INVENTORY

MANAGEMENT

CAÑARES, JOHN VINCENT F.

TICMAN, ROSE ANNE P.
Logistics and Supply Chain
Essentials for the firm
Business management and such
Integrate the supply and demand

This time
Let's talk about INVENT'RY
Everybody's got a clue already
This might be crazy
Let us help you now this can be easy
Terminologies, formulas, and process
Store of goods of the business
That's why managing of inventory
Distribution will be systemized
To produce what are required
Makes customer satisfied
Chorus(2x):
Raw materials and purchased parts
Then work-in-process now
Merch and finished-goods
Replacement parts and tools
Goods-in-transit to warehouse and
customer make it all
Yeah! 'Tis INVENTORY MANAGEMENT
Yeah! 'Tis INVENTORY MANAGEMENT
Music fans have a rotten time these days. Gigs by Beyonce and festivals such as
Glastonbury sell out in the time it takes to refresh a web browser. Ed Sheeran’s UK and
Ireland tour sold out in five minutes in February. One fan tweeted: “Devastated, been
on since 9.40 refreshing for tickets to get page after page error. Sold out.” Sheeran
released a statement saying he was “deeply concerned” and cautioned against
engaging with ticket touts. The problem is that the supply chain for tickets extends far
beyond his reach. Resellers, fan sites, auto-buying bots and bulk buyers all affect the
fan experience, whether he likes it or not.

Lesson: The end of your supply chain is not the end of the chain.

ED SHEEERAN TICKETS
INVENTOR
Y Stocks or Store of Goods

Vital part of the business

Major source of Revenues

 KINDS OF
INVENTORIES
INCLUDE THE
1. Raw materials and purchasedFOLLOWING::
parts
2. Work-in-Process (WIP)
3. Finished-goods inventories or merchandise
4. Tools and supplies
5. Maintenance and repairs (MRO) inventory
6. Goods-in-transit to warehouses, distributors,
or customers
1. To meet anticipated customer
demand
The average amount of
2. To smooth production requirements
3. To decouple operations inventory in a system is equal
to the product of the average
4. To protect against stockouts
5. To take advantage of order demand
cycles rate and the
6. To hedge against price increases
average time a unit is in the
7. To take advantage of quantity system.
discounts.
8. To permit operations

FUNCTIONS OF INVENTORY
 INVENTORY MANAGEMENT HAS TWO MAIN
CONCERNS/OBJECTIVES:
Level of Customer Service

Ordering and Carrying Costs

TWO FUNDAMENTAL DECISIONS:

TIMING of Orders

SIZE of Orders
MEASURES OF PERFORMANCE:
 EFFECTIVE
INVENTORY MANAGEMENT
A. A system to keep track of the inventory on hand and on
order. (Inventory Counting System)
B. A reliable forecast of demand that includes an indication
of possible forecast error.
C. Knowledge of lead times and lead time variability.
D. Reasonable estimates of inventory holding costs, ordering
costs, and shortage costs.
E. A classification system for inventory items.
 Periodic System
Perpetual Inventory System (Continual
System)
Two-bin System
Can be Batch or On-Line
• Universal Product Code (UPC)

Point-of-sale (POS) Systems

A. INVENTORY COUNTING
SYSTEM
 “The greater the potential variability,
the greater the need for additional
stock to reduce the risk of a shortage
between deliveries.”

B&C. DEMAND FORECASTS AND

LEAD-TIME INFORMATION
 Purchase Costs

Holding or Carrying
Costs

Ordering Costs
• Setup Costs

Shortage Costs

D. INVENTORY COSTS
 A-B-C Approach Key questions :
Classifying inventory 1. How much
according to some accuracy is
needed?
measure of importance,
and allocating control 2. When should
efforts accordingly. cycle counting be
performed?
Cycle Counting 3. Who should do it?

