000 2.90

28.
UiTMK/Chapter 10 28
• Answer how much & when to order
• Allow demand to vary
– Follows normal distribution
– Other EOQ assumptions apply
• Consider service level & safety stock
– Service level = 1 - Probability of stockout
– Higher service level means more safety stock
• More safety stock means higher ROP
Probabilistic Models

29.
UiTMK/Chapter 10 29
• Only one order is placed for a product
• Units have little or no value at the end of
the sales period
Fixed Period Model