INVENTORY MANAGEMENT

INVENTORY

 A stock of materials used to satisfy customer

demand or to support the production of services
or goods
 The objective of inventory management is to strike a balance
between inventory investment and customer service
 You can never achieve a low-cost strategy without good
inventory management.
 ABC ANALYSIS
 ABC analysis divides on-hand inventory into three classifications on the basis of annual dollar volume.
 The idea is to establish inventory policies that focus resources on the few critical inventory parts and not the
many trivial ones.
 It is not realistic to monitor inexpensive items with the same intensity as very expensive items.
 To determine annual dollar volume for ABC analysis, we measure the annual demand of each inventory item times
the cost per unit .
 Class A items are those on which the annual dollar volume is high.
 Class B items are those inventory items of medium annual dollar volume.
 Those with low annual dollar volume are Class C
POLICIES THAT MAY BE BASED ON ABC ANALYSIS INCLUDE THE
FOLLOWING:

1. Purchasing resources expended on supplier development should be much higher for

individual A items than for C items.
2. A items, as opposed to B and C items, should have tighter physical inventory control;
perhaps they belong in a more secure area, and perhaps the accuracy of inventory
records for A items should be verified more frequently.
3. Forecasting A items may warrant more care than forecasting other items.

Better forecasting, physical control, supplier reliability, and an

ultimate reduction in inventory can all result from classification
systems such as ABC analysis.
 ECONOMIC ORDER QUANTITY MODELS

 Economic order quantity model

 Economic production model

 Quantity discount model

 ASSUMPTIONS OF EOQ MODEL

 Only one product is involved

 Annual demand requirements known

 Demand is even throughout the year (for example, always 10 units per day)
 The lead time is constant (e.g., always 14 days) and known with certainty. The amount
received is exactly what was ordered, and it arrives all at once rather than piecemeal.

 There are no quantity discounts

THE INVENTORY CYCLE

Profile of Inventory Level Over Time

Q Usage
Quantity rate
on hand

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time
 Annual holding cost = (Average cycle inventory)*(Unit holding cost)
 Annual ordering cost = (Number of orders/Year)*(Ordering or setup
cost)
 Length of order cycle =Q/D
 Ordering cost includes costs of
supplies, forms, order processing,
purchasing, clerical support, and
so forth.
TOTAL COST

Annual Annual
Total cost = carrying + ordering
cost cost
Q + DS
TC = H
2 Q
COST MINIMIZATION GOAL

The Total-Cost Curve is U-Shaped

Q D
TC = H + S
Annual Cost

2 Q

Ordering Costs

Order Quantity
QO(optimal order quantity)
(Q)
DERIVING THE EOQ

Using calculus, we take the derivative of the total cost function and set the derivative
(slope) equal to zero and solve for Q.

2DS 2( Annual Demand )(Order or Setup Cost )

Q OPT = =
H Annual Holding Cost
MINIMUM TOTAL COST

The total cost curve reaches its minimum where the carrying and ordering
costs are equal.

2DS 2( Annual Demand )(Order or Setup Cost )

Q OPT = =
H Annual Holding Cost
PROBLEM

 Nelson’s Hardware Store stocks a 19.2 volt cordless drill that is a

popular seller. Annual demand is 5,000 units, the ordering cost is $15, and
the inventory holding cost is $4/unit/year.
a. What is the economic order quantity?
b. What is the total annual cost for this inventory item?
PROBLEM

 Sharp, Inc., a company that markets painless hypodermic needles

to hospitals, would like to reduce its inventory cost by
determining the optimal number of hypodermic needles to
obtain per order.
 The annual demand is 1,000 units; the setup or ordering cost is
$10 per order; and the holding cost per unit per year is $.50.
PRODUCTION ORDER QUANTITY
MODEL/
ECONOMIC PRODUCTION
QUANTITY
PRODUCTION ORDER QUANTITY MODEL/ECONOMIC
PRODUCTION QUANTITY

This model is applicable under two situations:

