Part 4:

QUANTITATIVE TECHNIQUES SOFTWARE GENERATED INFORMATION

INVENTORY CONTROL
Outcome 4: Use software-generated information to make decisions at operational, tactical and strategic levels in an organization. Assessment Criteria: 4.3 Prepare a spreadsheet to enable material requirements planning and calculate economic order quantities.

Part 4.2:

4.2.6
1.

Inventory Model EOQ

Fixed order-quantity models

Economic order quantity Production order quantity Quantity discount

2. Probabilistic models 3. Fixed order-period models

4.2.6
a. b. c. d. e. f. g.

Inventory Model
Known and constant stockholding cost Known and constant ordering cost Known and constant demand Known and constant lead time Instantaneous replenishment of material Constant price per unit /no discounts No stockouts

EOQ Assumptions

4.2.3

Inventory Cost
2. Costs of obtaining stock -

1. Costs of holding stock associated with holding or carrying inventory over time

3. Stockout Costs associated with

o t S

k c

t s o C

associated with costs of placing order and receiving goods

4. Cost of Stock itself cost of

buying in price/ direct

4.2.3

Inventory Cost
1.Costs of holding/ carrying stock a) Interest on capital invested in the stock b) Warehousing/ Storage charges (rent, lighting, heating, refrigeration, air conditioning, etc.)

Stock costs

c)

Stores staffing, equipment maintenance and running costs Insurance, security e) Pilferage, vermin damage f) Deterioration and obsolescence

d)

4.2.3

Inventory Cost
2.Costs of obtaining stock

Stock costs

a) Clerical & administration cost associated with purchasing, accounting, and Goods Received Dept. b) Transportation c) costs Cost associated with internal ordering

.2.6

Inventory Model (EOQ)

ustration 3: Graphical Illustration of EOQ

A company use 50,000 bulbs per annum which are RM7 each to purchase. The ordering costs are RM50 per order and carrying costs are 5% of purchase price per annum, i.e. it cost RM0.35 p.a to carry a widget in stock (RM7 x 5%) Various cost calculation: i. Total cost per annum = Co p.a + Cc p.a where Co p.a = No. of order x Cost per order No. of orders = Annual Demand/Order Quantity Cc p.a = Average stock level

.2.6

Inventory Model (EOQ)

ustration 3: Graphical Illustration of EOQ Total cost per annum = Co p.a + Cc p.a i. No. of orders = Annual Demand/Order
Quantity = 50,000 / 5,000 = 10 times ii. Co p.a = 10 x RM50 = RM500 iii. Average stock = 5,000 / 2 = 2,500 units iv. Cc p.a = 2,500 x RM0.35 = RM875 ** From various assumption of quantity order, we may plot the various cost in a graph as follows

.2.6

Inventory Model (EOQ)

Annual Cost

ustration 3: Graphical Illustration of EOQ

Minimu m total cost

Co l a t To
H

ve r u tC

ost C ing d l o

rve u C

Order (Setup) Cost Curve Optimal Order Quantity (EOQ)

h c u Order quantity m r? w de o H or to

.2.6

Inventory Model (EOQ)

Why Holding Cost Increase

More units must be stored if more are ordered

Purchase Order Description Qty. Microwave 1

Purchase Order Description Qty. Microwave 1000

Order quantity

Order quantity

.2.6

Inventory Model (EOQ)

Why Order Cost Decrease

Cost is spread over more units
Example: You need 1000 microwave ovens
1 Order (Postage RM 0.33)
Purchase Order Description Qty. Microwave 1000

1000 Orders (Postage RM330) PurchaseOrder Order Purchase PurchaseOrder Order Description Qty. Purchase Description Qty. Description Qty.1 Microwave Description Qty. Microwave 11 Microwave Microwave 1

Order quantity

.2.6

Inventory Model (EOQ)

asic Model Economic Order Quantit

EOQ formula: Ordering cost per order

EOQ =

2 Co D Demand per cycle CcCarrying cost per item

(per cycle)

Notes: Always take care that demand and carrying costs are expressed for the same time period. A year is the usual period used. In some problems the carrying cost is expressed as a percentage of the value whereas in others it is expressed directly as a

.2.6

Inventory Model (EOQ)

lustration 4: Economic Order Quantity

Based on Illustration 3 Demand = 50,000 bulbs, Price per item = RM7 Ordering cost = RM50 per order, Carrying cost = 5% x RM7 = RM0.35

EOQ =

2 Co D Cc

2 50 50,000 0.35

= 3779.64 3780 units

.2.6

Inventory Model (EOQ)

Cost Equation for Basic Model

Where D q C = Co + Cc C = total ordering cost + total q 2 carrying cost Co = Annual ordering cost Cc = Annual carrying cost As q get larger: q = quantity order Annual ordering cost become smaller Annual holding cost become larger

&

Total annual inventory cost is minimised when the order quantity, q takes the value of EOQ

.2.6

Inventory Model (EOQ)

ustration 5: Cost Equation for Basic Model

Based on Illustration 3 Demand = 50,000 bulbs, Price per item = RM7 Ordering cost = RM50 per order, Carrying cost = 5% x RM7 = RM0.35

D q C = Co + Cc q 2

50,000 3780 (50) + (0.35) = 3780 2 = 661.38 + 661.50 = RM1322.88

.2.6

Inventory Model (EOQ)

stration 5: Cost Equation for Basic Model (con

Suppose that the present quantity order by this company is; a. 5000 bulbs or, b. 2000 bulbs If other cost are unchanged, calculate the present total 50 ,000 by each 5000 annual cost incurred (50) + present (0.35quantity ) C q =5000 = 5000 2 order?

