Inventory Management Summary

Group 7
Inventory
●​ It refers to the goods and materials a business holds for the purpose of resale,
production, or repair. It includes all the items that are stored in warehouses, stores, or
production facilities and are used to fulfill customer orders or enable operations

Nature and Importance of Inventories

●​ Ensuring Continuity of Production and Sales
●​ Meeting Customer Demand
●​ Facilitating Production Scheduling
●​ Supporting Sales and Marketing

Kinds of Inventories
●​ Raw materials and purchased parts
●​ Partially completed goods, called work-in process (WIP)
●​ Goods-in-transit to warehouses, distributors, or customers (pipeline inventory)
●​ Finished-goods inventories (manufacturing firms) or merchandise (retail stores)
●​ Tools and Supplies
●​ Maintenance and repairs (MRO) inventory

Functions of Inventory
●​ To meet anticipated customer demand
●​ To smooth production requirements
●​ To decouple operations
●​ To reduce the risk of stockouts
●​ To take advantage of order cycles
●​ To hedge against price increases
●​ To permit operations
●​ To take advantage of quantity discounts

Objective of Inventory Management

Overall Objective of Inventory Management

●​ To achieve satisfactory levels of customer service while keeping inventory costs within
reasonable bounds
Two Basic Issues
●​ When to order
●​ How much to order
Useful Measures
●​ Inventory Turnover - the ratio of annual cost of goods sold to average inventory
investment
●​ Days of Inventory on Hand - number that indicates the expected number of days of sales
that can be supplied from existing inventory.
Requirements for Effective Inventory Management
●​ Establish a system to keep track of items in inventory
●​ Make decisions about how much and when to order.
To be effective, management must
have the following:
●​ A system to keep track of the inventory on hand
●​ A reliable forecast of demand that includes an indication of possible forecast error
●​ Knowledge of lead times and lead time variability.
●​ Reasonable estimates of inventory holding costs, ordering costs, and shortage costs.
●​ A classification system for inventory items.

Inventory Systems
●​ Periodic inventory system checks inventory at regular intervals, such as weekly or
monthly. Small retailers commonly use this approach, where managers manually count
items and place orders based on current stock and expected future demand.
●​ Perpetual inventory system continuously tracks inventory levels in real time. When
stock drops to a preset level, a new order is automatically placed. The system provides
better control, as it’s constantly monitoring stock, and allows businesses to order an
optimal quantity.

Basic Perpetual Inventory System

●​ Two Bin System - Inventory is divided into two containers. The first container is used
until it’s empty, and at that point, it’s time to reorder stock. Sometimes an order card is
placed at the bottom of the first bin to remind the person in charge to place a new order.
The second bin holds enough stock to meet demand while waiting for the order to be
delivered. It also includes extra stock in case the order is delayed or demand increases
unexpectedly.

Advance Systems of Perpetual Inventory System

●​ Point-of-Sale (POS) systems are especially beneficial because they give continuous
inventory updates, eliminating the need for periodic reviews, speeding up the checkout
process, and improving customer service by accurately showing the price and quantity of
items on receipts.
●​ Bar Coding is not only useful in retail, but also useful in other sectors too. In
manufacturing, bar codes on parts and products help track inventory more efficiently.
They even automate tasks like routing, scheduling, and packaging. In health care, bar
codes help prevent medication errors by ensuring the right drugs are given to patients.

Demand Forecasts and Lead Time.

Inventory exists to meet customer demand, so it’s crucial to accurately predict how much
stock will be needed and when. If demand or delivery times are uncertain, businesses must
keep additional stock on hand to prevent running out. The more unpredictable these factors
are, the higher the risk of shortages, making it essential to have solid forecasting methods.

Inventory Costs
Four main costs associated with managing inventory:
●​ Purchase cost - is what the company pays suppliers for the goods. This is usually the
largest portion of inventory costs.
●​ Holding cost - includes storage costs like rent, insurance, spoilage, and even theft.
Keeping items in inventory ties up money that could be used elsewhere, so there’s also
an opportunity cost.
●​ Ordering cost - involves the costs of placing and receiving an order. This includes
everything from preparing invoices to inspecting and moving goods into storage.
●​ Shortage cost - happens when demand exceeds available inventory. This could mean
losing sales, damaging customer relationships, or even halting production if internal
supplies run out.

