Inventory Management

1. Inventory Management
EOQ/EPQ
ENGR. JOVELLE P. ALOMIA

2. Inventory Management
Inventory decisions involve a delicate balance between
three classes of costs: ordering costs, holding costs, setup
costs and shortage costs
The practice of planning, directing and controlling inventory
so that it contributes to the business’ profits.

3. Inventory
the quantity of goods or materials on hand
usually a business’ largest asset
Base Stock: that portion of inventory that is replenished
after it is sold to customers
Safety Stock: the second portion of inventory that is held to
protect against the impact of uncertainty

4. Reasons to Hold Inventory
Meeting unexpected demands
Smoothing seasonal demands
Taking advantage of price discounts
Hedging against price increase
Getting quality discounts

5. Types of Inventory
Raw Material - Purchased but not processed
Work-in-process – Undergone some change but not
completed
Maintenance/repair/operating - Necessary to keep
machinery and processes productive
Finished goods - Completed product awaiting shipment

6. ABC Analysis
- derived from the term “The Pareto Principle” named after an
Italian economist Vilfredo Pareto, also called as 80/20 rule. This
principle suggests that 80% of the total output is generated only
by 20% of the valuable efforts.
Divides inventory into three classes based on annual dollar
volume
◦ Class A – critical few: high annual dollar volume (max 80%)
◦ Class B - medium annual dollar volume (15%)
◦ Class C – trivial many: low annual dollar volume ( max 5%)

7. ABC Analysis
Used to establish policies that focus on the few critical parts
and not the many trivial ones
Policies employed may include
◦ More emphasis on supplier development for A items
◦ Tighter physical inventory control for A items
◦ More care in forecasting A items

8. Example
Item Stock
Number
Annual Volume
Units
Unit Cost (Dollar)
1428 250 5
1468 2000 5.9
1479 500 129
1493 1000 28
1574 1550 28
1638 600 20
1651 1200 1.2
1707 350 110
1727 100 17
1793 1000 185

9. Solution
Annual Dollar Value
(Annual Volume x Unit Cost)
1428 250 5.0
$ 1,250.0
$
1468 2000 5.9
$ 11,800.0
$
1479 500 129.0
$ 64,500.0
$
1493 1000 28.0
$ 28,000.0
$
1574 1550 28.0
$ 43,400.0
$
1638 600 20.0
$ 12,000.0
$
1651 1200 1.2
$ 1,440.0
$
1707 350 110.0
$ 38,500.0
$
1727 100 17.0
$ 1,700.0
$
1793 1000 185.0
$ 185,000.0
$
TOTAL 8550 529.1
$ 387,590.0
$
Unit Cost (Dollar)
Annual Volume
Units
Item Stock Number
Step 1. Compute for each
item’s Annual Dollar Value

10. Solution
Step 2. Arrange each ADV in
decreasing order
Step 3. Compute for the each
item’s percentage to the total ADV
Formula: (item ADV/total ADV)
Step 4: Classify items based on
percentages:
Notes:
A ITEM – Max 80%
C ITEM – Max 5%
*B ITEM – Everything that is not
included in A and C item
Item Stock Number
Annual Dollar
Value
Percentage
Classification
based on
percentage
Classification
1793 185,000.0
$ 47.73%
1479 64,500.0
$ 16.64%
1574 43,400.0
$ 11.20%
1707 38,500.0
$ 9.93%
1493 28,000.0
$ 7.22%
1638 12,000.0
$ 3.10%
1468 11,800.0
$ 3.04%
1727 1,700.0
$ 0.44%
1651 1,440.0
$ 0.37%
1428 1,250.0
$ 0.32%
TOTAL 387,590.00
$ 99.99% 99.99%
20.25%
4.17%
A items
B items
C items
75.57%

11. 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

12. Cycle Counting
Items are counted and records updated on a periodic basis
Often used with ABC analysis to determine cycle
Has several advantage
◦ Eliminates annual inventory adjustment
◦ Eliminates shutdowns and interruptions
◦ Trained personnel audit inventory accuracy
◦ Allows causes of errors to be identified and corrected
◦ Maintains accurate inventory records

13. Cycle Counting Rate
Number of items to be counted in a DAILY basis.

14. Example
There are 5,000 items in inventory which comprise of 500 A
items, 1,750 B items, 2,750 C items. The policy is to count A
items every month (20 working days), B items every quarter
(60 days), and C items every six months (120 days). Compute
for daily counting rate.
Answer: 78 units

15. Solution
Classification Inventory Counting Policy No. of Days Daily Rate Notes:
A 500 Monthly 20
25
20 working days in a month
B 1750 Quarterly 60
30
20 days x 3 months
(there are 3 months in a quarter)
C 2750 Semi-annually 120
23
20 days x 6 months
(there are 6 months in a semi-annual)
Total Counting Rate 78
Goal: To convert all inventory in DAILY rate
Formula:
Daily Rate = Inventory Count/No. of Days

16. Example
There are 3,500 items in inventory which comprise of 850 A
items, 1000 B items, 1650 C items. The policy is to count A
items every month (26 working days), B items every quarter,
and C items every six months. Compute for daily counting
rate.