(1) when inventory continuously flows or builds up over a period of time after an order
has been placed or
(2) when units are produced and sold simultaneously.
Under these circumstances, we take into account daily production (or inventory-flow)
rate and daily demand rate.
 Economic production run is the most cost-efficient quantity of
units to produce at a time.
 Economic Batch Quantity (EBQ)
ECONOMIC PRODUCTION QUANTITY (EPQ)

 Production done in batches or lots

 Capacity to produce a part exceeds the part’s usage or demand rate
 Assumptions of EPQ are similar to EOQ except orders are received
incrementally during production
 ECONOMIC PRODUCTION QUANTITY 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
ECONOMIC RUN SIZE

2DS p
Q0 =
H p− u
PROBLEM
 Nathan Manufacturing, Inc., makes and sells specialty hubcaps for the retail
automobile aftermarket. Nathan’s forecast for its wire-wheel hubcap is 1,000
units next year, with an average daily demand of 4 units. However, the
production process is most efficient at 8 units per day. So the company
produces 8 per day but uses only 4 per day. The company wants to solve for
the optimum number of units per order. Holding cost $0.50 per unit per year,
Setup costs $10.
 ( Note: This plant schedules production of this hubcap only as needed, during
the 250 days per year the shop operates.)
 A toy manufacturer uses 48,000 rubber wheels per year for its popular dump truck
series. The firm makes its own wheels, which it can produce at a rate of 800 per day.
The toy trucks are assembled uniformly over the entire year. Carrying cost is $1 per
wheel a year. Setup cost for a production run of wheels is $45. The firm operates 240
days per year. Determine the following:
a. Optimal run size
b. Minimum total annual cost for carrying and setup
c. Cycle time for the optimal run size
d. Run time
PROBLEM

The Dine Corporation is both a producer and a user of brass couplings. The firm operates 220 days a year and uses
the couplings at a steady rate of 50 per day. Couplings can be produced at a rate of 200 per day. Annual storage cost
is $2 per coupling, and machine setup cost is $70 per run.
 a. Determine the economic run quantity.
 b. Approximately how many runs per year will there be?
 c. Compute the maximum inventory level.
 d. What is the average inventory on hand?
 e. Determine the length of the pure consumption portion of the cycle.
QUANTITY DISCOUNT
MODEL
QUANTITY DISCOUNT MODEL

 A quantity discount is simply a reduced price ( P ) for an item

when it is purchased in larger quantities.
PROBLEM

 Chris Beehner Electronics stocks toy remote control flying drones. Recently, the store has been offered a quantity
discount schedule for these drones. This quantity schedule was shown in Table 12.2 . Furthermore, setup cost is
$200 per order, annual demand is 5,200 units, and annual inventory carrying charge as a percent of cost, I , is 28%.
What order quantity will minimize the total inventory cost?
 STEP-1
STARTING WITH THE LOWEST POSSIBLE PURCHASE PRICE IN A QUANTITY DISCOUNT SCHEDULE AND
WORKING TOWARD THE HIGHEST PRICE, KEEP CALCULATING Q* UNTIL THE FIRST FEASIBLE EOQ IS
FOUND.

 First we calculate the Q * for the lowest possible price of $96

 Because 278 , 1,500, this EOQ is infeasible for the $96 price. So now we calculate Q * for the next-higher price of
$98:

 Because 275 is between 120 and 1,499 units, this EOQ is feasible for the $98 price.
 Thus, the possible best order quantities are 275 (the first feasible EOQ) and 1,500 (the price-break quantity for the
lower price of $96). We need not bother to compute Q * for the initial price of $100 because we found a feasible
EOQ for a lower price.
STEP II: TO COMPUTE THE TOTAL COST FOR EACH OF THE POSSIBLE BEST
ORDER QUANTITIES. THIS STEP IS TAKEN WITH THE AID OF TABLE 12.3 .

 Because the total annual cost for 275 units is lower, 275 units should be ordered.
 Even though Beehner Electronics could save more than $10,000 in annual product costs, ordering 1,500 units
(28.8% of annual demand) at a time would generate even more than that in increased holding costs.
 So in this example it is not in the store’s best interest to order enough to attain the lowest possible purchase
price per unit.
 On the other hand, if the price-break quantity for the $96 had been 1,000 units rather than 1,500 units, then total
annual costs would have been $513,680, which would have been cheaper than ordering 275 units at $98.
WHICH OF THE FOLLOWING IS NOT AN INVENTORY?

