Lesson 4: Inventory Management Flashcards
What is inventory?
All the stocks in a system for the purpose of sales or future use is known as inventory.
Inventory is equivalent to capital and thus must be treated very carefully. Keeping the Inventory in the system is costly and thus the right stock of inventory should be kept. Too much inventory is undesirable, but not enough inventory may affect the service level and may attract penalties associated with services.
What is inventory management?
Inventory management is all about maintaining the right amount to balance between the costs associated to under and overstock inventories.
(All about replenishing the inventory at the right interval and quantity)
What is the primary purpose of inventory?
To fulfill the demand.
How does inventory management help and protect?
Protects against risks associated with above average demand; Helps in availing bulk order discounts; Protects against quality issues in manufacturing; Protects against price fluctuations; Decouples the operations/supply chain.
What are the three costs associated with inventory?
- Maintain Inventory
- Order Inventory
- No Inventory
What are the costs related to maintaining inventory?
Costs related to storage, handling, insurance, capital cost i.e. interest, etc.
What are the costs related to ordering inventory?
Costs related to preparing/inspecting invoices, sending payments, inventory counting, receiving, etc.
What are the costs related to no inventory?
Costs related to shortage which could be lowering the value of brand/reputation, lost sales, etc.
What are the inventory costs?
- Holding costs
- Ordering costs
- Setup costs
- Shortage costs
What is holding costs?
Cost to carry an item in inventory (insurance, bank interest, rent, security, etc.).
What is ordering costs?
Cost of placing an order (not including purchase price), receiving it and paying for it (preparing the order, handling the invoice, making the payments, arranging the transport, etc.).
What are setup costs?
Time spent preparing equipment for the job by adjusting machines, changing tools, etc.
What are shortage costs?
Costs when demand excess supply; often unrealized profit per unit, loss of goodwill.
What is the ABC classification?
In order to manage the inventory of these items smoothly and economically, we classify these items into various categories. Typically, we use sales data of these items and classifies based on the revenue share. In general, we use 80-20 rule i.e. we identify top revenue earners and put in an A category. In general, total revenue of A category items should be around 80% of the total. In terms of numbers, these items could represent only 15-20% of total items.
Total revenue of A+B items should be around 95% and total revenue of A+B+C items should be 100%.
True or False:
An important function of inventories in manufacturing is to decouple operations.
True
True or False:
The two main concerns of inventory management relate to the costs of ordering and holding inventories and the level of customer service (item availability).
True
True or False:
A lower inventory turnover ratio indicates more efficient use of inventories.
False
True or False:
The principal objective of inventory management is to maximize customer service levels by ensuring items are available at all times.
False
True or False:
The overall objective of inventory management is to achieve satisfactory levels of customer service by having sufficient quantities while keeping inventory costs reasonable.
True
True or False:
Two fundamental decisions that buyers or inventory analysts must make about each item held in the inventory are the timing and size of orders.
True
True or False:
Two fundamental decisions that buyers or inventory analysts must make about each item held in the inventory are the timing and size of orders.
False
True or False:
The A-B-C approach involves classifying inventory items based on their unit cost.
False
Which of the following would not generally be considered as one of the functions for holding inventories?
- Decoupling successive operations
- Protecting against stock-outs
- Minimizing holding costs
- Hedging against price increases
- Smoothing seasonal production
Minimizing holding costs
Which of the following is not a function of inventory?
- Preventing decoupling of operations
- Taking advantage of quantity discounts
- Hedging against price increases
- Allowing for time, while goods are transported
- Preventing shortages
Preventing decoupling of operations
Effective use of inventories would be implied from which of the following?
- Understocking and overstocking of inventory items
- The right goods in sufficient quantities
- Low inventory turnover
- High numbers of days of inventory
- High number of back orders
The right goods in sufficient quantities
In an A-B-C inventory system, the typical percentage of the number of types of items in inventory that represent the A classification items is about:
- 15-20%
- 20-30%
- 40-50%
- 70-80%
- More than 90%
15-20%
With an A-B-C system, an item that had a high demand quantity but a low annual dollar volume would probably be classified as:
- (A) Very important
- (B) Moderately important
- (C) Least important
- (A) or (B)
(C) Least important
What is an inventory policy?
Inventory policy is a set of rules to refill and maintain the inventory.
What is inventory management all about?
Using an appropriate inventory policy or Inventory model to carefully balance the inventory availability and costs.
What is ordering cost?
Ordering cost is a fixed cost that incurs during the ordering process. So, if we place more orders, then we spend more on ordering costs.
What is holding cost?
Holding costs are those associated with storing inventory that remains unsold.
What is Economic Order Quantity (EOQ)?
The Economic Order Quantity, or EOQ, is the optimal order size that minimizes the total inventory related costs, both for ordering and for holding.
What are the assumptions we make based on our simple inventory model?
- Annual demand is known and deterministic
- Demand is uniform throughout the year (this model is linear)
- Lead time is deterministic and known
- Price is fixed and remains the same throughout the year
- Supplier is able to fulfill any order quantity
What are the EPQ (Economic Production Quantity) Assumptions?
- Demand is uniformly spread throughout the planning period
- Holding cost is associated with in stock inventory
- Production rate is constant
- Setup cost is associated with setting up the production
True or False:
Ordering costs are usually expressed as a variable cost equal to a percentage of the total purchase cost of an order.
False
True or False:
Inspection of goods for quality and quantity upon arrival is part of ordering cost.
True
True or False:
The EOQ approach minimizes the annual ordering cost of inventory.
False
True or False:
Warehousing costs, insurance costs, and spoilage costs are all associated with holding costs.
True
True or False:
The basic EOQ model assumes that the demand varies widely throughout the year.
