Inventory Management

Inventory

• Is basically the physical stock of items

having monetary value

• A stock or store of goods

12-2
 Inventory
Types of Demand

Dependent Demand Independent Demand

12-3
Independent demand
 When most of the major factors generating
the demand of particular items are not known
or not completely studied

Dependent demand
 Once the independent demand is determined
then the demand of items/units-
subcomponents of the main units is fixed.
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 A manufacturer decide to make a production
of 5000 scooters. (Independent Demand)

 The manufacturer order 10,000 tires and

tubes. 5000 head- lights bulb. (Dependent
Demand)

12-5
 Dependent Demand
Classify as /Method Use:
 Just in Time
 Material Requirements Planning (MRP)
 Manageable-in-time( MIT)

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 Independent Demand
Classify as / Method Use:
 Periodic review system (P-System)
 Fixed order system (Q-System)
 EOQ MODELS
 EOQ MODELS (Shortage Allowed)
 EOQ Price Breaks
 Record Level- Safety level/ Buffer Stock

12-7
 Types of Inventories
 Raw materials
 Partially completed goods called
work in progress
 Finished-goods inventories
 (manufacturing firms)
or merchandise
(retail stores)

12-8
 Functions of Inventory

 To meet anticipated demand

 To smooth production requirements
 To protect against stock-outs
 To take advantage of order cycles
 To help hedge against price increases
 To take advantage of quantity discounts

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Effective Inventory Management
 A system to keep track of inventory
 A reliable forecast of demand
 Knowledge of lead times
 Reasonable estimates of
 Holding costs
 Ordering costs
 Shortage costs
 A classification system
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Effective Inventory Management

12-11
Effective Inventory Management

12-12
 Inventory Counting Systems
 Periodic System
Physical count of items made at periodic
intervals
 Perpetual Inventory System
System that keeps track
of removals from inventory
continuously, thus
monitoring
current levels of
each item

12-13
 Inventory Counting Systems
(Cont’d)
 Two-Bin System - Two containers of
inventory; reorder when the first is
empty
 Universal Bar Code - Bar code
printed on a label that has
information about the item
to which it is attached 0

214800 232087768

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 Inventory Management: Cycle Counting

 A physical count of items in inventory

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 Key Inventory Terms
 Lead time: time interval between
ordering and receiving the order
 Holding (carrying) costs: cost to carry
an item in inventory for a length of time,
usually a year
 Ordering costs: costs of ordering and
receiving inventory
 Shortage costs: costs when demand
exceeds supply

12-16
 Classification of Inventory
 ABC Classification
 HML Classification
 XYZ Classification
 VED Classification
 FSN Classification
 SDF Classification
 GOLF Classification
 SOS Classification

12-17
 Classification of Inventory
ABC Classification
 Divides on-hand inventory into three
classification basis.
 Consider as a pareto principle
 80-20 rule

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 Classification of Inventory
HML Classification
 Aimed to control the purchase of raw
materials.
H – High, M- Medium, L – Low
XYZ Classification
 Whereas ABC was on the basis of value
of consumption to value.
 X – High Value Y – Medium value Z– Least value
 Aimed to identify items which are
extensively stocked.

12-19
 Classification of Inventory
VED Classification
 Mainly for spare parts because their
consumption pattern is different from raw
materials.
 Raw materials on market demand, Spare
parts on performance of plant and
machinery.
 V – Vital, E – Essential, D – Desirable

12-20
 Classification of Inventory
FSN Classification
 According to the consumption pattern
 To combat obsolete items
 F – Fast moving S – Slow moving N – Non Moving

12-21
 Classification of Inventory
SDF & GOLF Classification
Based on source of procurement
S – Scarce, D- Difficult, E- Easy.
GOLF
G – Government, O – Ordinary, L – Local, F – Foreign
SOS Classification
Raw materials especially for agriculture units
S – Seasonal ,OS – Off seasonal

12-22
 ABC Classification System

Classifying inventory according to some

measure of importance and allocating
control efforts accordingly.
A - very important
B - mod. important High
A
C - least important Annual
$ value B
of items

Low C
Low High
Percentage of Items
12-23
 ABC Classification System
Policies that may be based on ABC analysis include the
following:
1. Purchasing resources should be much higher for
individual A items than for C items.
2. A items, as opposed to B and C items, should have
tighter physical inventory control; perhaps they belong in a
more secure area, and perhaps the accuracy of inventory
records for A items should be verified more frequently.

