Inventory Management (Part 2)

Management of Inventory

An Inventory is a stock or store of goods. Most people consider inventory to be a wasteful and something to be eliminated – but, as we shall see in this section, it is almost impossible to run any manufacturing business without inventory. Not only are inventories necessary for operations, they also contribute significantly to customer satisfaction. For example – All the retail outlets are in business simply because they carry inventory of the goods their customers wish to buy.

Categories of Inventory –

A typical manufacturing firm carries different kinds of inventory, which are often categorized as follows

· Raw materials, purchased parts, sub-assemblies and assemblies

· Partially processed goods, called WIP (Work-in-progress)

· Finished goods that are ready to be sold

· Replacement parts, tools and supplies that is required in the production process

· Goods-in-transit to warehouses or customer’s premises (pipeline inventory)

Objectives of Inventory Control –

The purpose of managing inventories at the right level – neither too low or nor too high – is to maximize the profit of the firm.

· Result of carrying too low inventory levels

o Loss of production due to stoppage

o Loss of sales opportunity

o Customer dissatisfaction

· Result of carrying too high inventory levels

o Increase in costs of sales

o Risk of obsolescence

o Risk of damage / deterioration / fire during storage

o Risk of theft

o Increased space required

o Increased administration overheads

Main decision to be taken in Inventory Management –

· How much inventory

· When should goods be ordered

Note: Inventory is a Support Cost

Fixed interval reorder system

Q = D + L + S - I

· D = Projected demand over next interval of time

· L = Projected demand over present lead period

· S = Safety Stock

· I = Inventory on hand (at the time of re-order)

Lead time – Time interval between ordering and receiving the order

Fixed order / quantity system – EOQ model

Annual Total Cost = Annual Inventory Carrying Cost + Annual Ordering/Holding Cost

Annual Inventory Carrying Cost = (Q/2)*H (Variable Cost – Storage, Insurance, Interest)

Annual Ordering Cost / Holding Cost = (D/Q)*S (Fixed for each order)

Q0 = SQRT (2DS/H)

Where,

Q = Order Size (units) / Q0 = Economic Order Size (Units), EOQ is quantity when the total cost is minimum

H = Holding / Carrying Cost per unit

S = Ordering Cost per order

D = Annual Demand (Units / year)

Q/2 = Average inventory in absence of safety stock,

Shortage Cost

(Total Cost per year / Number of working days) * (Number of shut-down days) = Total Shortage Cost

Assumptions in EOQ model

1. Only one product is involved

2. Annual demand requirements are known

3. Demand is spread evenly throughout the year so that the demand rate is reasonably constant

4. Lead time does not vary

5. Each order is received in a single delivery

6. There are no quantity discounts