MGMT 339 Ch. 13 Inventory Management

ABC Approach
classifying inventory according to some measure of importance and allocating control efforts accordingly
Cycle Counting
a physical count of items in inventory.
Cycle Stock
the amount of inventory needed to meet expected demand.
Economic order quantity EOQ
the order size that minimizes annual cost

answers the the question how much to order

Excess cost
difference between cost and salvage value of items left over at the end of a period.

Excess= Cost per unit – salvage value per unit

Fill rate
the percentage % of demand filled by stock on hand.
Fixed-order-interval (FOI) model
orders placed at fixed time intervals

(weekly, bi-weekly)

Holding (carrying) cost
cost to carry an item in inventory for a length of time, usually a year.
a stock or store of goods.

Vital part of business
1) necessary for operations
2) contribute to customer satisfaction.

30% current assets
90% working capital invested in inventory

Inventory turnover
ratio of average cost of goods sold to average inventory investment
Lead time
time interval between ordering and receiving the order.
Little’s Law
the average amount of inventory in a system is equal to the product of the average demand rate and the average time a unit is in the system.
Ordering cost
Cost of ordering and receiving inventory.
Periodic System
Physical count of items in inventory made at periodic intervals (weekly, monthly)
Perpetual inventory system
system that keeps track of removals from inventory continuously, thus monitoring current levels of each item.
Point-of-sale (POS) system
record items at time of sale
Purchase cost
the amount paid to buy the inventory
Quantity discounts
Price reductions for larger orders.
Reorder Point (ROP)
when quantity on hand of an item drops to this amount, the item is reordered.
safety stock
extra inventory carried to reduce the probability of a stockout due to demand and/or lead time variability
service level
Probability that demand will not exceed supply during lead time.
setup cost
the cost involved in preparing equipment for a job.
shortage costs
costs resulting when demand exceeds the supply of inventory; often unrealized profit per unit.

shortage cost = revenue per unit – cost per unit

single-period model
model for ordering of perishables and other items wit limited useful lives.

(fruits, magazines, flowers)

goal is to identify the order quaint that will maximize the long-run excess and shortage cost

continous distribution
discrete distiribtion

two-bin system
two containers of inventory; reorder when the first is empty.

acts as a cousin for

universal product code (UPC)
bar code printed on a label that has information about theme to which it is attached.
Define the major reasons for holding inventories and list the main requirements for effective inventory management
1)establish a system for tracking items in inventory
2) make decisions about
i. when to order
ii. how much to order
Discuss the nature and importance of service inventories
Explain period and perpetual review systems
Explain the objectives of inventory management
Describe ABC approach
Describe the basic EOQ model and its assumptions & solve typical problems
Describe the Economic Production quantity model and solve typical problems
Describe the quantity discount model and solve typical problems
Describe reorder point models and solve typical problems
Describe situations in which the single-period model would be appropriate and solve typical problems.
The two basic questions in inventory management are
1. how much to order
2. when to order
Using EOQ model, if an item’s holding cost increases, its order quantity will decrease
True, it will crease because holding cost is the denominator of the EOQ formula

