SMG OM 323 Study Guide - Final Guide: Universal Product Code, Inventory Turnover, Perpetual Inventory
10 Feb 2017
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Department
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OM323
Final Study Guide
OM12/13 Inventory Management
Inventory – a stock or store of goods
• Types
o Independent-demand items – items that are ready to be sold or used
▪ Finished-goods inventories (manufacturing firms) or merchandise (retail)
o Dependent-demand items – components of finished products
▪ Raw materials and purchased parts
• Materials received
• Customers waiting in a bank
• Paperwork in inbox
▪ Work-in-process (WIP) – partially completed goods
• Semi-finished products
• Customers at the counter
• Paperwork on desk
▪ Tools and supplies
▪ Maintenance and repairs (MRO) inventory
▪ Goods-in-transit to warehouses, distributers, or customers (pipeline inventory)
• Between organizations
▪ Finished goods
• Products waiting to be shipped
• Customers leaving the bank
• Paperwork in outbox
• Metrics
o Return on investment (ROI) – profit after taxes divided by total assets
▪ Reduction of inventories can result in significant increase in ROI
• Importance: necessary for operations, contribute to customer satisfaction
• Functions
1. To meet anticipated customer demand
▪ Anticipation stocks – held to satisfy expected demand
2. To smooth production requirements
▪ Seasonal inventories – build up inventories during preseason periods to meet overly high requirements
during seasonal periods
▪ Pre-build stock
3. To decouple operations
▪ Inventory buffers – between successive operations to maintain continuity of production
4. To reduce the risk of stockouts
▪ Safety stocks – stocks in excess of expected demand; compensate for variabilities in demand/lead time
5. Take advantage of order cycles
▪ To minimize purchasing and inventory costs, a firm often buys in quantities that exceed immediate
requirements (excess stored for later use)
▪ Enables a firm to buy and produce in economic lot sizes
• Results in periodic orders or order cycles
6. To hedge against price increases
▪ Speculative stock
7. To permit operations
▪ Leads to pipeline inventories throughout a production-distribution system
▪ Little’s law useful in quantifying pipeline inventory
• Average amount of inventory in a system = average demand rate x average time unit is in system
8. To take advantage of quantity discounts
▪ Cycle stock – spread fixed costs, utilize quantity discounts
find more resources at oneclass.com
find more resources at oneclass.com
Costs of holding inventory
• Average ~30% of item cost:
o Opportunity cost of investment (interest) → usually the largest and most important element
o Warehousing, insurance, taxes
o Breakage, spoilage theft
o Devaluation and obsolescence
o Rework
o Price protection and returns (in some industries)
Inventory Management
• Objective: Achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds
• Fundamental decisions: what to order and how much to order
o Different situations/assumptions lead to different models
• Performance measures used to judge effectiveness of inventory management
o Inventory turnover – annual COGS / inventory
▪ Indicates how many times a year the inventory is sold (higher = better)
▪ Should be a balance between inventory investment and maintaining good customer service
o Inventory days = inventory / daily COGS
▪ indicates the expected number of days that can be supplied from existing inventory
Effective inventory management requirements
• A system to keep track of the inventory on hand and on order
o Inventory counting systems
▪ Periodic system – physical count of items in inventory made a periodic interval (weekly, monthly)
• Advantage: orders for many items occur at same time (economies in processing/shipping orders)
• Disadvantages: lack of control between reviews; need to protect against shortages between
review periods by carrying extra stock
▪ Perpetual system – system that keeps track of removals from inventory continuously, thus monitoring
current levels of each item
• Advantage: control provided by continuous monitoring of inventory withdraws; fixed-order
quantity
• Disadvantage: added cost of record keeping
• Two-bin system – two containers of inventory; reorder when first is empty
o Advantage: no need to record each withdrawal from inventory
o Disadvantage: the reorder card may not be turned in for a variety of reasons
• Universal product code (UPC) – bar code printed on a label that has information about the item
to which it is attached
• Point-of-sale (POS) systems – electronically record actual sales at time of sale
o Relays info about actual demand in real time, enabling management to make any
necessary changes to restocking decisions
o Reduce the need for periodic review and order-size determinations
o Improve level of customer service by indicating price/quantity on receipt
• A reliable forecast of demand that includes an indication of possible forecast error
• Knowledge of lead times and lead time variability