E. CLASSIFICATION SYSTEM
 A-B-C Approach
To solve an A-B-C problem, follow these steps:
1. For each item, multiply annual volume by unit price
to get the annual dollar value.
2. Arrange annual dollar values in descending order.
3. The few (10 to 15 percent) with the highest annual
dollar value are A items. The most
(about 50 percent) with the lowest annual dollar value
are C items. Those in between
(about 35 percent) are B items.

E. CLASSIFICATION SYSTEM
 Ex. A manager has
obtained a list of unit
costs and estimated
annual demands for 10
inventory items and
now wants to
categorize the items
on an A-B-C basis.
Multiplying each item’s
annual demand by its
unit cost yields its
annual dollar value:

E. CLASSIFICATION SYSTEM (ABC)

 7,591,000

E. CLASSIFICATION SYSTEM (ABC)

 Inventory
The amount that is held to reduce
of inventory needed to the probability of
meet experiencing a stockout
expected demand. due to demand and/or
lead time variability.
Forecast for BATANGAS
Industrial
Revolution
INVENTORY ORDERING
POLICIES
 BASIC ECONOMIC ORDER
QUANTITY MODEL
Simplest of the three models
Used to identify a fixed order size that will minimize cost
A
S 1. Only one product is involved.
S 2. Annual demand requirements are known.
U
M 3. Demand is spread evenly throughout the year so that the
P demand rate is reasonably constant.
T 4. Lead time is known and constant.
I
O 5. Each order is received in a single delivery.
N 6. There are no quantity discounts.
S
BASIC ECONOMIC ORDER
QUANTITY MODEL
Carrying
Cost
𝑸 𝑫
TC = 𝑯 + 𝑺
𝟐 𝑸
Ordering
Cost
OPTIMUM ORDER QUANTITY LENGTH OF ORDER CYCLE

2𝐷𝑆 𝑄𝑂
𝑄𝑜 = 𝐷
𝐻
MINIMUM TOTAL COST NUMBER OF ORDERS PER YEAR

2𝐷𝑆 𝐷
𝐷 𝐻
𝑇𝐶 = + (H) 𝑄𝑂
2𝐷𝑆 2
𝐻
 SAMPLE PROBLEM

Number
TC=
Length of
Carrying
EOQ
of Order
Orders
Cost per Year
+ Ordering
Cycle
Cost
2𝐷𝑆
$75 𝑄 = 300
9, 600 units 𝑄𝑂 𝑜
𝐷(𝐻) 9600
𝐷(𝑆)
𝐻
== +
𝐷𝑄𝑂2 9600
𝑄𝑂
300
2(9600)($75)
300(16) 9600(75)
𝑄𝑜 =
+orders
==932
workdays
$16
2 300
300
𝑄=𝑜 $=4, tires
800

288 days a year

$16 per tire
 ECONOMIC PRODUCTION QUANTITY
Orders are received incrementally during
production

Because the company makes the

product itself, there are no ordering
costs but in every production run,
there are setup costs.
 𝐼𝑚𝑎𝑥 𝐷
𝑇𝐶𝑚𝑖𝑛 = Carrying Cost + Setup Cost = ( )H + ( )S
2 𝑄𝑂

2𝐷𝑆 𝑝
𝑄𝑜 (Economic Run Quantity) = x
𝐻 𝑝−𝑢

𝐼𝑚𝑎𝑥 - Maximum
𝑄𝑂 𝐼𝑚𝑎𝑥
Inventory
𝐼𝑚𝑎𝑥 = (p-u) 𝐼𝑎𝑣𝑒 =
𝐼𝑎𝑣𝑒 - Maximum Inventory 𝑝 2
p- Production or Delivery
Rate 𝑄𝑂 𝑄𝑂
u- Usage Rate Run Time= Cycle Time=
𝑝 𝑢
 SAMPLE PROBLEM
EOQ Run size
a. Optimal
48, 000 units $45
2𝐷𝑆 𝑝
𝑄𝑂 𝐻 x
𝑄𝑜 (Economicc Run Quantity) =2𝐷𝑆
𝑄𝑜 == 𝑝−𝑢
𝐷 𝐻
9600
𝐷
=
𝑄𝑂 300
300
x=
2(48000)(45) 800
𝑄𝑜 =
1 800−200
$1 per wheel 240 days a year 9600

