INVENTORY MANAGEMENT

• Dependent and Independent Demand

• What is Inventory?
• Forms of Inventory
• Functions of having Inventory
• Inventory Costs
• Continuous Inventory System (Q-system)
• Periodic Inventory System (P-system)
• The Basic EOQ Model
Dependent and Independent Demand
• Dependent demand items are typically
component parts or materials used in the
process of producing a final product.
• Independent demand items are final or
finished products that are not a function of
internal production activity. Market conditions
determine independent demand.
 What is Inventory?
• Inventory is a stock of items kept to meet
demand (internal and external).
• Inventory management answers two
important questions---how much and when to
order.
• Inventory is an asset as well as a liability.
 Forms of Inventory
• Raw materials
• Parts and supplies purchased from suppliers
• Partial complete work in progress (WIP)
• Items being transported
• Finished products
Functions of having Inventory (Why to
keep Inventory?)
• Demand is usually not known with certainty;
buffer stock is kept to manage this uncertainty.
• To meet holiday/festival demand
• To attract customers (retailers)
• Variations in supplier deliveries
• To avail price discounts
• As a buffer between different stages of
production
 Inventory Costs
• Carrying costs
• Ordering costs
• Shortage costs
 Carrying costs
• Costs of holding items in inventory.
• Grows linearly with the number of units in stock.
• Includes:
1. Facility storage (rent, energy, security,
depreciation)
2. Labor
3. Record keeping
4. Borrowing to purchase inventory (interest on
loans, taxes, insurance)
 Carrying costs…..
5. Product deterioration, spoilage, breakage,
obsolescence, pilferage
• Determined by adding all the above individual
costs; 10 rupees per unit per year
• Range from 10-40% of the value of a
manufactured item.
 Ordering costs
• Costs associated with replenishing the stock of
inventory being held.
• As the size of order increases, fewer orders are
required, reducing ordering costs.
• Expressed as rupee amount per order
 Shortage costs
• Occur when customer demand cannot be met
because of insufficient inventory.
• Approximately 3% of sales are lost because of
insufficient inventory.
• Shortage costs are subjective estimates or
educated guess.
 Continuous Inventory System
• Also known as perpetual system, fixed-order-
quantity system, Q-system
• A constant amount is ordered when inventory
declines to a predetermined level.
This level is called the reorder point.
The constant/fixed amount is such that it
minimizes the total inventory costs and is
called economic order quantity.
 Continuous Inventory System…..
• The inventory level is continuously monitored.
• This system is advantageous for critical items
such as replacement parts or raw materials
and supplies.
• Maintaining a continual record is costly.
• Examples: checkbook order, getting the petrol
tank full when the reserve point is reached
 Periodic Inventory System
• Also known as fixed-time-period system, P-
system
• An order is placed for a variable amount after
a fixed passage of time.
The time period can be a week or month.
A new order quantity has to be determined
every time.
 Periodic Inventory System…..
• The inventory level is periodically monitored.
• It has the advantage of little or no record
keeping.
• Examples: smaller retail stores, drugstores,
grocery stores, offices
 The Basic EOQ Model
• Most widely used model to determine how
much to order in a continuous inventory
system.
• Economic order quantity (EOQ) is that
quantity which will minimize total inventory
costs.
• Assumptions:
1. Demand is known with certainty and is
constant over time.
 EOQ…..
2. No shortages are allowed (therefore no
shortage costs).
3. Lead time (time between placing and receipt
of order) is constant for orders.
4. The order quantity is received all at once (no
batch delivery).