Understanding Inventory Management AND ITS OWN Theories

Inventory management or inventory control can be an attempt to balance inventory needs and requirements with the necessity to minimize costs resulting from obtaining and retaining inventory. There are many classes of thought that view inventory and its function in a different way. These will be attended to later but first we present a basis to accomplish the readers knowledge of inventory and its own function.

Inventory Definition

Inventory is a number or store of goods that is organised for some purpose or use (the term could also be used as a verb so this means for taking inventory or to depend all goods kept in inventory). Inventory may be held in house so this means on the premises or local for immediate use or it can be held in a distant warehouse or circulation centre for future use. Apart from organizations utilizing just with time methods generally the word inventory indicates a stored quantity of goods that exceeds what's needed for the firm to function at the existing time (e. g. , next few time).

Why we ought to keep inventory

Why would a company carry more inventory than happens to be necessary to ensure the firm's operation? The following is a list of reasons for keeping what seems to be "excess" inventory.


In order for a dealer in which to stay business it will need to have the products that the client wants on hand when the customer wants them? If not the dealer will have to back order the merchandise. If the customer can get the good from various other source he or she might want to do so somewhat than electing to allow the original merchant to meet demand later (through rear order). Hence, in many instances if the good is not in inventory a sales is lost forever.


A manufacturer will need to have certain purchased items (recycleables components or subassemblies) in order to produce its product. Operating out of only 1 item can prevent a maker from completing the creation of its completed goods.

Inventory between successive based mostly operations also assists to decouple the dependency of the functions. A machine or work middle is often dependent upon the previous procedure to provide it with parts to focus on. If work ceases at a work middle then all subsequent centers will turn off for lack of work. If a supply of work in process inventory is held between each work center then each machine can maintain steadily its operations for a limited time ideally until operations job application the original middle.


Lead time is the time that elapses between your placing of the order (the purchase order or a creation order given to the shop or the manufacturer floor) and actually receiving the products ordered.

If a supplier (an external company or an internal department or place) cannot provide you with the required goods on demand then the client firm must keep an inventory of the needed goods. The longer the business lead time the larger the quantity of goods the company must bring in inventory.

A just in time (JIT) manufacturing organization such as Nissan in Smyrna Tennessee can maintain extremely low levels of inventory. Nissan requires delivery on pickup truck seats as many as 18 times each day. However steel mills may have a lead time as high as three months. Which means that a organization that uses material produced at the mill must place requests at least 90 days before their need. To keep their operations running for the time being an readily available inventory of three months metallic requirements would be necessary.


Inventory can even be used as a hedge against price rises and inflation. Salesmen routinely call purchasing agencies shortly before a cost increase goes into effect. This gives the buyer a chance to purchase materials in excess of current need at a cost that is leaner than it might be if the buyer waited until after the price increase occurs.


Often firms are given a price discount when purchasing large quantities of a good. This also frequently results inventory in excess of what is presently had a need to meet demand. However if the discount is sufficient to offset the excess positioning cost incurred as a result of the surplus inventory the decision to choose the variety is justified.


Sometimes inventory can be used to smooth demand requirements in a market where demand is relatively erratic. Consider the demand forecast and creation schedule discussed in Stand 1.

Notice the way the use of inventory has allowed the company to maintain a reliable rate of output thus avoiding the expense of selecting and training new personnel while building up inventory in expectation of a rise in demand. In fact this is often called expectation inventory. In essence the use of inventory has allowed the organization to go demand requirements to previous times thus smoothing the demand.

Controlling Inventory

Firms that take hundreds or even thousands of different part numbers can be faced with the impossible activity of monitoring the inventory levels of each part quantity. To be able to aid this many firm's use an ABC strategy. ABC analysis is based on Pareto Analysis also called the "80/20" rule. The 80/20 originates from Pareto's finding that 20 percent of the populace possessed 80 percent of the prosperity. From an inventory point of view it can restated thusly: about 20 percent of all inventory items signify 80 percent of inventory costs. Therefore a firm can control 80 percent of its inventory costs by monitoring and managing 20 percent of its inventory. But it must be the right 20 percent.

The top 20 percent of the firm's most costly items are termed "An" items (this will approximately represent 80 percent of total inventory costs). Items which are extremely inexpensive or have low demand are termed "C" items with "B" items falling among A and C items. The percentages can vary greatly with each company but B items usually stand for about thirty percent of the total inventory items and 15 percent of the costs. C items generally constitute 50 percent of all inventory items but only around 5 percent of the c By classifying each inventory item as an A B or C the firm can determine the resources (time effort and money) to devote to each item. Usually this means that the firm screens A items very tightly but can check up on B and C items over a periodic basis (for example monthly for B items and quarterly for C items).

Another control method related to the ABC concept is cycle keeping track of. Cycle counting is used instead of the original once a year inventory count number where firms turn off for a short time frame and physically count all inventory resources in an attempt to reconcile any possible discrepancies in their inventory documents. When cycle counting is used the organization is continually going for a physical count but not of total inventory.