800 per day 𝑄𝑜 = 2, 400 𝑤ℎ𝑒𝑒𝑙𝑠

 SAMPLE PROBLEM
b. Minimum
EOQ Total Annual Cost for
48, 000 units carrying and set up
$45

2𝐷𝑆
𝐼 𝑄 𝐷
𝑇𝐶𝑚𝑖𝑛 = Carrying Cost + Setup
= 9600
Cost = ( 𝑂 )H + ( )S
𝑚𝑎𝑥
𝑄𝑜 = 2 𝑄𝑂
𝐷 𝐻
𝐷
𝑄𝑂
=
2,400
𝑄𝑂 800 (800-200)
𝐼𝑚𝑎𝑥 = (p-u)= 300
300
=
𝑝
= 1, 800 wheels
$1 per wheel 240 days a year 9600
1800 48000
𝑇𝐶𝑚𝑖𝑛 = ( )$1 + ( )$45
2 2400
800 per day

TC= $1, 800

 SAMPLE PROBLEM

c. RunEOQ
Time
48, 000 units $45

2𝐷𝑆
𝑄𝑂
Run =
𝑄𝑜 =
Time=
𝐷
𝑄 𝑂
𝐻
𝑝9600
𝐷
=
𝑄𝑂 300
300
$1 per wheel 240 days a year Run Time= =
2,400 𝑤ℎ𝑒𝑒𝑙𝑠
9600
800 𝑤ℎ𝑒𝑒𝑙𝑠 𝑝𝑒𝑟 𝑑𝑎𝑦

RT= 3 𝐷𝑎𝑦𝑠
800 per day
 SAMPLE PROBLEM
d. Cycle
EOQTime for the optimal run
48, 000 units size
$45

𝑄2𝐷𝑆
𝑄𝑂𝑂
Cycle 𝐷
=
𝑄𝑜 =
Time= 𝐻
9600
𝑢𝐷
=
𝑄𝑂 300
300
$1 per wheel 240 days a year Cycle Time= =
2,400 𝑤ℎ𝑒𝑒𝑙𝑠
9600
200 𝑤ℎ𝑒𝑒𝑙𝑠 𝑝𝑒𝑟 𝑑𝑎𝑦

CT= 12 𝐷𝑎𝑦𝑠
800 per day
 QUANTITY
DISCOUNTS
Price reductions for larger orders offered to customers
to induce them to buy in large quantities.
For carrying costs that are constant, the procedure is as follows:
1. Compute the common minimum point.
2. Only one of the unit prices will have the minimum point in its
feasible range since the ranges do not overlap. Identify that
range.
a. If the feasible minimum point is on the lowest price range,
that is the optimal order quantity.
b. If the feasible minimum point is in any other range, compute
the total cost for the minimum point and for the price breaks of
all lower unit costs. Compare the total costs; the quantity
(minimum point or price break) that yields the lowest total cost
is the optimal order quantity.
 QUANTITY
DISCOUNTS
 QUANTITY
DISCOUNTS
Price reductions for larger orders.
 QUANTITY
DISCOUNTS
When carrying costs are expressed as a percentage of price,
determine the best purchase quantity with the following
procedure:
1. Beginning with the lowest unit price, compute the minimum
points for each price range until you find a feasible minimum
point (i.e., until a minimum point falls in the quantity range for its
price).
2. If the minimum point for the lowest unit price is feasible, it is
the optimal order quantity. If the minimum point is not feasible
in the lowest price range, compare the total cost at the price
break for all lower prices with the total cost of the feasible
minimum point. The quantity that yields the lowest total cost is
the optimum.
 QUANTITY
DISCOUNTS
Ex. Surge Electric uses 4,000 toggle switches
a year. Switches are priced as follows: 1 to
499, 90 cents each; 500 to 999, 85 cents
each; and 1,000 or more, 80 cents each. It
costs approximately $30 to prepare an order
and receive it, and carrying costs are 40
percent of purchase price per unit on an
annual basis. Determine the optimal order
quantity and the total annual cost.
 QUANTITY
DISCOUNTS
 REORDER POINT ORDERING
Occurs when the quantity on hand drops to a
predetermined amount.

