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Inventory Chapter 6
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InventoryChapter 6
Inventory - a stock or store of goods
- a list of goods on hand
Kinds of Inventory:
Inventory
Inventory Functionality and Definitions
Inventory Carrying Cost
Planning Inventory
Managing Uncertainty
Inventory Management Policies
Inventory Management Practices
Inventory Functionality and Definitions
Inventory management is risky.
Typical measures of inventory exposure:
Time duration
Depth
Width of commitment
For manufacturer
long-term risk
For wholesaler
Assortment of merchandise
For retailer
velocity of buying and selling
Emphasis on inventory turnover
Functions of Inventory
To meet the anticipated customer demand
To smooth production requirements
To decouple operations
To protect against stockouts
To hedge against price increases
To permit operations
To take advantage of quantity discounts
4 Prime Functions of Inventory
Inventory policy
Service level
Average inventory
Average inventory across multiple performance cycles
Inventory Definitions
Inventory Policy
Consists of guidelines concerning what to purchase or manufacture, when to take action, and in what quantity
Concerns inventory management practice
Service level
A performance target specified by management
Measured in terms of:
Performance cycle
The elapsed time between the release of purchase order by a buyer to the receipt of shipment.
Case fill rate
The percent of cases or units ordered that are shipped as requested
Line fill rate
The percent of order lines filled completely
Order fill
The percent customer orders filled completely
Service level
Average inventory The materials, components, WIP, and fnished product
typically stocked in the logistical system is called inventory and the typical amount across time is average inventory.
Order quantity
The amount ordered for replenishment
The difference between the maximum and minimum inventory levels.
Cycle inventory/base stock
Portion of average inventory that results from replenishment.
Average cycle inventory or base stock
The portion of average inventory that resullts from replinishment
Equals one-half order quantity
Stock level
At a maximum following stock receipt from the supplier.
Safety stock
The majority of inventory in the typical logistics system
Ave. Inventory = ½ order quantity plus safety stock
Transit inventory -amount typically in transit between facilities or on order but not received.
Obsolete inventory -stock that is out-of-date or that has not experienced recent demand. Eventually donated, destroyed, or sold at a loss.
Speculative inventory - bought prior to need to hedge a currency exchange or to take advantage of a discount.
Average inventory (continuation...)
Inventory Definitions:
Inventory Cycle for Typical Product
Average Inventory½ order quantity ($40,000/2 or
$20,000) + Safety Stock ($30,000) =
$50,000
$30,000
Transit/Obsolete/Speculative/ Safety stock
1 2
$70,000Maximum Inventory
Inventory Definitions:Average inventory across multiple performance cycles Reorder point
Defines when a replenishment order is initiated
Inventory turns
Total sales divided by the average inventory
Economic Order Quantity (EOQ)
Provides a specific quantity balacing the cost of orderingand the cost of maintaining average inventory
Inventory Definitions:
Inventory Cycle with No Demand Uncertainty
Average
Inventory (Q/2) = 100
0
200Order Arrives
Days 4060
Order Placed for 200
products
10
Reorder Point
If sales occur at the rate of 10 products/day, it takes 20 days to sell 200 products
Invento
ry o
n
hand
0
200
60
Order Arrives
20 40
Order Placed for 200
products
10
Reorder Point
Order Placed for 200
products
30
Reorder Point
Inventory Definitions:
Inventory Cycle with No Demand Uncertainty
Assuming a work year of 240 days,12(240/20) purchases will be req. during the year. Therefore, over a period of 1 year 2400 (200*12) unit will be purchased. Inventory turnover will be 24 (2400 unit/100 units of ave. inventory) times.
Order Arrives
20 40 50
Order Placed for 100
products
10Reorder Point
30
Average
Inventory
50 products
Reorder Point
Reorder Point
Reorder Point
Reorder Point
0
100
Inventory Definitions:More Frequent Orders, Smaller Order Quantity
Will have 24(240 days/10 days) purchases. Inventory turnover will be 48( 2400/50)times.
Ave. Inventory = 300
0
600
40 8020 60 100 120
Order Arrives
Order Placed for 600
products
Order Placed for 600
products
Inventory Definitions:Less Frequent Orders, Larger Order Quantity
Inventory Carrying Cost
The expense associated with maintaining inventory
Calculated by multiplying annual inventory carrying cost percent by average inventory value.
Capital
Ranges from the prime interest rate to a higher managerially-determined percent
Taxes
A direct levy based on inventory level on a specific day of the year or average inventory level over a period of time
Insurance
An expense based upon estimated risk or loss over time
Risks depends on the product and the facility storing the product.
Obsolescence
Results from deterioration of product during storage
Percent of ave. inventory value declared obsolete each year
Storage
Facility expense related to product holding rather than product handling
Inventory Carrying Cost Components
Element Average % % Ranges
Cost of Capital 10.00% 4-40%
Taxes 1.00 0.5-2
Insurance 0.05 0-2
Obsolescence 1.20 0.5-2
Storage 2.00 0-4
Totals 14.25% 5-50%
Planning Inventory
Inventory Planning consist of determining when and how much to order.
When to order is determined by average and variation in demand and replenishment.
How much to order is determined by the order quantity.