A company may physically matter a certain portion of the plant or warehouse shifting to other sections upon completion until the entire service is counted. Then your process starts yet again.

The firm could also choose to depend all the A items then the B items and lastly the C items. Certainly the counting frequency will vary with the classification of each item. In other words something may be counted every month B items quarterly and C items annually. In addition the mandatory precision of inventory data may vary regarding to classification using a items demanding the most appropriate record keeping.

Balancing Inventory and Cost

As stated early on inventory management can be an try to maintain an satisfactory supply of goods while minimizing inventory costs. We saw a variety of reasons companies maintain inventory and these reasons determine what is considered to be an enough supply of inventory. Now how do we balance this source with its costs? First let's check out the type of costs we live discussing.

There are three types of costs that collectively constitute total inventory costs: retaining costs create costs and purchasing costs.

Holding Costs.

Holding costs also known as carrying costs are the costs that result from keeping the inventory. Inventory more than current demand frequently means that its holder must definitely provide a place because of its storage you should definitely in use. This may range from a little storage area near to the production line to an enormous warehouse or syndication center. A storage facility requires personnel to go the inventory when needed also to keep track of what is stored and where it is stored. If the inventory is heavy or cumbersome forklifts may be necessary to move it around.

Storage facilities also require heating cooling, lighting and water. The organization must pay fees on the inventory and opportunity costs arise from the lost use of the funds that were spent on the inventory. Also obsolescence pilferage (fraud) and shrinkage are problems. All of these things add cost to possessing or hauling inventory.

If the firm can determine the price tag on holding one product of inventory for just one season (H) it can determine its total annual keeping cost by multiplying the cost of holding one device by the common inventory performed for a one year period. Average inventory can be computed by dividing the quantity of goods that are ordered every time an order is positioned (Q) by two. Thus average inventory is expressed asQ/2. Annual positioning cost then can be indicated asH(Q/2).

Set Up Cost

Set up costs will be the costs incurred from obtaining a machine ready to produce the desired good. In a very manufacturing setting this would require the use of a skilled technician (a cost) who disassembles the tooling that happens to be in use on the machine. The disassembled tooling is then taken up to an instrument room or tool shop for maintenance or possible repair (another cost). The specialist then calls for the currently needed tooling from the tool room (where it's been managed another cost) and brings it to the machine in question.

There the tech has to put together the tooling on the machine in the way required for the good to be produced (this is actually a create). Then your technician has to calibrate the device and probably will run a number of parts that should be scrapped (a cost) to be able to get the device appropriately calibrated and operating. Even while the device has been idle and not producing any parts (opportunity cost). As you can see there may be considerable cost involved in create.

If the firm buys the part or uncooked materials then an order cost rather than set up cost is incurred. Ordering costs include the purchasing agent's salary and travel entertainment budget administrative and secretarial support office space copiers and office items forms and documents long distance phone bills and personal computers and support. Also some businesses include the expense of shipping the purchased goods in the order cost.

If the firm can determine the cost of one set up (S) or one order it can determine its twelve-monthly set up order cost by multiplying the price tag on one create by the number of established ups made or purchases placed annually. Assume a firm has an annual demand (D) of 1 1, 000 units. If the organization orders 100 systems (Q) every time it places and order the firm will obviously place 10 purchases per time (D/Q). Hence, gross annual create order cost can be portrayed asS (D/Q).

Purchasing Cost

Purchasing cost is merely the expense of the purchased item itself. In the event the firm purchases a component that goes into its completed product the organization can determine its total annual purchasing cost by multiplying the cost of one purchased device (P) by the amount of completed products demanded in a year (D). Hence, purchasing cost is indicated asPD.

Now total inventory cost can be expressed as:

Total = Possessing cost + Set-up/Order cost + Purchasing cost


Total =H(Q/2) +S(D/Q) +PD

If holding costs and set-up costs were plotted as lines on a graph the point at which they intersect (that is the point at which they are equivalent) would indicate the cheapest total inventory cost. Therefore if we want to decrease total inventory cost every time we place an order, we should order the number (Q) that corresponds to the stage where the two ideals are similar. If we arranged both costs identical and solve forQwe get:

H(Q/2) =S(D/Q)

Q= 2DS/H

The quantity is recognized as the economic order variety (EOQ). To be able to reduce total inventory cost, the firm will order each time it places an order. For instance, a company with an gross annual demand of 12, 000 units (at a price of $25 each), twelve-monthly having cost of $10 per device and an order cost of $150 per order (with orders placed once a month) could save $800 yearly through the use of the EOQ. First, we determine the total costs without needing the EOQ method:

Q= $10(1000/2) + $150(12, 000/1000) + $25(12, 000) = $306, 800

Then we assess EOQ: EOQ = 2(12, 000)($150)/$10= 600

And we compute total costs at the EOQ of 600:

Q= $10(600/2) + $150(12, 000/600) + $25(12, 000) = $306, 000

Finally, we subtract the full total cost ofQfromQto determine the savings:

$306, 800 № ' 306, 000 = $800

Notice that if you remove purchasing cost from the formula the savings is still $800. We might assume which means that purchasing cost is not highly relevant to our order decision and can be eradicated from the formula. It must be observed that this holds true only so long as no variety discount exists. In case a quantity discount is offered the firm must determine if the savings of the number discount are sufficient to offset the loss of the savings caused by the utilization of the EOQ.

