Inventories

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Inventories include assets held for sale in
the ordinary course of business, assets
in the production process for sale in the
ordinary course of business, and
materials and supplies that are
consumed in production. (IAS2)

 Raw materials
 Work in Process
 Finished-goods

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 To meet anticipated demand
 To protect against stock-outs due to
unexpected events
 To smooth production requirements

 To help hedge against price increases

 To take advantage of quantity
discounts

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 Inventory Management

Inventory management is the practice

overseeing and controlling of the
ordering, storage and use of
components that a company uses in
the production of the items it sells
or of the goods to be sold to
customers.

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 A system to keep track of inventory
 A classification system
 A reliable forecast of demand
 Knowledge of lead times
 Reasonable estimates of
◦ Holding costs
◦ Ordering costs
◦ Shortage costs

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 Periodic System
Physical count of items made at periodic
intervals
 Perpetual Inventory System
System that keeps track
of removals from inventory
continuously, thus
monitoring
current levels of
each item

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 Universal Bar Code - Bar code
printed on a label that has
information about the item 0

to which it is attached
214800 232087768

 Two-Bin System - Two

containers of inventory;
reorder when the first is
empty

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Classifying inventory according to some
measure of importance and allocating
control efforts accordingly.
A - very important
B - mod. important
C - least important High
A
Annual
$ value B
of items

Low C
Few Many
Number of Items
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 Lead time: time interval between ordering
and receiving the order
 Holding (carrying) costs: cost to carry an
item in inventory for a length of time,
usually a year
 Ordering costs: costs of ordering and
receiving inventory
 Shortage costs: costs when demand
exceeds supply

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Quantity
on hand Inventory
Level

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time

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Questions to answer
How many units?
 Economic order quantity model
 Economic production model

When to order?
 Lead time, Safety Stock and Reorder point

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 Only one product is involved
 Annual demand requirements known
 Demand is even throughout the year
 Lead time does not vary
 Each order is received in a single delivery
 There are no quantity discounts

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 Annual Annual
Total cost = carrying + ordering
cost cost
Q + DS
TC = H
2 Q
Q is the quantity of inventory order
H is the annual holding cost
D is the annual demand
S is the cost incurred per setup/order

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Figure 11.4C

The Total-Cost Curve is U-Shaped

Q D
TC  H  S
2 Q
Annual Cost

Ordering Costs

Order Quantity
QO (optimal order quantity)
(Q)

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 2DS 2( Annual Demand )(Order or Setup Cost )
Q OPT = =
H Annual Holding Cost

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 2 DS
Optimal Order Quantity  Q* 
H
D
Expected Number Orders  N 
Q*
Working Days/Year
Expected Time Between Orders T 
N
D = Demand per year
S = Setup (order) cost per order
H = Holding (carrying) cost

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You’re a buyer for ABC Co.

ABC Co. needs 1000 coffee makers per year.

The cost of each coffee maker is $78.
Ordering cost is $100 per order. Carrying
cost is 40% of per unit cost.

What is the optimal order quantity?

 2 D S
EOQ 
H

2 1000  $100
D = 1000

EOQ 
S = $100
C = $ 78
R = 40%
H= CxR
$31.20
H = $31.20
EOQ = 80 coffeemakers

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 Reorder Point - When the quantity on hand
of an item drops to this amount, the item
is reordered
 Safety Stock - Stock that is held in excess
of expected demand due to variable
demand rate and/or lead time.
 Service Level - Probability that demand
will not exceed supply during lead time.

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 Without safety stock:
R  dL
where R  reorder point in units
d  daily/weekly demand in units
L  lead time in days/weeks

 With safety stock:

R  dL  SS
where SS  safety stock in units

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 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

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 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

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 Production
& Usage
Usage

Production
& Usage
Usage

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 Push system: System for moving work
where output is pushed to the next station
as it is completed
 Pull system: System for moving work where
a workstation pulls output from the
preceding station as needed. (e.g. Kanban)

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Push VS Pull Strategy
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 Just-in-time (JIT):
A highly
coordinated processing system in
which goods move through the
system, and services are performed,
just as they are needed,
 JIT   lean production
 JIT  pull (demand) system
 JIT operates with very little “fat”

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 Get top management commitment
 Obtain support of workers
 Gradually convert operations
 Strengthen the supply chain
 Prepare for obstacles

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 Reduced inventory levels
 High quality
 Flexibility
 Reduced scrap and rework
 Reduced space requirements

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 Management may not be committed
 Workers/management may not be
cooperative
 Suppliers may
resist
◦ Why?

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