Four determinants of the reorder point quantity:

1. The rate of demand.
2. The lead time.
3. The extent of demand and/or lead time variability.
4. The degree of stockout risk.
 REORDER POINT ORDERING
ROP = d(LT)
Ex. Peter takes Two-a-Day vitamins, which are delivered
to his home by a routeman seven days after an order is
called in. At what point should Peter reorder?

Usage= 2 vitamins per day

Lead time= 7 days
ROP= 14 vitamins
REORDER POINT
ORDERING
ROP= Expected demand
during lead time
+ Safety stock Safety Stock
Stock that is held in excess of expected demand
due to variable demand and/or lead time.

Service level = 100

Service Level percent - Stockout risk

Probability that demand will not exceed supply

during lead time.
 REORDER POINT ORDERING

The amount of safety stock that is appropriate for

a given situation depends on the following
factors:
1. The average demand rate and average lead
time.
2. Demand and lead time variability.
3. The desired service level.
 REORDER POINT ORDERING
ROP= Expected demand during
lead time + zσdLT
Ex. Suppose that the manager of a construction supply house
determined from historical record that demand for sand during lead
time averages 50 tons. In addition, suppose the manager determined
that demand during lead time could be described by a normal
distribution that has a mean of 50 tons and a standard deviation of 5
tons. Answer these questions, assuming that the manager is willing to
accept a stockout risk of no more than 3 percent:
a. What value of z is appropriate?
b. How much safety stock should be held?
c. What reorder point should be used?
 REORDER POINT ORDERING
ROP= Expected demand during
lead time + zσdLT
Expected lead time demand = 50 tons
σdLT= 5 tons
Risk= 3 percent
a.) From Appendix B, Table B, using a service level of 1 -
.03 = .9700, you obtain a value of z = +1.88
b.) Safety stock = zσdLT = 1.88(5) = 9.40 tons
c.) ROP = Expected lead time demand + Safety stock =
50 + 9.40 = 59.40 tons
 REORDER POINT ORDERING
ROP = d(LT)
ROP= Expected demand during
lead time + zσdLT
ROP = d̅(LT)+z 𝑳𝑻(σ𝒅)
ROP = d(LT)+z𝒅(σ𝑳𝑻)

ROP = dLT+z 𝑳𝑻σ𝟐𝒅 + 𝒅𝟐σ𝟐𝑳𝑻

 SHORTAGES AND SERVICE
LEVELS
The ROP computation does not reveal the expected
amount of shortage for a given lead time service
level. The expected number of units short can,
however, be very useful to a manager.