 Machines
 Raw material
 Finished products
 Consumable tools
WHICH OF THE FOLLOWING IS NOT AN INVENTORY?

 Machines
 Raw material
 Finished products
 Consumable tools
BUFFER STOCK’ IS THE LEVEL OF STOCK

 Half of the actual stock

 At which the ordering process should start
 Minimum stock level below which actual stock should not fall
 Maximum stock in inventory
BUFFER STOCK’ IS THE LEVEL OF STOCK

 Half of the actual stock

 At which the ordering process should start

 Minimum stock level below which actual stock should not fall
 Maximum stock in inventory
THE BEST STRATEGY OF MINIMIZING THE AMOUNT OF SAFETY INVENTORY TO
BE KEPT IN A STORE WITHOUT HURTING THE LEVEL OF CUSTOMER SERVICE IS

 reducing the supply lead time

 minimizing the uncertainty inherent in demand
 minimizing the uncertainty inherent in supply
 minimizing the cycle service level
THE BEST STRATEGY OF MINIMIZING THE AMOUNT OF SAFETY INVENTORY TO
BE KEPT IN A STORE WITHOUT HURTING THE LEVEL OF CUSTOMER SERVICE IS

 reducing the supply lead time

 minimizing the uncertainty inherent in demand
 minimizing the uncertainty inherent in supply
 minimizing the cycle service level
WHICH OF THE FOLLOWING IS TRUE FOR INVENTORY CONTROL?

 Economic order quantity has minimum total cost per order

 Inventory carrying costs increases with quantity per order
 Ordering cost decreases with lo size
 All of the above
WHICH OF THE FOLLOWING IS TRUE FOR INVENTORY CONTROL?

 Economic order quantity has minimum total cost per order

 Inventory carrying costs increases with quantity per order
 Ordering cost decreases with lo size

 All of the above

THE TIME PERIOD BETWEEN PLACING AN ORDER ITS RECEIPT IN
STOCK IS KNOWN AS

 Lead time
 Carrying time
 Shortage time
 Over time
THE TIME PERIOD BETWEEN PLACING AN ORDER ITS RECEIPT IN
STOCK IS KNOWN AS

 Lead time
 Carrying time
 Shortage time
 Over time
THE FOLLOWING CLASSES OF COSTS ARE USUALLY
INVOLVED IN INVENTORY DECISIONS EXCEPT

 Cost of ordering
 Carrying cost
 Cost of shortages
 Machining cost
THE FOLLOWING CLASSES OF COSTS ARE USUALLY
INVOLVED IN INVENTORY DECISIONS EXCEPT

 Cost of ordering
 Carrying cost
 Cost of shortages

 Machining cost
IF AN AVERAGE INVENTORY IS 2000 UNITS, ANNUAL RELEVANT CARRYING
COST OF EACH UNIT IS $5, THEN ANNUAL RELEVANT CARRYING COST WILL
BE

 $5,000
 $4,500
 $5,500
 $6,000
IF AN AVERAGE INVENTORY IS 2000 UNITS, ANNUAL RELEVANT CARRYING
COST OF EACH UNIT IS $5, THEN ANNUAL RELEVANT CARRYING COST WILL
BE

 $5,000
 $4,500
 $5,500
 $6,000
ACTIVITIES RELATED TO COORDINATING, CONTROLLING AND
PLANNING FLOW OF INVENTORY ARE CLASSIFIED AS

 decisional management
 throughput management
 inventory management
 manufacturing management
ACTIVITIES RELATED TO COORDINATING, CONTROLLING AND
PLANNING FLOW OF INVENTORY ARE CLASSIFIED AS

 decisional management
 throughput management

 inventory management
 manufacturing management
COSTS ASSOCIATED WITH STORAGE OF FINISHED GOODS SUCH AS
SPOILAGE, OBSOLESCENCE AND INSURANCE OF GOODS ARE CLASSIFIED
AS

 carrying costs
 purchasing costs
 stock-out costs
 ordering costs
COSTS ASSOCIATED WITH STORAGE OF FINISHED GOODS SUCH AS
SPOILAGE, OBSOLESCENCE AND INSURANCE OF GOODS ARE CLASSIFIED
AS

 carrying costs
 purchasing costs
 stock-out costs
 ordering costs
IF DEMAND IN UNITS ARE 18000, RELEVANT ORDERING COST FOR EACH YEAR
IS $150 AND AN ORDER QUANTITY IS 1500, THEN ANNUAL RELEVANT
ORDERING COST WOULD BE

