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Chapter 17 Inventory Control

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Learning Objectives Explain the different purposes for keeping inventory. Understand that the type of inventory system logic that is appropriate for an item depends on the type of demand for that item. Calculate the appropriate order size when a one-time purchase must be made. Describe what the economic order quantity is and how to calculate it. Summarize fixed–order quantity and fixed–time period models, including ways to determine safety stock when there is variability in demand. Discuss why inventory turn is directly related to order quantity and safety stock.

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Inventory You should visualize inventory as stacks of money sitting on forklifts, on shelves, and in trucks and planes while in transit For many businesses, inventory is the largest asset on the balance sheet at any given time Inventory is often not very liquid It is a good idea to try to get your inventory down as far as possible The average cost of inventory in the United States is 30 to 35 percent of its value LO 1

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**Definition of Inventory**

Inventory: the stock of any item or resource used in an organization and can include: raw materials, finished products, component parts, supplies, and work-in-process Manufacturing inventory: refers to items that contribute to or become part of a firm’s product Inventory system: the set of policies and controls that monitor levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be LO 2 3

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**Purposes of Inventory To maintain independence of operations**

To meet variation in product demand To allow flexibility in production scheduling To provide a safeguard for variation in raw material delivery time To take advantage of economic purchase-order size LO 2 4

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**Inventory Costs Holding (or carrying) costs**

Costs for storage, handling, insurance, and so on Setup (or production change) costs Costs for arranging specific equipment setups, and so on Ordering costs Costs of placing an order Shortage costs Costs of running out LO 3 5

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**Independent Versus Dependent Demand**

Independent demand: the demands for various items are unrelated to each other For example, a workstation may produce many parts that are unrelated but meet some external demand requirement Dependent demand: the need for any one item is a direct result of the need for some other item Usually a higher-level item of which it is part LO 2

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**Inventory Control-System Design Matrix: Framework Describing Inventory Control Logic**

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**Inventory Systems Single-period inventory model**

One time purchasing decision (Example: vendor selling t-shirts at a football game) Seeks to balance the costs of inventory overstock and under stock Multi-period inventory models Fixed-order quantity models Event triggered (Example: running out of stock) Fixed-time period models Time triggered (Example: Monthly sales call by sales representative) LO 2 7

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Multi-Period Models There are two general types of multi-period inventory systems Fixed–order quantity models Also called the economic order quantity, EOQ, and Q-model Event triggered Fixed–time period models Also called the periodic system, periodic review system, fixed-order interval system, and P-model Time triggered LO 5

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Key Differences To use the fixed–order quantity model, the inventory remaining must be continually monitored In a fixed–time period model, counting takes place only at the review period The fixed–time period model Has a larger average inventory Favors more expensive items Is more appropriate for important items Requires more time to maintain LO 5

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**Fixed-Order Quantity Model Models**

Demand for the product is constant and uniform throughout the period Lead time (time from ordering to receipt) is constant Price per unit of product is constant Inventory holding cost is based on average inventory Ordering or setup costs are constant All demands for the product will be satisfied LO 4

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**Basic Fixed–Order Quantity Model**

LO 4

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**Basic Fixed-Order Quantity (EOQ) Model Formula**

TC=Total annual cost D =Demand C =Cost per unit Q =Order quantity S =Cost of placing an order or setup cost R =Reorder point L =Lead time H=Annual holding and storage cost per unit of inventory Total Annual = Cost Annual Purchase Cost Annual Ordering Cost Annual Holding Cost + + 12

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**Annual Product Costs, Based on Size of the Order**

LO 4

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**We also need a reorder point to tell us when to place an order**

Deriving the EOQ Using calculus, we take the first derivative of the total cost function with respect to Q, and set the derivative (slope) equal to zero, solving for the optimized (cost minimized) value of Qopt We also need a reorder point to tell us when to place an order 13

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**EOQ Example Example Data**

Given the information below, what are the EOQ and reorder point and Total Inventory Cost? Annual Demand = 1,000 units Days per year considered in average daily demand = 365 Cost to place an order = $10 Holding cost per unit per year = $2.50 Lead time = 7 days Cost per unit = $15 14

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**Establishing Safety Stock Levels**

Safety stock: amount of inventory carried in addition to expected demand Safety stock can be determined based on many different criteria A common approach is to simply keep a certain number of weeks of supply A better approach is to use probability Assume demand is normally distributed Assume we know mean and standard deviation To determine probability, we plot a normal distribution for expected demand and note where the amount we have lies on the curve LO 4

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**Fixed–Order Quantity Model with Safety Stock**

LO 5

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**Fixed–Order Quantity Model with Safety Stock**

LO 5

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**Fixed–Time Period Inventory Model**

LO 5

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**Inventory Control and Supply Chain Management**

LO 6

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**Price Break Models Selling price varies with order size Steps**

Determine Q Determine if feasible or not Calculate TC Choose min TC

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**Example : The Data and Order Quantities**

i = 20 percent Cost per unit… 1-499 $5.00 $4.50 1,000 and up $3.90 LO 4

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ABC Classification LO 2

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**Inventory Accuracy and Cycle Counting**

Inventory accuracy: refers to how well the inventory records agree with physical count Cycle counting: a physical inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year LO 2 27

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© The McGraw-Hill Companies, Inc., 2004 1 Inventory Control.

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