Inventory management

Inventory is the stock of physical goods for eventual sale. Inventory consists of raw material, work-inprocess, and finished goods available Click tosale.Master subtitle style for edit There are many factors in a decision of how much inventory to have on hand. Theres a cost to too much inventory and theres a cost of too little inventory.

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Reasons for Holding Inventory

v The most obvious is that if you sell a

There are several reasons to hold inventory. product, you cant transact business without inventory.

v Another reason is that goods cannot be

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manufactured instantaneously. If you manufacture goods, you will likely have some inventory in various stages of production. This is referred to as work-inprocess.
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Rea..
v You also may want to have some

inventory of finished goods in case sales are greater than expected. Or you may want to hold some speculative inventory for dealing with events such as a change in the product or a change in the cost of the raw materials.
v Further, some firms hold inventory to satisfy contractual agreements.
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2 Costs Associated with Inventory

There are two types of inventory costs. The cost of holding inventory and the cost of obtaining more inventory.
1. Carrying/holding costs:, is the cost of

keeping inventorystorage, depreciation, and obsolescence and the opportunity cost of tying up funds in inventory

Holding cost = (Average quantity) (Holding cost per unit)

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Costs..
2. Ordering costs/set up costs: the cost of placing an order for payment for clerical and administrative or secretarial services written and other forms of communication. Ordering cost = (Fixed cost per order) (Number of orders per period) Total inventory cost = Holding cost + Ordering cost
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Costs.
Total inventory cost = Carrying cost per unit (Average balance) + (Cost per order) (Number of orders) Total Inventory Cost= c (Q/2) +K(S/Q)
Let, c = holding or carrying cost, in dollars

per unit
Q = quantity ordered K = cost per transaction S = total number management needed during 5/21/12 inventory of units 66

E g.
e.g. The ABCD Company has a total demand for 500,000 units during a month. If you order 50,000 units at a time, thats 10 orders. If it costs us $100 each time we place an order, the ordering costs are 10 $100 = $1,000. If you order 50,000 units each time you run out, you have, on average, 25,000 units on hand. Suppose the carrying cost per unit is 20. If you have 25,000 units, on average, on hand, you have holding costs of 20 25,000 or $5,000. Total inventory cost= $0.20(50000/2)+ $100(50000/50000)=$6000
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Techniques for Managing Inventory

Techniques that are commonly used in managing Inventory are:
a) ABC system b) Economic Order Quantity (EOQ) model c) Material Requirement Planning (MRP)

system and

d) Just-in-Time(JIT) system
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a. ABC system
Inventory is divided into three groups, A, B,

and C. The group A includes those items that require the largest birr investment. The group B consists of the items accounting for the next largest investment. The group C typically consists of a large number of items accounting for a relatively small birr investment. Dividing its inventory into A, B, and C items allows the firm to determine the level and types of inventory control procedures needed. Control of A items should be most intensive and the use of perpetual 99 5/21/12 inventory management

ABC
B items are frequently controlled via

periodic checking-possibly weekly-of their levels.

C items could be controlled by using

unsophisticated procedures such as a red line method, in which a reorder is placed when enough inventory has been removed from a bin containing the inventory item to expose a red line that has been drawn around the inside of the bin.
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b. The Economic Order Quantity Model model The Economic Order Quantity (EOQ)
helps us determine what quantity of inventory to order each time we order so that total inventory costs throughout the period are minimized. The economic order quantity model assumes that:

Inventory is received instantaneously. Inventory is used uniformly over the period. Inventory shortages are not desirable.
5/21/12 inventory management 1111 With these assumptions, firms can minimize

Cont.
Total cost = c (Q/2) +K (S/Q) EOQ= = = If, c = $0.20 per unit, K = $100 per transaction, and S = 500,000 units, then: Q= = =22,361 units

Then for this order quantity: Total inventory cost = Holding cost + Ordering cost Total cost = c (Q/2) +K (S/Q) = 0.20 (22,361/2) +$100 (500000/22,361) = 5/21/12 inventory management $4,472

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Cont..
Safety stock is an additional level of

inventory intended to enable the firm to continue to meet demand in case sales levels turn out to be higher than predicted and in case there are unexpected delays in either receiving raw materials or in producing goods. The level of safety stock depends on the degree of uncertainty in our sales and production and the cost of lost sales (where the cost of lost sales comprises sales lost and the loss of customer goodwill).
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Cont
Lead time is the time it takes between

placing an order for more inventories and the time when it is received or produced. tolerance for a shortage of goods for sale.

The allowance for stock-out is the

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c. Material Requirement Planning It is a system to determine what to order, (MRP) system when to order and what priorities to assign

to ordering materials. MRP uses EOQ concepts and a computer to compare production needs to available inventory balance. The advantage of the MRP system is that it forces the firm to more thoughtfully consider its inventory needs and plan accordingly. The objective is to lower the firms inventory investment without impairingmanagement production. 5/21/12 inventory 1515

d. Just-in-Time Inventory The goal of the just-in-time (JIT)

inventory model is to cut down on the firms need to keep inventory on hand, coordinating the supply of raw materials with the production and marketing of the goods. In JIT, the raw materials are only acquired precisely when they are needed just in time. The idea of JIT is to have zero inventories or as near zero as possible without adversely affecting 5/21/12 1616 productioninventory management or sales.

JIT
1. Holding less inventory, so that there are lower storage costs, lower levels of spoilage, and less risk of obsolescence. 2. Coordinating with suppliers to minimize the cost of reordering inventory. JIT requires coordination between a firm and its suppliers. To make JIT work, you must have timely, reliable delivery of goods and materials.
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Monitoring inventory management

We can monitor inventory by looking at

financial ratios in much the same way we can monitor receivables. The number of days of inventory is the ratio of the dollar value of inventory at a point in time to the cost of goods sold per day: inventory/average days cost of good sold

Number of days of inventory=

This ratio is an estimate of the number of days worth of sales you have on hand. Combined with an estimate of the demand for your goods, 5/21/12 inventory management 1818

Cont
Another way to monitor inventory is the

inventory turnover ratio the ratio of what you sell over a period (the cost of goods sold) to what you have on hand at the end of that period (inventory):
Inventory turnover = cost of good

sold/inventory

The inventory turnover ratio tells you, on average, how many times inventory flows through the firmfrom raw materials to 5/21/12 inventory management 1919 goods sold during the period

Thank you

2020 5/21/12 inventory management