 $200
 $190
 $160
 $180
IF DEMAND IN UNITS ARE 18000, RELEVANT ORDERING COST FOR EACH YEAR
IS $150 AND AN ORDER QUANTITY IS 1500, THEN ANNUAL RELEVANT
ORDERING COST WOULD BE

 $200
 $190
 $160

 $180
IF ECONOMIC ORDER QUANTITY FOR ONE YEAR IS 15000 PACKAGES AND
DEMAND IN UNITS FOR ONE YEAR ARE 1500 UNITS, THEN NUMBER OF
DELIVERIES IN A YEAR WILL BE

 16
 12
 10
 14
IF ECONOMIC ORDER QUANTITY FOR ONE YEAR IS 15000 PACKAGES AND
DEMAND IN UNITS FOR ONE YEAR ARE 1500 UNITS, THEN NUMBER OF
DELIVERIES IN A YEAR WILL BE

 16
 12

 10
 14
NUMBER OF PURCHASE ORDERS FOR EACH YEAR IS MULTIPLIED TO
RELEVANT ORDERING COST FOR EACH PURCHASE ORDER TO CALCULATE

 annual irrelevant ordering costs

 annual relevant carrying costs
 annual relevant ordering costs
 annual irrelevant carrying costs
NUMBER OF PURCHASE ORDERS FOR EACH YEAR IS MULTIPLIED TO
RELEVANT ORDERING COST FOR EACH PURCHASE ORDER TO CALCULATE

 annual irrelevant ordering costs

 annual relevant carrying costs

 annual relevant ordering costs

 annual irrelevant carrying costs
COSTS OF ISSUING PURCHASE ORDERS, MAKING OF DELIVERY RECORDS
FOR TRACKING PAYMENTS AND COSTS OF INSPECTION OF ITEMS ARE
CLASSIFIED AS

 stock-out costs
 ordering costs
 carrying costs
 purchasing costs
COSTS OF ISSUING PURCHASE ORDERS, MAKING OF DELIVERY RECORDS
FOR TRACKING PAYMENTS AND COSTS OF INSPECTION OF ITEMS ARE
CLASSIFIED AS

 stock-out costs

 ordering costs
 carrying costs
 purchasing costs
THE ORDER COST PER ORDER OF AN INVENTORY IS RS. 400 WITH AN ANNUAL
CARRYING COST OF RS. 10 PER UNIT. THE ECONOMIC ORDER QUANTITY (EOQ) FOR AN
ANNUAL DEMAND OF 2000 UNITS IS

 400
 440
 480
 500
THE ORDER COST PER ORDER OF AN INVENTORY IS RS. 400 WITH AN ANNUAL
CARRYING COST OF RS. 10 PER UNIT. THE ECONOMIC ORDER QUANTITY (EOQ) FOR AN
ANNUAL DEMAND OF 2000 UNITS IS

 400
 440
 480
 500
ABC ANALYSIS DIVIDES ON-HAND INVENTORY INTO THREE
CLASSES, BASED ON:

 a) unit price.
 b) the number of units on hand.
 c) annual demand.
 d) annual dollar values.
ABC ANALYSIS DIVIDES ON-HAND INVENTORY INTO THREE
CLASSES, BASED ON:

 a) unit price.
 b) the number of units on hand.
 c) annual demand.
 d) annual dollar values.
CYCLE COUNTING:

 a) means that we count all articles after a specified time period

 b) leads us to count A items more frequent then B items
 c) require all A items to be counted the same day
 d) is a legal requirement
CYCLE COUNTING:

 a) means that we count all articles after a specified time period

 b) leads us to count A items more frequent then B items

 c) require all A items to be counted the same day
 d) is a legal requirement
THE TWO MOST IMPORTANT INVENTORY-BASED QUESTIONS
ANSWERED BY THE TYPICAL INVENTORY MODEL ARE:

 a) when to place an order and the cost of the order.

