Inventory management is primarily about specifying the size and placement of stocked goods (Wikipedia).There are three basic reasons for keeping inventory (Wikipedia):
There are various types of inventory, which include (Wikipedia):
ABC Analysis provides a mechanism for identifying items that will have a significant impact on overall inventory cost and helps to identify different categories of stock that will require different management and controls (Wikipedia).
Related to Pareto analysis (80/20 rule) the A inventory items are the most important or items with the most capital tied up. These items are managed more carefully than the 'less important' or less costly items (B & C).Classification can be based on sales, profit contribution, inventory value, usage rate and item category (Bowersox, 2010).
Inventory management of the category A items should utilize the latest in inventory management techniques and technologies since this represents the most important inventory. The category B items should also be well managed, but do not require the investment that the A items warrent. The C category items are slower moving and represent a small investment and can be managed using less onerous methods.
A cycle count is an inventory auditing procedure where a small subset of inventory, in a specific location, is counted on a specified day (Wikipedia). For example, if the policy is to manually count the A cateogry items once per month (20 working days), the B items once per quarts (60 working days) and the C items once every six months (120 working days) you can calculate how many SKUs of each type should be counted each day as:
A perpetual inventory or continuous inventory describes systems of inventory where information on inventory quantity and availability is updated on a continuous basis as a function of doing business. Generally this is accomplished by connecting the inventory system with order entry and in retail the point of sale system (Wikipedia). For continuous review systems, the economic order quantity is the most common method.
The economic order quantity is the order quantity that minimizes total inventory holding costs and ordering costs (Wikipedia).
Economic order quantity is the level of inventory that minimizes the total inventory holding costs and ordering costs. It is one of the oldest classical production scheduling models (Wikipedia 2011).
The EOQ model is a continuous replenishment system, which means that inventory is checked upon every withdrawal to see if that withdrawal will cause the inventory level to fall below the restocking level. If so, an order is immediately place for the EOQ number of units. This is also known as a fixed order quantity model because the quantity ordered (EOQ) does not change unless the parameters of the model change.
Total annual cost = annual purchase cost + annual ordering cost + annual holding cost
TC = DC + (D/Q)*S + (Q/2)*H, where:
Quantity to Order = EOQ = Square Root of ((2*D*S)/H)
Reorder Point = R = d * L
When demand varies and is not constant, which is the usual case in business, you must protect against stockouts by holding additional inventory. This additional inventory held to protect against variation is called safety stock. To protect against variation given demand uncertainty, the Reorder Point is increased for safety stock with the following formula:
Reorder Point = R = (d * L) + (z * σL), where
Reorder Point = R = (d * L) + (NORMSINV(p) * [SqRoot(L * σd^2)])
Quantity to Order = EOQ = Square Root of ((2*D*S)/H)
If you have both demand and delivery (lead time) uncertainty, you must use a convolution formula (Bowersox 2010) to calculate the safety stock level.
Standard Deviation of Combined Probabilities
σc = Square Root of [(L * σd^2) + (d^2 * σl^2)], where
Reorder Point = R = (d * L) + (NORMSINV(p) * σc)
Reorder Point = R = (d * L) + (NORMSINV(p) * Square Root of [(L * σd^2) + (d^2 * σl^2)])
When you include safety stock in a model to accomodate variation, the amount of the average inventory on hand (Q/2) is incresaed by the amount of the safety stock. This new total average inventory is multiplied by the annual holding cost to obtain the total cost.
TC = DC + (D/Q)*S + [(Q/2)+SS]*H, where:
SS = Amount of Safety Stock
If a supply chain is either owned by one firm or the supplier partnerships in the supply chain are such that information is immediately shared and all members of the chain operate as one, you can use an Echelon inventory model.
The echelon inventory at any stage of the system is equal to the inventory on hand at that echelon, plus all downstream inventory (Simechi-Levy 2008).In the case of an echelon inventory system, the Reorder Point (R) uses the Echelon Lead Time (Le) instead of the standard lead time in its calculation. The Echelon Lead Time (Le) is the lead time between the entity doing its inventory calculation PLUS the lead times between all downstream supply chain partners. For example, for a distributor to a retailer, the echelon lead time (Le) is the lead time between the retailer and distributor PLUS the lead time between the distributor and their supplier. The average demand and standard deviations of demand are those of all the retail customers in this model, even when calculating reorder point for the distributor.
For systems with stable, constant lead times, use the following formula:
Reorder Point = R = (d * Le) + (NORMSINV(p) * [SqRoot(Le * σd^2)])
A periodic inventory review system is one where inventory is checked and reordered at a set time interval (e.g. weekly). In this case the quantity ordered varies based on the amount of inventory on hand following the review. The danger of this system is that inventory is not being checked until the review system. The benefit is that since inventory levels are only checked periodically, the administrative cost of the system can sometimes be less than with a fixed order quantity (EOQ) model.
The formula for calculating the quantity to order is:
Fixed Order Quantity = Q = d(T+L) + zσT+L – I, where
A single period inventory model is used to identify the amount of inventory to purchase given a perishable good or single opportunity to purchase.
A single period inventory model is used to identify the amount of inventory to purchase given a perishable good or single opportunity to purchase.The amount of the single order is based on balancing the cost of over- and under-estimating demand. This is a very common problem in areas such as:
1. Calculate the probability of a unit will not be sold:
P <= Cu / (Co + Cu)
2. Find the point on our demand distribution that corresponds to the cumulative probability of a unit not being sold by finding the Z-score (using a table or by using the NORMSINV function in Excel).
Z-score = NORMSINV(P)
3. Calculate the amount of safety stock as:
Safety stock = ROUND(Z-score * σ)
4. Total order = µ + Safety stock
The inventory service level (α) is the probability that all customer orders in a given time interval will be completely delivered from stock on hand.
The inventory fill rate (β) is the proportion of total demand within a period which is delivered from stock on hand.
Fill rate (β) = 1 - (expected backorders / expected demand)
Fair share allocation is an inventory management method that provides each facility with an equitable distribution of available inventory.
The days of supply for each facility, DS, is calculated as follows:
DS = [AQ + Sum(Ij)] / Sum(Dj), where
The amount to be allocated to each warehouse facility is given by:
Aj = (DS - (Ij/Dj)) * Dj, where
Bowersox, Closs & Cooper, 2010. Supply Chain Logistics Management, 3rd Edition. McGraw-Hill, New YorkSimchi-Levi, Kaminsky, Simchi-Levi, 2008. Designing and Managing the Supply Chain: Concepts, Strategies and Case Studies, 3rd Edition. McGraw-Hill, New York