INVENTORY CONTROL

Introduction
Inventory Management is one of the

major crucial aspects of any business.

Inventory is one of the most important
assets especially to manufacturing, food
and

retail

businesses

worldwide.

Since

inventory represents cost, it is critical to

have

good

management.

inventory

control

and

Introduction
Cost Minimization is the key to inventory

control and management. Minimizing loss

of goodwill due to frequent stock outs (no
inventory at hand) and minimizing carrying
costs is another. Production and logistic
managers should strike a balance between
minimizing

inventory

customers goodwill.

costs

and

losing

Kinds of Inventory
Raw Materials
Work in Process
Finished Product

Kinds of Inventory
Inventory of finished goods is a function of

demand. in turn, the inventory of raw materials

and work-in process inventory is a function of
the demand for finished goods.
Small and big business do follow a system of

inventory

control

and

management.

it

is

important to know that the goal of the system

is to minimize cost.

Basic Components of Inventory

Planning and Control System
Planning what and how of inventory

system. What to order and ho to acquire

the what
Forecasting predicting demand for

inventory
Controlling - what level and when to

order
Feedback Mechanism provides

Several Functions of
Inventories
Decoupling
Storing Resources
Adapting to Irregular Supply and Demand
Enabling the company to take advantage of

Quantity Discounts
Avoiding Stockouts and Shortages

Inventory Decisions
The

fundamental

questions

in

inventory

control and management are:

How much to order?
When to order?
As inventory level goes up, so does the cost.
Minimizing the total inventory cost is the

main objective in controlling inventory.

Important Costs in Inventory

Control
Cost of Items (purchase cost or material

cost)
Cost of Ordering (Incurred every time an

order is placed
Cost of Carrying or Holding Inventory
Cost of Safety Stock
Cost of Stock outs

Economic Order Quantity

Model
The Economic Order Quantity (EOQ) Model is

one of the oldest and easiest to use model.

Though many of todays firms use this model,
EOQ makes a lot of assumptions.

EOQ Assumptions
Demand is known and constant
Lead time is known and constant
Receipt of inventory is instantaneous
Quantity discounts are not possible
The only variable costs are the cost of setting up or

placing an order and the cost of holding is storing

inventory over time
Stockouts can be completely avoided if orders are

placed at the appropriate time

EOQ Assumptions
The basic assumptions of the EOQ model yield

a sawtooth-shaped inventory usage over time.

To use EOQ, follow the steps in finding the

optimum inventory given below:

Develop an expression for the ordering cost
Develop and expression for the carrying cost
Set the ordering cost equal to the carrying cost
Solve this equation for the optimum desired

Developing the EOQ

Minimizing Inventory Cost is the goal of

most inventory models. Two relevant cost in

the picture are:
Ordering cost
Holding cost

Other cost like the material or purchase

cost is constant
Thus, minimizing total inventory cost is

minimizing the sum of the 2 relevant costs

Developing the EOQ

Developing the EOQ

Inventory changes daily as it is being used

in production. Because of this, it is proper

to use the average inventory in finding the
annual carrying cost. Average Inventory
Level is denoted by the expression;

Developing the EOQ

EOQ
To solve for the optimum order quantity,

ordering cost must equal holding cost

Inputs and Outputs of the EOQ

Model and the Reorder Point
Now we know how to obtain the number of units. The

second inventory question that needs to be answered I

when to order, which is known as the Reorder Point.
The reorder point (ROP) determines when to order

inventory. In symbols:
ROP = demand per day x lead time for a new order in

days
ROP = d X L, where L = time between the placing and

receipt of an order

Inventory Control and the

Production Process
The

Production

without

the

Run

Model

instantaneous

is

EOQ

receipt

assumption. It is applicable in production

environment where inventory continuously
builds up over a period of time after an
order has been placed or when units are
produced and sold simultaneously.

Inventory Control and the

Production Process
There are differences in using this model

than the basic EOQ.

Setup Cost instead of the ordering cost,

we are going to use the setup cost. This is

the cost of setting up the production facility
to produce the desired product.
To find the optimal order quantity, setup

cost equal carrying cost

Inventory Control and the

Production Process
To set up the equation for the production

run model, we need to derive the equation

for

the

average

inventory.

Since

the

replenishment of the inventory happens

over

period

of

time

and

demand

continues during this time, the maximum

inventory will be less than the order
quantity Q.

Inventory Control and the

Production Process
Maximum Inventory is as follows:

Inventory Control and the

Production Process
Production Run Model then is:

Quantity Discount Models

The only difference in the assumption here

is that material cost or the purchase cost

becomes

relevant

cost.

All

other

assumptions in the traditional EOQ remain

the same.
The total inventory cost then is:

Quantity Discount Models

To find the EOQ that yields the lowest total

cost considering quantity discounts, follow

these steps:
1.

Calculate Q for each discount

2.

Adjust Q upward if quantity is too low for

discount

3.

Compute total cost for each discount

4.

Select Q with the lowest total cost

The use of Safety Stocks

The Use of Safety Stock is basically to

address

the

concern

of

stockouts

or

shortages. When demand is high especially

during the peak season, having safety
stock will prevent stockouts
Safety Stocks is an extra stock kept on

hand for emergency purposes

The use of Safety Stocks

One of the best ways to implement a safety

stock policy is to adjust the ROP. When

demand during the lead time is uncertain,
ROP becomes:

The use of Safety Stocks

A. ROP with known Stockout Costs
Assumptions:
EOQ is fixed
ROP is used to place an order
Stockout can only occur during lead time
.The

objective is to find the safety stock

quantity

that

will

minimize

the

expected

stockout cost plus the expected holding cost.

The use of Safety Stocks

Example

The use of Safety Stocks

When ROP is less than demand over lead

time;
total cost = stockout cost
= number units short X stockout cost/unit X
number of orders/year
When ROP is greater than the expected

demand over the lead time;

total cost = additional carrying cost

The use of Safety Stocks

When ROP = 30 units but the demand is 40

units, there will be a shortage of 10 units

total cost = stockout cost = 10(40)(6) =

P2,400
When ROP = 70 units but the demand is

60units, there will be a surplus of 10 units.

total cost = additional carrying cost = 10(5)

= P50

The use of Safety Stocks

B. ROP with unknown Stockouts

The previous method discuss earlier is no longer

applicable here. An alternative to determining the
safety stock is to use service level and the normal
distribution

A Service Level

is the percent of the time that you

will not have a stockout, the P of having a stockout is:

Service level = 1 P of a stockout or
P of a stockout = 1 service level

The use of Safety Stocks

Example

ABC Inventory Analysis

ABC Analysis is a qualitative technique of

inventory

implementation

that

aims

to

divide all of a companys inventories into 3

groups (A, B, C) based on the overall
inventory value of the items.

ABC Inventory Analysis

In ABC Analysis, as a rule:
Group A items accounts for a major portion of the

inventory costs. These items should be monitored

regularly.
A items makes up 70% of the inventory value but may

consist 10% of all the physical inventory items

Group B items represents the moderately priced

items making up 20% of the company investment

peso and consist 20% of all the items
Group C are the very low-cost items, needs only
very simple inventory policy and this may include
a relatively large safety stock. Since holding cost
is low, carrying large amount of these items is
not too costly.

ABC Inventory Analysis

Recommended inventory policies for the

ABC analysis:
Greater expenditure on supplier development

for A items than for B items or C items

Tighter physical control on A items than on B

items or on C items
Greater expenditure on forecasting A items

than on B items or on C items