Operations Post Midterm Material

Inventory Management Reading (Pg. 175-188)

- Pressures to reduce inventory in a system:

o Inventory is a monetary investment for which firm pays interest, rather
than receives interest (ties up cash)
o As inventory increases, throughput time increases
- Typically, the cost to hold one unit of inventory annually is 20% to 40%
- However, a firm may want to hold high inventory because of the following:
o Customer service higher on hand finished goods can speed up delivery,
it also reduces potential stockouts and backorders
o Ordering costs each time a firm places a new order, it incurs an ordering
cost, such as the cost of preparing a purchase order for a supplier
o Setup costs higher levels of inventory reduce setup cost
o Other reasons ordering costs, labour and equipment utilization,
transportation cost, purchasing cost discounts

- To identify the critical inventory items you would use ABC analysis, you can also
use this to determine which customers are important
- ABC analysis divides items into three classes according to their dollar usage so
that managers can focus on items that have the highest dollar value
o A items represent 20% of items but account for 80% of dollar usage
o B items account for 30% of items but account for 15% of dollar usage
o C items account for 50% of items but 5% of dollar usage
- This would imply that class A items should be reviewed frequently to reduce the
average lot size and keep inventory records current
- Class C items would have very low inventory holding costs, this would imply that
higher inventory levels can be tolerated and that more safety stock can be used
- To balance inventory holding and ordering costs the EOQ model can be used
- Assumptions of EOQ model:
o Demand rate is constant, ex. 10 units per day
o There are no constraints on the size of each lot
o The only two relevant costs are inventory holding and inventory ordering
costs
o There is no uncertainty in lead time or supply. Lead time is constant and
known with certainty
- Total annual cost formula given on formula sheet
- Everything in the formula has to be on an annual basis