Inventory Management
Chapter 13
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You should be able to:LO 13.1 Define the term inventoryLO 13.2 List the different types of inventoryLO 13.3 Describe the main functions of inventory LO 13.4 Discuss the main requirements for effective managementLO 13.5 Explain periodic and perpetual review systemsLO 13.6 Describe the costs that are relevant for inventory managementLO 13.7 Describe the A-B-C approach and explain how it is usefulLO 13.8 Describe the basic EOQ model and its assumptions and solve typical
problemsLO 13.9 Describe the economic production quantity model and solve typical
problemsLO 13.10 Describe the quantity discount model and solve typical problemsLO 13.11 Describe reorder point models and solve typical problemsLO 13.12 Describe situations in which the fixed-order interval model is
appropriate and solve typical problemsLO 13.12 Describe situations in which the single-period model is
appropriate, and solve typical problems
Chapter 13: Learning Objectives
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InventoryA stock or store of goods
Independent demand itemsItems that are ready to be sold or used
Inventory
Inventories are a vital part of business: (1) necessary for operations and (2) contribute to customer satisfaction
A “typical” firm has roughly 30% of its current assets and as much as 90% of its working capital invested in inventory
LO 13.1
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Inventories serve a number of functions such as:1. To meet anticipated customer demand2. To smooth production requirements3. To decouple operations4. To protect against stockouts5. To take advantage of order cycles6. To hedge against price increases7. To permit operations8. To take advantage of quantity discounts
Inventory Functions
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Inventory management has two main concerns:1. Level of customer service
Having the right goods available in the right quantity in the right place at the right time
2. Costs of ordering and carrying inventories The overall objective of inventory management is to
achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds1.Measures of performance2. Customer satisfaction
Number and quantity of backorders Customer complaints
3. Inventory turnover
Objectives of Inventory Control
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Requires:1. A system keep track of inventory2. A reliable forecast of demand3. Knowledge of lead time and lead time variability4. Reasonable estimates of
holding costs ordering costs shortage costs
5. A classification system for inventory items
Effective Inventory Management
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Periodic SystemPhysical count of items in inventory made at
periodic intervalsPerpetual Inventory System
System that keeps track of removals from inventory continuously, thus monitoring current levels of each itemAn order is placed when inventory drops to a
predetermined minimum levelTwo-bin system
Two containers of inventory; reorder when the first is empty
Inventory Counting Systems
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Purchase costThe amount paid to buy the inventory
Holding (carrying) costsCost to carry an item in inventory for a length of time,
usually a yearOrdering costs
Costs of ordering and receiving inventorySetup costs
The costs involved in preparing equipment for a jobAnalogous to ordering costs
Shortage costsCosts resulting when demand exceeds the supply of
inventory; often unrealized profit per unit
Inventory Costs
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A-B-C approach Classifying inventory according to some measure of
importance, and allocating control efforts accordingly A items (very important)
10 to 20 percent of the number of items in inventory and about 60 to 70 percent of the annual dollar value
B items (moderately important) C items (least important)
50 to 60 percent of the number of items in inventory but only about 10 to 15 percent of the annual dollar value
ABC Classification System
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How Much to Order: EOQ ModelsEconomic order quantity models identify the
optimal order quantity by minimizing the sum of annual costs that vary with order size and frequency1. The basic economic order quantity model2. The economic production quantity model3. The quantity discount model
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The basic EOQ model is used to find a fixed order quantity that will minimize total annual inventory costs
Assumptions:1. Only one product is involved
2. Annual demand requirements are known
3. Demand is even throughout the year
4. Lead time does not vary
5. Each order is received in a single delivery
6. There are no quantity discounts
Basic EOQ Model
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Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q.
The total cost curve reaches its minimum where the carrying and ordering costs are equal.
Deriving EOQ
cost holdingunit per annual
cost)der demand)(or annual(22O
H
DSQ
LO 13.8
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When to ReorderReorder point
When the quantity on hand of an item drops to this amount, the item is reordered.
Determinants of the reorder point1. The rate of demand2. The lead time3. The extent of demand and/or lead time variability4. The degree of stockout risk acceptable to
management
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Demand or lead time uncertainty creates the possibility that demand will be greater than available supply
To reduce the likelihood of a stockout, it becomes necessary to carry safety stock Safety stock
Stock that is held in excess of expected demand due to variable demand and/or lead time
Reorder Point: Under Uncertainty
StockSafety timelead during
demand Expected ROP
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Fixed-order-interval (FOI) model Orders are placed at fixed time intervals
Reasons for using the FOI model Supplier’s policy may encourage its use Grouping orders from the same supplier can produce
savings in shipping costs Some circumstances do not lend themselves to
continuously monitoring inventory position
How Much to Order: FOI
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