Inventory Management Flashcards

Question 1

What is inventory in the context of operations management?

Accepted Answer

Inventory is the stock of goods a business holds, including raw materials, work in process, finished goods, and supplies used in operations. Companies hold it to meet customer demand, buffer against uncertainty, smooth production, and take advantage of quantity discounts. Holding stock is useful, but it carries costs that managers must weigh.

Question 2

What are the main categories of inventory costs that managers balance?

Accepted Answer

The main categories are holding costs, ordering costs, and shortage costs. Holding costs cover capital tied up in stock, storage, insurance, obsolescence, and spoilage. Ordering costs cover the expense of placing and receiving an order. Shortage costs arise when demand cannot be met, including lost sales and backorder expenses.

Question 3

What is the ABC classification method used for in inventory control?

Accepted Answer

ABC classification ranks items by their annual value, which is usually unit cost multiplied by annual usage, and groups them into classes. A items are high value and receive the closest control, B items get moderate attention, and C items are low value and managed with simpler rules. The method helps managers focus effort where it matters most.

Question 4

Why do holding costs and ordering costs pull inventory levels in opposite directions?

Accepted Answer

Ordering large quantities less often reduces the number of orders and their fixed ordering costs, but it raises average stock on hand and holding costs. Ordering small quantities more often does the reverse, lowering holding costs while increasing ordering costs. The tradeoff is why managers look for an order size that minimizes the total.

Question 5

What is the difference between independent demand and dependent demand?

Accepted Answer

Independent demand is demand for finished goods or items whose needs are driven by the market, such as customer orders or forecasts. Dependent demand is demand for components whose requirements are calculated from the planned production of a parent item. Dependent demand is typically planned directly rather than forecast.

Question 6

What happens when a business runs out of an item customers want?

Accepted Answer

A stockout occurs when an item is unavailable at the moment a customer or production process needs it. Stockouts can lead to lost sales, customer dissatisfaction, backorders, and production delays. Some stockouts are unavoidable, so managers use safety stock and reorder rules to reduce how often they happen.

Question 7

What does a bill of materials record, and why do inventory planners use it?

Accepted Answer

A bill of materials is a structured list of the components, subassemblies, and quantities required to make one unit of a finished product. Planners use it to convert planned production into component requirements, which is how dependent demand is calculated. It also shows which parts are shared across products.

Question 8

What is work in process inventory, and where does it appear?

Accepted Answer

Work in process inventory consists of partially finished goods that are somewhere between raw materials and finished products. It appears on the production floor between operations, such as components waiting for assembly or sub-assemblies awaiting testing. Reducing work in process shortens lead times and exposes bottlenecks.

Question 9

What does lead time mean in inventory management planning?

Accepted Answer

Lead time is the total elapsed time between placing an order for an item and having that item available to use or sell. It includes supplier processing, production or preparation, transportation, receiving, and inspection. Longer or more variable lead times usually require more safety stock to protect against shortages.

Question 10

What is average daily demand, and how is it estimated?

Accepted Answer

Average daily demand is the typical quantity of an item consumed or sold per day over a chosen period. It is estimated by dividing total units sold over a historical period by the number of days in that period. Analysts often adjust the figure for seasonality, promotions, or known changes in customer behavior.

Question 11

What is demand variability, and why does it matter?

Accepted Answer

Demand variability describes how much actual daily or weekly demand fluctuates around its average. Greater variability means the average is a less reliable guide, so a business must hold extra stock to avoid running out. Managers often measure it with standard deviation of demand over a time period.

Question 12

What is safety stock, and what is its purpose?

Accepted Answer

Safety stock is extra inventory held beyond expected demand during the lead time, kept to protect against unexpected spikes in demand or delays in supply. Its purpose is to reduce the chance of a stockout rather than to meet normal requirements. Holding more safety stock improves service but increases holding costs.

Question 13

What is a service level, and how does it relate to safety stock?

Accepted Answer

A service level is the target probability that demand will be met from stock during a replenishment cycle, often expressed as a percentage. Higher service level targets require larger safety stock because the buffer must cover more of the possible demand variation. Choosing a target balances customer expectations against cost.

Question 14

Why does lead time variability increase the amount of safety stock needed?

Accepted Answer

When lead times are unpredictable, a reorder may arrive later than expected, leaving stock to cover demand for longer than planned. Safety stock acts as a buffer for that extra exposure. Combined with demand variability, uncertain lead times compound the risk of a stockout.