= 500 + 875 = RM1375.00

.2.6

Inventory Model (EOQ)

stration 5: Cost Equation for Basic Model (con

50,000 2000 (50) + (0.35) C q =2000 = 2000 2

r u o y ? s n o t = 1250 + 350 i a s h lu W = RM 1600 c n o c Total annual cost for quantity order based on

calculated EOQ is the lowest compared to other two order quantities which are larger and smaller than the EOQ. These calculated cost proved that the EOQ minimise the balance of costs between inventory holding cost and re-

.2.6

Inventory Model (EOQ)

Illustration 6 (Graphical): EOQ

Inventory Model
DO IT YOURSELF!!!
1. A company uses 100,000 units of EG per year which cost RM3 each. Carrying costs are 1% per month and ordering costs are RM250 per order. Currently, the company purchase this EG in batches of 7500 units each. Suggest the best quantity order for this company and explains the total cost saved by using EOQ.

Inventory Model
DO IT YOURSELF!!!

A building materials supplier obtains its bagged cement from a single supplier. Demand is reasonably constant throughout the year and last year the company sold 2000 tones of this product. It estimates the cost of placing an order at around RM25 each time an order is placed, and calculates that the annual cost of holding inventory is 20% of purchase cost. The company purchases the cement at RM60 per tone. How much should the company order at a time? After calculating the EOQ the operations manager feels that placing an order using EOQ

Inventory Model
SOLUTION
EOQ = 2 Co D Cc 2 250 100 ,000 = 12% 3 = 11785.11 11785 units

C EOQ

D q 100 ,000 11785 = Co + C c = ( 250 ) + ( 0.36 ) q 2 11785 2 = 2121.34 + 2121.30

= RM 4242.64

Inventory Model
SOLUTION (cont.)
C7500 D q = Co + C c q 2
100 ,000 7500 ( 250 ) + ( 0.36 ) = 7500 2 = 3333.33 + 1350
= RM 4683.33

4.2.6

Inventory Model

EOQ with Discount

Unrealistic assumption with the basic EOQ assumption is that the price per item remains constant Consider the costs associated with the normal EOQ and compare these costs with the costs at each succeeding discount point Find the best quantity to order

4.2.6

Inventory Model
Financial consequences of discount

EOQ with Discount

Three financial effect; Saving comes from lower price per item it The larger order quantity means that fewer f orders e n tare need to be placed so that total ordering costs c e B ffe reduced. E Increased costs arise from the extra stockholding costs caused by the average stock level being e s higher due to the larger order quantity. er t

v c d A ffe E

4.2.6

Inventory Model

Calculating EOQ with Discount

1. Find EOQ using basic price 2. Compare the savings from the lower price and ordering costs and the extra stock-holding at each discount point, with the costs associated with the basic EOQ. - find various costs and saving comparisons based on EOQ

.2.6

Inventory Model (EOQ)

A company uses a special bracket in the manufacturer of its product which it orders from outside suppliers. The appropriate data are Demand 2,000 per annum Order cost RM20 per order Carrying cost 15% of item price Basic item price RM10 per bracket The company is offered the following discounts on the basic price: For order quantities 400 700 less 2% 800 1,599 less 4% 1,600 and over less 5% What is the most economical quantity to order?

lustration 6: Equation with Discount

.2.6
No . 1. 2.

Inventory Model (EOQ)

Order Quantity Discount
2000

lustration 6: Equation with Discount

EOQ = 230 400 2%
2000

800 4%
2000

1600 5%
2000

3.

Minimum = quantity Average No. of Comparison = 8.7 =5 2.5 = 1.25 230 800 for each 1600 Quantity, EOQ 400 entitled Order per discount rate annum 8.7 2.5 8.7 1.25 8.7 5 = 6.2 times = 7.45 times = 3.7 times Average No. of Order Saver 3.7 RM 20 6.2 RM 20 7.45 RM 20 per annum

4.

Ordering Cost Saving per annum Price Saving

= RM 74

= RM 124

= RM 149

RM 10 2% D RM 10 4% D RM 10 5% D = RM 1000 = RM 400 = RM 800

5.

RM 474

RM 924 RM 1149

.2.6

Inventory Model (EOQ)

EOQ 400 800

lustration 6: Equation with Discount

No Order . Quantity 7. Stockholding Cost per annum 8. Additional Costs Incurred by Increased Order

10 X 2% = RM0.20 Price after disc = 10 0.20 = RM9.80

1600

800 1600 400 230 9.60 9.50 9.80 10 2 2 2 2 15% 15% 15% 15% = RM 172.50 = RM 294 = RM 576 = RM 1140
294 172.50 576 172.50 1140 172.50 = RM 121.50 = RM 403.50 = RM 967.50

RM 352.50 RM 520.50 RM 181.50

Net most Gain/ economical quantity to order? hat9. is the 1600 buckets Loss Company Why? will saved RM710 due to discount offered (5%) a frequency of orders to made

.2.6

Inventory Model (EOQ)

EOQ = 2 Co D Cc 2 20 2000 = 15% 10 = 230.94 230 brackets

lustration 6: Equation with Discount

EOQ
DO IT YOURSELF!!!
KABANA Bhd buy 100,000kg per annum of barites, a raw materials. The company purchases this commodity in batches of 2,000kg and pays RM10 per kg. The cost of ordering is estimated at Rm70 and the cost of holding each kg in stock is estimated at 10% of the purchase costs. Calculate the economic order quantity How much money would be saved by ordering the EOQ rather than the present