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Inventory management. Elements of Inventory Management. Inventory is defined as a stock of items kept on hand by an organization to use to meet customer demand.
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Elements of Inventory Management Inventory is defined as a stock of items kept on hand by an organization to use to meet customer demand. Virtually every type of organization maintains some form of inventory. A department store carries inventories of all the retail items it sells; a nursery has inventories of different plants, trees, and flowers; a rental car agency has inventories of cars; and a major league baseball team maintains an inventory of players on its minor league teams. Even a family household will maintain inventories of food, clothing, medical supplies, personal hygiene products, and so on.
The Role of Inventory A company or an organization keeps stocks of inventory for a variety of important reasons. The most prominent is holding finished goods inventories to meet customer demand for a product, especially in a retail operation. Additional stocks of inventories are sometimes built up to meet seasonal or cyclical demand. A company will often purchase large amounts of inventory to take advantage of price discounts, as a hedge against anticipated future price increases, or because it can get a lower price by purchasing in volume. Safety stocks are additional inventory to compensate for demand uncertainty.
Demand: Dependent demand items are used internally to produce a final product. Independent demand items are final products demanded by an external customer. Inventory Costs: Inventory costs include carrying, ordering, and shortage costs. Carrying costs are the costs of holding inventory in storage.
Ordering costs are the cost of replenishing inventory. • Shortage costs are incurred when customer demand cannot be met. • The purpose of inventory management is to determine how much and when to order.
Inventory Control Systems An inventory system is a structure for controlling the level of inventory by determining how much to order (the level of replenishment) and when to order. There are two basic types of inventory systems: a continuous (or fixed–order quantity) system and a periodic (or fixed–time period) system. The primary difference between the two systems is that in a continuous system, an order is placed for the same constant amount whenever the inventory on hand decreases to a certain level, whereas in a periodic system, an order is placed for a variable amount after an established passage of time.
In a continuous inventory system, a constant amount is ordered when inventory declines to a predetermined level. In a periodic inventory system, an order is placed for a variable amount after a fixed passage of time.
Economic Order Quantity Models • EOQ is a continuous inventory system. • The most widely used and traditional means for determining how much to order in a continuous system is the economic order quantity (EOQ) model, also referred to as the economic lot size model. • The function of the EOQ model is to determine the optimal order size that minimizes total inventory costs. • There are several variations of the EOQ model, depending on the assumptions made about the inventory system.
The Basic EOQ Model The simplest form of the economic order quantity model on which all other model versions are based is called the basic EOQ model. It is essentially a single formula for determining the optimal order size that minimizes the sum of carrying costs and ordering costs. The model formula is derived under a set of simplifying and restrictive assumptions, as follows: Demand is known with certainty and is relatively constant over time. No shortages are allowed. Lead time for the receipt of orders is constant. The order quantity is received all at once.
EOQ is the optimal order quantity that will minimize total inventory costs. Assumptions of the EOQ model include constant demand, no shortages, constant lead time, and instantaneous order receipt. Instantaneous receipt means inventory is received almost immediately after it is ordered.
Average inventory=Q/2 Annual carrying cost=CcQ/2 annual ordering cost=CoD/Q Total inventory const= TC = CoD/Q + CcQ/2
The optimal order quantity occurs at the point in Figure where the total cost curve is at a minimum, which also coincides exactly with the point where the ordering cost curve intersects with the carrying cost curve. This enables us to determine the optimal value of Q by equating the two cost functions and solving for Q, as follows:
Example The I-75 Carpet Discount Store in north Georgia stocks carpet in its warehouse and sells it through an adjoining showroom. The store keeps several brands and styles of carpet in stock; however, its biggest seller is Super Shag carpet. The store wants to determine the optimal order size and total inventory cost for this brand of carpet, given an estimated annual demand of 10,000 yards of carpet, an annual carrying cost of $0.75 per yard, and an ordering cost of $150. The store would also like to know the number of orders that will be made annually and the time between orders (i.e., the order cycle), given that the store is open every day except Sunday.
