Ready to Use

8/8/2019 Ready to Use

1/40

Inventory Management


2/40

IntroductionInventories are assets of the firm and assuch they represent an Investment.Because such investment requirescommitment of funds, managers mustensure that the firm maintainsinventories at Optimal Level.Inventory is one of the most expensive

assets of many companies.It represents as much as 40% of totalinvested capital.


3/40

Types of InventoriesRaw materials & purchased partsPartially completed goods called work in

progressFinished-goods inventories(manufacturing firms ) or merchandise(retail stores)

Replacement parts, tools & SuppliesGoods-in-transit to warehouses orcustomers


4/40

Two Fundamental

Inventory DecisionsHow much to order of eachmaterial when orders are placedwith either outside suppliers orproduction departments withinorganizations

When to place the orders


5/40

Why We Want to Hold

InventoriesImprove customer serviceReduce certain costs such as

ordering costsstockout costsacquisition costsstart-up quality costs

Contribute to the efficient and effectiveoperation of the production system


6/40

Inventory and Supply Chain

ManagementBullwhip effect

demand information is distorted as it movesaway from the end-use customer

higher safety stock inventories to are stored tocompensateSeasonal or cyclical demandInventory provides independence fromvendors

Take advantage of price discountsInventory provides independence betweenstages and avoids work stop-pages


7/40

Inventory and Quality

ManagementCustomers usually perceive qualityservice as availability of goodsthey want when they want themInventory must be sufficient toprovide high-quality customerservice in TQM


8/40

Inventory Costs

Carrying costCarrying costcost of holding an item in inventorycost of holding an item in inventory

Ordering costOrdering costcost of replenishing inventory.cost of replenishing inventory.

These costs are opposing costs, i.e., as These costs are opposing costs, i.e., asone increases the other decreasesone increases the other decreases

Shortage costShortage costtemporary or permanent loss of salestemporary or permanent loss of saleswhen demand cannot be metwhen demand cannot be met


9/40

Inventory Control Systems

Continuous system (fixed-Continuous system (fixed-order-quantity)order-quantity)

constant amount orderedconstant amount orderedwhen inventory declines towhen inventory declines topredetermined levelpredetermined level

Periodic system (fixed-time-Periodic system (fixed-time-period)period)

order placed for variableorder placed for variableamount after fixed passage of amount after fixed passage of timetime


10/40

Economic Order

Quantity (EOQ) ModelsEOQ

optimal order quantity thatwill minimize total inventorycosts

EOQ= 2DO/C


11/40

Assumptions of BasicEOQ Model

Demand is known with certainty andDemand is known with certainty and

is constant over timeis constant over timeNo shortages are allowedNo shortages are allowedLead time for the receipt of orders isLead time for the receipt of orders isconstantconstantOrder quantity is received all at onceOrder quantity is received all at once


12/40

Model I: Basic EOQ Typical assumptions made

annual demand (D), carrying cost (C) and

ordering cost (O) can be estimatedaverage inventory level is the fixed orderquantity (Q) divided by 2 which implies

no safety stock

orders are received all at oncedemand occurs at a uniform rateno inventory when an order arrives

. . . more


13/40

Model I: Basic EOQAssumptions (continued)

Stockout, customer responsiveness, and other

costs are inconsequentialacquisition cost is fixed, i.e., no quantitydiscounts

Annual carrying cost = (average inventory level) x

(carrying cost) = (Q/2)CAnnual ordering cost = (average number of ordersper year) x (ordering cost) = (D/Q)O


14/40

EOQ Cost Model

C C oo - cost of placing order - cost of placing order DD - annual demand- annual demandC C cc - annual per-unit carrying cost- annual per-unit carrying cost QQ - order quantity- order quantity

Annual ordering cost =Annual ordering cost =C C oo DD

QQ

Annual carrying cost =Annual carrying cost =C C cc QQ

22

Total cost = +Total cost = +C C oo DD

QQ

C C cc QQ

22


15/40

EOQ Cost Model (cont.)

