INVENTORY MANAGEMENT

WHAT IS INVENTORY?
• Inventory is a quantity or store of goods
that is held for some purpose or use.

Why keep inventory?

• Meet Demand
• Keep operations running
• Lead time
• Hedge
 INVENTORY MANAGEMENT

•Inventory requirements
•Targets
•Replenishment techniques

TYPES OF INVENTORY SYSTEMS

• Single and multi-stage inventory systems

• Out-of-stock situations
 Inventory values and decisions

• The value of inventory can be small in some

operations e.g. an insurance company and very large
in others e.g. a warehouse.
Basic inventory decisions involve
• Replenishment quantities
• Timing
• How to control the stock system security
Inventory Replenishment
To avoid stock-out situation,
inventory replenishment is
necessary. There are two types of
replenishment
• Fixed period system
• Fixed quantity ordering system
 Costs of Inventory
Holding costs
• cost of capital
• storage costs
• stock losses/wastage
Acquisition/ordering costs
• Costs arise from ordering goods
regardless of the actual value of the
goods.
Purchasing order processing costs
• Receiving the goods, delivery for
large or small orders and invoice
processing.
 Basic inventory mathematics

• Stock control mathematics are very

straightforward and relate to the identification of
re-order levels, calculation of economic order
quantities, safety and service levels and so on.
Generally the input and output sides of the
inventory management system are separated
and it is assumed that :
• on the demand side
• on the supply side
ASSUMPTION OF BASICS ECONOMICS
ORDER QUANTITY MODEL

•Demand is known with certainty

•Demand is relative constant over time
•No storages are allowed
•Lead time for the receipts of orders is
constant
•The order of quantity is received all at a
time.
 Economic Order Quantity

Simplified inventory level with uniform demand rate

EOQ COST MODEL:
•Annual per unit holding cost=CC
•The average inventory holding cost=CC
Q/2
•Annual demand =D
•Cost of placing order=C0
•The annual order cost =C0D/Q
 MODIFIED INVENTORY MODEL

Q(p-d)/p
Cost
(Rs.) p

P-d

tp
MODIFIED INVENTORY MODEL (Cont’d)
 MODIFIED INVENTORY MODEL (Cont’d)

P=production rate
D=demand rate
 EXAMPLE

•CC=$0.75 per yard

•C0=$150
•D=10,000yards
•d=10,000/311=32.2yard per day
•p=150yard/day
 QUANTITY DISCOUNT

• These are price reductions given for large purchases

• The rationale behind them is to obtain economies of scale

• In some industries, buyer groups and co-ops have formed to

take advantage of these discounts.
 TYPES OF QUANTITY DISCOUNT

• Cumulative quantity discounts

Price reductions based on the quantity purchased over a
set period of time

• Non-cumulative quantity discounts

Price reductions based on the quantity of a single order.
 Example

Annual requirement, R = 12,000 units

Unit cost C for lot size below 1000 = Rs.1,200
Unit cost C, for lot size 1000 and above = 1,200(1-0.02) = 1,176
Ordering cost , S = Rs. 3,000
Inventory carrying cost 1 = 24% per annum
2 * 12,000 * 3,000
Economic lot size , Q = 2RS =
12,00 * 0.24
C.I

= 500 units
Economic lot size with discount price,
Q= 2 * 12,000 * 3,000 = 505 units
1176 * 0.24
• So, total cost/unit = C + Ci

• in case (i), total cost/unit = C + [(1/2CIQ) /R ] + S/Q

= 1200 + [(1/2*1200*0.24*500/1200] +3000/500
= Rs. 1,212 per unit
• The economic batch size is 505 but the quantity
discount is only available for a minimum batch size of
1000
hence, total cost / unit
= 1,176+[(1/2*1176*0.24*1000)/12000]+3000/1000
=Rs. 1,190.76
 ABC classification of inventory items

• It is an analysis of a range of items, such as finished products

or customers into three categories: A - outstandingly
important; B - of average importance; C - relatively
unimportant as a basis for a control scheme

• Group A covers 70% of annual usage value of all items

• Group C consists of items whose total value is less than 10%
of annual cost of all items
• Remaining items are grouped in class B
Sr.No Item code Annual usage value Percent of
(Rs.) total value
1. 962 1,000,000 41.47
2. 261 785,000 32.56
3. 846 260,000 10.78
4. 439 125,000 5.18
5. 612 83,000 3.44
6. 115 35,000 1.45
7. 35 28,500 1.18
8. 311 27,500 1.14
9. 782 26,300 1.09
10. 886 15,500 0.64
11. 472 13,200 0.547
12. 339 12,000 0.498
2,411,000 100
 RE ORDER POINT

• It occurs when the level of inventory drops down to zero

• In real life situations one never encounters a zero lead time

• The decision on how much stock to hold is generally referred

to as the order point problem i.e. how low should the
inventory be depleted before it is reordered
• The two factors that determine the appropriate
order point are the delivery time stock and
safety stock . Therefore,
Reorder Point = Normal consumption during
lead-time + Safety Stock

• Another method of calculating reorder level

involves the calculation of usage rate per day
and the safety stock level expressed in terms of
several days' sales. Therefore,
Reorder level = Average daily usage rate x
lead-time in days
 What is Safety Stock?

•Safety Stock is the quantity

of stock held to satisfy
unexpectedly high
requirements in the
stocking-up period.
•Safety stock as the name
suggest is the stock level till
which the dead stock or
stock out situation will not
arise.
Safety Stock:

Projected Lead Time = 8 Days

Demand = 1 piece/day
On Order with Vendor = 0
Purpose:
• The purpose of the safety stock is
to prevent a material shortage
from occurring.
• Safety stock is needed for those
occasions when actual usage
exceeds forecasted demand. It is
"insurance" to help ensure that
you can fulfill customer requests
for a product during the time
necessary to replenish inventory
 Safety Stock Level:

Terminology and calculations:

• Lead time:   Lead time is the amount of time from the point
at which you determine the need to order to the point at which the
inventory is on hand and available for use. 

• Lead-time demand: Forecasted demand during the lead-

time period. 

• Forecast:  Forecasting is a process of estimating a future

event on the basis of past data.

• Forecast period: The period of time over which a forecast

is based. 
• Order cycle: Also called replenishment cycle, order
cycle refers to the time between orders of a specific
item. Most easily calculated by dividing the order
quantity by the annual demand and multiplying by the
number of days in the year.
• Reorder point: Inventory level which initiates an
order. 

Reorder Point = Lead Time Demand + Safety Stock.

• Service level: In inventory management service

level measures the performance of an inventory
system.

• Service Factor: Factor used as a multiplier with the

Standard Deviation to calculate a specific quantity to
meet the specified service level

• Demand History : The history of demand broken

down into forecast periods
Safety Stock level with demand fluctuation
and constant Lead Time:

Safety Stock Level=

Ln*(dm-dn)
Ln= Normal Lead Time
dm= Maximum Demand Rate
dn= Normal Demand Rate
 Safety Stock level with Lead Time Varies
And Stable Demand Rate:

Safety Stock Level= dn*(Lm-Ln)

Ln= Normal Lead Time
Lm= Maximum Lead Time
dn= Normal Demand Rate
 Coverage Analysis:

• Coverage Analysis is a technique used for determining the

optimal ordering policy and it is applicable to only purchased
items. The stock items supplied to manufacturing, assembly or
service which are manufactured internally are beyond the
scope of this technique.

N= number of order/year
R=annual requirement
QE=economic order point
S=ordering cost
I=inventory carrying cost
C=unit cost
•Optimum number or orders is
directly proportional to the annual
usage value
ANY QUESTION...?