Supply Chain

Management
Inventory
Management

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Inventory Management

The objective of inventory management is to strike a balance

between inventory investment and customer service

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Inventory as a percentage of Current Assets

Manufacturing Retail/Wholesale

40% 60%

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Fundamental Questions

• What is the appropriate order quantity for replenishment of the items

recently consumed?
• Should we order more than we need in the near term in order to get a
volume discount from this new supplier?
• What are the relevant costs we should be considering?

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Two major issues with mismanagement of inventory

Holding Costs Stock outs

Cost of carrying TOO much! Cost of carrying TOO low!

• Cash blocked
• Space utilization • Lost customer
cost • Lost Sales
• Pilferage • Backorder/special
• Insurance Costs shipment
• Ordering costs

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Inventory Control

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Types of inventory

• Raw materials/Packaging Material

• WIP – Work in process
• Finished Goods
• Spare parts

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ABC Analysis

 Divides inventory into three classes based on annual

dollar volume

 Class A - high annual dollar volume

 Class B - medium annual dollar volume

 Class C - low annual dollar volume

 Used to establish policies that focus on the few critical

parts and not the many trivial ones

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ABC Analysis

Percent of Percent of
Item Number of Annual Annual Annual
Stock Items Volume Unit Dollar Dollar
Number Stocked (units) x Cost = Volume Volume Class
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A
#11526 500 154.00 77,000 33.2% A 72%
#12760 1,550 17.00 26,350 11.3% B
#10867 30% 350 42.86 15,001 6.4% B
#10500 1,000 12.50 12,500 5.4% B 23%

#12572 600 $ 14.17 $ 8,502 3.7% C

#14075 2,000 .60 1,200 .5% C

#01036 50% 100 8.50 850 .4% C 5%

#01307 1,200 .42 504 .2% C

#10572 250 .60 150 .1% C

8,550 $232,057 100.0%

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ABC Analysis
 Policies employed may include
 More emphasis on supplier

Percent of annual dollar usage

80 – A Items development for A items
 Tighter physical inventory
70 –
control for A items
60 –  More care in forecasting A
50 – items
40 – B Items
30 –
20 –
10 – C Items
0 – | | | | | | | | | |

10 20 30 40 50 60 70 80 90 100
Percent of inventory items

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Dependent Vs Independent demand

• An inventory of an item is said to be falling into the category of

independent demand when the demand for such an item is not
dependent upon the demand for another item. Finished goods Items,
which are ordered by External Customers or manufactured for stock
and sale, are called independent demand items.
• If the demand for inventory of an item is dependent upon another
item, such demands are categorized as dependent demand.
• Raw materials and component inventories are dependent upon the
demand for Finished Goods and hence can be called as Dependent
demand inventories.

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 Inventory Ordering

Fixed
EOQ
EOQ Periodic

When

ROP Lot for Lot Variable

Fixed Variable
How much
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Basic EOQ Model
Important assumptions
1. Demand is known, constant, and
independent
2. Lead time is known and constant
3. Receipt of inventory is instantaneous and
complete
4. Quantity discounts are not possible
5. Only variable costs are setup/ordering and
holding
6. Stock outs can be completely avoided
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 Inventory Usage Over Time

Usage rate Average

Order inventory
quantity = Q
Inventory level
on hand
(maximum Q
inventory
level) 2

Minimum
inventory

0
Time

© 2011 Pearson Education, Inc. publishing as Prentice Hall

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 EOQ – Economic Order Quantity
• Storage space,
• costs of creating a purchase order, • Rent,
• processing an order, • Property tax,
• receiving and inspecting the goods • Insurance,
• Custom clearance • Expiries/damages
Annual cost

Annual cost
Order Quantity Order Quantity

Ordering Cost Holding Cost

OC = No. of orders placed x ordering cost per order HC = Avg inventory level x Holding cost per unit
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Minimizing Costs
Objective is to minimize total costs
Total cost of
holding and
setup (order)

Minimum
total cost
Annual cost

Holding cost

Setup (or order)

cost
Optimal order Order quantity
quantity (Q*)
© 2011 Pearson Education, Inc. publishing as Prentice Hall
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 Re-order Point (ROP)

Reorder level (or reorder point) is the

inventory level at which a company would
place a new order to avoid stock out
situation.
ROP tells you when to order!

Important!
Identifying the correct reorder level is important. If a company places a new
order too soon, it may receive the ordered units earlier than expected and it
would have to bear additional HOLDING COSTS in the form of warehousing
rent, opportunity cost, etc. However, if the company places an order too late,
it would result in STOCK-OUT COSTS, for example lost sales, etc.

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How to calculate reorder point ?
1. Calculate your lead time demand
LTD = Lead Time X Demand
2. Calculate your safety stock
= (Max. Lead Time X Max. Demand) – (Avg. Lead Time X Avg.
Demand)
Sum your lead time demand and your safety stock to determine
your Reorder Point.

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ROP without safety stock ROP with safety stock

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Class Example
ABC Ltd. is a retailer of footwear. It sells 500 units of one of a famous
brand daily. Its supplier takes a week to deliver any ordered units. What
will be the ROP for ABC Ltd?
ABC Ltd. has decided to hold a safety stock equivalent to average usage
of 5 days. Calculate the reorder level.

