This document discusses inventory management. It covers the types of inventory a manufacturing firm holds, including raw materials, work-in-progress, and finished goods. It describes the costs of carrying too much inventory, like storage and opportunity costs, and the costs of not carrying enough inventory, like lost sales. The Economic Order Quantity (EOQ) model is introduced to minimize total inventory costs by balancing ordering and carrying costs. Extensions to the EOQ model like safety stocks and reorder points are also discussed.

1. Chapter
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
10
Inventory
Management

2. 21-2
1)Inventory Management
• Inventory can be a large percentage of a
firm’s assets
• There can be significant costs associated
with carrying too much inventory
• There can also be significant costs
associated with not carrying enough
inventory
• Inventory management tries to find the
optimal trade-off between carrying too
much inventory versus not enough

3. 21-3
2)Types of Inventory
• Manufacturing firm
• Raw material – starting point in production
process
• Work-in-progress
• Finished goods – products ready to ship or sell
• Remember that one firm’s “raw material”
may be another firm’s “finished good”
• Different types of inventory can vary
dramatically in terms of liquidity

4. 21-4
3)Inventory Costs
• Carrying costs – range from 20 – 40% of
inventory value per year
• Storage and tracking
• Insurance and taxes
• Losses due to obsolescence, deterioration or theft
• Opportunity cost of capital
• Shortage costs
• Restocking costs
• Lost sales or lost customers
• Consider both types of costs and minimize the
total cost

5. 21-5
4)EOQ Model
• The EOQ model minimizes the total inventory cost
• EOQ assumptions: constant/uniform demand, constant
unit price, constant carrying cost, constant ordering cost,
instantaneous delivery & independent orders.
• Total carrying cost = (average inventory) x (carrying cost
per unit) = (Q/2)(CC)
• Total restocking cost = (fixed cost per order) x (number of
orders) = F(T/Q)
• Total Cost = Total carrying cost + total restocking cost =
(Q/2)(CC) + F(T/Q)
CC
TF
Q
2*
=

6. 21-6
Figure 21.3

7. 21-7
Example: EOQ
• Consider an inventory item that has
carrying cost = $1.50 per unit. The fixed
order cost is $50 per order and the firm
sells 100,000 units per year.
• What is the economic order quantity?
2582
50.1
)50)(000,100(2*
==Q

8. 21-8
Extensions
• Safety stocks
• Minimum level of inventory kept on hand
• Increases carrying costs
• Reorder points
• At what inventory level should you place an
order?
• Need to account for delivery time

9. Example
• Consider the following inventory information:
-order can be placed only in multiple of 100 units
-annual unit usage is 300,000. (assume a 50-week in your
calculation)
-the carrying cost is 30% of the purchase price of the goods.
-the purchase price is $10 per unit.
-the ordering cost is $50 per order.
-the desired safety stock is 1,000. (this does not include delivery-
stock)
-delivery time is 2 weeks.
• Given this information:
a. what is the optimal EOQ?
b. how many orders will be placed annually?
c. at what inventory level should a reorder be made? (keown et al 2011)
9

10. a) EOQ = √2SO/C = √[2(300,000)($50)]/$3 = 3,162 unit (but
because orders must be placed in 100-unit lots, the effective
EOQ becomes 3,200
b) Total usage/EOQ = 300,000/3,200 = 93.75 orders per year
c) Inventory point = delivery-time stock + safety stock
= (2/50) x 300,000 + 1,000
= 12,000 + 1,000
= 13,000 units.
10

11. Inflation and EOQ
11
Inflation affects the EOQ model in 2 ways
1) EOQ model can be modified when price
increases-modified by anticipatory buying
2) Inflation also pushes the interest up and will
increases the carrying cost.

12. Other Inventory Management
Techniques
• Derived-Demand Inventories
• Materials Requirements Planning (MRP)
- a set of procedures used to determine
inventory levels for demand-dependent
inventory types such as work-in-progress and
raw materials.
• Just-in-Time Inventory (JIT)
- a system for managing demand-dependent
inventories that minimizes inventories holding.
12

13. 13
Inventory Management - ABC
• Classify inventory by cost, demand and
need
• Those items that have substantial shortage
costs should be maintained in larger
quantities than those with lower shortage
costs
• Generally maintain smaller quantities of
expensive items
• Maintain a substantial supply of less
expensive basic material