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85 Cards in this Set

  • Front
  • Back

The objective of Inventory Management

To strike a balance between inventory investment and customer service

Reasons Inventory Exists

1. Separate the firm from fluctuations in demand

2. Decouple various parts of the production process

3. Take advantage of quantity discounts

4.Hedge against inflation or other possible future events

Reason Inventory Exists #1

Separate the firm from fluctuations in demand

Reason Inventory Exists #2

Decouple various parts of the production process

Reason Inventory Exists #3

Take advantage of quantity discounts

Reason Inventory Exists #4

Hedge against inflation or other possible future events

When there is predictable variation in demand throughout the year, andwhen an organization does not have the capacity to produce peak demand when it isdemanded, the organization may have to produce (or acquire) and store finished productsin advance of that demand

Seasonal Inventory

When there isunpredictable (i.e. erratic and random) short term variation in demand, the organizationmay have to maintain additional inventory to cover the unpredictable spikes in demand

Safety Stock

If there is an interruption in output at one stage, succeedingstages may be able to continue operation by feeding off the inventory held betweenstages

Buffering Inventory

Purchases in large quantities may result inreduced purchase price and/or reduced delivery cost. Often leads organizations to acquire more inventory than is immediately needed.

Volume Discount Inventory

Whenorganizations may choose toorder more inventory than is immediately needed to provide protection in the event that situations of uncertainty, disaster, or interruption may occur.

Hedge Inventory

Materials that are usually purchased and have not yet enteredthe transformation process

Raw Materials Inventory

Materials and components that have undergone somechange but have not yet advanced to the stage of completed product

Work-In-Progress (WIP) Inventory

Supplies necessary to keep machinery,processes, facilities, and office operations running. Not part of products being made, but are crucial to the smooth operation of the organization.

ie Lubricating Oil, Custodial Products, Toner and Office Supplies

Maintenance/Repair/Operating (MRO) Inventory

Completed products awaiting shipment

Finished-goods inventory

Basic Inventory Decisions

How Much?


Determination of thequantity to be ordered

How Much?

Lot Sizing Decision

Determination of thetiming for the orders


Lot Timing Decision

Inventory item whose demand is not related to (or dependent upon) some higher level item. Demand for such items is usually thought of asforecasted demand. These items are usually thought of as finishedproducts.

Independent Demand Inventory Item

Inventory item whose demand is related to (or dependent upon) some higher level item. Demand for such items is usually thought of as derived demand. These items are usually thought of as the materials, parts, components,and assemblies that make up the finished product.

Dependent Demand Inventory Item

Relevant Inventory Costs

-Item Costs

-Holding Costs

-Ordering/Setup Costs

-Shortage Costs

Direct cost forgetting an item.Purchase cost foroutside orders,manufacturingcost for internalorders.

Item Costs

Costs associatedwith carryingitems in inventory.Storage and otherrelated costs.

Holding Costs

Fixed costsassociated withplacing an order.

Ordering/Setup Costs

Ordering Costs are for _____ orders


Setup Costs are for _____ orders


Costs associatedwith not havingenough inventoryto meet demand.

Shortage Costs

The time interval typically used for comparing costs

One Year

How the per unit item cost is measured depends upon...

...whether the item is one that isobtained from an external source of supply, or is one that is manufactured internally

For itemsthat are ordered from external sources, the per unit item cost is...

...predominantly the purchase pricepaid for the item. On some occasions this cost may also include some additional charges, likeinbound transportation cost, duties, or insurance.

For items that are obtained from internalsources, the per unit item cost is composed of...

...the labor and material costs that went into itsproduction, and any factory overhead that might be allocated to the item.

In many instances theitem cost is a constant, and is not affected by the lot sizing decision.

In those cases, the totalannual item cost will be unaffected by the order size

Regardless of the order size (which impactshow many times we choose to order that item over the course of the year)...

...our total annualacquisitions will equal the total annual need. Acquiring that total number of units at the constantcost per unit will yield the same total annual cost

Graph of Item Costs

Lot Size (x) versus Cost (y)

In regards to Total Annual Item Cost (assuming no quantity discounts)

Straight Horizontal Line

Straight Horizontal Line

Other, more subtle expenses that add to Holding Cost

Insurance on the held inventory; taxes on the held inventory; damage to, theft of, deterioration of,or obsolescence of the held items, and opportunity costs associated with having money tied up ininventory.

Graph of Holding Costs

Lot Size (how much decision) (X) versus Cost (Y)

In regards to Total Annual Holding Cost

Straight, constant upward slope (make graph)

Graph of Ordering (or Setup) Costs

Make Graph

Shortage costs can manifest themselves in the form of...

...lost sales, lossof good will, customer irritation, backorder and expediting charges, etc.

Large order sizes will lead to...

...lower annual shortage costs

Graph of Shortage Costs

Make Graph

All Four Cost Categories Combined Graph

CP3 Page 11

A technique for determining the best answers to the how much and whenquestions. It is based on the premise that there is an optimal order size that will yield the lowestpossible value of the total inventory cost.

