Chapter 11: Inventory Management
Inventory is the stock of any item or resource used in an organization and can include: raw materials, finished products,
component parts, supplies, and work-in-process. They contribute to customer satisfaction. Most companies have 30% of
assets in inventory, and 90% of working capital. A reduction in inventories may lead to a significant increase in ROI.
An inventory system is the set of policies and controls that monitor levels of inventory and determines what levels
should be maintained, when stock should be replenished, and how large orders should be
Inventory Management is planning, coordinating, and controlling activities related to the flow of inventory into,
through, and out of an organization
Functions of inventory:
– To meet anticipated demand: companies need to hold some inventory of the average demand, as lead time may
– To smooth production requirements: beer and ice cream manufacturers build up inventory during offseason
periods to meet high requirements during peak season.
– To decouple components of the production-distribution: painting cars in big batches even though dealers will
require a combo of colors.
– To protect against stock-outs: holding more than the average demand to compensate for lead time and
variability in delays.
– To take advantage of order cycles
– To help hedge against price increases or to take advantage of quantity discounts: if price is expected to increase
for a buyer he will unexpectedly purchase larger than normal amounts to avoid increase.
– To permit operations
Inventory management has 2 main concerns:
1. Level of customer service.
2. Costs of ordering and holding inventories.
Requirements for effective inventory management:
1. A system to safely store and use inventories:
– In a warehouse so not outdoors
– Access to the building should be controlled
– Outdated items should either be sent back to the supplier or sold at a discount
2. A system to keep track of inventories and replenishment models
– Periodic counting: physical count of items in inventory made at periodic intervals.
– Perpetual Inventory System: a system that keeps track of removals from inventory continuously, thus
monitoring current levels of each item
– Two-Bin System: Two containers of inventory; reorder when the first is empty
– Universal Bar Code: Bar code printed on a label that has information about the item to which it is
3. Reliable forecasts of demands and knowledge of lead times
– Lead time: time interval between ordering and receiving the order
– Point of sale system: POS electronically records actual sales and updates inventory levels at the time
and location of the sale.
4. Reasonable estimates of inventory holding, ordering and shortage costs.
– Holding (carrying) costs: cost to carry an item in inventory for a length of time, usually a year
– Ordering costs: costs of ordering and receiving inventory
– Shortage costs: costs when demand exceeds supply
5. A B C classification: Classifying inventory to three classes according to some measure of importance and
allocating control efforts accordingly. A: Very important, B: mod important, C: least important. A items should
receive close attention through better forecasting, more frequent replenishment, and
better safety stock determination.
Cycle counting: regular physical count of the items in inventory on a cyclic schedule.
To reduce discrepancies between the amounts indicated by inventory records and
the actual quantities of inventory on hand. And to investigate the cause of
inaccuracy and fix it. – How much