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mgmt 339 ch 13

Inventory
A stock or store of goods
Independent demand items
Items that are ready to be sold or used
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
Types of Inventory
Raw materials and purchased parts
Work-in-process (WIP)
Finished goods inventories or merchandise
Tools and supplies
Maintenance and repairs (MRO) inventory
Goods-in-transit to warehouses or customers (pipeline inventory)
Functions of Inventory – Why have?
1. Meet anticipated customer demand
(anticipated stocks)
2. Smooth operational requirements
3. Decouple operations
4. Protect against stock outs
5. Take advantage of order cycles
6. Hedge against price increases
7. To permit operations
8. Take advantage of quantity discounts
Objectives of Inventory Control
Inventory management has two main concerns:
Level of customer service
Having the right goods available in the right quantity in the right place at the right time
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 bounds
Measures of performance
Customer satisfaction
Number and severity of backorders
Customer complaints
Inventory turnover
Inventory management
Management has two basic functions concerning inventory:
Establish a system for tracking items in inventory
Make decisions about
When to order
How much to order
Effective Inventory Management
Requires:
A system to keep track of inventory
A reliable forecast of demand
Knowledge of lead time and lead time variability
Reasonable estimates of
holding costs
ordering costs
shortage costs
A classification system for inventory items
Periodic System
Physical count of items in inventory made at periodic intervals
Perpetual Inventory System
System that keeps track of removals from inventory continuously, thus monitoring current levels of each item
An order is placed when inventory drops to a predetermined minimum level
Two-bin system
Two containers of inventory; reorder
when the first is empty
A periodic system
Use of the fixed-interval model requires having
Perpetual Inventory System
System that keeps track of removals from inventory continuously, thus monitoring current levels of each item
An order is placed when inventory drops to a predetermined minimum level
Two-bin system
Two containers of inventory; reorder
when the first is empty
Two-bin system
Two containers of inventory; reorder
when the first is empty
True: It will decrease because holding cost is in the denominator of the EOQ formula.
Using the EOQ model, if an item’s holding cost increases, its order quantity will decrease.
The two basic questions in inventory management
are how much to order and when to order.
A-B-C
A-B-C is based on the product of unit cost and annual volume.
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
In an A-B-C system, B items typically represent about this percentage of items:
30%
Cycle counting
A physical count of items in inventory
Count some every day or every week
Cycle counting management
How much accuracy is needed?
A items: ± 0.2 percent
B items: ± 1 percent
C items: ± 5 percent
False: Unless demand, holding cost, or ordering cost changing, the order quantity will not change.
When using EOQ ordering, the order quantity must be computed in every order cycle.
Using an economic order quantity is an example of this.
Inventory might be held to take advantage of order cycles.
Holding and ordering costs are inversely related to each other.
Changes in order quantity will cause one to increase and the other to decrease.
The objective of inventory management is
to minimize total cost, which includes ordering costs and sometimes purchase costs (e.g., quantity discount models).
A two-bin system is essentially a simple reorder point system.
Reorder when the first bin is empty.
A fixed-interval ordering system
would be used for items that have independent demand.
In the basic EOQ model
annual ordering cost and annual ordering cost are equal for the optimal order quantity.
The total cost curve is flat to the right of the EOQ.
Increasing the order quantity so that it is slightly above the EOQ would not increase the total cost by very much.
A store that sells daily newspapers could use the single-period model for reordering
The period is one day, and the news in “perishable” beyond one day.
Other things beings equal, an increase in lead time for inventory orders will result in an increase in the:
reorder point
Feedback: Quantity models do not involve lead time.
Which product is usually bought on an ROP basis?
sugar
If average demand for an item is 21 units per day, safety stock is 4 units, and lead time is 2 days, the ROP will be:
46

Feedback: ROP = d x LT + SS = 21 x 2 + 4 = 46.

Which model does not take into account the amount of inventory on hand?
EOQ
Feedback: The EOQ factors are demand, ordering costs, and carrying costs.
ROP formula
ROP= d X LT (demand rate X Lead time in days or weeks)
ROP=Expected demand during lead time+Safety Stock
In the two-bin system, the quantity in the second bin is equal to the
ROP
Feedback: The second bin holds the reorder point quantity,
Forecasts
Inventories are necessary to satisfy customer demands, so it is important to have a reliable estimates of the amount and timing of demand
Point-of-sale (POS) systems
A system that electronically records actual sales
Such demand information is very useful for enhancing forecasting and inventory management
Which product is usually bought on a fixed interval basis?
textbooks

Feedback: Usually bought once a semester.

Inventory Costs
-Purchase cost
The amount paid to buy the inventory
largest of all inventory costs
-Holding (carrying) costs
Cost to carry an item in inventory for a length of time
physically having items in storage
two ways:
1) as a percentage of unit price or as a dollar
amount per unit
2)as a dollar amount per unit
-Ordering costs
Costs of ordering and receiving inventory
expressed as fixed dollar amount per order
-Setup costs
The costs involved in preparing equipment for a job
Analogous to ordering costs
expressed as a fixed charge per production run
-Shortage (stock-out) costs
Costs resulting when demand exceeds the supply of inventory
unrealized profit per unit
expedite costs
Lead time
Time interval between ordering and receiving the order
the EOQ
annual holding cost
the ROP
safety stock
are a function of demand.
Using the basic EOQ model, if the ordering cost doubles, the order quantity will be
Feedback: Because S in under the square root sign, multiplying its value be 2 will increase the EOQ by the square root of 2, which is .707.
about 71% of its former value
If a decrease in unit price causes the average demand rate to increase, which would not increase?
lead time
Setup costs are analogous to which one of these costs?
ordering
Feedback: Both setup and ordering costs are in the numerator of the quantity formula; and both are independent of order size.

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