Inventory planning & control, Types of inventory, Objectives of Inventory Control, Requirements for effective inventory management, Counting Systems,Inventory Costs, Economic order quantity (EOQ)

Inventory planning & control

A stock or store of goods

- The stored accumulation of material resources in a transformation system

• Allow the flexibility

• Exceptional quality

• Give a level of dependability

• Better return on investment  (ROI)

Functions of Inventory

• To meet anticipated customer demand
• To smooth production requirements
• To protect against stock outs & take advantage of order cycles
• To hedge against price increases
• To permit operations
• To take advantage of quantity discounts

Types of inventory

• Buffer inventory (safety inventory)

- Purpose is to compensate for the unexpected fluctuations in supply & demand

• Cycle inventory

- One or more stages in the process can't supply all produced items simultaneously

• Decoupling Inventory

- Allows each operation to be set to the optimum processing speed

• Pipeline inventory

- Goods-in-transit to warehouses, distributors, or customers

• Raw materials & purchased parts

• Work-in-process (WIP)

• Finished-goods inventories

• Maintenance & repairs (MRO) inventory

Objectives of Inventory Control

Although inventory plays an important role, there are a number of negative aspects

• Inventory ties up money, in the form of working capital

• Inventory incurs storage costs (leasing space, maintaining appropriate conditions)

• Inventory may become obsolete as alternatives become available

• Inventory can be damaged, or deteriorate

• Inventory could be lost, or be expensive to retrieve

• Inventory might be hazardous to store & require special facilities

• Inventory uses space that could be used to add value

• Inventory involves administrative & insurance costs

Inventory turnover: Ratio of average cost of goods sold to average inventory investment

• A widely used performance measures to judge the effectiveness of inventory management

Requirements for effective inventory management

Management has two basic functions concerning inventory

- To establish a system to keep track of items in inventory

- To make decisions about how much & when to order

• A system to keep track of the inventory on hand & on order

• A reliable forecast of demand that includes an indication of possible forecast error

• Knowledge of lead times & lead time variability

• Reasonable estimates of inventory holding costs, ordering costs, & shortage costs

• A classification system for inventory items

Inventory Counting Systems

• Periodic system: Physical count of items in inventory made at periodic intervals (weekly, monthly)

• Perpetual inventory system: Keeps track of removals from inventory continuously, thus monitoring current levels of each item

• Two-bin system: Two containers of inventory; reorder when the first is empty

Inventory Costs

Basic costs which associated with inventories are as follows

• Purchase cost 

- The amount paid to buy the inventory

• Holding or carrying cost

- Cost to carry an item in inventory for a length of time, usually a year

• Transaction or ordering cost

- Costs of ordering & receiving inventory

• Setup costs

- The costs involved in preparing equipment for a job

• Shortage cost

- Costs resulting when demand exceeds the supply of inventory; often unrealized profit per unit

• Obsolescence costs

- There is a risk that the items might either become obsolete (change in fashion) or deteriorate with age (foodstuffs)

Inventory priorities ( ABC system)

Classifying inventory according to some measure of importance (usually annual dollar value), & allocating control efforts accordingly

Typically, three classes of items are used

- A (very important), B (moderately important), & C (least important)

A item generally (10-20) % of total inventory but (60-70) % of total annual dollar value

On the other hand, C item might account about (50-60) % total inventory but only about (10-15) % of the dollar value of an inventory cost.

These percentages vary from firm to firm

Steps to solve an A-B-C problem

• For each item, multiply annual volume by unit price to get the annual dollar value

• Arrange annual dollar values in descending order

• The few (10-15)% with the highest annual dollar value are A items. The most about 50% with the lowest annual dollar value are C items. Those in between about 35% are B items

Economic order quantity (EOQ)

The order size that minimizes total annual cost

- Find the best balance between the advantages & disadvantages of holding stock
- Find a fixed order size that minimize annual cost of holding & ordering inventory

Holding costs are including

• Working capital costs

• Storage costs

• Obsolescence risk costs

Order costs are including

• Cost of placing the order

• Price discount costs

Reorder point (ROP)

When the quantity on hand of an item drops to this amount, the item is reordered

ROP = d × LT   (Where, d = demand rate & LT = Lead time in days or weeks)

Safety stock: Stock that is held in excess of expected demand due to variable demand &/or lead time

Safety stock reduces risk of stock out during lead time

Determinants of the reorder point quantity

• The rate of demand (based on a forecast)
• The lead time
• The degree of stock out risk acceptable to management
• The extent of demand &/or lead time variability