inventory management session 3

8/11/2019 Inventory Management Session 3

1/46

12 - 1

Inventory Management

Session 3

August 12, 20

14


2/46

12 - 2

In v en tory Man agem en t

The objective of inventorymanagement is to strike a balancebetween inventory investment and

customer service


3/46

12 - 3

Fun c t ion s o f Inv en to ry

1. To decouple or separate variousparts of the production process

2. To decouple the firm fromfluctuations in demand andprovide a stock of goods that willprovide a selection for customers

3. To take advantage of quantitydiscounts4. To hedge against inflation


4/46

12 - 4

Typ es of Inv en tory

Raw materialPurchased but not processed

Work-in-process

Undergone some change but not completedA function of cycle time for a product

Maintenance/repair/operating (MRO)

Necessary to keep machinery andprocesses productive

Finished goodsCompleted product awaiting shipment


5/46

12 - 5

The Mater ial Flo w Cyc le

Input Wait for Wait to Move Wait in queue Setup Run Outputinspection be moved time for operator time time

Cycle time

95% 5%


6/46

12 - 6

Managing Inv ento ry

1. How inventory items can beclassified

2. How accurate inventory recordscan be maintained


7/46


8/46

12 - 8

A B C Analys i s

ItemStock

Number

Percent ofNumber of

ItemsStocked

AnnualVolume(units) x

UnitCost =

AnnualDollar

Volume

Percent ofAnnualDollar

Volume Class

#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A

#11526 500 154.00 77,000 33.2% A

#12760 1,550 17.00 26,350 11.3% B

#10867 30% 350 42.86 15,001 6.4% B

#10500 1,000 12.50 12,500 5.4% B

72%

23%


9/46

12 - 9

A B C Analys i s

ItemStock

Number

Percent ofNumber of

ItemsStocked

AnnualVolume(units) x

UnitCost =

AnnualDollar

Volume

Percent ofAnnualDollar

Volume Class

#12572 600 $ 14.17 $ 8,502 3.7% C

#14075 2,000 .60 1,200 .5% C

#01036 50% 100 8.50 850 .4% C

#01307 1,200 .42 504 .2% C

#10572 250 .60 150 .1% C

8,550 $232,057 100.0%

5%


10/46

12 - 10

C Items

A B C Analys i s

A Items

B Items

P e r c e n

t o

f a n n u a l

d o

l l a r u s a g e

80 70 60 50 40 30 20

10 0 | | | | | | | | | |

10 20 30 40 50 60 70 80 90 100

Percent of inventory itemsFigure 12.2


11/46

12 - 11

A B C Analys i s

Other criteria than annual dollarvolume may be used

Anticipated engineering changesDelivery problemsQuality problems

High unit cost


12/46

12 - 12

A B C Analys i s

Policies employed may includeMore emphasis on supplier

development for A itemsTighter physical inventory control forA items

More care in forecasting A items


13/46

12 - 13

Reco rd A ccu racy

Accurate records are a criticalingredient in production and inventorysystemsAllows organization to focus on what

is neededNecessary to make precise decisionsabout ordering, scheduling, andshippingIncoming and outgoing recordkeeping must be accurateStockrooms should be secure


14/46

12 - 14

Cycle Cou n t ingItems are counted and records updatedon a periodic basisOften used with ABC analysisto determine cycle

Has several advantages1. Eliminates shutdowns and interruptions2. Eliminates annual inventory adjustment

3. Trained personnel audit inventory accuracy4. Allows causes of errors to be identified and

corrected5. Maintains accurate inventory records


15/46

12 - 15

Cycle Cou n t ing Exam p le

5,000 items in inventory, 500 A items, 1,750 B items, 2,750 CitemsPolicy is to count A items every month (20 working days), Bitems every quarter (60 days), and C items every six months(120 days)

ItemClass Quantity Cycle Counting Policy

Number of ItemsCounted per Day

A 500 Each month 500/20 = 25/day

B 1,750 Each quarter 1,750/60 = 29/day

C 2,750 Every 6 months 2,750/120 = 23/day

77/day


16/46

12 - 16

In d ep en d ent Vers u s

Dep en d en t Dem an dIndependent demand - thedemand for item is independentof the demand for any otheritem in inventoryDependent demand - the

demand for item is dependentupon the demand for someother item in the inventory


17/46

12 - 17

Hold ing , Order in g , an d

Setup Cos tsHolding costs - the costs of holdingor carrying inventory over time Ordering costs - the costs ofplacing an order and receivinggoods

