inventory management
DESCRIPTION
Group presentation on the important theories and calculations associated with inventory managementTRANSCRIPT
Presentation on:
“Inventory Management”
To hold or not to hold?
ObjectivesAppreciate the importance of effective inventory
management.
Understand the different reasons for holding inventory
and the different types of inventory
Describe the different costs of inventory.
Realize the significance of independent and dependent
demand in inventory control systems.
ObjectivesBe aware of the concept of Economic Order Quantity
and its limitations.
Describe the different inventory systems based on
independent demand.
Explain technologies as used for classifying and
controlling inventory.
IntroductionInventory-A physical resource that a firm holds in stock
with the intent of selling it or transforming it into a more
valuable state.
Inventory System- A set of policies and controls that
monitors levels of inventory and determines what levels
should be maintained, when stock should be replenished,
and how large orders should be placed.
Inventory One of the most expensive assets of many companies,
representing as much as 30-40% of total invested capital
Operations managers must balance inventory
investment and customer service
Inventory Management It is the planning and control of inventories (or stock) in
the transformation system of an organization in order to
meet customer demand while also being effective.
Key questions to answer1. What to stock?
2. How much to stock?
3. Where it should be located?
4. How much should be ordered?
Reasons for holding inventoryTo anticipate changes in customer demand.
To decouple (or uncouple) operations.
To protect against stock-outs due to uncertainties in
supply, demand and lead times.
To allow for transit and transit time.
As a hedge against price increases.
To minimize purchasing and inventory costs.
Types of inventoryRaw materials- all commodities, parts and
components.
MRO: Maintenance, Repairs and Operating Supplies
Work-in-Process
Finished Goods
The Costs of InventoryOrdering Costs (Including set-up costs)
Holding costs (Capital costs, Storage costs, Insurance
costs and obsolescence costs)
Stock-out costs (costs involved in dealing with stock-
outs)
Independent Demand vs. Dependent Demand
Inventory systems based on Independent Demand
Fixed-Order Quantity System (sometimes referred to as
EOQ or Q systems).
Fixed-time Period Systems(or Period Review system or
Fixed order interval or P systems).
The Economic Order Quantity (EOQ) Model
The EOQ is the order quantity that minimizes the
ordering cost and the holding cost of an item i.e.
minimizing the total costs in acquiring and holding
assets
Basic EOQ Model
1. Demand is known, constant, and independent2. Lead time is known and constant3. Receipt of inventory is instantaneous and
complete4. Quantity discounts are not possible5. Only variable costs are setup and holding6. Stock-outs can be completely avoided
Important assumptions
Inventory Usage Over Time
Order quantity = Q (maximum inventory level)
Inve
ntor
y le
vel
Time
Usage rate Average inventory on
handQ2
Minimum inventory
Minimizing CostsObjective is to minimize total costs
Annu
al c
ost
Order quantity
Curve for total cost of holding
and setup
Holding cost curve
Setup (or order) cost curve
Minimum total cost
Optimal order
quantity
The EOQ ModelQ = Number of pieces per orderQ* = Optimal number of pieces per order (EOQ)D = Annual demand in units for the Inventory itemS = Setup or ordering cost for each orderH = Holding or carrying cost per unit per year
Annual setup cost = DSQ
Annual holding cost = QH2
Annual setup cost = (Number of orders placed per year) x (Setup or order cost per order)
Annual demandNumber of units in each order
Setup or order cost per order
=
= (S)DQ
The EOQ ModelQ = Number of pieces per orderQ* = Optimal number of pieces per order (EOQ)D = Annual demand in units for the Inventory itemS = Setup or ordering cost for each orderH = Holding or carrying cost per unit per year
Annual holding cost = (Average inventory level) x (Holding cost per unit per year)
Order quantity2
= (Holding cost per unit per year)
= (H)Q2
Annual setup cost = DSQ
Annual holding cost = QH2
The EOQ ModelQ = Number of pieces per orderQ* = Optimal number of pieces per order (EOQ)D = Annual demand in units for the Inventory itemS = Setup or ordering cost for each orderH = Holding or carrying cost per unit per year
Annual setup cost = DSQ
Annual holding cost = QH2
Optimal order quantity is found when annual setup cost equals annual holding cost
DQ
S = HQ2
Solving for Q*2DS = Q2HQ2 = 2DS/H
Q* = 2DS/H
An EOQ ExampleDetermine optimal number of needles to orderD = 1,000 unitsS = $10 per orderH = $.50 per unit per year
Q* =2DS
H
Q* =2(1,000)(10)
0.50= 40,000 = 200 units
