Intro to Industrial Engineering Unit 4 Review: Inventory Management Fundamentals

What's Inventory Management?

• Involves overseeing and controlling the ordering, storage, and use of components that a company uses in the production of the items it sells
• Encompasses the monitoring of inventory from the point of purchase to the final sale of goods
• Aims to minimize the cost of holding inventory while maximizing its use
• Balances current and future needs with the goal of avoiding stockouts (running out of inventory)
• Analyzes inventory to predict future needs, which informs decisions about what to purchase, how much, and when
• Utilizes various formulas and methods (EOQ, JIT) to optimize inventory levels and minimize costs
• Requires accurate tracking of inventory levels, which can be done manually or through software systems
• Plays a critical role in supply chain management and can significantly impact a company's bottom line

Types of Inventory

• Raw materials are components or parts used in the production process to create finished goods
• Work-in-progress (WIP) inventory refers to partially completed goods in the production process
  • Includes materials, labor, and overhead costs incurred
  • WIP is an asset on the balance sheet
• Finished goods are completed products ready for sale to customers
• Maintenance, Repair, and Operating (MRO) inventory includes supplies used in production that are not part of the final product (lubricants, cleaning supplies)
• Buffer or safety stock is extra inventory held to protect against stockouts due to uncertainties in supply and demand
• Decoupling inventory is used to allow different stages of the production process to operate independently
• Transit inventory is goods currently being moved from one location to another (pipeline inventory)

Key Inventory Metrics

• Inventory turnover measures how quickly inventory is sold and replaced, calculated as: $\text{Cost of Goods Sold} \div \text{Average Inventory}$
• Days of Inventory on Hand (DOH) indicates how long it takes to sell the entire inventory, calculated as: $365 \div \text{Inventory Turnover}$
• Inventory accuracy measures the difference between recorded and actual inventory levels
  • Can be calculated as: $(\text{Recorded Inventory} - \text{Actual Inventory}) \div \text{Recorded Inventory} \times 100$
• Fill rate measures the percentage of customer orders that are filled from available inventory
• Stockout rate is the percentage of times a product is unavailable when a customer order is placed
• Inventory carrying cost is the total cost of holding inventory, including capital costs, storage costs, and risk costs
• Inventory velocity measures how quickly products move through the supply chain

Inventory Control Systems

• Perpetual inventory system continuously updates inventory records as transactions occur
  • Utilizes technology (barcode scanners, RFID) to track inventory in real-time
  • Provides up-to-date information for better decision-making
• Periodic inventory system updates inventory records at specific intervals (weekly, monthly)
  • Requires physical counting of inventory at the end of each period
  • Less accurate than perpetual systems but often less costly
• Two-bin system uses two containers for each item, with a reorder placed when the first bin is empty
• ABC analysis categorizes inventory based on value and importance
  • A items are high-value and closely monitored
  • B items are moderate-value and less closely monitored
  • C items are low-value and loosely monitored
• Economic Order Quantity (EOQ) model determines the optimal order quantity to minimize total inventory costs
• Just-In-Time (JIT) system aims to reduce inventory by ordering goods only as needed for production

Demand Forecasting

• Involves predicting future customer demand for a product or service
• Time-series methods use historical data to identify trends, seasonality, and cyclical patterns
  • Moving average takes the average of a specified number of past periods
  • Exponential smoothing assigns greater weight to more recent data points
• Causal methods examine the relationship between demand and other variables (price, advertising)
  • Regression analysis is commonly used to model these relationships
• Qualitative methods rely on expert opinions, market research, and customer surveys
• Collaborative forecasting involves sharing information among supply chain partners to improve accuracy
• Forecast accuracy can be measured using Mean Absolute Deviation (MAD) or Mean Absolute Percentage Error (MAPE)
• Forecasting helps businesses make informed decisions about production, staffing, and inventory management

Economic Order Quantity (EOQ)

• Determines the optimal order quantity that minimizes total inventory costs
• Assumes constant demand, lead time, and ordering and holding costs
• Balances the cost of placing an order (ordering cost) with the cost of holding inventory (holding cost)
• EOQ formula: $Q^* = \sqrt{\frac{2DS}{H}}$
  • $Q^*$ is the optimal order quantity
  • $D$ is the annual demand
  • $S$ is the ordering cost per order
  • $H$ is the annual holding cost per unit
• Helps determine the Reorder Point (ROP), which is when to place an order to avoid stockouts
  • ROP formula: $ROP = \text{Lead Time Demand} + \text{Safety Stock}$
• EOQ model assumes instantaneous replenishment, which may not always be realistic

Inventory Costs

• Ordering costs are associated with placing and receiving an order (processing, shipping, handling)
• Holding costs are incurred from storing inventory (capital costs, storage costs, insurance, obsolescence)
  • Often expressed as a percentage of inventory value
• Shortage costs result from not having enough inventory to meet customer demand (lost sales, backorders)
• Purchase costs are the actual cost of buying the inventory
• Quality costs are associated with preventing, detecting, and correcting defective items
• Shrinkage costs result from theft, damage, or loss of inventory
• Total inventory cost is the sum of all these individual costs
  • Goal is to minimize total cost while meeting customer demand

Just-In-Time (JIT) and Lean Principles

• JIT is a production strategy that aims to reduce inventory and improve efficiency
  • Goods are ordered and received just as they are needed in the production process
  • Reduces holding costs and waste but requires precise coordination
• Lean principles focus on eliminating waste and creating value for the customer
  • Waste can include overproduction, waiting, transportation, overprocessing, inventory, motion, and defects
• Value Stream Mapping (VSM) is used to visualize the flow of materials and information in a process
  • Helps identify and eliminate non-value-added activities
• Kanban is a scheduling system that uses visual signals to control the flow of materials
  • Commonly uses cards or containers to signal when more parts are needed
• 5S is a workplace organization method that emphasizes sort, set in order, shine, standardize, and sustain
• Kaizen refers to continuous improvement through small, incremental changes
  • Involves all employees in identifying and implementing improvements