EOQ Model

EOQ Assumption 1

Demand for the item is known and constant

EOQ Assumption 2

Lead time is known and constant. (Lead time is the amount of time that elapses betweenwhen the order is placed and when it is received.)

EOQ Assumption 3

When an order is received, all the items ordered arrive at once (instantaneousreplenishment)

EOQ Assumption 4

The cost of all units ordered is the same, regardless of the quantity ordered (no quantitydiscounts)

EOQ Assumption 5

Ordering costs are known and constant (the cost to place an order is always the same,regardless of the quantity ordered).

EOQ Assumption 6

Since there is certainty with respect to the demand rate and the lead time, orders can betimed to arrive just when we would have run out. Consequently the model assumes thatthere will be no shortages.

The only two costs that will vary with changes in the orderquantity

EOQ Assumptions

(1) the total annual ordering cost and (2) the total annual holding cost. Shortage costcan be ignored because of assumption 6.

Since the cost per unit of all items orderedis the same...

...the total annual item cost will be a constant and will not be affected by the orderquantity.

Inventory Levels Graph

CP3 Page 12

EOQ stands for...

Economic Order Quantity

Total Annual Ordering Cost equation


D= Annual Demand

Q= Size of Order

S= Cost of Placing an Order

Total Annual Holding Cost equation


Q= Size of Order (Maximum Value)

H= Cost to Carry a Unit in Inventory for a Year

Total Annual Cost equation

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

Annual Ordering Cost + Annual Holding Cost

EOQ, optimal value of the order quantity (Q) equation

Q* = sqrt(2DS/H)

(Q* represents the optimal value for Q; this is what we call the EOQ)

EOQ Graph

CP3 Page 14

ReOrder Point (ROP)

Daily Demand * Lead Time

When replenishment items come from insidesources, the entire batch is usually not received all at once (instantaneous replenishment), butinstead is gradually received as a production batch is run (continuous replenishment).

Economic Production Quantity (EPQ) Model

When the supplier is willing to offer a lower price if large quantitiesof an item are ordered, the total annual purchase cost line will no longer be horizontal, but willinstead have step decreases in it.

Quantity Discount Model

When therewill be demand for an item in only one period, so the challenge is to determine the order size(stock size) that will best accommodate the anticipated (and uncertain) demand. Any itemsstocked in excess of demand will be scrapped. Any demand in excess of what has been stockedwill be a missed opportunity for more profit.

Single-Period Inventory Model

This approach maintains a constant order size, but allows thetime between the placement of orders to vary

Fixed Quantity or Q System

Fixed Quantity or Q System is sometimes referred to as...

Perpetual review method, a continuous review system, a reorder point system,and a two-bin system

Fixed Quantity or Q System Graph

CP3 Page 23

This approach maintains a constant time between the placement oforders, but allows the order size to vary.

Fixed Period System


Fixed Interval System

Fixed Period System

CP3 Page 24

This approach allows both the order size and the time between the placementof orders to vary

Hybrid System


Optional Replenishment System


Min-Max System

Hybrid System Graph

CP3 Page 25

Fixed Quantity Advantages

-provides tighter control overinventory items

-less safety stock needed

Fixed Quantity Disadvantages

-requires constant monitoring(constant scrutiny)

-problems with multiple itemsfrom same source (many itemsarrive in separate shipments)

Fixed Period Advantages

-joint shipping advantage withmultiple items from same source

-does not require constantmonitoring

Fixed Period Disadvantages

-requires more safety stock

-occasional small “nuisance”orders may result

-provides looser control overinventory items

Hybrid System Advantages

-joint shipping advantage withmultiple items from same source

-does not require constantmonitoring

-no small “nuisance” orders

Hybrid System Disadvantages

-requires more safety stock

-provides looser control overinventory items

Category A Inventory Items (ABC)

Need the tightest degree of control

Category B Inventory Items (ABC)

Medium degree of control

Category C Inventory Items (ABC)

Do not need very close scrutiny

ABC Explained

Start at CP3 Page 28

Generates a set of time phased requirements for each of theitems in the product structure, and then make the timing and sizing decisions to accommodatethose time phased requirements

Material Requirements Planning (MRP)

Parts that go into Material Requirements Planning (MRP)

-Master Production Schedule (MPS)

-Inventory Records File (IRV)

-Planned Order Releases (POR)

-Bill of Materials (BOM)

Statement of the gross requirements for the finished product (anticipated need schedule for the finished product).

Master Production Schedule

Product structure information, showing exactly what components are needed to produce a finished product, and how they are assembled together (the hierarchical product structure information).

Bill of Materials

Information regarding the available on hand inventory and on order inventory for each item in the bill of materials

Inventory Records File

These are the answers to the how much and when questions for each inventory item in the product structure. They are time phased statements about planned orders.

Planned Order Releases

Reflects the total need for an inventory item to support demand (either demand for a finished product, or demand for some higher level item in the product structure)

Gross Requirements

Reflects the production need for an inventory item to support demand. These are generally found by taking the gross requirements (total need) and subtracting any available inventory (either on hand or on order). This is what we actually have to produce.

Net Requirements