Question 15

How is a simple safety stock estimate calculated from demand and lead time?

Accepted Answer

One common approach multiplies a z value for the target service level by the standard deviation of demand during lead time. When demand is independent from day to day, that deviation equals daily standard deviation times the square root of lead time in days.

Question 16

Why do forecasts become less accurate as the planning horizon gets longer?

Accepted Answer

Longer horizons leave more room for unexpected changes in customer preferences, competitor actions, economic conditions, and supply disruptions to alter demand. Short-term forecasts rely on recent sales and confirmed orders, which are more informative. Because of this, planners often freeze near-term schedules and update longer-term forecasts more loosely.

Question 17

What is a reorder point, and how is it used?

Accepted Answer

A reorder point is the inventory level at which a new order should be placed so that stock arrives before the existing supply runs out. In its basic form it equals average demand during lead time plus safety stock. When on-hand plus on-order inventory falls to this level, the item triggers replenishment.

Question 18

What is the basic formula for reorder point under constant demand and lead time?

Accepted Answer

Under constant demand and lead time with no safety stock, reorder point equals daily demand multiplied by lead time in days. For example, an item that sells 20 units per day with a 5 day lead time should be reordered when stock reaches 100 units. Adding safety stock raises this level.

Question 19

What is the economic order quantity model trying to minimize?

Accepted Answer

The economic order quantity model seeks the order size that minimizes the total of annual ordering costs and annual holding costs for an item with steady, known demand. It assumes demand is constant, costs are fixed per order, and holding cost is a fixed percentage of unit value.

Question 20

What is the standard formula for economic order quantity, and what do its inputs mean?

Accepted Answer

The standard formula is the square root of two times annual demand times ordering cost per order, divided by annual holding cost per unit. Annual demand is total units used per year, ordering cost is the fixed expense of each order, and holding cost per unit is the yearly cost of keeping one unit.

Question 21

How does the EOQ change if annual demand doubles, all else equal?

Accepted Answer

Doubling annual demand multiplies the economic order quantity by the square root of two, about 1.41, rather than by two. Because demand sits under a square root, order size grows more slowly than demand does. Total annual ordering and holding costs also rise, but more slowly than volume.

Question 22

How does a periodic review system differ from a continuous review reorder point system?

Accepted Answer

A continuous review system monitors inventory level constantly and places an order whenever stock reaches the reorder point, usually with a fixed order quantity. A periodic review system checks stock at fixed intervals, such as every week, and orders enough to bring inventory up to a target level.

Question 23

Why do quantity discounts complicate the order quantity decision?

Accepted Answer

Quantity discounts lower the unit purchase price when orders reach certain sizes, so the cheapest per-unit option may not be the lowest total cost. Managers must compare total annual cost at each discount break, including purchase price, ordering cost, and holding cost. The best choice may be a larger order than EOQ alone would suggest.

Question 24

What happens to the reorder point if lead time gets longer?

Accepted Answer

A longer lead time increases the demand expected during the replenishment period, so the reorder point must rise to trigger orders earlier. Shortening lead time has the opposite effect and lowers the required reorder point. Safety stock may also need adjustment, because the variation in demand over a longer period grows as well.

Question 25

What is the difference between a perpetual and a periodic inventory system?

Accepted Answer

A perpetual inventory system updates inventory records continuously, so the book balance is always current. A periodic system updates records only at set intervals, relying on a physical count at the end of the period to determine ending stock. Perpetual systems offer more timely information, while periodic systems are simpler and cheaper to run.

Question 26

What is cycle counting, and why is it used?

Accepted Answer

Cycle counting is a method of counting a subset of inventory items on a regular schedule rather than shutting down operations for one full annual physical count. High-value or fast-moving items are often counted more frequently than low-value items. The approach helps locate errors early, improving record accuracy over time.

Question 27

What is inventory shrinkage, and what causes it?

Accepted Answer

Inventory shrinkage is the gap between recorded inventory and the physical stock actually on hand. It can result from theft, damage, spoilage, administrative errors, or unrecorded transfers. Shrinkage reduces accuracy in financial statements and can hide problems in purchasing or receiving processes.

Question 28

What are the main methods used to value inventory on financial statements?