 b) when to place an order and how much of an item to order.
 c) how much of an item to order and the cost of the order.
 d) how much of an item to order and with whom the order should be placed.
THE TWO MOST IMPORTANT INVENTORY-BASED QUESTIONS
ANSWERED BY THE TYPICAL INVENTORY MODEL ARE:

 a) when to place an order and the cost of the order.

 b) when to place an order and how much of an item to order.

 c) how much of an item to order and the cost of the order.

 d) how much of an item to order and with whom the order should be placed.
EXTRA UNITS IN INVENTORY TO HELP REDUCE STOCKOUTS ARE
CALLED:

 a) reorder point.
 b) safety stock.
 c) just-in-time inventory.
 d) all of the above.
EXTRA UNITS IN INVENTORY TO HELP REDUCE STOCKOUTS ARE
CALLED:

 a) reorder point.

 b) safety stock.
 c) just-in-time inventory.
 d) all of the above.
THE DIFFERENCE(S) BETWEEN THE BASIC EOQ MODEL AND THE
PRODUCTION ORDER QUANTITY MODEL IS (ARE) THAT:

 a) the production order quantity model does not require the assumption of known, constant demand.
 b) the EOQ model does not require the assumption of negligible lead time.
 c) the production order quantity model does not require the assumption of instantaneous delivery
 d) all of the above.
THE DIFFERENCE(S) BETWEEN THE BASIC EOQ MODEL AND THE
PRODUCTION ORDER QUANTITY MODEL IS (ARE) THAT:

a) the production order quantity model does not require the assumption of known, constant demand.
b) the EOQ model does not require the assumption of negligible lead time.
c) the production order quantity model does not require the assumption of instantaneous
delivery
d) all of the above.
THE SAFETY STOCK IN RE-ORDER POINT SYSTEM:

a) shall with a certain probability cover demand exceeding the expected during the
lead-time
b) is a non-linear function of lead-time
c) is not depending on the order-quantity
d) all of the above.
THE SAFETY STOCK IN RE-ORDER POINT SYSTEM:

 a) shall with a certain probability cover demand exceeding the expected during the lead-time
 b) is a non-linear function of lead-time
 c) is not depending on the order-quantity

 d) all of the above.

THE RE-ORDER POINT IS:

 The point at which stock will fall to zero minus lead-time.

 The level inventory will have reached when delivery is made.
 The point when one unit of sock remains in stock.
 The point when stock reaches zero.
THE RE-ORDER POINT IS:

 The point at which stock will fall to zero minus lead-time.

 The level inventory will have reached when delivery is made.
 The point when one unit of sock remains in stock.
 The point when stock reaches zero.
A COMPANY WISHES TO DETERMINE THE EOQ FOR AN ITEM THAT HAS AN
ANNUAL DEMAND OF 2,000 UNITS, A COST PER ORDER OF $75, AND
ANNUAL CARRYING COST OF $7.50 PER UNIT. WHAT IS THE EOQ?

 200 units
 100
 73
 40,000 units
A COMPANY WISHES TO DETERMINE THE EOQ FOR AN ITEM THAT HAS AN
ANNUAL DEMAND OF 2,000 UNITS, A COST PER ORDER OF $75, AND
ANNUAL CARRYING COST OF $7.50 PER UNIT. WHAT IS THE EOQ?

 200 units
 100
 73
 40,000 units
POLICIES BASED ON ABC ANALYSIS MIGHT INCLUDE INVESTING

 extra care in forecasting for C items.

 the most time and effort verifying the accuracy of records for B items.
 more in inventory security for C items.
 more in supplier development for A items.
POLICIES BASED ON ABC ANALYSIS MIGHT INCLUDE INVESTING

 extra care in forecasting for C items.

 the most time and effort verifying the accuracy of records for B items.
 more in inventory security for C items.
 more in supplier development for A items.