Order Quantity,Order Quantity, QQ

AnnualAnnualcost ($)cost ($) Total CostTotal Cost

Carrying Cost =Carrying Cost =C C cc QQ

22

Slope = 0Slope = 0

MinimumMinimumtotal costtotal cost

Optimal order Optimal order QQ optopt

Ordering Cost =Ordering Cost = C C

oo DD

QQ


16/40

EOQ Example

C C cc = $0.75 per yard= $0.75 per yard C C oo = $150= $150 DD = 10,000 yards= 10,000 yards

QQ optopt ==22C C oo DD

C C cc

QQ optopt ==2(150)(10,000)2(150)(10,000)

(0.75)(0.75)

QQ optopt = 2,000 yards= 2,000 yards

TC TC minmin = += +C C oo DD

QQ

C C cc QQ

22

TC TC minmin = += +(150)(10,000)(150)(10,000)

2,0002,000(0.75)(2,000)(0.75)(2,000)

22

TC TC minmin = $750 + $750 = $1,500= $750 + $750 = $1,500

Orders per year =Orders per year = DD //QQ optopt== 10,000/2,00010,000/2,000== 5 orders/year 5 orders/year

Order cycle time =Order cycle time = 311 days/(311 days/( DD //QQ optopt ))

== 311/5311/5== 62.2 store days62.2 store days


17/40

Quantity Discounts

Price per unit decreases as order Price per unit decreases as order

quantity increasesquantity increases

TC TC = + += + + PDPDC C oo DD

QQ

C C cc QQ

22

wherewhereP P = per unit price of the item= per unit price of the item

DD = annual demand= annual demand


18/40

Quantity Discount:Example

QUANTITYQUANTITY PRICEPRICE

1 - 491 - 49 $1,400$1,40050 - 8950 - 89 1,1001,100

90+90+ 900900

C C oo == $2,500$2,500

C C c c == $190 per computer $190 per computer

DD == 200200

QQ optopt = = = 72.5 PCs= = = 72.5 PCs22C C oo DD

C C cc

2(2500)(200)2(2500)(200)190190

TC TC = + += + + PDPD = $233,784= $233,784C C oo DD

QQ optopt

C C cc QQoptopt

22

For For QQ = 72.5= 72.5

TC TC = + += + + PDPD = $194,105= $194,105C C oo DD

QQ

C C cc QQ

22

For For QQ = 90= 90


19/40

Reorder Point

Level of inventory at which a new order Level of inventory at which a new order is placed is placed

R R == d X Ld X Lwherewhere

d d = demand rate per period= demand rate per periodLL = lead time= lead time


20/40

Reorder Point: Example

Demand = 10,000 yards/year Demand = 10,000 yards/year

Store open 311 days/year Store open 311 days/year Daily demand = 10,000 / 311 = 32.154Daily demand = 10,000 / 311 = 32.154yards/dayyards/dayLead time = L = 10 daysLead time = L = 10 days

R = d X L = (32.154)(10) = 321.54 yardsR = d X L = (32.154)(10) = 321.54 yards


21/40

Inventory Management Techniques

Reorder point under certaintylead time

average usageReorder point = Lead time x average usage

Reorder point under uncertaintysafety stock

Reorder point = (Lead time x average usage)+ safety stock


22/40

Safety Stocks

Safety stockSafety stockbuffer added to on hand inventory during leadbuffer added to on hand inventory during lead

timetimeStockoutStockout

an inventory shortagean inventory shortage

Service levelService levelprobability that the inventory available duringprobability that the inventory available duringlead time will meet demandlead time will meet demand


23/40

Reorder Point witha Safety Stock

Reorder Reorder point,point, R R

Q Q

LTLTTimeTime

LTLT

Inventory

level

Inventory

level

00Safety Stock


24/40

ABC ClassificationClass A

5 15 % of units70 80 % of value

Class B30 % of units15 % of value

Class C

50 60 % of units5 10 % of value


25/40

ABC Classification: Example

11 $ 60$ 60 909022 350350 4040

33 3030 13013044 8080 606055 3030 10010066 2020 180180

77 1010 17017088 320320 505099 510510 6060

1010 2020 120120

PARTPART UNIT COSTUNIT COST ANNUAL USAGEANNUAL USAGE


26/40

ABC Classification:Example (cont.)