Inventory Control – the process of monitoring inventory status
When to Order(When No Demand/Performance Cycle Uncertainty)
Reorder Point Formula:
R = D X T
R = Reorder Point in Units (of product)
D = Average Daily Demand in Units (of product)
T =Average Performance Cycle in Days (i.e., order cycle time, or the number of days between placing an order and receiving the order)
Reorder Point Formula
R = D X T
D = 20 products/day
T = 10 days (time between placing order and receiving order)
R = 20 X 10
Reorder Point = 200 products
That is, an order is initiated whenever there are 200 products left in inventory
Safety stock is necessary to accommodate uncertainty
Reorder Point Formula
R = D X T + SS
SS = Safety stock in units
D = 20 products/day
T = 10 days (time between placing order and receiving order)
SS = 100 products
R = 20 X 10 + 100
Reorder Point = 300 products
That is, an order is initiated whenever there are 300 products left in inventory
When to Order(When Demand/Performance Cycle is Uncertain)
How much to Order The objective is to identify the ordering quantity
that minimizes the total inventory carrying and ordering cost.
Significant cost are setup cost and holding cost, all other cost s, such as the inventory itself, is constant so minimizing the sum of setup and holding costs will also minimize total cost (TC).
Holding ( Carrying ) cost – the cost to keep or carry inventory over time.
Ordering ( Set Up ) cost – cost of the ordering process
EOQ – the replenishment practice that minimizes the combined inventory carrying and ordering cost
EOQ = Economic Order Quantity
Co = Cost per Order (Ordering Cost)
Ci = Annual Inventory Carrying Cost %
D = Annual Product Sales (in units)
U = Cost per Product
EOQ =2Co D
Ci U
How Much to Order Economic Order Quantity (EOQ)
Alternate formula based on Heizer book
Q* = optimum number of units per order (EOQ)
D = Annual demand in units for the inventory items
S =Setup/Ordering cost for each order
= Co
H = Holding/Carrying cost per unit per year
= Ci * U
Total Ordering cost = (D/Q) * S
Total Carrying/Holding cost = (Q/2) * H
(D/Q) * S = (Q/2) * H
Q* = 2DS/H
EOQ =2 * $19.00 * 2400
20% * $5.00
EOQ = Economic Order Quantity
Co = $19.00 (ordering cost)
Ci = 20% (annual carrying cost %)
D = 2400 (annual number of products sold)
U = $5.00 (cost of each product)
302 rounded to 300 =2 * $19.00 * 2400
20% * $5.00
How Much to Order Considering Transportation Rates
Order Quantity = 300 products per order
Number of orders placed per year = 2400/300 or 8
Ordering Cost per year = {( D/Q)*S} (2400 / 300)* $19 = $152.00
Inventory Carrying Costs per year = {(Q/2) * H} (300/2) * ($5.00 * 20%) = $150.00
Transportation Costs (per year) for Small Shipments:
$1.00 (per product) * 2400 (products purchased per year) = $2400.00
TOTAL COSTS = $150.00 + $152.00 + $2400.00 = $2702.00
Order Quantity = 480 products per order
Number of orders placed per year = 2400/480 or 5
Ordering Cost per year = 5 orders * $19.00 = $95.00
Inventory Carrying Costs per year = 240 * $5.00 * 20% = $240.00
Transportation Costs (per year) for Large Shipments:
$0.75 (per product) * 2400 (products purchased per year) = $1800.00
TOTAL COSTS = $95.00 + $240.00 + $1800.00 = $2135.00
How Much to Order Considering Transportation Rates
Alternative 1
TOTAL COSTS (300 product order size)
$150.00 + $152.00 + $2400.00 = $2702.00
Alternative 2
TOTAL COSTS (480 product order size)
$95.00 + $240.00 + $1800.00 = $2135.00
How Much to Order Considering Transportation Rates
How Much to Order Considering Transportation Rates & Price/Quantity Discounts
How Much to Order Considering Transportation Rates & Price/Quantity Discounts
Order Quantity = 300 products per order
Number of orders placed per year = 2400/300 or 8
Ordering Cost per year = 8 orders * $19.00 = $152.00
Inventory Carrying Costs per year = 150 * $4.00 * 20% = $120.00
Transportation Costs (per year) for Small Shipments:
$1.00 (per product) * 2400 (products purchased per year) = $2400.00
Product Cost per year = 2400 * $4.00 = $9600.00
TOTAL COSTS = $120.00 + $152.00 + $2400.00 + $9600.00 = $12,272.00
How Much to Order Considering Transportation Rates & Price/Quantity
Discounts
Order Quantity = 480 products per order
Number of orders placed per year = 2400/480 or 5
Ordering Cost per year = 5 orders * $19.00 = $95.00
Inventory Carrying Costs per year = 240 * $3.00 * 20% = $144.00
Transportation Costs (per year) for Large Shipments:
$0.75 (per product) * 2400 (products purchased per year) = $1800.00
Product Cost per year = 2400 * $3.00 = $7200.00
TOTAL COSTS = $95.00 + $144.00 + $1800.00 + $7200.00 = $9239.00
Alternative 1
TOTAL COSTS (300 product order size)
$152.00 + $120.00 + $2400.00 + $9600.00= $12,272.00
Alternative 2
TOTAL COSTS (480 product order size)
$95.00 + $144.00 + $1800.00 + $7200.00 = $9239.00
How Much to Order Considering Transportation Rates & Price/Quantity
Discounts
