Chapter 21 Inventory Management

Chapter 21
Inventory Management:
Economic Order
Quantity, JIT, and the
Theory of Constraints
Vertue Volcano C1F015016
Fakultas Ekonomi dan Bisnis

Universitas Jenderal
Soedirman
2016
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
Study Objectives
2016
1.
Describe the just-in-case inventory

management model.
2.
Discuss just-in-time (JIT) inventory

management.
3.
Explain the basic concepts of constrained

optimization.
4.
Define the theory of constraints, and tell

how it can be used to manage inventory.
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
Just-in-Case Inventory
Management
2016
Three types of inventory costs can be

readily identified with inventory:
The cost of acquiring inventory.
The cost of holding inventory.
The cost of not having inventory on hand
when needed.
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
Management
2016
Ordering Costs: The costs of placing

and receiving an order.
Examples: Clerical costs, documents,
insurance for shipment, and unloading.
Setup Costs: The costs of preparing

equipment and facilities so they can
be used to produce a particular
product or component.
Examples: Setup labor, lost income (from
idled facilities), and test runs.
4
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
Management
2016
Stock-Out Costs: The costs of not

having sufficient inventory.
Examples: Lost sales, costs of expediting
(extra setup, transportation, etc.) and the
costs of interrupted production.
Carrying Costs: The costs of

carrying inventory.
Examples: Insurance, inventory taxes,
obsolescence, opportunity cost of capital
tied up in inventory, and storage.
5
Management
Management
Economic Order Quantity
TC = PD/Q + CQ/2
Where
TC =
The total ordering (or setup) and
carrying cost
P=
The cost of placing and receiving an
order (or the cost of setting up a production run)
Q=
The number of units ordered each time
an order is placed (or the lot size for production)
D=
The known annual demand
C=
The cost of carrying one unit of stock for
one year
7
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
Management
2016
Economic Order Quantity illustrated

Assume
P=
$40
per order
D=
25,000 units
C=
$2
per unitEOQ =
2DP C
(2 25,000 50)
40 $2
= 1,000,000
= 1,000
Management
When to Order or Produce
Example: Assume that the average rate of usage is
100 parts per day. Assume also that the
lead time is 4 days. What is the reorder
point?
Reorder point
= rate of usage lead time
= 4 100 = 400 units

An order should be placed when inventory
drops to 400 units.
Management
10
Management
Demand Uncertainty and Reordering
To avoid running out of parts, organizations often
choose to carry safety stock (extra inventory
carried to serve as insurance against fluctuations in
demand).
Example: If the maximum
usage of the VCR
part is 120 units per
day, the average
usage is 100 units
per day, and the lead
time is four days, the
safety stock is 80.
Maximum usage
Average usage
Difference
Lead time
Safety stock
120
(100)
20
4
80
11
Management
12
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
JIT Inventory Management
2016
Setup and Carrying Costs: The JIT Approach
JIT reduces the costs of acquiring inventory

to insignificant levels by
Drastically reducing setup time
Using long-term contracts for outside purchases
Carrying costs are reduced to insignificant

levels by reducing inventories to
insignificant levels.
13
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
2016
Avoidance of Shutdown: the JIT

approach
Total preventive maintenance

to reduce machine failures
Total quality control

To reduce defective parts
The Kanban system

To control production
14
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
2016
The Kanban system is responsible for

ensuring that the necessary products are
produced in the necessary quantities at the
necessary time.
A card system is used to monitor work in
process
A withdrawal Kanban
A production Kanban
A vendor Kanban
15
16
17
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
2016
Managing discounts and price increases

Traditional: holding inventories
JIT: negotiate long-term contracts
Vendors
Careful selection; consider more than price
Close to production facility
Establish more extensive supplier involvement
18
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
2016
JIT Limitations
Patience in implementation is needed.
Time is required.
JIT may cause lost sales and stressed
workers.
Production may be interrupted due to an
absence of inventory.
19
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
Basic Concepts of
Constrained Optimization
2016
Every firm faces limited resources and

limited demand for each product.
External constraints (e.g., market demand)
Internal constraints (e.g., machine or labor time
availability)
Constrained optimization is choosing the

optimal mix given the constraints faced by
the firm.
20
Basic Concepts of
Linear Programming
A method that searches among possible solutions until
the optimal solution is identified
Example: Two products, X and Y,
provide contribution
margins of $300 and
$600, respectively.
The objective function:

Z = $300X + $600Y
The objective is to
maximize total
contribution margin.
21
Basic Concepts of
Linear Programming
22
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
Basic Concepts of
2016
Internal constraints:
X+Y 80
X + 3Y 120
2C + Y 90
External constraints:
X 60
Y 100
Linear Programming
X+Y
X + 3Y
2C + Y
X
Y
X
Y
80
120
90
60
100
0
0
23
Basic Concepts of
24
Basic Concepts of
Linear Programming
Corner Point
X-Value
Y-Value
Z = $300X + $600Y
40
24,000
30
30
27,000
45
13,500
C is the optimal solution!

25
Measures of Systems Performance
Throughput*
The rate at which an organization generates
money through sales
Inventory
The money the organization spends in turning
materials into throughput
Operating expenses
The money the organization spends in turning
inventories into throughput
Sales - Unit-level
Rev
Var Exp
*Throughput =
Time
26
S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3
2016
Five-Step Method for Improving

Performance
Identify an organizations constraints.
Exploit the binding constraints.
Subordinate everything else to the

decisions made in Step 2.
Elevate the organizations binding

constraints.
Repeat the process as a new constraint

emerges to limit output.
27
28
29
30
End Chapter 21
Thank you
31

Chapter 21 Inventory Management

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Chapter 21 Inventory Management

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Chapter 21

Vertue Volcano C1F015016

Fakultas Ekonomi dan Bisnis

Describe the just-in-case inventory

Discuss just-in-time (JIT) inventory

Explain the basic concepts of constrained

Define the theory of constraints, and tell

Three types of inventory costs can be

Ordering Costs: The costs of placing

Setup Costs: The costs of preparing

Stock-Out Costs: The costs of not

Carrying Costs: The costs of

The known annual demand

Economic Order Quantity illustrated

= rate of usage lead time

= 4 100 = 400 units

JIT Inventory Management

Setup and Carrying Costs: The JIT Approach

JIT reduces the costs of acquiring inventory

Carrying costs are reduced to insignificant

JIT Inventory Management

Avoidance of Shutdown: the JIT

Total preventive maintenance

Total quality control

The Kanban system

JIT Inventory Management

The Kanban system is responsible for

JIT Inventory Management

JIT Inventory Management

JIT Inventory Management

Managing discounts and price increases

JIT Inventory Management

Every firm faces limited resources and

Constrained optimization is choosing the

The objective function:

C is the optimal solution!

Five-Step Method for Improving

Identify an organizations constraints.

Exploit the binding constraints.

Subordinate everything else to the

Elevate the organizations binding

Repeat the process as a new constraint

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