o Lead time – time interval between ordering and receiving the order
▪ The greater the potential variability, the greater the need for additional stock to reduce the risk of a
shortage between deliveries
• Reasonable estimates of inventory holding costs, ordering costs, and shortage costs
1. Purchase cost – the amount paid to buy the inventory
2. Holding, or carrying, costs – cost to carry an item in inventory for a length of time, usually a year
▪ Costs include: interest, insurance, taxes, depreciation, obsolescence, deterioration, spoilage, pilferage,
breakage, tracking, picking, and warehousing costs; opportunity costs associated with having funds that
could be used elsewhere tied up in inventory
o Variable portion of these costs that are important
▪ Stated in either of two ways:
o A percentage of unit price
o A dollar amount per unit
3. Ordering cost – costs of ordering and receiving inventory
find more resources at oneclass.com
find more resources at oneclass.com
▪ Generally, a fixed dollar amount of order, regardless of order size
▪ Fixed ordering costs do not depend on the order size:
i. Determining the order quantity
ii. Preparing purchase orders
iii. Receiving and inspection costs
iv. Setting up machines (for internal orders)
v. Any fixed component of shipping costs
o Setup costs – costs involved in preparing equipment for a job (analogous to ordering costs)
4. Shortage cost – costs resulting when demand exceeds the supply of inventory; often unrealized profit per unit
▪ Include opportunity cost of not making a sale, loss of customer goodwill, late charges, backorder costs
• A classification system for inventory items
o A-B-C approach – classifying according to some measure of importance, and allocating control efforts accordingly
▪ Three classes of items are used:
1. A (very important)
o Should receive close attention through
frequent reviews of amounts on hand and
control over withdrawals where possible to
make sure that customer service levels are
attainted
2. B (moderately important)
3. C (least important)
o Should receive only loose control (two-bin
system, bulk orders)
▪ To solve an A-B-C problem:
1. For each item, multiply annual volume by unit price to get the annual dollar value
2. Arrange annual dollar values in descending order
3. The few (10-15%) with highest annual dollar value are A items. The most (~50%) with the lowest
annual dollar value are C items. Those in between (~35%) are B items
▪ Key use: a manager can focus attention on the most important aspects of customer service
▪ Guide to cycle counting, a physical count of items in inventory
• Purpose: to reduce discrepancies between the amounts indicated by inventory records and the
actual quantities on hand
• Key questions concerning cycle counting for management:
1. How much accuracy is needed?
2. When should cycle counting be performed?
3. Who should do it?
• A items counted most frequently, C items counted least
Inventory ordering policies
• Cycle stock – amount of inventory needed to meet expected demand
• Safety stock – extra inventory carried to reduce the probability of a stockout due to demand and/or lead time variability
• Address the basic issues of how much to order and when to order
How much to order: economic order quantity (EOQ)
• Economic order quantity – the order size that minimizes total annual cost
• Three order size models
o Basic economic order quantity (EOQ) model (simplest)
▪ Used to identify a fixed order size that will minimize the sum of annual costs of holding/ordering inventory
▪ Assumptions:
• Only one product is involved
• Annual demand requirements are known
• Demand is known and constant
• Lead time is known and constant
• Each order us received in a single delivery
• There are no quantity discounts
▪ Trade-off:
• Fixed cost to order / Holding cost of inventory
▪ The inventory cycle
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Inventory a stock or store of goods. Independent-demand items items that are ready to be sold or used. Finished-goods inventories (manufacturing firms) or merchandise (retail: dependent-demand items components of finished products, raw materials and purchased parts, work-in-process (wip) partially completed goods, materials received. Tools and supplies: maintenance and repairs (mro) inventory, goods-in-transit to warehouses, distributers, or customers (pipeline inventory, between organizations. Paperwork in outbox: metrics, return on investment (roi) profit after taxes divided by total assets, reduction of inventories can result in significant increase in roi. Importance: necessary for operations, contribute to customer satisfaction. Functions: to meet anticipated customer demand, anticipation stocks held to satisfy expected demand, to smooth production requirements. Seasonal inventories build up inventories during preseason periods to meet overly high requirements during seasonal periods. Inventory buffers between successive operations to maintain continuity of production: to reduce the risk of stockouts.