False
True or False:
Holding or carrying cost is directly proportional to order size, as order size increases, so does the holding cost.
True
True or False:
Using the EOQ model, the higher an item’s holding costs, the more frequently it will be ordered.
True
True or False:
In the basic EOQ model, at the optimal order quantity annual holding cost is equal to the annual ordering cost.
True
True or False:
Annual ordering cost is a function of order size.
True
True or False:
In the model, if usage and production/delivery rates are equal, there will be no inventory build-up, and thus the order quantity for batches or lots cannot be calculated.
True
Which is not considered a holding cost?
- Opportunity cost of funds
- Building depreciation
- Preparing purchase orders
- Insurance
- Warehousing costs
Preparing purchase orders
Which of the following is not included in ordering cost?
- Taking an inventory count to determine how much needs to be ordered
- Moving delivered goods to temporary storage
- Time spent paying invoices
- Inspecting incoming goods
- Cost of the items purchased
Cost of the items purchased
The basic EOQ model is most relevant for which one of the following?
- Determining fixed order quantities
- Ordering items with dependent demand
- Determining fixed interval order quantities
- Determination of safety stock
- Ordering perishable items
Determining fixed order quantities
In the basic EOQ model, if annual demand doubles, the effect on the EOQ is that:
- it is four times its previous amount
- it increases by about 40%
- it doubles
- it is about 70% of its previous amount
- it is half its previous amount
it increases by about 40%
In the basic EOQ model, if lead time increases from five to 10 days, the EOQ will:
- decrease by a factor of two
- increase by the same ratio as lead time
- increase, but not double
- double
- remain the same
remain the same
Relative to the basic EOQ model, the introduction of quantity discounts will cause the optimum order quantity to be:
- always smaller
- always unchanged
- always greater
- smaller or unchanged
- unchanged or greater
unchanged or greater
In the quantity discount model, in order for the EOQ of the lowest curve to be optimum, it must:
- have the lowest total cost
- be in a feasible range
- have the largest quantity compared to other EOQs
- have the smallest quantity compared to other EOQs
be in a feasible range
The time interval between ordering and receiving an order is called:
- Order interval
- Order cycle
- Lead time offset
- Purchase lead time
- Order delay
Purchase lead time
Given the same demand, setup/ordering costs, and holding costs, the EPQ will be _________ the EOQ.
Given the same demand, setup/ordering costs, and holding costs, the EPQ will be GREATER THAN the EOQ.
What is the assumption for basic inventory model?
The price of the item is fixed.
(Discount on bigger orders require a new way to compute EOQ known as EOQ with quantity discounts).
What is basic EOQ?
We order the exact EOQ by ignoring the discount.
What is modified EOQ?
We increase the order quantity to get a disount.
What is the quantity discount procedure phases?
Phase 1: Cheapest Price
Phase 2: Compare all Discounts
What is the “cheapest price” phase 1 steps?
- Choose the cheapest price.
- Compute EOQ.
- If EOQ fulfills the discount condition, then this is the best solution. Otherwise, go Phase 2.
What is the “compare all discounts” phase 2 steps?
- Compute EOQ.
If EOQ fulfills the price condition, then compute the total inventory cost and purchasing cost.
Otherwise, compute the inventory cost and purchasing cost at the minimum quantity applicable for the price.
Choose the order quantity that gives the lowest total inventory and purchasing cost.
True or False:
Total cost in the EOQ with quantity discount model is calculated in the same way as it is in the basic EOQ model.
False
True or False:
In the EOQ with quantity discounts model, a graph of the total cost curves will have the same EOQ for each curve.
False
True or False:
In the EOQ with quantity discount model, the optimum quantity will always be found on the lowest total cost curve.
False
True or False:
The reorder point (ROP) models determine the point at which the inventory, in terms of quantity must be reordered.
True
True or False:
The EOQ with quantity discounts model focuses on purchase cost and does not account for holding and ordering costs.
False
What is the single period model for?
A model for ordering perishables and other items with limited useful lives.
(ex. newspaper)
What is continuous stocking levels?
Identifies optimal stocking levels. Optimal stocking level balances unit shortage and excess cost. (ordering a precise quantity minimizes the excess and shortage costs).
What is discrete stocking levels?
Desired level is equaled or exceeded. Compare service level to cumulative probability of demand. (quantities are defined in intervals and thus we may need to order more than the required amount i.e. maintaining more than the required service level).
True or False:
The single period model can be very helpful in determining when to order.
False
True or False:
The single period model can be very helpful in determining how much to order.
True
True or False:
Service level in a single period model is the ratio of shortage cost to the sum of shortage and excess cost.
True
True or False:
The single-period model for inventory management is well suited for planning orders for perishables.
True
True or False:
When the inventory item is a spare part for a production machine, shortage cost in the single period model refers to the cost of lost production.
True
True or False:
In the single period model, the service level is the probability that demand will not exceed the stocking level in any period.
True
True or False:
In the single-period model, with discrete stocking levels, the service level must equal or exceed the ratio Cs/(Cs + Ce).
True
Which of these products would be most likely to involve the use of a single period model for ordering?
- Hammers
- Frozen corn
- Fresh fish
- Gold coins
- Calculators
Fresh fish
Which inventory model is most appropriate if unused or unsold items cannot be carried over to subsequent periods?
- Reorder point
- Single period
- Economic order quantity
- Quantity discount
- Economic production quantity
Single period
In the single period model, if excess cost is double shortage cost, the approximate stock-out risk, assuming an optimum service level, is:
- 100%
- 33%
- 5%
- 50%
- 67%
67%
In a single period model, if shortage cost is four times excess cost, then the optimum service level is:
- 80%
- 100%
- 20%
- 60%
- 40%
80%