A-B-C Classification System

Not all items are equally important, this system helps focus efforts on the most critical items:
●​ A items are the most valuable, making up around 60–70% of the inventory’s value but
only 10–20% of the actual items. These require close attention and frequent reviews to
avoid stockouts.
●​ B items are moderately important and need less monitoring.
●​ C items make up the majority of inventory but only a small percentage of its value.
These can be managed with looser controls, often in bulk or with less frequent orders.
This classification allows businesses to prioritize their resources on the most impactful items,
ensuring high-value items are carefully managed while lower-value items are less tightly
controlled.

Cycle Counting
●​ A method of frequently counting small portions of inventory instead of doing a full count
once a year.

Inventory Ordering Policies

●​ Guidelines or strategies that businesses use to determine when and how much inventory
to order to meet customer demand while minimizing costs.

Cycle Stock
●​ Definition: The portion of inventory that is intended to meet normal, expected demand
during a specific period. It is replenished regularly through standard ordering and
production cycles.
●​ Purpose: To ensure that regular, predictable demand is met without interruption.
Safety Stock
 ●​ Definition: An additional buffer of inventory kept to protect against uncertainties in
demand or supply, such as unexpected spikes in demand, supplier delays, or inaccurate
forecasts.
●​ Purpose: To prevent stockouts and ensure customer satisfaction in case of unexpected
variations.
ECONOMIC ORDER QUANTITY MODELS
●​ Economic Order Quantity (EOQ) models are quantitative tools used in inventory
management to determine the optimal order quantity that minimizes total inventory costs.
These costs typically include ordering costs (costs of placing and receiving orders) and
holding costs (costs of storing and managing inventory).

BASIC ECONOMIC ORDER QUANTITY (EOQ) MODEL

●​ It is a mathematical formula used in inventory management to determine the optimal
order quantity that minimizes the total cost of inventory, which includes ordering costs
and holding costs.
●​ It assumes constant demand, constant lead time, and instantaneous replenishment of
inventory with no discounts.

ECONOMIC PRODUCTION QUANTITY (EPQ) MODEL

●​ It is an extension of the Basic EOQ Model, designed for situations where inventory is
replenished gradually through production rather than delivered all at once.
●​ It determines the optimal production lot size that minimizes total inventory costs while
considering both production and consumption rates.

QUANTITY DISCOUNT MODEL

●​ It is a variation of the EOQ Model that incorporates price discounts offered by suppliers
for ordering larger quantities.
●​ It determines the optimal order quantity by balancing lower purchasing costs from
discounts with higher holding costs and ordering costs to achieve the minimum total
cost.

REORDER POINT ORDERING

●​ It is an inventory control method where a new order is triggered once inventory falls to a
predetermined level, known as the reorder point (ROP).
●​ The ROP ensures that stock is replenished in time to prevent shortages, considering
factors like demand during lead time and safety stock.

FIXED PERIOD MODEL

●​ Inventory is reviewed and replenished at fixed intervals, regardless of the current
inventory levels.
●​ Orders are placed to restock the inventory up to a predetermined level, known as the
reorder point or target stock level.
●​ Useful when demand is relatively stable, and ordering at regular intervals is more
efficient than continuous tracking.
SINGLE PERIOD MODEL
●​ Used for products with a limited selling period, such as perishable goods or seasonal
items.

●​ It aims to determine the optimal order quantity by balancing the cost of overstocking
(wasting unsold goods) and understocking (losing potential sales).
●​ Typically uses a trade-off between the cost of excess inventory and the cost of stockouts
to decide on the optimal order quantity.

OPERATIONS STRATEGY
Improving inventory processes can significantly reduce costs and improve customer satisfaction.
Key areas for improvement include:

Record Keeping: Maintaining accurate and up-to-date inventory records is crucial for making
informed inventory decisions. Regular updates to estimates of costs, demand, and lead times
are necessary.

Variation Reduction: Reducing lead time variations and forecast errors can enhance
inventory management and efficiency.

Lean Operation: Lean systems, which are demand-driven and use smaller lot sizes, help
lower inventory carrying costs, streamline operations, reduce space requirements, and improve
workflow.

Supply Chain Management: Close coordination with suppliers, using strategies like blanket
orders, vendor-managed inventories, and consignment agreements, can reduce stockouts,
inventory carrying costs, and transaction costs. Cross-docking can also minimize storage costs
by bypassing warehouse handling.

Overall, optimizing these areas can lead to more efficient inventory management and greater
cost savings.