6.2 Inventory Control

Inventory decisions

The basic inventory decisions are:

		When to replenish the inventory of certain item.
		How much of an item to order.

ABC analysis

	ABC analysis of inventory means that inventories can be classified into three classes: A, B, and C according to its value, as follows:
	ABC analysis is an analysis of arrange of items that have different levels of significance and should be handled on controlled differently.

6.2 Inventory Control

	It is a form of Paretto Analysis in which the items (such as activities, customers, sales, inventory items) are grouped into three categories (A,B, and C) in order of their estimated importance A items are very important, B items are important, C items are marginally important.
	Example 1: Gulf company Purchases items every year of $50 million. According to ABC analysis we can classify these items as follows.

Costs of inventories

Raw materials, purchased parts, and packaging for manufacturers are stocks of the basic material inputs into the organizations manufacturing process.

6.2 Inventory Control

	As labor and other material are added to these inputs, they are transformed into work-in- process inventories.
	When production is completed, they become finished goods.
	In general, the forms are distinguished by the amount of labor and materials added by the organizations.
	The classification is relative in that a suppliers finished goods may become a purchasers raw materials.
	For resource industries, service organizations, and public organizations, MRO inventories may be substantial.
	In resource industries, a significant portion of such inventory may be maintenance or repair parts to support the heavy capital investment base.
	In resale organizations, the main categories are goods for resale and inventories to maintain building and equipment.
	For many consumer goods industries, such a food and beverage, packaging represents a major purchase inventory category with substantial environmental implication.
	The main types of inventory costs are described below.

Carrying, holding, or possession costs

6.2 Inventory Control

			Include handling charges; the cost of storage facilities or warehouse rentals; the cost of equipment to handle inventory; storage, labor, and operating costs; insurance premiums; breakage; pilferage; obsolescence; taxes; and investment or opportunity costs.
			In short, any cost associated with having, as opposed to not having, inventory is included.
			The cost to carry inventory can be very high.
			For example, recent estimates of the annual cost to carry production inventory ranged from 25 to 50 percent of the value of the inventory.
			Many firms do not do a very good job of estimating carrying costs.
			While there are several methods for calculating inventory carrying costs, the basic elements are (1) capital costs, (2) inventory service costs, (3) storage space costs, and (4) inventory risk costs.

Ordering costs

Ordering costs include search and identification of appropriate sources of supply, price negotiation, contracting and purchase ordering generation, follow up and receipt of material and eventual stocking in the stores after necessary accounting and verification.

6.2 Inventory Control

Economic Ordering Quantity (EOQ)

Fixed-quantity models

			The classic trade-off in determining the lot sizes in which to make or buy cycle inventories is between the costs of carrying extra inventory and the costs of purchasing or making more frequently.
			The objective of the model is to minimize the total annual costs.
			In the very simplest form of this model, annual demand (D), lead time (L), price (P), variable order or setup cost (S), and holding cost percentage (H), are all constant now and in the future.
			When inventory drops to the reorder point (R), a fixed economic order quantity (Q) is order and stockouts are not allowed.

Example 2: A local distributor for a national tire company expects to sell approximately 9,600 steel belted radial tires of a certain size and tread design next year. Annual carrying cost is $16 per tire, and ordering cost is $75. The distributor operates 288 days a year.

What is the EOQ?
How many times per year does the store reorder?
What is the length of an order cycle?
What is the total annual cost if the EOQ quantity is ordered?...

6.2 Inventory Control

... Solution:
D = 9,600 tires per year
H = $16 per unit per year
S = $75

EOQ = √ 2DS /H = √ (2×9,600×75) /16 = 300 TIRES
Number of orders per year: D/Q = 9,600 tires / 300 tires = 32.
Length of order cycle: Q/D = 300 tires/ 9,600 tires /yr = 1/32 of a year, which is 1/32 × 288, or nine workdays.
TC (total costs) = carrying cost + Ordering cost
= (Q/2)H + (D/Q)S
= (300/2)16 + (9,600/300)75
= $2,400 + $2,400
= $4,800

Note that the ordering and carrying costs are equal at the EOQ. Carrying costs is sometimes stated as a percentage of the purchase price of an item rather than as a dollar amount per unit. However, as long as the percentage is converted into a dollar amount. The EOQ formula is still appropriate.

6.2 Inventory Control

Example 3: Piddling Manufacturing assembles security monitors. It purchases 3,600black and white cathode ray tubes a year at 465 each. Ordering costs are $31, and annual carrying costs are 20 percent of the purchase price. Compute the optimal quantity and the total annual cost of ordering and carrying the inventory. Solution:
D = 3,600 cathode ray tubes per year
S = $31
H = .20($65) = $13
EOQ = √2DS/H = √(2×3,600× 31)/13 ≈ 131 cathode tubes
TC = Carrying costs + Ordering costs
    = (Q /2)H + (D/Q)S
    = (131/2)13 + (3,600/131)31
    = $852 + $852 = $1,704