1. CHAPTER 7 Managing Inventories
McGraw-Hill/Irwin
Copyright © 2014 McGraw-Hill Higher Education. All rights reserved.

2. Learning Objectives
LO7-1 Define the different types and roles of inventory
LO7-2 Explain the financial impact of inventory
LO7-3 Explain and compute measures of performance
LO7-4 Calculate inventory policy parameters to minimize total acquisition cost
LO7-5 Determine the cost of a company’s service level policy
LO7-6 Explain the advantages and disadvantages of different inventory location strategies
LO7-7 Describe practical techniques for inventory planning and management

3. Types of Inventory Inventory: supply of items held to meet demand
Suppliers
Suppliers
MRO
MRO
Raw Material
Raw Material
Components
Components
Maintenance, repair &
Maintenance, repair &
operating supplies
operating supplies
Work in
Work in
Process (WIP)
Process (WIP)
Finished
Finished
Types of Inventory
Goods (FGI)
Goods (FGI)
Transportation
Distribution
Distribution
Customers
Customers
LO7-1
7–3

4. Financial Impact of Inventory
Carrying (Holding) Costs
Opportunity cost (including cost of capital)
Storage and warehouse management
Taxes and insurance
Obsolescence, spoilage, & shrinkage
Material handling, tracking and management
Ordering and Set-up Costs
Purchased items: placing and receiving orders
Make items: change-over between items
Stockout Costs
Lost sales or customer loyalty
Expediting
Schedule disruption
LO7-2 4

5. Measures of Inventory Performance: Inventory Turnover
Inventory turnover: ratio of average inventory on-hand and level of sales
= Cost of goods sold / Average inventory at cost
= Net sales / Average inventory at selling price
= Unit sales / Average inventory in units
With an annual cost of goods sold of $500M and average inventory of $80M.
Inventory turns = $500/$80 = 6.25 turns
Example 7-2
LO7-3
7–5 5

6. Measures of Inventory Performance: Days, Service Level, Stock outs
Days of Supply: length of time operations can be supported with inventory on-hand
Days of supply = Inventory/Daily demand
If inventory is 2M and daily demand is 25,000 day
Days of supply = 2M/25,000 = 80 days
Service Level: ability to meet customer demand without a stock out
Stock out: no inventory is available
Example 7-3
LO7-3

7. Inventory Management Systems
Independent Demand: demand is beyond control of the organization
Dependent Demand: demand is driven by demand of another item
LO7-4
7–7

8. Continuous Review Model
Continuous Review: inventory levels are constantly monitored to determine when to place a replenishment order
Units in Inventory
Average Inventory
Order Point
Time
Figure 7-1
LO7-4
7–8

9. Total Acquisition Costs
Total Acquisition Costs: sum of all relevant annual inventory costs
Holding costs: associated with storing and assuming risk of having inventory
Ordering costs: associated with placing orders and receiving supply
TAC = annual ordering cost + annual carrying cost
LO7-4
7–9

10. Economic Order Quantity (EOQ)
Economic Order Quantity (EOQ): minimizes total acquisition costs; point at which holding and orders costs are equal
How much to order
D = Annual Demand
Co= Ordering cost
U = Unit cost
Ci = Holding cost
LO7-4
7–10

11. Periodic Review Model
Order Interval: fixed time between inventory review, on-hand level is unknown during this uncertainty period
UP = Uncertainty period
OI = Order interval
t = average lead time
d = average lead time
z = standard deviations needed for service level
= standard deviation of demand during the uncertainty period
A = inventory on hand
LO7-4
7–11

12. Single Period Inventory Model
Single Period Inventory Model: items are ordered once, and have little left over value (newsvendor problem)
Target Service Level: probability of meeting demand
LO7-4
7–12

13. Managing Inventory Managing Cycle Stock: reducing lot sizes
Managing Safety Stock: using ABC analysis and reducing lead time
Managing Locations: balance inventory, lead time and service levels
Implementing Inventory Models: matching management system to specific items
LO7-6
7–13

14. Inventory Information Systems and Accuracy
Identification Systems
Global Trade Item Number (GTIN): identification system for finished goods sold to consumers
Part Number: unique identifier used by a specific firm
Inventory Record Accuracy
Cycle Counting: inventory is physically counted on a routine schedule
LO7-7

15. Managing Inventories Summary
There are multiple types of inventory
Inventory fulfills multiple roles
Inventory is an asset, and has multiple costs
An inventory policy determines how much and when to order
Continuous systems monitor on-hand levels
Safety stock levels are linked with service levels
Periodic systems count inventory at specific intervals
Number of storage locations impact inventory levels
Managers should work to reduce inventory levels