This document discusses inventory management and inventory management models. It begins by defining inventory and listing reasons for holding inventory. The objectives of inventory management are then discussed, including maximizing turnover and minimizing costs. Several inventory management models are described, including the economic order quantity model, quantity discount model, reorder point model, and single period model. The document also discusses inventory costs, valuation methods, and the ABC classification approach.

1. Inventory Management And Inventory
Management Models

2. Learning Objectives
• Define the term inventory and list the major reasons for
holding inventories; and list the main requirements for
effective inventory management.
• Discuss the objectives of inventory management.
• Discuss the nature and importance of service inventories
• Discuss periodic and perpetual review systems.

3. • Describe the basic EOQ model and its assumptions and solve
typical problems.
• Describe the economic production quantity model and solve
typical problems.
• Describe the quantity discount model and solve typical
problems.
• Describe reorder point models and solve typical problems.
• Describe situations in which the single-period model would
be appropriate, and solve typical problems.
• Describe the A-B-C approach.

4. Inventory
Inventory
• A physical resource that a firm holds in stock with the intent of
selling it or transforming it in to a more valuable state. It is a
constitute significant part of current assets.
Or,
• The assets that are:
- Held for sale in the ordinary course of business; or
- In the process of production for such a sale; or
- In the form of materials or supplies to be consumed in the
production process ; or
- In the rendering of service

5. Contd…
Types of Inventory
• Raw materials
• Purchased parts and supplies
• Finished goods
• Work-in-process (partially
completed) products (WIP)
• Items being transported
• Tools and equipment

6. Overall Objective of Inventory Control
• To achieve satisfactory levels of customer service while
keeping inventory costs within reasonable bounds
–Level of customer service
–Costs of ordering and carrying inventory
• Inventory turnover is the ratio of
average cost of goods sold to
average inventory investment
12-6

7. Inventory Management Objectives
• Maximize inventory turnover
• Minimize damage and waste while in inventory
• Minimize handing and storage
• Minimize out of stock situations (stockouts)
• Minimize the after “best before date” cases
• Minimize engineering/ design/ customer changes
• Minimize time from request to shipping
• Minimize ordering costs from producer to stock
• Minimize interest costs of holding materials

8. Reasons for Inventories
• Improve customer service
• Encourage production, purchase, and transportation economics
• Act as a hedge against price change
• Protect against uncertainties in demand and lead times
• Act as a hedge against contingencies

9. What are the functions of Inventory
• Smooth Seasonal production requirements
• Protect against stockout
• Hedge against price increases
• 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

10. Decisions to Make
• Where should stores be placed & why
• What should be stored there & why
• How much of an item should be stored & why
• How much safety stock should be stored & why
• How long before an order is placed (safety time)
• How to find and keep track of what is stored
• How to move/ use items from different stores
• What is the Min/Max for each item

11. Inventory controls
• Levels of customer service
• Costs of inventories
• Cost of carrying inventories
• Good personnel selection, training, and discipline
• Tight control of incoming shipments
• Effective control of all goods leaving the facility

12. Importance of Inventory Management
• Inventory is a significant asset and for many companies the
largest asset.
• Inventory is central to the main activity of merchandising and
manufacturing companies.
• Mistakes in determining inventory cost can cause critical errors
in financial statements.
• Inventory must be protected from external risks (such as fire
and theft) and internal fraud by employees.

13. Inventory and supply chain management
Bullwhip effect
Seasonal or cyclical demand
Inventory provides independence from vendors
Take advantage of price discount
inventory provides independence between stages and avoids work stoppages WIP
inventories
• Demand information is distorted as it moves away from the
end- use customer (forecast)
• Higher safety stock inventories are stored to compensate

14. Two Forms of Demand
Independent demand
Dependent demand
B(4)
D(2) E(1) D(3) F(2)
C(2)
A
Independent demand: demand for items used by external customers.
Dependent demands : demand for items used to produce final products.

15. Inventory Management Challenges
Carrying Too much Inventory Carrying Too Little Inventory
• Increased overhead costs
• Increased financial holding costs
• Increased risk of loss of market
value
• Decreased inventory flexibility
• Increased inventory shrinkage
• Increased risk of lost sales
• Increased ordering cost
• increased risk of supplier price increases
• Increased exposure to non delivery
• Decreased bulk order discount

16. Inventory Costs
Carrying cost
• cost of holding an item in inventory
Ex: Insurance, extra staffing, Damage, Warehousing
Ordering cost
• cost of replenishing inventory
Ex: Supplies, forms, Clerical support
Shortage cost
• temporary or permanent loss of sales when demand cannot
be met

17. Methods of Valuation
An inventory valuations allows a company to provide a monetary
value for items that make up its inventory.
Methods:
• First in First out (FIFO) methods
• Last in first out (LIFO) methods
• Weighted Average Cost/ price method

18. Inventory Control Systems
• Continuous system (fixed-order-quantity)
constant amount ordered when inventory declines to predetermined
level
• Periodic system (fixed-time-period)
order placed for variable amount after fixed passage of time

19. 01.Economic Order Quantity (EOQ) Models
a) Basic EOQ model
b) EOQ cost model
optimal order quantity that will minimize total inventory costs
c) Production quantity model

20. a). Assumptions of Basic EOQ Model
• Demand is known with certainty and is constant over time
• No shortages are allowed
• Lead time for the receipt of orders is constant
• Order quantity is received all at once

21. EOQ
Cost
Quantity
Total Cost
Carrying Cost
Ordering Cost
Minimum
total cost

22. Inventory Order Cycle
Profile of Inventory Level Over Time
Quantity
on hand
Q
Receive
order
Place
order
Receive
order
Place
order
Receive
order
Lead time
Reorder
point
Usage
rate
Time

23. b). EOQ cost model
Co - cost of placing order D - annual demand
Cc - annual per-unit carrying cost Q - order quantity
Annual ordering cost =
Cod
Q
Annual carrying cost =
Total cost = +
Cod
Q
Ccq
2
Ccq
2

24. c). Production quantity model
• Order is received gradually, as inventory is
simultaneously being depleted
• AKA non-instantaneous receipt model
• Assumption that Q is received all at once is relaxed
• P - daily rate at which an order is received over time,
a.K.A. Production rate
• D - daily rate at which inventory is demanded

25. Production quantity model assumptions
• Only one item is involved
• Annual demand is known
• Usage rate is constant
• Usage occurs continually
• Production rate is constant
• Lead time does not vary
• No quantity discounts

26. 02.Quantity discount model assumptions
• Same as the EOQ, except:
– Unit price depends upon the quantity ordered
• Adjusted total cost equation:
PDH
Q
S
Q
D
TCQD 












2
P= per unit price of the item
D = annual demand

27. 03.Reorder point models
Inventory level at which a new order is placed
R = d*L
d = demand rate per period
L = lead time
Reorder with EOQ Ordering
• Reorder Point - When the quantity on hand of an item drops to this amount, the item
is reordered
• Safety Stock - Stock that is held in excess of expected demand due to variable
demand rate and/or lead time.
• Service Level - Probability that demand will not exceed supply during lead time with
EOQ Ordering

28. 04.Single-period model
• Single period model:
model for ordering of perishables and other items with limited useful lives
• Shortage cost:
generally the unrealized profits per unit
• Excess cost:
difference between purchase cost and salvage value of items left over at the end of a period
• Continuous stocking levels
• Identifies optimal stocking levels
• Optimal stocking level balances unit shortage and excess cost
• Discrete stocking levels
• Service levels are discrete rather than continuous
• Desired service level is equaled or exceeded

29. ABC classification
• Classifying inventory according to some measure of importance
and allocating controls effort accordingly
Annual
$ value
of items
A
B
C
High
Low
Low High
Percentage of Items
A - very important
B - mod. important
C - least important

30. ABC analysis – Basis & policy
• Divides on hand inventory into 3 classes
–A class, B class, C class
• Basis is usually annual Rupee value
⁻ Value = 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