There are a number of assumptions that must definitely be made with the use of the EOQ. Included in these are:

Only one product is engaged.

Deterministic demand (demand is well known with certainty).

Constant demand (demand is secure through-out the year).

No quantity savings.

Constant costs (no price raises or inflation)

While these assumptions would seem to make EOQ irrelevant for use in a realistic situation it is pertinent for items which have independent demand. This means that the demand for the item is not derived from the demand for another thing usually a father or mother item for which the unit in question is a component. Including the demand for steering wheels would be derived from the demand for cars dependent demand however the demand for bags is not produced from anything else purses and handbags have self-employed demand.

Other Whole lot Sizing Techniques

There are a number of other lot sizing techniques available in addition to EOQ. These include the set order quantity set order interval model the solitary period model and part period balancing.

Fixed Order Quantity Model

EOQ can be an example of the fixed order amount model because the same number is ordered every time an order is positioned. A firm might also use a set order quantity when it is captive to packaging situations. If you were to walk into an office source store and ask to buy 22 newspaper clips you would go out with 100 paper videos. You were captive to the product packaging requirements of paper videos i. e. they come 100 to a field therefore you cannot buy a partial pack. It works the same way for other purchasing situations. A dealer may offer their goods using amounts so that their customers must buy that volume or a multiple of that quantity.


The set order period model is employed when orders have to be placed at resolved time intervals such as every week biweekly or regular. The great deal size is dependent after how much inventory is necessary from the time of order until the next order must be located order cycle. This system requires periodic bank checks of inventory levels and is used by many retail firms such as drug stores and small grocery stores.


The solitary period model is used in purchasing perishables such as food and blooms and items with a limited life such as newspapers. Unsold or unused goods are not typically transported over from one period to some other and there may even be some disposal costs involved. This model tries to balance the price of lost customer goodwill and opportunity cost that is incurred from devoid of enough inventory with the expense of having excessive inventory left at the end of an interval.


Part period controlling attempts to choose the number of periods covered by the inventory order that will make total carrying costs as close as you possibly can to the setup order cost.

When a proper great deal size has been identified utilizing one of the aforementioned techniques the reorder point or point of which an order should be placed can be dependant on the speed of demand and the lead time. If safety stock is necessary it would be added to the reorder point quantity.

Reorder point =Expected demand during lead time + Safe practices stock

Thus an inventory item with a demand of 100 monthly a two month lead time and a desired basic safety stock of fourteen days would have reorder point of 250. In other words an order would be placed whenever the inventory level for this good reached 250 units.

Reorder point =100/month - 2 a few months + 2 weeks' security stock = 250

Other thoughts in Inventory Management

There are a number of techniques and philosophies that view inventory management from different perspectives.


MRP and MRP II are computer based mostly source management systems made for items which may have based mostly demand. MRP and MRP II take a look at order amounts period by period and as such allow discrete buying only what's currently needed. In this way inventory levels can be placed at a very low level a necessity for a complex item with based mostly demand.


Just in time (JIT) is a idea that advocates the lowest possible degrees of inventory. JIT espouses that firms need only keep inventory in the right quantity at the right time with the right quality. The perfect lot size for JIT is one even though one hears the term "zero inventory" used.

Theory of Constraints

Theory of constraints (TOC) is a beliefs which emphasizes that management activities should centre about the firm's constraints. Although it will abide by JIT that inventory should be at the cheapest level possible in most instances it advocates that there be some buffer inventory around any capacity constraint e. g. the slowest machine and before completed goods.

Future of Inventory Management

The development through altruism or legislation of environmental management has added a new dimensions to inventory management reverse supply chain logistics. Environmental management has expanded the number of inventory types that businesses have to organize. Furthermore to recycleables work in process finished goods and MRO goods organizations now have to cope with post consumer items such as scrap returned goods reusable or recyclable containers and any number of items that require repair reuse recycling or secondary use within another product. Suppliers have the same type problems working with inventory that is returned credited to defective materials or make poor fit surface finish or color or outright "I altered my mind reactions from customers.

Finally supply string management has had a considerable effect on inventory management. Rather than managing one's inventory to maximize profit and decrease cost for the individual firm today's organization must make inventory decisions that profit the entire supply chain.

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