The amount of material, a company has in stock at a specific time is known as inventory or in terms of money it can be defined as the total capital investment over all the materials stocked in the company at any specific time. Inventory may be in the form of,
As a lot of money is engaged in the inventories along with their high carrying costs, companies cannot afford to have any money tied in excess inventories. Any excessive investment in inventories may prove to be a serious drag on the successful working of an organization. Thus there is a need to manage our inventories more effectively to free the excessive amount of capital engaged in the materials.
Inventories are needed because demand and supply can not be matched for physical and economical reasons. There are several other reasons for carrying inventories in any organization.
In order to control inventories appropriately, one has to consider all cost elements that are associated with the inventories. There are four such cost elements, which do affect cost of inventory.
If one year planning horizon is used, the total annual cost of inventory can be expressed as:
Total annual inventory cost = Cost of items + Annual procurement cost + Annual carrying cost + Stockout cost
Variables in Inventory Models
Number of orders per year =
Total procurement cost per year = S.D / Q
Total carrying cost per year = Carrying cost per unit * unit cost * average inventory per cycle
Cost of items per year = Annual demand * unit cost
Total annual inventory cost (TC) =
The objective of inventory management team is to minimize the total annual inventory cost. A simplified graphical presentation in which cost of items, procurement cost and carrying cost are depicted is shown in Figure 1 . It can be seen that large values of order quantity Q result in large carrying cost. Similarly, when order quantity Q is large, fewer orders will be placed and procurement cost will decrease accordingly. The total cost curve indicates that the minimum cost point lies at the intersection of carrying cost and procurement cost curves.
Inventory Operating Doctrine
When managing inventories, operations manager has to make two important decisions:
Reorder point is usually a predetermined inventory level, which signals the operations manager to start the procurement process for the next order. Order quantity is the order size.