Inventory Management: Types, Pressures, and Control Systems
Inventory Management
Types of Inventory
- Raw Materials (RM)
- Work-in-Process (WIP)
- Finished Goods (FG)
Pressures for Inventory
Pressures for Small Inventories
- Temporary monetary investment
- Inventory holding cost (or carrying cost)
- Cost of capital
- Storage and handling costs
- Taxes, insurance, and shrinkage
Pressures for Large Inventories
- Customer service
- Ordering cost
- Setup cost
- Labor and equipment utilization
- Transportation cost
- Payments to suppliers
Inventory Control Systems
Two Important Questions
- How much?
- When?
Nature of Demand
- Independent demand
Two Inventory Control Systems
- Continuous review (Q) system
- Periodic review (P) system
Continuous Review (Q) System
Also called reorder point system or fixed order-quantity system
An order is placed when the inventory position reaches a predetermined level called reorder point (R).
Inventory Position (IP)
On-hand inventory + scheduled receipts – backorders
An order must be placed when there is enough stock to satisfy demand from the time the order is placed until the new stock arrives (called lead time).
Reorder Point
Average demand during lead time + Safety stock
= dL + safety stock
where: d = average demand per week or day or month
L = constant lead time in weeks or days or months
Advantages of Q Systems
- Review frequency may be individualized.
- Fixed lot sizes can result in quantity discounts.
- Lower safety stocks
Periodic Review (P) System
Convenient.
Orders can be combined.
Only need to know IP when review is made
Economic Order Quantity (EOQ)
Developed in 1913 by F.W. Harris
Answers the question ‘How much do I order?’
Used for
Independent demand items.
Objective
To find order quantity (Q) that minimizes total annual inventory holding and ordering costs.
Must be
Calculated separately for each SKU.
Widely used
And very robust (i.e. works well in a lot of situations, even when its assumptions don’t hold exactly).
Assumptions
- Demand rate for the item is constant and known with certainty.
- No constraints are placed on the size of each lot.
- The only two relevant costs are the inventory holding cost and the fixed cost per lot for ordering or setup.
- Decisions for one item can be made independently of decisions for other items.
- The lead time is constant and known with certainty. The amount received is exactly what was ordered and it arrives all at once rather than piecemeal.
Calculating EOQ
Annual Holding Cost
= (average cycle inventory) x (unit holding cost)
Annual Ordering Cost
= (number of orders per year) x (ordering or setup cost)
Total Annual Cycle-Inventory Cost
= annual holding cost + annual ordering or setup cost
C= Q/2 x H + D/Q x S
Where c= total annual cycle inventory cost
Q= lot size, in units
H= cost of holding one unit in inventory for a year, often expressed as a percentage of the items value
D= annual demand, in units per year
S= cost of ordering or setting up one lot in dollars per lot
THE EOQ FORMULA
raiz cuadrada 2DS/H
time between orders expressed in months EOQ/D (12 months/year)
ABC Analysis
Stock-keeping unit (SKU). Identify the classes so management can control inventory levels. A Pareto chart