 Inventory is a stock or store of goods.

 Different types of inventories include the following:

1. Raw materials and purchased parts.
2. Partially completed goods, called work in process (WIP).
3. Finished goods inventories (manufacturing) or merchandise (retail).
4. Tools and supplies.
5. Maintenance and repairs (MRO) inventory.
6. Goods-in-transit to warehouses, distributors, or customers (pipeline inventory).
 Functions of inventory:
1. To meet anticipated customer demand: inventories held to satisfy expected demand
are called anticipation stocks.
2. To smooth production requirements: build inventory during preseason period to
meet overly high demand during seasonal periods.
3. To decouple operations: manufacturing firms use inventories as buffers between
successive operations to maintain continuity of production that would otherwise be
disrupted by events such as breakdowns or accidents.
4. To reduce risk of stockouts.
5. To take advantage of order cycles: to minimize purchasing and inventory costs, a firm
often buys in quantities that exceed immediate requirements.
6. To hedge against price increases: a firm will suspect that a substantial price increase
is about to occur and purchase larger than normal amounts to beat the increase.
7. To permit operations: production operations take a certain amount of time meaning
there will generally be some work-in-process inventory. Little’s law can be useful in
quantifying pipeline inventory.
8. To take advantage of quantity discounts: suppliers may give discounts on large
orders.
 Little’s Law: The average amount of inventory in a system is equal to the product of the
average demand rate and the average time a unit is in the system.
 Inventory turnover: ratio of annual cost of goods sold to average inventory investment.
 Main requirements for effective management:
1. A system to keep track of the inventory on hand and on order.
2. A reliable forecast of demand that includes an indication of possible forecast error.
3. Knowledge of lead times and lead time variability.
4. Reasonable estimates of inventory holding, ordering, and shortage costs.
5. A classification system for inventory items.
 Inventory counting systems can be periodic or perpetual.
 Periodic systems: physical count of items in inventory made at periodic intervals (weekly,
monthly).
 Perpetual inventory system: 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 first is empty. Second bin
contains safety stock. Advantage is no need to record each withdrawal from inventory.
Disadvantage is card may not be turned in.
 Universal Product Code (UPC): bar code printed on a label that has information about the
item to which it is attached.
 Point-of-sales (POS) systems: record items at time of sale.
 Lead time: time interval between ordering and receiving the order.
 4 basic costs are associated with inventories:
1. Purchase costs: the amount paid to buy the inventory.
2. Holding (carrying) cost: cost to carry an item in inventory for a length of time,
usually a year.
3. Ordering costs: costs of ordering and receiving inventory.
4. Shortage costs: costs resulting when demand exceeds the supply of inventory; often
unrealized profit per unit.
 Setup costs: the costs involved in preparing equipment for a job.
 A-B-C approach: classifying inventory according to some measure of importance and
allocating control efforts accordingly. Typically, 3 classes of items are used: A (very
important), B (moderately important), C (least important). Actual number of categories may
vary from organization to organization. A categorically account for less as number of items in
inventory (10-20%) but account for a lot in terms of dollar value (60-70%)
 To conduct ABC analysis:
1. For each item, multiply annual volume by unit price to get the annual dollar sales
value.
2. Arrange annual dollar values in descending order.
3. The few with the highest annual dollar values are A items. The most with the lowest
annual dollar value are C items. Those in between are B items.
 Cycle counting is physical count of items in inventory.
 A items are counted most frequently and C items least frequently.
 Cycle stock: the 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.
 Assumptions of the basic EOQ model:
1. Only one product is involved.
2. Annual demand requirements are known.
3. Demand is spread evenly throughout the year so that the demand rate is reasonably
constant.
4. Lead time is known and constant.
5. Each order is received in a single delivery.
6. There are no quantity discounts.
 Carrying/Holding costs are linearly related to order size.
 Ordering costs are inversely and nonlinearly related to order size.