Setup costs - cost to prepare amachine or process formanufacturing an order


18/46

12 - 18

Hold ing Cos t s

Category

Cost (and range)as a Percent ofInventory Valu e

Housing costs (building rent ordepreciation, operating costs, taxes,

insurance)

6% (3 - 10%)

Material handling costs (equipment lease ordepreciation, power, operating cost)

3% (1 - 3.5%)

Labor cost 3% (3 - 5%)

Investment costs (borrowing costs, taxes,and insurance on inventory)

11% (6 - 24%)

Pilferage, space, and obsolescence 3% (2 - 5%)

Overall carrying cost 26%


19/46

12 - 19

Hold ing Cos t s

Category

Cost (and range)as a Percent ofInventory Valu e

Housing costs (building rent ordepreciation, operating costs, taxes,

insurance)

6% (3 - 10%)

Material handling costs (equipment lease ordepreciation, power, operating cost)

3% (1 - 3.5%)

Labor cost 3% (3 - 5%)

Investment costs (borrowing costs, taxes,and insurance on inventory)

11% (6 - 24%)

Pilferage, space, and obsolescence 3% (2 - 5%)

Overall carrying cost 26%


20/46

12 - 20

In vento ry Mo dels fo r

In d ep en dent Dem an d

1. Basic economic order quantity

2. Production order quantity3. Quantity discount model

Need to determine when and how

much to order


21/46

12 - 21

B asic EOQ Mod el

1. Demand is known, constant, andindependent

2. Lead time is known and constant3. Receipt of inventory is instantaneous and

complete

4. Quantity discounts are not possible5. Only variable costs are setup and holding6. Stockouts can be completely avoided

Important assumptions


22/46

12 - 22

In vento ry Usage Over Tim e

Orderquantity = Q (maximuminventory

level)

Usage rate Averageinventoryon hand

Q2

Minimuminventory

I n v e n

t o r y

l e v e

l

Time0


23/46

12 - 23

Minim izing Cos t s

Objective is to minimize total costs

A n n u a

l c o s

t

Order quantity

Total cost ofholding and

setup (order)

Holding cost

Setup (or order)cost

Minimumtotal cost

Optimal orderquantity ( Q *)


24/46

12 - 24

The EOQ Mo d el

Q = 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 = (Number of orders placed per year)x (Setup or order cost per order)

Annual demand

Number of units in each orderSetup or ordercost per order

=

Annual setup cost = SDQ

= (S )DQ


25/46

12 - 25

The EOQ Mo d el



Annual holding cost = (Average inventory level)x (Holding cost per unit per year)

Order quantity

2= (Holding cost per unit per year)

= (H )Q2


Annual holding cost = HQ

2


26/46

12 - 26

The EOQ Mo d el



Optimal order quantity is found when annual setup costequals annual holding cost


Annual holding cost = HQ

2

DQ

S = HQ2

Solving for Q *2DS = Q 2HQ 2 = 2 DS /H

Q * = 2DS /H


27/46

12 - 27

A n EOQ Exam ple

Determine optimal number of needles to orderD = 1,000 unitsS = $10 per orderH = $.50 per unit per year

Q * = 2DSH

Q * = 2(1,000)(10)0.50

= 40,000 = 200 units


28/46

12 - 28

A n EOQ Exam ple

Determine optimal number of needles to orderD = 1,000 units Q * = 200 unitsS = $10 per orderH = $.50 per unit per year

= N = =Expectednumber of

orders

DemandOrder quantity

DQ *

N = = 5 orders per year1,000200


29/46

12 - 29

A n EOQ Exam ple

Determine 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 betweenorders

Number of workingdays per year

N

T = = 50 days between orders2505


30/46

12 - 30

A n EOQ Exam ple

Determine 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)1,000200200

2

TC = (5)($10) + (100)($.50) = $50 + $50 = $100


31/46

12 - 31

Reo rd er Po in ts

EOQ answers the how much question The reorder point (ROP) tells when toorder

ROP = Lead time for anew order in daysDemandper day

= d x Ld = DNumber of working days in a year


32/46

12 - 32

Reo rd er Poin t Curv e

Q *

ROP(units) I n

v e n

t o r y

l e v e

l ( u n

i t s

)

