Inventory Management

Module - 2

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 What Is Inventory?

 Stock of items kept to meet an unexpected

future demand or distribution.

 Purpose of inventory management

 how many units to order
 when to order

12-2
 Types of Inventory

Inputs Outputs
• Raw Materials Process • Finished Goods
• Purchased • Scrap and Waste
parts (in
• Maintenance  warehouses,
In Process or “in
and Repair
• Partially transit”)
Materials (often on
Completed
Products and the factory
floor)
 Types of Inventory

 Raw materials
 Purchased parts and supplies
 Work-in-process (partially completed)
products (WIP)
 Items being transported
 Tools and equipment

12-4
 Water Tank Analogy for Inventory

Inventory Level
Supply Rate

Buffers
Inventory Level
Demand
Rate from
Supply Rate
Demand Rate
 Two Forms of Demand
 Dependent
 Demand for items used to produce
final products
 Tires stored at a Goodyear plant are
an example of a dependent demand
item
 Independent
 Demand for items used by external
customers
 Cars, appliances, computers, and
houses are examples of independent
demand inventory

12-6
 Reasons To Hold Inventory

 Meet variations in customer demand:

 Meet unexpected demand
 Smooth seasonal or cyclical demand
 Pricing related:
 Temporary price discounts
 Hedge against price increases
 Take advantage of quantity discounts
 Process & supply surprises
 Internal – upsets in parts of or our own processes
 External – delays in incoming goods
 Transit
 Reasons To NOT Hold Inventory

 Carrying cost
 Financially calculable
 Takes up valuable factory space
 Especially for in-process inventory
 Inventory covers up “problems” …
 That are best exposed and solved
 Inventory Costs

 Carrying cost
 cost of holding an item in inventory
 Costs connected directly with materials
 Financial Cost
 Ordering cost
 cost of replenishing inventory
 Cost of placing order
 Ordering from plant
12-9
 Inventory Control Systems

 Continuous system (fixed-order-quantity / Q

System)
 constant amount ordered when inventory
declines to predetermined level

 Periodic system (fixed-time-period / P System)

 order placed for variable amount after fixed
passage of time

12-10
 Difference between “Q” System &
“P” System
Point of Difference Q System P System
Initiation of Order Stock on hand reaches to Based on Fixed review
reorder point period & not stock level
Period of Order Any time when stock level Only after the
reaches to reorder level predetermined period

Record keeping Continuously each time a Only at the review period

withdrawal or addition is
made
Order Quantity Constant Varies each time order is
placed
Size of inventory Less than the P system Larger than the Q system

Time to maintain Higher due to perpetual Less time due to only at

record keeping the review period
12-11
 Inventory Control Techniques
 Always Better Control (ABC) Classification
 High, Medium & Low (HML) Classification
 Vital, Essential & Desirable (VED) Classification
 Scarce, Difficult & Easy to obtain (SDE)
 Fast Moving, Slow Moving & non Moving (FSN)
 Seasonal – off Seasonal Classification (SOS)
 XYZ Analysis
 GOLF Analysis
 Economic Order Quantity (EOQ)
 Max – Min System
 Two Bin System
12-12
 ABC Analysis

 Based on “Pareto Chart” concept.

 Classification of items as A, B, or C often
based on Total Value.
 Purpose: set priorities for management
attention.

Copyright 2006 John Wiley & Sons, Inc. 12-13

 ABC Classification

 Class A
 5 – 15 % of units
 70 – 80 % of value
 Class B
 30 % of units
 15 % of value
 Class C
 50 – 60 % of units
 5 – 10 % of value

12-14
ABC Classification: Example
PART UNIT COST ANNUAL USAGE
1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120

12-15
 ABC Classification:
Example (cont.)
TOTAL % OF TOTAL % OF TOTAL
PART PART
VALUE UNIT
VALUECOSTQUANTITY
ANNUAL USAGE
% CUMMULATIVE
9 1
$30,600 $ 60
35.9 6.0 90 6.0
8 16,000
2 18.7
350 5.0 11.0
2 14,000 16.4 4.0
A40 15.0
3 30 130
1 5,400 6.3 9.0 24.0
4 4
4,800 5.680 6.0 B60 30.0
3 5
3,900 4.630 10.0 100 40.0
% OF TOTAL % OF TOTAL
6 6
3,600
CLASS ITEMS20
4.2 18.0
VALUE 180QUANTITY
58.0
5 3,000
7 3.510 13.0 170 71.0
10 2,400
A 9, 8,2.8
2 12.0
71.0 C 83.0
8 320 50 15.0
7 1,700
B 1, 4,2.0
3 17.0
16.5 100.0
25.0
9
C 5107
6, 5, 10, 12.5 60 60.0
$85,400
10 20 120
Example 10.1