E(n)= E(z)σ𝒅𝑳𝑻
Normal distribution service levels
and unit normal loss function
SHORTAGES AND SERVICE
LEVELS
Table
13.3
 Ex. Suppose the
SHORTAGES AND SERVICE
standard deviation of
lead time demand is
E(n)= E(z)σ𝒅𝑳𝑻 LEVELS
known to be 20 units. σdLT = 20 units
Lead time demand is a.) Lead time (cycle) service level = .90.
approximately normal. From Table 13.3, E(z) = .048.
a.) For a lead time E(n) = .048(20 units) = .96, or about 1 unit
service level of 90 b.) For the case where E(n) = 2, you must
percent, determine
the expected number solve for E(z) and then use Table 13.3 to
of units short for any determine the lead time service that
order cycle. implies. So E(z) = E(n)/σdLT = 2/20 = .100.
b.) What lead time From Table 13.3, this implies a service
service level would an
expected shortage of
level of approximately 81.7 percent
two units imply? (interpolating).
 SHORTAGES AND SERVICE
LEVELS
Having determined the expected
number of units short for an order cycle,
you can determine the expected number
of units short per year. It is simply the
expected number of units short per cycle
multiplied by the number of cycles
(orders) per year. Thus,
𝑫
E(N)= E(n)
𝑸
 SHORTAGES AND SERVICE
LEVELS
Fill Rate
The percentage of
demand filled by the stock on
hand.
E(z)σ𝒅𝑳𝑻
SLannual= 1-
𝑸
Fixed-order-interval
Orders are placed at fixed time intervals

Q= d̅ (OI + LT)+ (z𝝈𝒅𝑳𝑻) OI + LT − 𝑨

Fixed-order-interval
benefits disadvantage
tight control s amount of safety stock
larger
for a given risk of stockout

yield savings increases the carrying cost

SINGLE-PERIOD MODEL
NEWSBOY PROBLEM

Model Shortage Cost

Cshortage = Cs = Revenue per unit -
for ordering of perishables and
Cost per unit
other items with limited useful
lives.
Excess Cost
Cexcess = Ce = Original cost per
unit - Salvage value per unit
SINGLE-PERIOD MODEL

Continuous Stocking
Levels

Discrete Stocking
Levels
 Continuous Stocking
Levels

𝐶𝑠
Service Level=
𝐶𝑠 + 𝐶𝑒

- Probability that demand will not exceed the stocking level,

and computation of the service level is the key to
determining the optimal stocking level.
SINGLE-PERIOD MODEL
SINGLE-PERIOD MODEL
Discrete Stocking Levels

Historical records on the use of spare parts for

several large hydraulic presses are to serve as
an estimate of usage for spares of a newly
installed press. Stockout costs involve downtime
expenses and special ordering costs. These
average $4,200 per unit short. Spares cost $800
each, and unused parts have zero salvage.
Determine the optimal stocking level.
 Inventories often represent a substantial investment. More
important, improving inventory processes can offer significant
benefits in terms of cost reduction and customer satisfaction.
Among the areas that have potential are the following:
RECAP OF THE
FORMULAS
 ?
2𝐷𝑆
Basic EOQ
Q0 = ?
𝐻

Q0 = Economic Order Quantity

D= Annual Demand
S= Order Cost
H= Annual Carrying Cost per unit
Basic EOQ
TC =
𝑸
?𝑯 +
𝑫
?𝑺
𝟐 𝑸

Q0 = Economic Order Quantity

D= Annual Demand
S= Order Cost
H= Annual Carrying Cost per unit
 Length of order
? cycle=
Basic EOQ 𝑸𝟎
𝑫

Q0 = Economic Order Quantity

D= Annual Demand
S= Order Cost
H= Annual Carrying Cost per unit
 𝟐𝑫𝑺 𝒑
Basic EPQ
𝑸𝟎 = ? ?
𝑯 𝒑−𝒖

Q0 = Optimal Run or Order Size

p= Production or Delivery Rate
u= Usage Rate
Basic EPQ
TC = ?𝑯
𝒍𝒎𝒂𝒙
+
𝑫
?𝑺
𝟐 𝑸

Q0 = Optimal Run or Order Size

p= Production or Delivery Rate
u= Usage Rate
lmax= Maximum Inventory Level
 𝑸
Basic EPQ
𝑪𝒚𝒄𝒍𝒆? 𝑻𝒊𝒎𝒆 =
𝒖

Q0 = Optimal Run or Order Size

p= Production or Delivery Rate
u= Usage Rate
lmax= Maximum Inventory Level
 𝑸
Basic EPQ
𝑹𝒖𝒏 𝑻𝒊𝒎𝒆 = ?
𝒑

