Inventory management

By :Nabiya Khan Divya Kerketta Aparajita Bhattacharya Abhishek Rai

Definitions
Inventory-A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state.

Inventory System- A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be

Types of Inventory
Raw material
Purchased but not processed

Work-in-process
Undergone some change but not completed A function of cycle time for a product

Maintenance/repair/operating (MRO)
Necessary to keep machinery and processes productive

Finished goods
Completed product awaiting shipment

Zero Inventory?
Reducing amounts of raw materials and purchased parts and subassemblies by having suppliers deliver them directly. Reducing the amount of works-in process by using just-in-time production. Reducing the amount of finished goods by shipping to markets as soon as possible.

Reasons for Inventories

Improve customer service Economies of purchasing Economies of production Transportation savings Hedge against future Unplanned shocks (labor strikes, natural disasters, surges in demand, etc.) To maintain independence of supply chain

Nature of Inventory: Adding Value through Inventory

Quality - inventory can be a buffer against poor quality; conversely, low inventory levels may force high quality Speed - location of inventory has gigantic effect on speed Flexibility - location, level of anticipatory inventory both have effects Cost - direct: purchasing, delivery, manufacturing indirect: holding, stockout. HR systems may promote this-3 year postings

Reasons Against Inventory

Non-value added costs Opportunity cost Complacency Inventory deteriorates, becomes obsolete, lost, stolen, etc.

Inventory Costs
Procurement costs Carrying costs Out-of-stock costs

Independent Demand
Independent demand items are finished products or parts that are shipped as end items to customers. Forecasting plays a critical role Due to uncertainty- extra units must be carried in inventory

Dependent Demand
Dependent demand items are raw materials, component parts, or subassemblies that are used to produce a finished product. MRP systems---next week

Inventory Models for Independent Demand

Need to determine when and how much to order 1. Basic economic order quantity

2. Production order quantity

3. Quantity discount model
2011 Pearson Education, Inc. publishing as Prentice Hall

Objectives of Inventory Control

1) Maximize the level of customer service by avoiding understocking. 2) Promote efficiency in production and purchasing by minimizing the cost of providing an adequate level of customer service.

Balance in Inventory Levels

When should the company replenish its inventory, or when should the company place an order or manufacture a new lot? How much should the company order or produce? Next: Economic Order Quantity

Basic EOQ Model

Important assumptions
1. Demand is known, constant, and independent 2. Lead time is known and constant 3. Receipt of inventory is instantaneous and complete 4. Quantity discounts are not possible 5. Only variable costs are setup and holding

6. Stockouts can be completely avoided

Inventory Usage Over Time

Order quantity = Q (maximum inventory level) Usage rate Average inventory on hand Q 2

Inventory level

Minimum inventory
0

Time
Figure 12.3

2011 Pearson Education, Inc. publishing as Prentice Hall

Holding, Ordering, and Setup Costs

Holding costs - the costs of holding or carrying inventory over time Ordering costs - the costs of placing an order and receiving goods

Setup costs - cost to prepare a machine or process for manufacturing an order

2011 Pearson Education, Inc. publishing as Prentice Hall

MINIMIZING COSTS
Objective is to minimize total costs
Total cost of holding and setup (order) Minimum total cost Annual cost Holding cost

Setup (or order) cost Optimal order quantity (Q*) Order quantity

Table 12.4(c)
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The EOQ Model

Q Q* D S H = Number of pieces per order = Optimal number of pieces per order (EOQ) = Annual demand in units for the inventory item = Setup or ordering cost for each order = Holding or carrying cost per unit per year Annual setup cost = (Number of orders placed per year) x (Setup or order cost per order) Setup or order cost per order

= =

Annual demand Number of units in each order D (S) Q

D SQ

Annual setup cost =

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The EOQ Model

Q Q* D S H

Annual setup cost =

Annual holding cost = = Number of pieces per order = Optimal number of pieces per order (EOQ) = Annual demand in units for the inventory item = Setup or ordering cost for each order = Holding or carrying cost per unit per year

D Q Q H 2

Annual holding cost =

(Average inventory level) x (Holding cost per unit per year) (Holding cost per unit per year)

Order quantity 2 Q (H) 2

2011 Pearson Education, Inc. publishing as Prentice Hall

The EOQ Model

Q Q* D S H

Annual setup cost =

Annual holding cost = = Number of pieces per order = Optimal number of pieces per order (EOQ) = Annual demand in units for the inventory item = Setup or ordering cost for each order = Holding or carrying cost per unit per year

D Q Q H 2

Optimal order quantity is found when annual setup cost equals annual holding cost D S = Q Solving for Q*
2DS = Q2H Q2 = 2DS/H Q* =
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Q H 2

2DS/H

An EOQ Example
Determine optimal number of needles to order D = 1,000 units S = $10 per order H = $.50 per unit per year

Q* = Q* =

2DS H 2(1,000)(10) 0.50

= 40,000 = 200 units

2011 Pearson Education, Inc. publishing as Prentice Hall

An EOQ Example
Determine optimal number of needles to order D = 1,000 units Q* = 200 units S = $10 per order H = $.50 per unit per year

Expected number of orders =N=

Demand Order quantity 1,000 200

D = Q*

N=

= 5 orders per year

2011 Pearson Education, Inc. publishing as Prentice Hall

An EOQ Example
Determine optimal number of needles to order D = 1,000 units Q* = 200 units S = $10 per order N = 5 orders per year H = $.50 per unit per year

Expected time between orders

=T=

Number of working days per year N

T=

250 5

50 days between orders

2011 Pearson Education, Inc. publishing as Prentice Hall

An EOQ Example
Determine optimal number of needles to order D = 1,000 units Q* = 200 units S = $10 per order N = 5 orders per year H = $.50 per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost TC = DS + Q Q H 2 200 2 ($.50)

TC =

1,000 200 ($10) +

TC = (5)($10) + (100)($.50) = $50 + $50 = $100

2011 Pearson Education, Inc. publishing as Prentice Hall

Reorder Points
EOQ answers the how much question The reorder point (ROP) tells when to order

ROP =

Demand per day

Lead time for a new order in days

=dxL
d=
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D Number of working days in a year

Reorder Point Curve

Q*
Inventory level (units) Resupply takes place as order arrives

Slope = units/day = d

ROP (units)

Figure 12.5
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Lead time = L

Time (days)

Reorder Point Example

Demand = 8,000 iPods per year 250 working day year Lead time for orders is 3 working days

d=

D Number of working days in a year = 8,000/250 = 32 units

ROP = d x L = 32 units per day x 3 days = 96 units

2011 Pearson Education, Inc. publishing as Prentice Hall