3. Forecasting A items may warrant more care than

forecasting other items.

12-24
 Inventory Models for Independent Demand

Economic order quantity (EOQ) model

 The order size that minimizes total annual
cost
Annual Annual
Ordering/
Total cost = Carrying/ +
Setup
Holding
cost cost
Q + DS
TC = H
2 Q

12-25
 Assumptions of EOQ Model

 Only one product is involved

 Annual demand requirements known
 Demand is even throughout the year
 Lead time does not vary
 Each order is received in a single
delivery
 There are no quantity discounts
12-26
 EOQ EXAMPLE
 Sharp, Inc., a company that markets
painless hypodermic needles to
hospitals, would like to reduce its
inventory cost by determining the optimal
number of hypodermic needles to obtain
per order. The annual demand is 1,000
units; the setup or ordering cost is $10
per order; and the holding cost per unit
per year is $.50.

12-27
 EOQ EXAMPLE
 Sharp, Inc. has a 250-day working year
and wants to find the number of orders
and the expected time between orders.
 Determine the Total Annual Inventory
cost

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 The Inventory Cycle
Figure 12.2

Profile of Inventory Level Over Time

Q Usage
Quantity rate
on hand

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time

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 Cost Minimization Goal
Figure 12.4C

The Total-Cost Curve is U-Shaped

Q D
TC  H  S
Annual Cost

2 Q

Ordering Costs

Order Quantity
QO (optimal order quantity)
(Q)

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When to Reorder with EOQ Ordering

 Reorder Point – The inventory level

(point) which action is taken to
replenish the stocked item.
 Safety Stock - Stock that is held in
excess of expected demand. Extra
stock to allow for uneven demand; a
buffer
 Service Level - Probability that demand
will not exceed supply during lead time.

12-31
Reorder Point (ROP)
 Reorder Point (ROP)

Electronic Assembler, Inc., has a demand

for 8,000 VCRs per year. The firm
operates a 250-day working year. On
average, delivery of an order takes 3
working days. Determine the ROP
Production Order Quantity Model

 An Economic order quantity techniques

applied to production orders
 Material is not received
instantaneously.
 For example, it is produced in-house.
 Other EOQ assumptions apply.
 POQ Model Equations
D = Annual demand (relatively constant)
S = Setup cost per setup Given
H = Holding (carrying) cost per unit per year
d = Demand rate (units per day, units per week, etc.)
p = Production rate (units per day, units per week, etc.)

Determine: Q = Production run size (number of items per production run)

D
Number of Production Runs per year =
Q
D
Setup Cost per year = S
Q
Holding Cost per year = (average inventory level)  H
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 POQ Model Equations
D = Annual demand (relatively constant)
S = Setup cost per setup Given
H = Holding (carrying) cost per unit per year
d = Demand rate (units per day, units per week, etc.)
p = Production rate (units per day, units per week, etc.)

Determine: Q = Production run size (number of items per production run)

D
Number of Production Runs per year =
Q
D
Setup Cost per year = S
Q
Q
Holding Cost per year = (ave. inventory level)  H = H [1-(d/p)]
2
12-36
 POQ Model Equations
D = Annual demand
S = Setup cost per setup Given
H = Holding (carrying) cost per unit per year
d = Demand rate
p = Production rate

Optimal Production Run Size = Q* =

2 ×D ×S 2DS p
=
H[1-(d/p)] H p-d
Maximum inventory level = Q [1- (d/p)]
D Q
Total Cost = S+ H [1-(d/p)]
Q 2
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 Run Length & Cycle Length
Production Run length (time) = Q /p
Inventory Level