Q0 = Optimal Run or Order Size

p= Production or Delivery Rate
u= Usage Rate
lmax= Maximum Inventory Level
 𝑸𝟎
Basic EPQ
𝒍𝒎𝒂𝒙= (𝒑?− 𝒖)
𝒑

Q0 = Optimal Run or Order Size

p= Production or Delivery Rate
u= Usage Rate
lmax= Maximum Inventory Level
 𝑸 𝑫
Quantity
discounts TC = ?𝑯 + 𝑺 ?
+ 𝑷𝑫
𝟐 𝑸

P= Unit Price
Rop under:
Constant
demand & Lead
time
ROP = d(LT)
?

ROP= Quantity on hand at

reorder point
d= demand rate
LT= Lead Time
Rop under:
variable
demand rate
ROP =
d̅(?LT)+z 𝑳𝑻(σ
? 𝒅)

d̅ = Average Demand Rate

z= Standard Normal Deviation
σ𝒅= Standard Deviation of
Demand Rate
Rop under:
variable
Lead time
ROP =
d(LT)+z𝒅(σ
? ? 𝑳𝑻)

LT= Average Lead Time

σ𝑳𝑻= Standard Deviation of Lead
Time
Rop under:
variable
Lead time &
ROP =
demand dLT+z 𝑳𝑻σ 𝒅?+ 𝒅 σ 𝑳𝑻
𝟐 𝟐 𝟐

LT= Average Lead Time

σ𝑳𝑻= Standard Deviation of Lead
Time
Rop shortages:
Units
short per cycle
E(n)=
? E(z)σ𝒅𝑳𝑻

E(n)= Expected number short per

cycle
E(z)= Standardized number short
σ𝒅𝑳𝑻= Standard Deviation of
Lead Time Demand
Rop shortages:
Units
𝑫
short per year
E(N)= E(n)
?𝑸

E(N)= Expected Number Short per

Year
Rop shortages:
E(z)σ𝒅𝑳𝑻
annual service
level SLannual= 1- ?
𝑸

SLannual= Annual Service Level

 Q=
d̅ (OI + LT)+
FIXED INTERVAL

(z𝝈𝒅𝑳𝑻) OI
? + LT − 𝑨

OI= Time between Orders

A= Amount on hand at Order
Time
 𝑪𝑺
Single period
SL= ?
𝑪𝑺+𝑪𝒆

SL= Service Level

CS= Shortage Cost per Unit
Ce= Excess Cost per Unit
ROP for constant demand and variable
lead time. The motel in the preceding
example uses approximately 600 bars of
soap each day, and this tends to be fairly
constant. Lead time for soap delivery is
normally distributed with a mean of six days
and a standard deviation of two days. A
service level of 90 percent is desired.
a.) Find the ROP.
b.) How many days of supply are on hand
at the ROP?
A.) 5, 126 bars of soap A.) 5, 146 bars of soap
B.) 9.56 days B.) 8.65 days

A.) 5, 136 bars of soap A.) 5, 116 bars of soap

B.) 8.56 days B.) 7.56 days
A.) 5, 136 bars of soap
B.) 8.56 days
Logistics and Supply Chain
Essentials for the firm
Business management and such
Integrate the supply and demand

This time
Let's talk about INVENT'RY
Everybody's got a clue already
This might be crazy
Let us help you now this can be easy
Terminologies, formulas, and process
Store of goods of the business
That's why managing of inventory
Distribution will be systemized
To produce what are required
Makes customer satisfied
Chorus(2x):
Raw materials and purchased parts
Then work-in-process now
Merch and finished-goods
Replacement parts and tools
Goods-in-transit to warehouse and
customer make it all
Yeah! 'Tis INVENTORY MANAGEMENT
Yeah! 'Tis INVENTORY MANAGEMENT