17. Inventory Costs
Visible Costs of Inventory
• Holding costs - the costs of holding or “carrying” inventory
over time
• Ordering costs - the costs of placing an order and receiving
goods
• Setup costs - cost to prepare a machine or process for
manufacturing an order
• Shortage costs - temporary or permanent loss of sales when
demand cannot be met

18. Inventory Costs
Hidden Costs of Inventory
• Longer lead times
• Reduce responsiveness
• Underlying problems are hidden rather than being exposed
and solved
• Quality problems are not identified immediately
• No incentive for improvement of the process

19. Economic Order Quantity (EOQ)
•a mathematical tool for determining the order quantity that
minimizes the costs of ordering and holding inventory
•Attempts to minimize total inventory cost by answering the
following two questions:
• How much should I order? (EOQ)
• How often should I place each order? (Cycle Time)

20. EOQ Assumptions
•Demand is known, constant, and independent
•Lead time is known and constant
•Receipt of inventory is instantaneous and complete
•Quantity discounts are not possible
•Only variable costs are setup and holding
•Stockouts can be completely avoided

21. EOQ Formula

22. Example
Determine optimal number of needles to order with the
given data:
D=1000 units
S=Php10 per order
H=Php0.5 per unit per year
What is the total inventory cost?

23. Solution
𝐸𝑂𝑄 =
2𝐷𝑆
𝐻
=
2𝑥1000𝑥10
0.5
𝑬𝑶𝑸 = 𝟐𝟎𝟎 𝒖𝒏𝒊𝒕𝒔
𝑇𝐼𝐶 = 𝐻𝐶 + 𝑂𝐶
=
𝑄
2
∗ 𝐻 +
𝐷
𝑄
∗ 𝑠
=
200
2
∗ 0.5 +
1000
200
∗ 10
𝑻𝑰𝑪 = 𝑷𝒉𝒑 𝟏𝟎𝟎

24. Example
A company makes bicycles. It produces 450 bicycles a
month. It buys the tires for bicycles from a supplier at a cost
of $20 per tire. The company’s inventory carrying cost is
estimated to be 15% of cost and the ordering is $50 per
order. Compute for EOQ.

25. Solution
𝐸𝑂𝑄 =
2𝐷𝑆
𝐻
=
2𝑥10800𝑥50
0.15𝑥20
𝑬𝑶𝑸 = 𝟔𝟎𝟎 𝒘𝒉𝒆𝒆𝒍𝒔
Note:
𝐷 = 450 𝑏𝑖𝑐𝑦𝑐𝑙𝑒/𝑚𝑜𝑛𝑡ℎ 𝑥 2 𝑤ℎ𝑒𝑒𝑙𝑠 𝑥 12 𝑚𝑜𝑛𝑡ℎ𝑠
𝐷 = 10 800 𝑤ℎ𝑒𝑒𝑙𝑠

26. Economic Production Order Quantity
Model (EPQ)
Used when inventory builds up over a period of time after
an order is placed
Used when units are produced and sold simultaneously

27. EPQ Formula

28. Example
Determine EPQ with below given data:
D=1000 units
S=Php10 per order
H=Php0.5 per unit per year
p=8 units/day
d=4 units/day

29. Solution
𝐸𝑃𝑄 =
2𝐷𝑆
𝐻 (1−
𝑑
𝑝
)
=
2𝑥1000𝑥50
0.5(1−
4
8
)
𝑬𝑷𝑸 = 𝟐𝟖𝟐. 𝟖𝟒 ≈ 𝟐𝟖𝟑 𝒖𝒏𝒊𝒕𝒔

30. Example
A semiconductor manufactures an inexpensive audio card
for assembly into several models of its microcomputers. The
annual demand for this part is 100,000 units. The annual
inventory carrying cost is $5 per unit and the cost of
preparing an order and making production setup for the
order is $750. The company operates 250 days per year. The
machine used to manufacture this part has a production
rate of 2000 units per day. Calculate the optimum lot size.

31. Solution
𝐸𝑃𝑄 =
2𝐷𝑆
𝐻 (1−
𝑑
𝑝
)
=
2𝑥100000𝑥750
5(1−
400
20000
)
𝑬𝑷𝑸 = 𝟔𝟏𝟐𝟑. 𝟕𝟐 ≈ 𝟔𝟏𝟐𝟒 𝒂𝒖𝒅𝒊𝒐𝒄𝒂𝒓𝒅
Note:
𝑑 = 𝑑𝑎𝑖𝑙𝑦 𝑑𝑒𝑚𝑎𝑛𝑑
𝑑 =
100000 𝑢𝑛𝑖𝑡𝑠/𝑦𝑒𝑎𝑟
250 𝑑𝑎𝑦𝑠/𝑦𝑒𝑎𝑟
𝑑 = 400 𝑢𝑛𝑖𝑡𝑠/𝑑𝑎𝑦