Chapter 9: Managing Inventories
Inventory management = The planning and controlling of inventories to meet the
competitive priorities of the organitation.
Lot size = The quantity of an inventory item management either buys from a supplier or
manufactures using internal processes.
Inventory Trade-Ofs
Inventory = A stock of materials used to satisfy customer demand or to support the
production of services or goods.
Scrap = to get rid of something.
Inventories rise when more material fows into the tank than fows out; they fall when more
material fows out than fows in.
Firms utilite Six Sigma and total quality management (TQM) to reduce defective materials:
The larger the scrap fows, the larger the input fow of materials required for a given level of
output.
Pressures for Small Inventories
The primary reason for keeping inventories small is that inventory represents a temporary
monetary investment. As such, the frm incurs an opportunity costs, which we call the cost
of capital, arising from the money tied up in inventory that could be used for other
purposes.
Inventory holding cost = The sum of the cost of capital and the variable costs of keeping
items on hand, such as storage and handling, taxes, insurance, and shrinkage.
Components of holding cost create pressures for small inventories:
- Cost of Capital = the opportunity cost of investing in an asset relative to the expected
return on assets of similar risk.
Use of weighted average cost of capital (WACC) = the average of the required return
on a frm’s stock equity and the interest rate on its debt, weighted by the proportion
of equity and debt in its portolio.
- Storage and Handling Costs
- Taxes, Insurance, and Shrinkage
Shrinkage takes three forms:
o Pilferage (thef)
o Obsolescence (inventory cannot be used or sold at full value)
o Deterioration (damage)
Pressures for Large Inventories
- Customer Service speed delivery and improve the frm’s on-time delivery of
goods.
Stockout = an order that cannot be satisfed, resulting in loss of the sale.
, Backorder = a customer order that cannot be flled when promised or demanded but
is flled later.
- Ordering cost = The cost of preparing a purchase order for a supplier or a production
order for manufacturing.
- Setup cost = The cost involved in changing over a machine or workspace to produce
a diferent item.
- Labor and Equipment Utilitation
Three ways:
o Placing larger, less frequent production orders reduces the number of
unproductive setups.
o Holding inventory reduces the chance of the costly rescheduling of
production orders.
o Building inventories improve resource utilitation by stabiliting the output
rate when demand is cyclical or seasonal.
- Transportation Cost
- Payment of Suppliers
Quantity discount = A drop in the price per unit when an order is sufciently large.
Types of Inventory
Accounting Inventories
- Raw materials (RM) = The inventories needed for the production of services or
goods.
- Work-in-process (WIP) = Items, such as components or assemblies, needed to
produce a fnal product in manufacturing or service operations.
- Finished goods (FG) = The items in manufacturing plants, warehouses, and retail
outlets that are sold to the frm’s customers.
Independent demand items = Items for which demand is infuenced by market conditions
and is not related to the inventory decisions for any other item held in stock or produced.
Managing an independent demand inventory can be tricky because demand is infuenced by
external factors. Should be forecasted.
Dependent demand items = Items whose required quantity varies with the production plans
for other items held in the frm’s inventory. Should be calculated.
Operational Inventories
- Cycle inventory = The portion of total inventory that varies directly with lot site.
Lot sizing = The determination of how frequently and in what quantity to order
inventory.
Formula:
- Safety stock inventory = Surplus inventory that a company holds to protect against
uncertainties in demand, lead time, and supply changes.
- Anticipation inventory = Inventory used to absorb uneven rates of demand or supply
- Pipeline inventory = Inventory that is created when an order for an item is issued
but not yet received.
Formula:
Inventory management = The planning and controlling of inventories to meet the
competitive priorities of the organitation.
Lot size = The quantity of an inventory item management either buys from a supplier or
manufactures using internal processes.
Inventory Trade-Ofs
Inventory = A stock of materials used to satisfy customer demand or to support the
production of services or goods.
Scrap = to get rid of something.
Inventories rise when more material fows into the tank than fows out; they fall when more
material fows out than fows in.
Firms utilite Six Sigma and total quality management (TQM) to reduce defective materials:
The larger the scrap fows, the larger the input fow of materials required for a given level of
output.
Pressures for Small Inventories
The primary reason for keeping inventories small is that inventory represents a temporary
monetary investment. As such, the frm incurs an opportunity costs, which we call the cost
of capital, arising from the money tied up in inventory that could be used for other
purposes.
Inventory holding cost = The sum of the cost of capital and the variable costs of keeping
items on hand, such as storage and handling, taxes, insurance, and shrinkage.
Components of holding cost create pressures for small inventories:
- Cost of Capital = the opportunity cost of investing in an asset relative to the expected
return on assets of similar risk.
Use of weighted average cost of capital (WACC) = the average of the required return
on a frm’s stock equity and the interest rate on its debt, weighted by the proportion
of equity and debt in its portolio.
- Storage and Handling Costs
- Taxes, Insurance, and Shrinkage
Shrinkage takes three forms:
o Pilferage (thef)
o Obsolescence (inventory cannot be used or sold at full value)
o Deterioration (damage)
Pressures for Large Inventories
- Customer Service speed delivery and improve the frm’s on-time delivery of
goods.
Stockout = an order that cannot be satisfed, resulting in loss of the sale.
, Backorder = a customer order that cannot be flled when promised or demanded but
is flled later.
- Ordering cost = The cost of preparing a purchase order for a supplier or a production
order for manufacturing.
- Setup cost = The cost involved in changing over a machine or workspace to produce
a diferent item.
- Labor and Equipment Utilitation
Three ways:
o Placing larger, less frequent production orders reduces the number of
unproductive setups.
o Holding inventory reduces the chance of the costly rescheduling of
production orders.
o Building inventories improve resource utilitation by stabiliting the output
rate when demand is cyclical or seasonal.
- Transportation Cost
- Payment of Suppliers
Quantity discount = A drop in the price per unit when an order is sufciently large.
Types of Inventory
Accounting Inventories
- Raw materials (RM) = The inventories needed for the production of services or
goods.
- Work-in-process (WIP) = Items, such as components or assemblies, needed to
produce a fnal product in manufacturing or service operations.
- Finished goods (FG) = The items in manufacturing plants, warehouses, and retail
outlets that are sold to the frm’s customers.
Independent demand items = Items for which demand is infuenced by market conditions
and is not related to the inventory decisions for any other item held in stock or produced.
Managing an independent demand inventory can be tricky because demand is infuenced by
external factors. Should be forecasted.
Dependent demand items = Items whose required quantity varies with the production plans
for other items held in the frm’s inventory. Should be calculated.
Operational Inventories
- Cycle inventory = The portion of total inventory that varies directly with lot site.
Lot sizing = The determination of how frequently and in what quantity to order
inventory.
Formula:
- Safety stock inventory = Surplus inventory that a company holds to protect against
uncertainties in demand, lead time, and supply changes.
- Anticipation inventory = Inventory used to absorb uneven rates of demand or supply
- Pipeline inventory = Inventory that is created when an order for an item is issued
but not yet received.
Formula:
