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Inventory (ABC & EOQ)

Inventory Functions and Types ABC Analysis & Cycle Counting Fixed Period System

MGNT 3430

EOQ Inventory Model

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**Inventory: Functions & Types
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Expensive asset Functions

Buffer between demand and supply Decouple production processes Hedge against inflation Take advantage of quantity discounts

Overview

Inventory Functions and Types ABC Analysis & Cycle Counting Fixed Period System EOQ Inventory Model

Types

Raw material: unprocessed by the firm Work-in-process (WIP): partially transformed

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200 850 504 150 Percent of Annual Dollar Volume 38.00 42. B or C Annual dollar volume Item Stock Numbe r #10286 #11526 #12760 #10867 #10500 #12572 #14075 #01036 #01307 5 Percent of Number of Items Stocked 20% Annual Volume (units) 1.Usage Cycle counting Taking partial inventory daily Frequency of counting A items most frequent C items least frequent 50% 100 1. 1.000 items in inventory: 500 A items.86 12.4% 5.000 600 2.001 12.8% 33.750 2.ABC Analysis Inventory Classification ABC Analysis Pareto principle Classify items as A.4% .000 On hand=Purchases .42 .50 .2% 11.5% .4% 3.750/60 = 29/day 2.2% .60 8.000 500 1.7% .00 17.750/120 = 23/day 7 77/day Overview Inventory Functions and Types ABC Analysis & Cycle Counting Fixed Period System EOQ Inventory Model 8 .750 B items.750 Cycle Counting Policy Each month Each quarter Every 6 months Number of Items Counted per Day 500/20 = 25/day 1.50 $ 14.500 $ 8.000 77.350 15.200 250 #10572 C Cycle Counting 5.502 1.00 154.60 = Annual Dollar Volume $ 90.17 .000 26. 2.3% 6.1% 5% 23 % 72 % Class A A B B B C C C C 6 Taking Inventory Audit of what is in stock/storage Reconcile purchases and usage 30% 350 1.550 x Unit Cost $ 90.750 C items Policy is to count: A items every month (20 working days) B items every quarter (60 days) C items every six months (120 days) Item Class Quantity A B C 500 1.

Only variable costs are setup and holding 6. Receipt of inventory is instantaneous and complete 4. and independent 2.Fixed-period system Inventory counted at end of period Ordering policy is “order up to” type Set target or par levels for each item Costs of Inventory Holding Costs Housing/storage Material handling & labor Investment Shrinkage & obsolescence Example: The GAP Order amount (Q) = Target – (On-hand inventory) . processing time. Quantity discounts are not possible 5. Stockouts completely avoidable 11 12 . clerical support Machine preparation Unit Costs Purchase cost per item 10 Overview Inventory Functions and Types ABC Analysis & Cycle Counting Fixed Period System EOQ Inventory Model Basic EOQ Model Important assumptions 1. Demand is known. Lead time is known and constant 3.Earlier orders not yet received + Back orders 9 Ordering / Setup Costs Supplies. constant.

Inventory Usage Over Time Minimizing Total Costs Objective is to minimize total costs Average inventory on hand Q 2 Inventory level Order quantity = Q (maximum inventory level) Minimum inventory Usage rate Curve for total cost of holding and setup Minimum total cost Annual cost Holding cost curve Time Figure 12.5 EOQ Model Q Q* D S H Annual setup cost = D S Q 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) = 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 S Q Q Annual holding cost = H 2 Annual setup cost = Annual holding cost = (Average inventory level) x (Holding cost per unit per year) = Order quantity (Holding cost per unit per year) 2 Q (H) 2 16 = Annual demand Setup or order Number of units in each order cost per order = D (S) Q 15 = .3 13 Setup (or order) cost curve Optimal order quantity Order quantity 14 Table 11.

000 units S = $10 per order H = $.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 D S Q Q Annual holding cost = H 2 Annual setup cost = EOQ Example: optimal order quantity Determine optimal number of needles to order D = 1.000 = 200 units 18 2DS = Q2H Q2 = 2DS/H Q* = 2DS/H 17 EOQ Example: # of orders/ year Determine optimal number of needles to order D = 1.50 per unit per year Optimal order quantity is found when annual setup cost equals annual holding cost D Q S = H Q 2 Solving for Q* Q* = 2DS H Q* = 2(1.50 per unit per year Expected time between = T = orders T= Number of working days per year N 250 = 50 days between orders 5 20 .50 per unit per year Expected Demand D number of = N = = Q* Order quantity orders 1.000)(10) 0.000 N= = 5 orders per year 200 19 EOQ Example: Order cycle length 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 = 40.000 units Q* = 200 units S = $10 per order H = $.

9 units D = 1.000 units 1.9 2 TC = TC = $61.50 per unit per year T = 50 days Total (relevant) annual cost = Setup cost + Holding cost D Q TC = S + H Q 2 TC = 1.9 TC = ($10) + ($.500 units S = $10 per order H = $.50) = $75 + $50 = $125 200 2 TC = Total annual cost increases by only 25% Only 2% less than the total cost of $125 when the order quantity was 200 23 24 .24 = $122.50) 200 2 EOQ Example:New optimal order quantity Determine optimal number of needles to order D = 1.500 units Q* = 200 units S = $10 per order N = 5 orders per year H = $.9 units 22 TC = (5)($10) + (100)($.24 + $61.000 = 244.000 200 ($10) + ($.48 EOQ Robustness: 1st Q* but D=1500 Management underestimated demand by 50% D = 1.000 units Q* = 200 units S = $10 per order N = 5 orders per year H = $.EOQ example: Total Cost Determine optimal number of needles to order D = 1.50 per unit per year T = 50 days D Q S + H Q 2 1.500 200 TC = ($10) + ($.50 = 60.50) = $50 + $50 = $100 21 EOQ Robustness: New TC Actual EOQ for new demand is 244.9 units S = $10 per order N = 5 orders per year H = $.500 units Q* = 244.50 per unit per year Q* = 2DS H Q* = 2(1.500 244.50 per unit per year T = 50 days Q D S + H 2 Q 1.000 units 1.500)(10) 0.50) 244.

8 25 26 .4.5. 12.Robustness of EOQ Homework Discussion Questions 1.1. 3. 4 • The EOQ model is robust • It works even if all parameters and assumptions are not met • The total cost curve is relatively flat in the area of the EOQ Problems 12. 12. 12.

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