Inventory
Functions and costs
Inventory exists as cycle stock (order quantity), safety stock (variability), anticipation stock (seasonal prebuild), pipeline stock (in transit), and decoupling stock (WIP between processes). Costs are carrying (capital, storage, obsolescence, insurance, handling - often 15–30% of value per year), ordering/setup, and shortage (lost sales, expediting, goodwill). EOQ balances ordering and carrying costs only: EOQ = sqrt(2DS ÷ H).
Accuracy and control
ABC classifies items by annual dollar usage - A items are few but carry most of the value and get tight control and frequent cycle counts; C items get simple rules. Cycle counting replaces the annual wall-to-wall count and targets known error sources. Turns = COGS ÷ average inventory value; days of supply = inventory ÷ daily usage.
Traps
- Classifying by unit cost rather than annual usage value.
- Ignoring lead-time variability: safety stock = z × sqrt(L × sigma-d squared + d squared × sigma-L squared).
- Forgetting that raising service from 95% to 99% (z 1.65 → 2.33) adds roughly 40% more safety stock.
- Treating EOQ as fixed when setup reduction changes the answer.
- Mixing FIFO, LIFO, and standard cost conventions in a period of rising prices.
Worked example
D = 10,000 units/year, S = $50 per order, H = $4 per unit per year. EOQ = sqrt(2 × 10,000 × 50 ÷ 4) = sqrt(250,000) = 500 units. Orders per year = 20; ordering cost $1,000 and carrying cost $1,000 - equal at EOQ. Rule of thumb: use that equality as a check on your arithmetic.