Inventory - Management - Ch1 - Lec2

LEC 02
INVENTORY MANAGEMENT
FUNCTIONS OF INVENTORY
Inventories serve a number of functions.

Among the most important are the following:
1) To meet anticipated customer demand.
A customer can be a person who walks in off the
street to buy a new stereo system, a mechanic
who requests a tool at a tool crib, or a
manufacturing operation. These inventories are
referred to as anticipation stocks because they
are held to satisfy expected (i.e., average )
demand.
2) To smooth production requirements.

Firms that experience seasonal patterns in
demand often build up inventories during
preseason periods to meet overly high
requirements during seasonal periods. These
inventories are aptly named seasonal
inventories. Companies that process fresh
fruits and vegetables deal with seasonal
inventories. So do stores that sell greeting
cards, skis, snowmobiles, or Christmas trees.
3) To decouple operations.
Historically, manufacturing firms have used
inventories as buffers between successive operations
to maintain continuity of production that would
otherwise be disrupted by events such as
breakdowns of equipment & accidents that cause a
portion of the operation to shut down temporarily.
The buffers permit other operations to continue
temporarily while the problem is resolved. Similarly,
firms have used buffers of raw materials to insulate
production from disruptions in deliveries from
suppliers & finished goods inventory to buffer sales
operations from manufacturing disruptions.
More recently, companies have taken a closer

look at buffer inventories, recognizing the cost &
space they require, and realizing that finding &
eliminating sources of disruptions can greatly
decrease the need for decoupling operations.
Inventory buffers are also important in supply
chains. Careful analysis can reveal both points
where buffers would be most useful and points
where they would merely increase costs without
adding value.
4) To protect against stockouts.

Delayed deliveries & unexpected increases in
demand increase the risk of shortages. Delays
can occur because of weather conditions,
supplier stockouts, deliveries of wrong
materials, quality problems, & so on. The risk
of shortages can be reduced by holding safety
stocks, which are stocks in excess of expected
demand to compensate for variabilities in
demand & lead time.
5) To take advantage of order cycles.

To minimize purchasing and inventory costs, a firm
often buys in quantities that exceed immediate
requirements. This necessitates storing some or all
of the purchased amount for later use. Similarly,
it is usually economical to produce in large rather
than small quantities.
Again, the excess output must be stored for later
use. Thus, inventory storage enables a firm to buy
and produce in economic lot sizes without having to
try to match purchases or production with demand
requirements in the short run. This results in
periodic orders or order cycles..
6) To hedge against price increases.

Occasionally a firm will suspect that a
substantial price increase is about to occur &
purchase larger-than-normal amounts to
beat the increase. The ability to store extra
goods also allows a firm to take advantage
of price discounts for larger orders. .
7) To permit operations.
The fact that production operations take a
certain amount of time (i.e., they are not
instantaneous) means that there will generally
be some work-in-process inventory. In addition,
intermediate stocking of goods—including raw
materials, semifinished items, & finished goods
at production sites, as well as goods stored in
warehouses—leads to pipeline inventories
throughout a production-distribution system.
Little’s Law can be useful in quantifying pipeline

inventory. It states that the average amount of
inventory in a system is equal to the product of the
average rate at which inventory units leave the
system (i.e., the average demand rate) & the
average time a unit is in the system. Thus, if a
unit is in the system for an average of 10 days, &
the demand rate is 5 units per day, the average
inventory is 50 units: 5 units/day 10 days 50 units.
8) To take advantage of quantity discounts.

Suppliers may give discounts on large orders.
INVENTORY CONTROL SYSTEM
Inventory Control
➢ can be defined as the coordination &

supervision of the supply, storage,
distributíon, & recording of materials to
maintain quantities adequate for the
current customer needs without excessive
supply or loss.
➢ is used to show how much stock you have at

any time, & how you keep track of it.
IMPORTANCE OF INVENTORY CONTROL
➢ Improve customer service

➢ Aids in continuing production operation
➢ Reduce the risk of loss
➢ Protects from the fluctuation in demand
➢ Minimized the administrative work load
➢ Make effective use of working capital
➢ It has to minimize the investment in
inventory to enhance firm's profitability.
OBJECTIVES OF INVENTORY CONTROL
Inadequate control of inventories can

result in both under- & overstocking of
items.
Understocking results in missed deliveries,
lost sales, dissatisfied customers, &
production bottlenecks.
Overstocking unnecessarily ties up funds
that might be more productive elsewhere.
Although overstocking may appear to be the

lesser of the 2 evils, the price tag for
excessive overstocking can be staggering when
inventory holding costs are high, and matters
can easily get out of hand. It is not unheard of
for managers to discover that their firm has a
10-year supply of some item. (No doubt the
firm got a good buy on it!)
Inventory management has two main concerns.

One is the level of customer service, that is,
to have the right goods, in sufficient
quantities, in the right place, at the right
time. The other is the costs of ordering &
carrying inventories.
The overall objective of inventory management

is to achieve satisfactory levels of customer
service while keeping inventory costs within
reasonable bounds. Toward this end, the
decision maker tries to achieve a balance in
stocking. He/she must make 2 fundamental
decisions: the timing & size of orders (i.e.,
when to order & how much to order).
Managers have a number of performance

measures they can use to judge the
effectiveness of inventory management. The
most obvious, of course, is customer
satisfaction, which they might measure by the
number and quantity of backorders and/or
customer complaints.
A widely used measure is inventory turnover,

which is the ratio of annual cost of goods sold
to average inventory investment. The turnover
ratio indicates how many times a year the
inventory is sold. Generally, the higher the
ratio, the better, because that implies more
efficient use of inventories.
However, the desirable number of turns

depends on the industry and what the profit
margins are. The higher the profit margins,
the lower the acceptable number of inventory
turns, & vice versa. Also, a product that takes
a long time to manufacture, or a long time to
sell, will have a low turnover rate.
This is often the case with high-end retailers

(high profit margins). Conversely, supermarkets
(low profit margins) have a fairly high turnover
rate.
Note, though, that there should be a balance
between inventory investment & maintaining
good customer service. Managers often use
inventory turnover to evaluate inventory
management performance; monitoring this
metric over time can yield insights into changes
in performance.
Another useful measure is days of inventory

on hand, a number that indicates the expected
number of days of sales that can be supplied
from existing inventory. Here, a balance is
desirable; a high number of days might imply
excess inventory, while a low number might
imply a risk of running out of stock.

Inventory - Management - Ch1 - Lec2

Uploaded by

Copyright:

Available Formats

Inventory - Management - Ch1 - Lec2

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Inventory - Management - Ch1 - Lec2

Uploaded by

Copyright:

Available Formats

LEC 02

Inventories serve a number of functions.

2) To smooth production requirements.

More recently, companies have taken a closer

4) To protect against stockouts.

5) To take advantage of order cycles.

6) To hedge against price increases.

Little’s Law can be useful in quantifying pipeline

8) To take advantage of quantity discounts.

➢ can be defined as the coordination &

➢ is used to show how much stock you have at

➢ Improve customer service

Inadequate control of inventories can

Although overstocking may appear to be the

Inventory management has two main concerns.

The overall objective of inventory management

Managers have a number of performance

A widely used measure is inventory turnover,

However, the desirable number of turns

This is often the case with high-end retailers

Another useful measure is days of inventory

You might also like