Example 10.1Example 10.1

11 $ 60$ 60 909022 350350 404033 3030 13013044 8080 606055 3030 10010066 2020 180180

77 1010 17017088 320320 505099 510510 6060

1010 2020 120120

PARTPART UNIT COSTUNIT COST ANNUAL USAGEANNUAL USAGETOTAL % OF TOTAL % OF TOTALPART VALUE VALUE QUANTITY % CUMMULATIVE9 $30,600 35.9 6.0 6.08 16,000 18.7 5.0 11.0

2 14,000 16.4 4.0 15.01 5,400 6.3 9.0 24.04 4,800 5.6 6.0 30.03 3,900 4.6 10.0 40.06 3,600 4.2 18.0 58.0

5 3,000 3.5 13.0 71.010 2,400 2.8 12.0 83.07 1,700 2.0 17.0 100.0

$85,400

A A

BB

C C

% OF TOTAL % OF TOTALCLASS ITEMS VALUE QUANTITY

A 9, 8, 2 71.0 15.0B 1, 4, 3 16.5 25.0C 6, 5, 10, 7 12.5 60.0


27/40

Just-in-Time Inventory

Just in Time

Inventory is theminimuminventory that

is necessary tokeep a systemperfectlyrunning.


28/40


With just in time (JIT) inventory,

The exact amount of items arriveat the moment they areneeded , Not a minute before ORnot a minute after.


29/40


To achieve JIT inventory, Managersshould Reduce the Variability Caused by some Internal andExternal Factors.Existence of Inventory hides the

variability. What causesvariability?


30/40


Most variability is caused bytolerating waste (inventory).

(1) For example, employees ormachines produce units that do notconform to standards. These arewaste. And they cause variability.


31/40


(2) Or, engineering drawings areinaccurate, Again resulting in loss of

production And consecutivelyresulting in Variability. These are the internal (controllable)factors that cause Variability.However, Some of the variability iscaused by some external factors.


32/40


For example, customer demandsmay change due to some externalfactors (such as competitorsactions or promotions)In summary, To achieve JIT

inventory, Managers must beginwith Reducing Inventory.


33/40


Reducing Inventory uncovers theRocks located along the way on ariver, And the water streambecomes more clear.


34/40



35/40


In the figure, the section calledOthers are the Rocks on theriver.

Those rocks include QualityVariability, In-transit Delays,

Machine Breakdowns, Large Lot-sizes, Inaccurate drawings,Employee attendance variability.


36/40

Just-In-Time Production JIT production means (1) Elimination of Waste, (2) Synchronized Manufacturing, and(3) Little Inventory.Reducing the order batch size can be a majorhelp in reducing inventory.Average Inventory = (Maximum Inventory +

Minimum Inventory) / 2


37/40

Just-In-Time Production

Average Inventory drops as theinventory re-order quantity drops

because the maximum inventorylevel drops. (show by drawing)Moreover, the smaller the lot size,the fewer the problems are hidden.One way to achieve small lot sizesis to Move Inventory through theshop Only as needed.


38/40


Sending a card authorizes theprevious work center to send its

finished batch to the subsequentwork center.Batches are typically very small.

Such a system requires tightschedules and frequent set-ups formachines.


39/40


This is called a pull system. In thissystem, Ideal Lot size is 1.

Japanese call this system asKanban system.Kanban is a Japanese word for Card.

A card is used to signal the need formaterial in a work center.


40/40


On the other hand,Small batches allow a

very limited amountof faulty material,less damages, lessspace occupation,less materialhandling, lessaccidents, etc.

Documents

Ready to Use