Accepted Answer

The most widely taught methods are first in first out, last in first out, and weighted average cost. FIFO assumes the oldest units are sold first, so ending inventory reflects recent costs. LIFO assumes the newest units are sold first, and weighted average blends all costs into one average per unit.

Question 29

How does FIFO affect ending inventory when prices are rising?

Accepted Answer

When prices are rising, FIFO leaves the most recent, higher-cost units in ending inventory, so the balance sheet value is higher. Because older, lower-cost units flow into cost of goods sold, reported gross profit is also typically higher. The opposite pattern generally holds for LIFO during rising prices.

Question 30

What is a cycle count variance, and how should it be handled?

Accepted Answer

A cycle count variance is the difference between the quantity in the system record and the quantity physically counted. Teams should first recheck the count and look for receiving, picking, or unit of measure errors before adjusting records. Recurring variances for the same item point to process problems that need root cause analysis.

Question 31

Why is inventory accuracy important even when a company has plenty of stock?

Accepted Answer

Accurate records let planners trust reorder triggers, promise realistic delivery dates, and avoid buying stock that is already on the shelf. When records are wrong, a business may appear out of stock while holding excess units, or it may believe it has stock it does not. Both errors waste money and harm customer service.

Question 32

What is obsolete inventory, and how should it be recorded?

Accepted Answer

Obsolete inventory is stock that can no longer be sold at its normal price because demand has disappeared, the product has been superseded, or it has expired. Companies typically write its value down to net realizable value when that amount falls below cost, recognizing the loss in the period it becomes evident.

Question 33

What is inventory turnover and how is it calculated?

Accepted Answer

Inventory turnover measures how many times a business sells and replaces its average inventory during a period. It is calculated by dividing cost of goods sold for the period by average inventory over that same period. Higher turnover generally means stock moves quickly, though very high turnover can signal stockout risk.

Question 34

What is days inventory outstanding, and how is it related to turnover?

Accepted Answer

Days inventory outstanding estimates the average number of days stock is held before it is sold. It equals the number of days in the period divided by inventory turnover, or equivalently average inventory divided by cost of goods sold per day. Lower values usually indicate faster-moving stock and less cash tied up.

Question 35

What is fill rate, and how does it differ from in-stock rate?

Accepted Answer

Fill rate is the percentage of demanded units shipped from available stock. In-stock rate is the percentage of times an item or location has inventory available when a customer looks for it. A business can have a high in-stock rate yet a lower fill rate if available stock covers only part of large orders.

Question 36

What is a stockout cost, and why is it hard to measure?

Accepted Answer

A stockout cost is the financial impact of unmet demand, such as lost margin on a sale, a backorder expense, or a customer who switches to a competitor. It is hard to measure because many customers never report the lost sale, and the effect on future loyalty may appear long after the event.

Question 37

How does ABC analysis guide cycle counting frequency?

Accepted Answer

ABC analysis assigns counting frequency by value class, so A items may be counted monthly, B items quarterly, and C items once or twice a year. This concentrates counting effort on items where errors would cost the most. Exact intervals vary by organization and should be set using error history.

Question 38

What is the bullwhip effect in supply chains?

Accepted Answer

The bullwhip effect describes how small changes in customer demand can produce growing swings in orders as they move upstream through distributors, wholesalers, and manufacturers. Each stage may over-react by inflating orders to protect against shortages or by batching orders, which amplifies variability. Shared demand information and shorter lead times help reduce it.

Question 39

How should a manager decide between holding more safety stock and accepting higher stockout risk?

Accepted Answer

Compare the expected margin lost per stockout with the added holding cost of extra safety stock at each service level. For a high-margin item, a stockout is usually expensive, so a higher service level often pays off despite added holding cost. Lower-margin or slow-moving items may justify a lower target.

Question 40

Why should inventory performance be reviewed alongside cash flow and sales?

Accepted Answer

Inventory affects cash flow, profit, and customer service at the same time, so reviewing it alone can mislead decisions. Cutting stock may improve turnover while causing sales losses, and adding stock may protect sales while tying up cash. Reviewing inventory with sales and cash data shows whether changes create real value.

Inventory Management Flashcards

1Inventory Basics and Costs

2Demand, Lead Time and Safety Stock

3Reorder Points and Order Quantities

4Counting, Records and Valuation

5Performance and Applied Decisions

Learning Resources