Inventory Control

THE MILLENNIUM UNIVERSITY

COLLEGE

Finance In the Hospitality Industry

 INVENTORY
 Any stored resource used to satisfy a
current or future need (raw
materials, work-in-process, finished
goods, etc.)
 Represents as much as 50% of
invested capital at some companies.
 Excessive inventory levels are costly.
 Insufficient inventory levels lead to
stock outs.
 INVENTORY PLANNING AND CONTROL
 For maintaining the right balance
between high and low inventory to
minimize cost.
 MAIN USES OF INVENTORY

1. Storing resources
2. Irregular supply and demand
3. Quantity discounts
4. Avoiding stock outs and shortages
 TYPES OF INVENTORY
 Raw material
 Purchased but not processed
 Work-in-process
 Undergone some change but not completed
 A function of cycle time for a product

 Maintenance/repair/operating (MRO)
 Necessary to keep machinery and processes
productive
 Finished goods
 Completed product awaiting shipment
 INVENTORY CONTROL DECISIONS
Objective: Minimize total inventory cost

Decisions:
 How much to order?
 When to order?
 ORDER QUANTITY STRATEGIES
 Lot-for-lot
 Order exactly what is needed for the next period
 Fixed-order quantity
 Order a predetermined amount each time an order is
placed
 Min-max system
 When on-hand inventory falls below a predetermined
minimum level, order enough to refill up to maximum
level
 Order n periods
 Order enough to satisfy demand for the next n
periods
 RELEVANT INVENTORY COSTS
 Item Cost
 Cost per item plus any other direct costs associated
with getting the item/
 Holding Costs
 Capital, storage, labour and risk cost typically stated
as a % of the unit value, e.g. 15-25%
 Ordering Cost
 Amount incurred for each order placed.
 Shortage Costs
 These costs, also called stock-out costs, occur when
businesses become out of stock for whatever reason
 HOLDING COSTS
 Inventory financing costs – This includes everything related
to the investment made in inventory, including costs like
interest on working capital.
 Opportunity cost of the money invested in inventory – This
is found by factoring in the lost alternatives of tying money
up in inventory.
 Storage space costs – These are costs related to the place
where the inventory is stored, and will vary by location.
There will be the cost of the storage facility itself, or lease
payments if it is not owned.
 Inventory services costs – This includes the cost of the
physical handling of the goods, as well as insurance,
security, and IT hardware, and applications if these are
used.
 Inventory risk costs – Loss of products between purchasing
from the supplier and final sale due to any number of
reasons: theft, vendor fraud, shipping errors, damage in
transit or storage.
 ORDERING COST
 Clerical costs of preparing purchase orders –
There are many kinds of clerical costs, such as
invoice processing, accounting, and
communication costs.
 Cost of finding suppliers and expediting orders
– Costs spent on these will likely be
inconsistent, but they are important expenses
for the business.
 Transportation costs – The costs of moving the
goods to the warehouse or store. These costs
are highly variable across different industries
and items.
 SHORTAGE COSTS
 These costs, also called stock-out costs, occur when
businesses become out of stock for whatever reason.
 Disrupted production – When the business involves
producing goods as well as selling them, a shortage
will mean the business will have to pay for things like
idle workers and factory overhead, even when nothing
is being produced.
 Emergency shipments – For retailers, stock-outs
could mean paying extra to get a shipment on time, or
changing suppliers.
 Customer loyalty and reputation – These costs are
hard to pinpoint, but there are certainly losses to
these when customers are unable to get their desired
product or service on time.
 MODEL FOR DETERMINING ORDER
QUANTITY
 Economic Order Quantity (EOQ or Q
System)
 An optimizing method used for
determining order quantity and reorder
points
 Basically, EOQ helps you identify the
most economical way to replenish your
inventory by showing you the best order
quantity.
 ECONOMIC ORDER QUANTITY
1. Demand is known and
constant.
2. Lead time is known and constant
3. Receipt of inventory is
instantaneous.
4. Quantity discounts are not available
5. Variable costs are limited to: ordering cost and
carrying (or holding) cost
6. If orders are placed at the right time, stock
outs can be avoided
INVENTORY USAGE OVER TIME
 INVENTORY USAGE OVER TIME

Usage rate Average

Order inventory
quantity = Q
Inventory level

on hand
(maximum
Q
inventory
level) 2

Minimum
inventory

0
Time
 THE EOQ MODEL
Q = Number of pieces per order
D = Annual demand in units for the inventory item
S = Ordering cost for each order

Annual Order cost = (Number of orders placed per year)

x (order cost per order)

Annual demand order cost per

=
Number of units in each order order

= D (S)
Q
 THE EOQ MODEL
Q = Number of pieces per order
H = Holding or carrying cost per unit per year

Annual holding cost =(Average inventory level)

x (Holding cost per unit per year)

Order quantity
= (Holding cost per unit per year)
2

= Q (H)
2
 THE EOQ MODEL
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = ordering cost for each order
H = Holding or carrying cost per unit per year

Optimal order quantity is found when annual order cost

equals annual holding cost

D Q
S = H
Q 2
Solving for Q* 2DS = Q2H
Q2 = 2DS/H
Q* = 2DS/H
 EXAMPLE
 Assume a Hotel that faces demand for 5,000 bed
sheets per year, and that it costs Rs 150,000 to
have the bed sheets shipped to the Hotel. Holding
cost is estimated at Rs 300 per bed sheet per
year. what should be the economical order size?

2SD
Q* =
H

2(150,000)(5,000)
Q 
*
 2236
300
 REORDER POINT
 If delivery is not instantaneous, but there is a
lead time L:
When to order? How much to order?
 REORDER POINT

Order Q: When shall we order?

Quantity A: When inventory = ROP
Q Q: How much shall we order?
A: Q = EOQ
Inventory

Reorder
Point
(ROP)
ROP = LxD

Lead Time
Time
D: demand per period
Place Receive
L: Lead time in periods
order order
 EXAMPLE
Assume a Hotel that faces demand for 5,000 bed
sheets per year, and it takes 10 days to receive
shipments of bed sheets, calculate reorder point for
bed sheets ?
ROP = LxD

10 10
R = D = 5000 = 137
365 365

Hotel should order new bed sheets when 137 bed sheets
are remaining in Inventory.