Time (days)Lead time = L

Slope = units/day = d

Resupply takes place as order arrives


33/46

12 - 33

Reo rd er Poin t Exam p le

Demand = 8,000 iPods per year250 working day yearLead time for orders is 3 working days

ROP = d x L

d = DNumber of working days in a year

= 8,000/250 = 32 units

= 32 units per day x 3 days = 96 units


34/46

12 - 34

Quant i ty Disc o un t Mo dels

Reduced prices are often available whenlarger quantities are purchased

Trade-off is between reduced product costand increased holding cost

Total cost = Setup cost + Holding cost + Product cost

TC = S + H + PDDQ

Q2


35/46

12 - 35


DiscountNumber Discount Quantity Discount (%) DiscountPrice ( P )

1 0 to 999 no discount $5.00

2 1,000 to 1,999 4 $4.80

3 2,000 and over 5 $4.75

A typical quantity discount schedule

S = $49Holding Cost = 20%

Demand = 5000 p.a.


36/46

12 - 36


1. For each discount, calculate Q *

2. If Q * for a discount doesnt qualify,choose the smallest possible order sizeto get the discount

3. Compute the total cost for each Q * oradjusted value from Step 2

4. Select the Q * that gives the lowest totalcost

Steps in analyzing a quantity discount


37/46

12 - 37


1,000 2,000

T o

t a l c o s

t $

0

Order quantity

1st pricebreak

2nd pricebreak

Total costcurve for

discount 1

Total cost curve for discount 2

Total cost curve for discount 3

Figure 12.7


38/46

12 - 38

Quan t ity Disco u nt Exam ple

Calculate Q * for every discount Q* = 2DSIP

Q 1* = = 700 cars/order2(5,000)(49)

(.2)(5.00)

Q 2* = = 714 cars/order2(5,000)(49)

(.2)(4.80)

Q 3* = = 718 cars/order2(5,000)(49)

(.2)(4.75)


39/46

12 - 39


Calculate Q * for every discount Q* = 2DSIP

Q 1* = = 700 cars/order2(5,000)(49)

(.2)(5.00)

Q 2* = = 714 cars/order2(5,000)(49)

(.2)(4.80)

Q 3* = = 718 cars/order2(5,000)(49)

(.2)(4.75)

1,000 adjusted

2,000 adjusted


40/46

12 - 40


DiscountNumber

UnitPrice

OrderQuantity

AnnualProduct

Cost

AnnualOrdering

Cost

AnnualHolding

Cost Total

1 $5.00 700 $25,000 $350 $350 $25,7002 $4.80 1,000 $24,000 $245 $480 $24,725

3 $4.75 2,000 $23.750 $122.50 $950 $24,822.50

Table 12.3

Choose the price and quantity that givesthe lowest total cost

Buy 1,000 units at $4.80 per unit


41/46

12 - 41

Prob abi l is t i c Mod els and

Safety Sto c kUsed when demand is not constantor certain

Use safety stock to achieve a desiredservice level and avoid stockouts

ROP = d x L + s s


42/46

12 - 42

Other Pro b abi l i s t ic Mo d els

Both demand and lead time are variable

ROP = (average daily demandx average lead time) + Z d LT

where d = standard deviation of demand per day

LT = standard deviation of lead time in days

d LT = (average lead time x d 2)+ (average daily demand) 2 x LT 2


43/46

12 - 43

Fixed -Perio d (P) Sys tem s

Orders placed at the end of a fixed periodInventory counted only at end of period

Order brings inventory up to target level

Only relevant costs are ordering and holdingLead times are known and constantItems are independent from one another


44/46

12 - 44

Fixed -Perio d (P) Sys tem s

O n - h a n

d i n v e n t o r y

Time

Q 1

Q 2

Target quantity ( T )

P

Q 3

Q 4

P

P

Figure 12.9


45/46

12 - 45

Fixed -Perio d (P) Exam p le

Order amount ( Q ) = Target ( T ) - On-hand inventory - Earlier orders not yet

received + Back orders

Q = 50 - 0 - 0 + 3 = 53 jackets

3 jackets are back ordered No jackets are in stockIt is time to place an order Target value = 50


46/46

Fixed-Per io d Sys tem s

Inventory is only counted at eachreview period

May be scheduled at convenient timesAppropriate in routine situationsMay result in stockouts between

periodsMay require increased safety stock

inventory management session 3

Documents