Chapter 12: Inventory Management

What is the fixed-time period model (P-model)?

An inventory control model that specifies inventory is ordered at the end of a predetermined time period. The interval of time between orders is fixed and the order quantity varies.

What is the fixed-order quantity model (Q-model)?

An inventory control model where the amount requisitioned is fixed and the actual ordering is triggered by inventory dropping to a specified level of inventory.

What is the reorder point?

An order is placed when the inventory position drops to this level.

What is a single-period problem?

Answers the question of how much to order when an item is purchased only one time and it is expected that it will be used and then not reordered.

Explain the major assumptions of the basic EOQ model.

Demand is known and constant over time; lead time is known and constant; receipt of the inventory is instantaneous; quantity discounts are not possible; the only variable costs are the costs of placing an order or setting up production and the cost of holding or storing inventory over time; and if orders are placed at the right time, stock-outs or shortages can be completely avoided.

When quantity discounts are offered, why is it not necessary to check discount points that are below the EOQ or points above the EOQ that are not discount points?

Discount points below the EOQ have higher inventory costs, and the prices are no lower than at the EOQ. Points above the EOQ have higher inventory costs than the corresponding price breaks or the EOQ (it depends on whether there exists a discount point above the EOQ).

What is ABC inventory classification?

Divides inventory into dollar volume categories that map into strategies appropriate for the category.

Describe the difference between a fixed quantity and a fixed period system.

Fixed quantity (Q) is when the quantity on hand reaches the reorder point, an order is places for the specified quantity. Fixed period system (P) an order is placed at the end of the period. The quantity order is that needed to bring on-hand inventory up to a specified level.

Explain the following: "All things being equal, the production order quantity will be larger than the economic order quantity."

If the same costs hold more will be ordered using the production order quantity model because the average inventory is less than the corresponding EOQ system.

Explain why it is not necessary to include product cost (price or price times quantity) in the EOQ model, but the quantity discount model requires this information.

Price times quantity is not variable in the EOQ model but it is variable in the discount model. When quantity discounts are available, the unit purchase price of the item depends on the order quantity.

What is meant by "service level"?

Refers to the probability that demand will not be greater than supply during lead time. It is complement of the probability of a stock out.

What is safety stock? What does safety stock provide safety against?

Safety stock is inventory beyond average demand during lead time, held to control the level of shortages when demand and/or lead time are not constant; inventory carried to ensure that the desired service level is reached.

What is the relationship of the economic order quantity (EOQ) to demand? To holding cost? To the setup cost?

The EOQ increases as demand increases or as the setup costs increases; it decreases as the holding cost increases. The changes in the EOQ are proportional to the square root of the changes in the parameters.

Explain what is meant by the expression "robust model". Specifically, what would you tell a manager who exclaimed, "We're in trouble. The calculated EOQ is wrong, actual demand is 10% greater than estimated."

The EOQ model gives quite good results under inexact inputs; a 10% error in actual demand alters the EOQ by less than 5%.

State a major advantage, and a disadvantage, of a fixed period system.

The advantage is there is no physical count of inventory when items are withdrawn. The disadvantage is there is a possibility of stock out during the time between orders.

With the advent of low-cost computing, do you see alternatives to the popular ABC classifications?

The advent of low-cost computing should not be seen as obviating the need for the ABC inventory classification scheme. Although the cost of computing, has decreased considerably, the cost of data acquisition has not decreased in a similar fashion. Business organizations still have many items for which the cost of data acquisition for a "perpetual" inventory system is still considerably higher than the cost of the item.

What is safety stock?

The amount of inventory carried in addition to the expected demand.

What is the price-break model?

The model is useful for finding the order quantity of an item when the price of the item varies with the order size.

What is the purpose of the ABC classification system?

The purpose of the ABC system is to identify those items that require more attention due to cost or volume.

What is the optimal order quantity?

This order size minimizes total annual inventory-related costs.

When demand is not constant, the reorder point is a function of what four parameters?

1. Demand per unit of time. 2. Lead time. 3. Customer service level. 4. Standard deviation of demand.

What are the advantages of cycle counting?

1. Eliminating the shutdown and interruption of production necessary for annual physical inventories. 2. Eliminating annual inventory adjustments. 3. Providing trained personnel to audit the accuracy of inventory. 4. Allowing the cause of errors to be identified and remedial action to be taken. 5. Maintaining accurate inventory records.

Identify and explain the types of cost that are involved in an inventory system.

1. Holding cost. The cost of capital invested and space required. 2. Shortage cost. The cost of lost sales or customers who never return; the cost of lost goodwill. 3. Ordering cost. The costs associated with ordering, transporting, and receiving the items. 4. Unit cost: The actual cost of the item.

Describe the four types of inventory.

1. Raw material. Items that are to be converted into product. 2. Work-in-process. Items that are in the process of being converted. 3. Finished goods. Completed items for which title has not been transferred. 4. MRO (Maintenance, repair, and operating supplies). Items that are necessary to keep the transformation process going.

What impact does a decrease in setup time have an EOQ?

A decrease in setup time decreases the cost per order, encourages more and smaller orders, and thus decreases the EOQ.

What is inventory turn?

A measure of the expected number of times that inventory is replaced over a year.

What is cycle counting?

A physical inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year. It is a useful method for scheduling the audit of each item carried in inventory.