SQRT(2*annual usage in units)*(ordering cost)/annual carrying cost per unit

Use of the fixed-interval model requires having a perpetual inventory system.
False, use of a fixed interval model requires having a period inventory system.
With the ABC approach, items which have a high unit cost are classified as “A” items.
False, ABC is based on the product of unit cost and annual volume.
When using EOQ, the ordering, the order quantity must be computed in every order cycle.
False, unless demand, holding cost, or ordering cost changing, the order quantity will not change.
Inventory might be held to take advantage of order cycle.
True, using an economic order quantity is an example of this.
The EOQ economic order quantity cannot be used when holding costs are a percentage of purchase.
False, carrying cost is sometime stated as percentage of the price of an item rather than as a dollar amount per unit. However as long as the percentage is converted into a dollar amount, the EOQ formula is still appropriate.
Companies that can successfully use the ABC approach can avoid using EOG models
False, they still need to determine what to order.
The objective of inventory managment is to minimize holding costs.
False, the objective of inventory management is to minimize TOTAL cost, which includes ordering costs and sometimes purchase cots.
Holding costs and ordering cost are inversely related to each other.
True, changes in order quantity will cause one to increase and the other to decrease.
A two-bin system is essentially a simple reorder point system.
True, reorder when the first bin is empty.
The basic EOQ model, annual ordering cost and annual cost are qual for the optimal order quantity.
Increasing the order quantity so that it is slightly above the EOQ would not increase the total cost by very much.
True, the total cost curve is flat to the right of the EOQ.
A foxed-interval system would be used for items that have independent demand.
a store that sells daily newspapers could use the single-period model for reordering.
True, the period is one day and the news is perishable beyond one day.
Other things being equal, an increase in lead time for inventory orders will result in an increase in the :
Reorder point, quantity models do not involve lead time.
If average demand for an item is 21 units per day, safety stock is 4 units and lead time is 2 days the ROP:

ROP=demand * lead time + safety stock
ROP= 21*2+4

In an ABC system, B typically represents about this percentage of items:
Which model does not take into account the amount of inventory on hand.


the EOQ factors are demand, ordering costs, & carrying costs.
Which product is usually bought on an ROP basis?

wedding gifts

Sugar, buy more when the quantity on hand gets low.
Which product is usually bought on a fixed interval basis?

wedding gifts

textbooks, usually bought once a semester.
In the two-bin system the quantity in the second bin is equal to the:


ROP, the second bin holds the reorder point quantity.
using the basic EOQ model, if ordering cost doubles, the order quantity will be

double its former value
about 50% of its former value
about 71% of its former value

71% of its former value.

because S in the under the square root sign, multiplying its value be 2 will increase the EOQ by the square root of 2 which is 0.707

EOQ= SQRT(2)/2
EOQ= 0.707

It a decrease in unit price causes the average demand rate to increase which of these would NOT increase?

lead time
annual holding cost
safety stock

Lead time, every other choice is a function of demand.
Setup cost are analogous to which of these costs?


Ordering, both setup and ordering costs are in the numerator of the quantity formula and both are independent.
What are the types of inventory?
1. Raw materials & purchases parts
2. WIP work in process
3. finished goods,
4. tools and supplies
5. maintenance and repais (MRO) inventory
6. goods in transit to warehouse or customer (pipeline inventory)
What is the objective of inventory control?
1.level of customer service
the right goods viable in the right quantity in the right place
(establish a system of tracking)

2. costs of ordering and carrying inventories

What is the OVERALL objective of inventory management?
to achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds.

1. measure performance
2.customer satisfaction:
(how many back orders) (how many complaints)
3. inventory turnover

ABC approach
“A” items: very important
10%-20% # of items in inventory
70% of annual dollar value

“B” moderately important

“C” least important
50%-60% # of items in inventory
10%-15% of annual dollar value

What is the purpose of cycle counting?
to reduce discrepancies between amount indicated by inventory levels and and actual quantities
accuracy is important because because it leads to disruption in operations, poor customer service and unnecessary high levels of inventory cost

Accuracy is needed

A items: ± 0.2 %
B items: ± 1 %
C items: ± 5 %

When do you reorder?
at the Reorder point
When the quantity on hand of an item drops to this amount, the item is reordered.

Determinants of the reorder point
The rate of demand
The lead time
The extent of demand and/or lead time variability
The degree of stockout risk acceptable to management.

Reorder Point uncertainty
Demand or lead time uncertainty creates the possibility that demand will be greater than available supply
To reduce the likelihood of a stockout, it becomes necessary to carry safety stock
Safety stock
Stock that is held in excess of expected demand due to variable demand and/or lead time
EOQ answers the equation of how much to order
True, but not the question when to order.
As the amount of safety stock carried increases, the risk of stockout decreases.
True, this improves customer service level.
How much to order: FOI
saving in shipping cost
improving inventory process can offer significant cost reduction and customer satisfaction benefits
I. record keeping
II. variation reduction
III. lean operations
IV. supply chain management.

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