Time

Cycle length (time) = Q /d

12-38
 POQ Example
Demand = 1000/year (of product A)
Setup cost = $100/setup
Holding cost = $20 per year per item
Production rate = 10/day
365 working days per year
Determine the optimal production size, maximum inventory,
production run length, Cycle Length
 POQ Example
ABC Manufacturing company makes and sells specialty
hubcaps for the retail automobile aftermarket. The company
forecast for its wire-wheel hubcap is 1,000 units next year,
with an average daily demand of 4 units. However, the
production process is most efficient at 8 units per day. So
the company produces 8 per day but uses only 4 per day.
Given the following values, solve for the optimum number
of units per order . Note: this plant schedules production of
this hubcap only as needed, during 250 days per year.
Setup cost is $10 and Holding cost is $0.50 per unit per
year.
 Quantity Discount Model
 Variation of EOQ (not POQ).
 Allows quantity discounts.
 Reduced price for purchasing larger quantities.
 Other EOQ assumptions apply.
 Total cost must include annual purchase cost.
Total Cost = Order cost + Holding cost + Purchase cost

12-41
Quantity Discount Model - Holding
Cost
 Holding cost:
 Depends on price.
 Usually expressed as a % of price per unit time.
 20% of price per year, 2% of price per month, etc.

 I = Holding cost percent of price per year

 P = Price per unit
 H = Holding cost = IP

12-42
 Quantity Discount Equations
D = Annual demand
S = Order cost per order
H = Holding (carrying) cost = IP
I = Inventory holding cost % per year
P = Price per unit

2 ×D ×S
Order Quantity = Q* =
IP
Annual purchase cost

Total Cost ($/yr) =

D Q
S+ IP + PD
Q 2

12-43
Discount store stocks toy race cares. Recently, the store
has been given a quantity discount schedule for these
cars. This quantity schedule is shown in the table. The
normal cost for the toy race cars is $5.00. For orders
between 1,000 and 1,999 units, the units cost drops to
$4.80; for orders 2,000 or more units, the units cost is
only $4.75. Furthermore, ordering cost is $49.00 per
order, annual demand is 5,000 race cars, and an
inventory carrying charge, as a percentage of cost is
20%. What order quantity will minimize the total inventory
cost?
 Quantity Discount Model
Q P IP
D = 1000/year
<500 $100 $20
S = $100/order
I = 20% per year 500-1000 $ 95 $19
 1000 $ 90 $18

To solve:
1. Find EOQ amount for each discount level.
2. If EOQ is not in range for discount level, adjust to the nearest
end of range.
3. Calculate total cost for each discount level.
4. Select lowest cost and corresponding Q.

12-45
 Quantity Discount Example
Q P IP
D = 1000/year
S = $100/order <500 $100 $20
I = 20% per year 500-1000 $ 95 $19
 1000 $ 90 $18
1. P = $100 IP = $20
EOQ = 100 in range!
Total Cost = 1,000 + 1,000 + 100,000 = $102,000/year

2. P = $95 IP = $19
EOQ = 102.6 not in range (500-1000)!
Adjust to Q = 500
Total Cost = 200 + 4,750 + 95,000 = $99,950/year

12-46
Quantity Discount Example - cont.
Q P IP
D = 1000/year
S = $100/order <500 $100 $20
I = 20% per year 500-1000 $ 95 $19
 1000 $ 90 $18
3. P = $90 IP = $18
EOQ = 105.4 not in range (>1000)!
Adjust to Q = 1000
Total Cost = 100 + 9,000 + 90,000 = $99,100/year

Q Total costs
<500 $102,100
500-1000 $ 99,950
 1000 $ 99,100 Lowest cost, so order 1000
12-47
1.) Annual demand for notebook binders at Meyer’s Stationery Shop is
10,000 units. Brad Meyer operates his business 300 days per year
and finds that deliveries from his supplier generally take 5 working days.
Calculate the reorder point for the notebook binders.

2.) leonard Presby, Inc., has an annual demand rate of 1,000 units but can
produce at an average production rate of 2,000
units. Setup cost is $10; carrying cost is $1. What is the optimal number of units to
be produced each time?

3.) whole Nature Foods sells a gluten-free product for which the annual demand is
5,000 boxes. At the moment, it is paying $6.40 for each box; carrying cost is
25% of the unit cost; ordering costs are $25. A new supplier has offered to sell
the same item for $6.00 if Whole Nature Foods buys at least 3,000 boxes per
order. Should the firm stick with the old supplier, or take advantage of the new
quantity discount?