12-16
 Economic Order Quantity
(EOQ) Models

 EOQ
 optimal order quantity that will
minimize total inventory costs
 Basic EOQ model
 Production quantity model

12-17
 Assumptions of Basic
EOQ Model

 Demand is known with certainty and

is constant over time
 No shortages are allowed
 Lead time for the receipt of orders is
constant
 Order quantity is received all at once

12-18
 Economic Order Quantity (EOQ)
Model

 Demand rate D is constant, recurring, and known

 Amount in inventory is known at all times
 Ordering (setup) cost S per order is fixed
 Lead time L is constant and known.
 Unit cost C is constant (no quantity discounts)
 Annual carrying cost is i time the average $ value of the
inventory
 No stock outs allowed.
 Material is ordered or produced in a lot or batch and the
lot is received all at once
 Inventory Order Cycle
Order quantity, Q
Demand
rate
Inventory Level

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
placed receipt placed receipt

12-20
 EOQ Cost Model
Co - cost of placing order D - annual demand
Cc - annual per-unit carrying cost Q - order quantity

Co D
Annual ordering cost =
Q
CcQ
Annual carrying cost =
2
CoD CcQ
Total cost = +
Q 2

12-21
 EOQ Cost Model

Proving equality of
Deriving Qopt
costs at optimal point
Co D CcQ Co D CcQ
TC = + =
Q 2 Q 2
∂ TC Co D C
= + c 2CoD
∂Q Q2 2 Q =2

Cc
C0 D Cc
0= +
Q2 2 2CoD
Qopt =
2CoD Cc
Qopt =
Cc

12-22
 EOQ Cost Model (cont.)
Annual
cost ($) Total Cost
Slope = 0

CcQ
Minimum Carrying Cost =
2
total cost

CoD
Ordering Cost =
Q

Optimal order Order Quantity, Q

Qopt

12-23
 EOQ Example
Cc = $0.75 per yard Co = $150 D = 10,000 yards

2CoD CoD CcQ

Qopt = TCmin = +
Cc Q 2
2(150)(10,000) (150)(10,000) (0.75)(2,000)
Qopt = TCmin = +
(0.75) 2,000 2

Qopt = 2,000 yards TCmin = $750 + $750 = $1,500

Orders per year = D/Qopt Order cycle time = 311 days/(D/Qopt )

= 10,000/2,000 = 311/5
= 5 orders/year = 62.2 store days
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 Reorder Point
Level of inventory at which a new order
is placed

R = dL
where
d = demand rate per period
L = lead time

12-25
 Reorder Point: Example

Demand = 10,000 yards/year

Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154
yards/day
Lead time = L = 10 days

R = dL = (32.154)(10) = 321.54 yards

12-26
 Safety Stocks
 Safety stock
 buffer added to on hand inventory during lead
time
 Stockout
 an inventory shortage
 Service level
 probability that the inventory available during
lead time will meet demand

12-27
 Reorder Point With
Variable Demand

R = dL + zσ d L
where
d = average daily demand
L = lead time
σ d = the standard deviation of daily demand
z = number of standard deviations
corresponding to the service level
probability
zσ d L = safety stock

12-28
 Reorder Point for
Variable Demand
The carpet store wants a reorder point with a 95%
service level and a 5% stockout probability
d = 30 yards per day
L = 10 days
σ d = 5 yards per day

For a 95% service level, z = 1.65

R = dL + z σ d L Safety stock = z σ d L
= 30(10) + (1.65)(5)( 10) = (1.65)(5)( 10)
= 326.1 yards = 26.1 yards

12-29
 Order Quantity for a
Periodic Inventory System

Q = d(tb + L) + zσ d tb + L - I

where
d = average demand rate
tb = the fixed time between orders
L = lead time
σ d = standard deviation of demand

zσ d tb + L = safety stock
I = inventory level
12-30
Fixed-Period Model with
Variable Demand
d = 6 bottles per day
σ d = 1.2 bottles
tb = 60 days
L = 5 days
I = 8 bottles
z = 1.65 (for a 95% service level)

Q = d(tb + L) + zσ d tb + L - I
= (6)(60 + 5) + (1.65)(1.2) 60 + 5 - 8
= 397.96 bottles
12-31
 Thought of the day

The society
based on production
is only productive,
not creative.

12-32