An EOQ ExampleDetermine optimal number of needles to orderD = 1,000 units Q* = 200 unitsS = $10 per orderH = $.50 per unit per year
= N = =Expected number
of ordersDemand
Order quantityD
Q*
N = = 5 orders per year 1,000200
An EOQ ExampleDetermine optimal number of needles to orderD = 1,000 units Q* = 200 unitsS = $10 per order N = 5 orders per yearH = $.50 per unit per year
= T =Expected time
between ordersNumber of working
days per yearN
T = = 50 days between orders2505
An EOQ ExampleDetermine optimal number of needles to orderD = 1,000 units Q* = 200 unitsS = $10 per order N = 5 orders per yearH = $.50 per unit per year T = 50 days
Total annual cost = Setup cost + Holding cost
TC = S + HDQ
Q2
TC = ($10) + ($.50)1,000200
2002
TC = (5)($10) + (100)($.50) = $50 + $50 = $100
Robust Model
The EOQ model is robust
It works even if all parameters and
assumptions are not met
The total cost curve is relatively flat in
the area of the EOQ
Reorder Points EOQ answers the “how much”
question The reorder point (ROP) tells when
to orderROP =
Lead time for a new order in
days
Demand per day
= d x L
d = DNumber of working days in a year
Reorder Point CurveQ*
ROP (units)In
ven
tory
leve
l (u
nit
s)
Time (days)Lead time = L
Slope = units/day = d
Reorder Point Example
Demand = 8,000 DVDs per year250 working day yearLead time for orders is 3 working days
ROP = d x L
d = D
Number of working days in a year
= 8,000/250 = 32 units
= 32 units per day x 3 days = 96 units
Fixed-time Period (P) Systems Here the inventory levels are reviewed at fixed intervals.
Four of the original EOQ assumptions maintained
No constraints are placed on lot size
Holding and ordering costs
Independent demand
Lead times are certainOrder is placed to bring the inventory position up to the target
inventory level, T, when the predetermined time, P, has elapsed
Fixed-time Period System(P)
P P
T
L L L
Protection interval
Time
On
-han
d i
nve
nto
ry
IP3
IP1
IP2
OrderplacedOrderplaced
Orderplaced
Orderreceived
Orderreceived
Orderreceived
IP IPIP
OH OHQ1
Q2
Q3
P System When Demand Is Uncertain
Inventory Control Mechanism
Pareto Principle
80/20 rule
Based on the work of an economist & avid horticulturalist,
V. Pareto in late 19th century Italy.
80% of the land was owned by 20% of the people.
80% of the peas were produced by 20% of the pods
Applied to business by quality guru Dr. Juran
Pareto principle applied:
Applied to Meetings: 80% of decisions come from 20% of
meeting time.
Applied to product defects: 20% of the quality problems
cause 80% of the defects.
Applied to Salespeople: Roughly 20% of a sales force will
develop 80% of the annual results
Applied to Business Units: Roughly 20% of a company's
business units will produce 80% of the annual revenue.
Applied to time-management…
Moral of the Pareto principle
Find the significant 20%
Manage that 20%
Pareto principal + Inventory = ABC Analysis
“critical few and the trivial many”
Create a Pareto chart for the inventory dollars per year of
each item – dollar-volume
Generally the top 80% of dollars are from approximately 20%
of the items.
Categorize all items into
Class A items – top ~20% items by dollar-volume
Class B items
Class C items
ABC Analysis
10 20 30 40 50 60 70 80 90 100
Percentage of items
Per
cen
tag
e o
f d
oll
ar v
alu
e
100 —
90 —
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0 —
ABC Analysis
10 20 30 40 50 60 70 80 90 100
Percentage of items
Per
cen
tag
e o
f d
oll
ar v
alu
e
100 —
90 —
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0 —
ABC Analysis
10 20 30 40 50 60 70 80 90 100
Percentage of items
Per
cen
tag
e o
f d
oll
ar v
alu
e
100 —
90 —
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0 —
ABC Analysis
10 20 30 40 50 60 70 80 90 100
Percentage of items
Per
cen
tag
e o
f d
oll
ar v
alu
e
100 —
90 —
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0 —
ABC Analysis
10 20 30 40 50 60 70 80 90 100
Percentage of items
Per
cen
tag
e o
f d
oll
ar v
alu
e
100 —
90 —
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0 —
Class C
Class A
Class B
ABC AnalysisPolicies based on ABC analysis
Develop Class A suppliers moreImplement tighter physical control of Class
A itemsForecast Class A items more carefullyModel inventory for Class A items
Cycle countingPhysically counting a sample of total inventory on
a regular basis
Used often with ABC classificationClass A items counted most often (e.g., daily)
Class B items counted less frequently (e.g. weekly)
Class C items counted least often (e.g. monthly)
Advantages of Cycle Counting
Eliminates shutdown and interruption of production
necessary for annual physical inventories
Eliminates annual inventory adjustments
Provides trained personnel to audit the accuracy of
inventory
Allows the cause of errors to be identified and
remedial action to be taken
Maintains accurate inventory records
Thank you