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Class Example
An Apple store has a demand for 8000 iPods per year. The firm operates
a 250 day working year. On average, delivery of any order takes 3
working days, but has known to take as long as 4 days. The store wants
to calculate the ROP without a safety stock and then with a safety
stock.
If there are only 200 working days per year, what is the ROP without
safety stock and with safety stock.

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Vendor Managed Inventory - VMI
• Vendor managed inventory or VMI is an integrated inventory management
approach that offers relief from the inventory concerns. In VMI, the inventory
at the buyer’s end is managed and monitored essentially by the
supplier/vendor or the upstream supply chain partner.
• “Vendor Managed Inventory is the term for inventory management systems
where the supplier manages the day to day inventory activity. In a VMI
relationship, the manufacturer becomes responsible for the management of
his customer’s inventory.” (Pol, Inamdar, 2012)
• VMI is a reverse inventory replenishment process that electronically connects
supply chain partners to felicitate demand and inventory replenishment
planning based on real-time demand information sharing between them.

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 Vendor Managed Inventory - VMI

Product Activity Report: Product Activity Report:

- Delivery schedules - In hand inventory
- SKU wise scheduling - Sales forecast
- Order fulfillment - Demand for new
tracking orders

Benefits: Benefits:
o Reduction in safety stocks as the actual o Reduced inventory as the safety stocks
real-time demand information is readily needed earlier is reduced
available due to increased visibility o Reduced administrative and labor costs of
o Reduced distribution cost daily inventory management, planning and
o Strategic partnership is formalized with the order processing.
customers o Reduced stock-outs / shortages as the
supplier manages his own inventory
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Days of Cover (DOC’s)
The average number of days goods remain in inventory before being
sold. As a measure of short-term sales potential, a number above the
industry norm indicates problems with sales forecasts. ... Also called
days cover, stock cover, days of inventory.
And a number below the norm/standard indicates loss of sales due to
the company's inability to fulfill demand.

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SLOB (Slow Moving and Obsolete)
An inventory that doesn’t get consumed with in a specified time period
is considered as a Slow Moving inventory.

Obsolete inventory is the inventory which can not be used any further
because either it can not be used because of expiry or it is damaged.

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Inventory Turnover Ratio
Inventory turnover is a ratio showing how many times a company has
sold and replaced inventory during a given period.
The speed at which a company can sell inventory is a critical measure of
business performance.

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 Inventory Turnover Ratio – Continued
Cost of Goods Sold (COGS):
It is a measurement of the production costs of goods and services for a company.
COGS can include the cost of materials, labor costs directly related to goods produced, and
any factory overhead or fixed costs that are directly used in the production of goods.

Average Inventory:
Average inventory is calculated by dividing the sum of beginning inventory and ending
inventory by two. Average is taken because companies might have higher or lower inventory
levels at certain times in the year.

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 Inventory Turnover Ratio – Continued

What does Inventory Turnover Ratio tell you

o How fast a company sells inventory and how analysts compare it to industry averages
o Inventory turnover provides insight as to whether a company is managing its stock
properly
o Inventory turnover also shows whether a company’s sales and purchasing departments
are in sync
o Low inventory turnover ratio implies weak sales and possibly excess inventory
o High inventory turnover ratio implies either strong sales or insufficient inventory

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Days Sales Inventory (DSI)
Days Sales of Inventory (DSI) measures how many days it takes for inventory to turn
into sales. DSI, also known as days inventory, is calculated by taking the inverse of
the inventory turnover ratio multiplied by 365. This puts the figure into a daily
context.

DSI = (Average Inventory ÷ Cost of Goods Sold) x 365  

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Class Example
For the fiscal year ending Dec 2018, Wal-Mart Stores (WMT) reported annual sales
of $500.34 billion, year-end inventory of $43.78 billion while the beginning
inventory was $64.58 billion, and an annual cost of goods sold of $373.40 billion. 
What will be the inventory turn over ratio and DSI of WMT for the subject year?

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Class Example
Company ABC balance sheet is showing Current Asset data from 2007 to 2015. Please help company
analyze current inventory data and give recommendation on the current situation.
Note: All amounts are in Million PKR

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FIFO, LIFO and FEFO
FIFO (First In First Out):
This method assumes that the first unit making its way into inventory is
the first sold. FIFO gives us a good indication of ending inventory value,
but it also increases net income because inventory that might be
several years old is used to value COGS. And although increasing net
income sounds good, remember that it also has the potential to
increase the amount of taxes that a company must pay.

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FIFO, LIFO and FEFO
LIFO (Last In First Out):
This method assumes that the last unit to arrive in inventory is sold
first. The older inventory, therefore, is left over at the end of the
accounting period.
LIFO is not a good indicator of ending inventory value because the
leftover inventory might be extremely old, perhaps obsolete, which
results in a valuation much lower than today's prices. The LIFO method
results in less net income because COGS is greater.

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FIFO, LIFO and FEFO
How Expiration Dates Affect Consumer Interest
FEFO (First Expire First Out):
Inventory is managed on the
basis of ‘First Expiry’ or ‘Best
Before’ dates. This method is
extremely workable in FMCG.
All food companies prefer to
manage their inventories on
FEFO basis.

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