DECISION MAKING

(Quantitative Evaluation using Inventory Model)

Decision-making is an integral part of modern management. Essentially, Rational or sound
decision making is taken as primary function of management. Every manager takes hundreds and
hundreds of decisions subconsciously or consciously making it as the key component in the role of a
manager. Thus, making a sound decision is a must in management. Today, we will explore how we can
make a quantitative evaluation using inventory models to help us make a sound and wise decision, but
first we must know the basic terms that we will encounter as we go on through this paper.

Inventory
Inventory also referred as stocks are basically the goods and raw materials that any business
would hold and are ready or will be ready for sale.

Inventory Model
Inventory model is a mathematical model that helps business in determining the optimum level of
inventories that should be maintained in a production process, managing frequency of ordering, deciding
on quantity of goods or raw materials to be stored, tracking flow of supply of raw materials and goods to
provide uninterrupted service to customers without any delay in delivery.
There are two types of Inventory model widely used in business.
1. Fixed Reorder Quantity System
2. Fixed Reorder Period System.
Fixed Reorder Quantity System
Fixed Reorder Quantity System is an Inventory Model, where an alarm is raised immediately
when the inventory level drops below a fixed quantity and new orders are raised to replenish the
inventory to an optimum level based on the demand. The point at which the inventory is ordered for
replenishment is termed as Reorder Point. The inventory quantity at Reorder Point is termed as Reorder
Level and the quantity of new inventory ordered is referred as Order Quantity.
Average Demand (DAv): It is the average number of order requests made per day.
Average Lead Time (TL): The time required to manufacture goods or product.
Average Lead Time Demand (DL): Average number of orders requested during the Lead Time

Average Lead Time Demand ( DL ) =Average Demand ( Dav ) × Average Lead Time(TL)

Safety Stock (S): It is the extra stock that is always maintained to mitigate any future risks arising due to
stock-outs because of shortfall of raw materials or supply, breakdown in machine or plant, accidents,
natural calamity or disaster, labor strike or any other crisis that may the stall the production process.
 The quantity of safety stock is often derived by analyzing historical data and is set to an
optimized level by evaluating carefully the current cost of inventory and losses that may be incurred due
to future risk.
Reorder Level (RL): Reorder level is the inventory level, at which an alarm is triggered immediately to
replenish that particular inventory stock. Reorder level is defined, keeping into consideration the Safety
Stock to avoid any stock-out and Average Lead Time Demand because even after raising the alarm, it
would take one complete process cycle (Lead Time) till the new inventories arrive to replenish the
existing inventory.

Reorder Level( RL)=Safety Stock (S)+ Average Lead Time Demand (DL)
Order Quantity (O): Order quantity is the Demand (Order requests) that needs to be delivered to the
customer.
Minimum Level: At least Safety Stock has to be always maintained to avoid any future stock- outs as per
the standard practices of inventory management.

Minimum Level( LMin)=Safety Stock ( S)

Maximum Level: The maximum level that can be kept in stock is safety stock and the demand (the
quantity ordered).

Maximum Level (LMax)=Safety Stock (S )+Order Quantity (O)

Figure 1: Inventory Model: Fixed Reorder Quantity System

Sample Quantitative Evaluation
Ayesha is a newly hired inventory manager in A&A Automobiles, a company that provides
services related to car maintenance and customization. This is her 40 day of working as an inventory
manager of the said company and she is already having a hard time deciding if there is a need to reorder
car wheels that has a remaining 300 stocks and if purchasing another 300 side mirrors is okay because
the remaining stocks are only 245 items. She decided to use a quantitative analysis using the Fixed
Reorder Quantity System, a type of inventory model. Based on the previous transactions and activities of
the past management reports, she found out the following information:

Sid e Mirro r C a r Whe e ls

Minim um Le ve l 100 un its 200 units
Ma xim um Le ve l 300 un its 800 units
Ave ra g e Le a d TIm e 2 d a ys 5 d a ys
Ave ra g e De m a nd 20 units 40 units

Activity: Take Ayesha’s position and do a quantitative analysis using Fixed Reorder Quantity System in
order to arrive in a sound and good decision that will help A&A Company to have a good inventory
control.
Step 1: Defining the problem.
There are two problems in the situation. First, if there is a need to reorder car wheels because
there are only 300 car wheels left as their inventory. The second problem is if it right to consider
purchasing 300 side mirrors because the remaining stocks of it is only 245 items.
Step 2: Gathering information and collecting data.
The table above shows the information and data from the previous transactions of A&A
Company before Ayesha was hired. These information are really helpful in developing and weighing
options.
Step 3: Developing and weighing the options.
After gathering those data and information needed, we can now proceed to our computations and
make some options using those formulas presented on the discussion part of this paper.
Sid e M irro r C a r W h e e ls
Av e ra g e Le a d Tim e De m a nd = 20 u n its × 2 d a ys = 40 u n its × 5 d a ys =
( De m a n d (DA v ) X Le a d Tim e (TL) 40 units 200 units
Sa fe ty Sto c k (M in im u m Le v e l) 100 units 200 units
Re o rd e r Le v e l (RL) = Sa fe ty
100 u n its + 40 u n its = 200 u n its + 200 u n its =
Sto c k (S) + A v e ra g e Le a d Tim e 140 units 400 units
De m a n d (DL)

Based on our computations above, we can now develop and weighs some options. In the first
problem, we can come up with two options: to purchase again car wheels because the remaining stock
is below the reorder level or wait for the stock to reach the minimum level before purchasing again. For
the second problem, we also have three options: first, continue to order the 300 units of side mirror
even if the number of inventory will exceed the maximum level, second, to order only 55 units of side
mirror to make the total inventory equal to the maximum level which 300 units, or to wait until the
inventory reach the reorder point before purchasing again.
Weighing our options, 300 units of car wheels are okay because it is still above on the minimum
level so not purchasing another inventory is still okay. However, if the number or customers looking for
car wheels will increase for 5 consecutive days, we might face a problem of having not enough inventory.
 On the hand, if we will follow the reorder level and be a “segurista” by purchasing 500 units to
attain the maximum level, we will have the assurance that there will be enough inventory for our
operations even if there is a sudden increase in number of customers per day.
Note: Here is the computation how we reached 500 units.

𝑂𝑟𝑑𝑒𝑟 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝐿𝑒𝑣𝑒𝑙 − 𝑆𝑡𝑜𝑐𝑘𝑠

𝑂𝑟𝑑𝑒𝑟 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 800 𝑢𝑛𝑖𝑡𝑠 − 300 𝑢𝑛𝑖𝑡𝑠
𝑂𝑟𝑑𝑒𝑟 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 500 𝑢𝑛𝑖𝑡𝑠

When it comes to the second problem, the first option is quite aggressive because there might be
an oversupply and it will take a long period of time to sell those items. On the second option, it is okay
because through this, we can be sure that we will have enough supply for the consumers. However,
purchasing a few numbers of items might cost you larger delivery fees compare to buying bulk numbers
of items. The third option is also a good one because having 245 items is far from the 140 unit reorder
point so we can conclude that there is still enough inventory for the business operation and we can order
again if the number of items left reach the reorder point and if that happens, we will need to order 160
units of it (300 units maximum level – 140 units reorder point).
Step 4: Choosing best possible option.
After weighing all options available, we can conclude that the beast thing to do for the first
problem is to reorder 500 units to ensure that there will be enough supply of car wheels that can be
purchased by our customers. For the second problem, the best choice for me is to wait until the stocks
reach the reorder point because we can save amount for bulk orders and 245 units of side mirror is
still enough.
Step 5: Plan and execute.
After choosing the best option, we can now take some actions. We should fill-up purchase order
slip and contact our supplier for the car wheels so that we can restock right away our inventory. For the
side-mirror, we must monitor the stocks of it until it reaches the reorder point so that we can also order
items from our supplier right away if that case will happen.
6. Take follow up action.
Of course, the operation of business is a cycle so we must monitor properly the inventories of the
products that we are selling. Knowing those maximum and minimum level and of course the reorder point
of the inventories will help us properly decide when to order of if there is a need to restock items. Records
and reports are also needed to guide us on the daily business operations. All of those are important for
making a sound and wise decision as a manager or as a decision-maker.