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Inventory system
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Yoshiki Kurata, CIE, AAE

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Yoshiki Kurata, CIE, AAE

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Inventory systems
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Yoshiki Kurata, CIE, AAE

Yoshiki Kurata, CIE, AAE, Instructor at Technological Institute of the Philippines

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   Yoshiki Kurata, CIE, AAE

Published on Jun 29, 2013

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Project planning and control
Yoshiki Kurata, CIE, AAE
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 Inventory systems
1. Inventory System
2. INVENTORY SYSTEM InventoryInventory is the stock of any item or resource used in an
organization and can include: raw materials, finished products, component parts, supplies, and
work-in-process An inventory systeminventory system is the set of policies and controls that
monitor levels of inventory and determines what levels should be maintained, when stock should
be replenished, and how large orders should be
3. INVENTORY COSTS Holding (or carrying) costs Costs for storage, handling, insurance,
etc Setup (or production change) costs Costs for arranging specific equipment setups, etc
Ordering costs Costs of someone placing an order, etc Shortage costs Costs of canceling
an order, etc
4. E(1 ) Independent vs. Dependent Demand Independent Demand (Demand for the final end-
product or demand not related to other items) Dependent Demand (Derived demand items for
component parts, subassemblies, raw materials, etc) Finished product Component parts
5. Inventory Systems Single-Period Inventory Model One time purchasing decision (Example:
vendor selling t-shirts at a football game) Seeks to balance the costs of inventory overstock
and under stock Multi-Period Inventory Models Fixed-Order Quantity Models Event
Triggered (Example: running out of stock) Fixed-Time Period Models Time triggered
(Example: Monthly sales call by sales representative)
6. Fixed-order quantity model also called economic order quantity (EOQ) an inventory
control model where the amount requisitioned is fixed and the actual ordering is triggered by
inventory dropping to a specified level of inventory
7. Fixed-Order Quantity Model Assumptions Demand for the product is constant and uniform
throughout the period Lead time (time from ordering to receipt) is constant Price per unit of
product is constant
8. Fixed-Order Quantity Model Assumptions Inventory holding cost is based on average
inventory Ordering or setup costs are constant All demands for the product will be satisfied
(No back orders are allowed)
9. Basic Fixed-Order Quantity Model and Reorder Point Behavior R = Reorder point Q =
Economic order quantity L = Lead time L L Q QQ R Time Number of units on hand 1. You
receive an order quantity Q. 2. Your start using them up over time. 3. When you reach down to a
level of inventory of R, you place your next Q sized order. 4. The cycle then repeats.
10. Cost Minimization Goal Ordering Costs Holding Costs Order Quantity (Q) C O S T Annual
Cost of Items (DC) Total Cost QOPT By adding the item, holding, and ordering costs together,
we determine the total cost curve, which in turn is used to find the Qopt inventory order point that
minimizes total costs By adding the item, holding, and ordering costs together, we determine the
total cost curve, which in turn is used to find the Qopt inventory order point that minimizes total
costs
11. Basic Fixed-Order Quantity (EOQ) Model Formula H 2 Q +S Q D +DC=TC Total Annual =
Cost Annual Purchase Cost Annual Ordering Cost Annual Holding Cost + + TC=Total annual cost
D =Demand C =Cost per unit Q =Order quantity S =Cost of placing an order or setup cost R
=Reorder point L =Lead time H=Annual holding and storage cost per unit of inventory TC=Total
annual cost D =Demand C =Cost per unit Q =Order quantity S =Cost of placing an order or
setup cost R =Reorder point L =Lead time H=Annual holding and storage cost per unit of
inventory
12. Deriving the EOQ Using calculus, we take the first derivative of the total cost function with
respect to Q, and set the derivative (slope) equal to zero, solving for the optimized (cost
minimized) value of Qopt Using calculus, we take the first derivative of the total cost function with
respect to Q, and set the derivative (slope) equal to zero, solving for the optimized (cost
minimized) value of Qopt Q = 2DS H = 2(Annual Demand)(Order or Setup Cost) Annual Holding
CostOPT Reorder point, R = d L _ (constant)timeLead=L (constant)demanddailyaverage=d _ We
also need a reorder point to tell us when to place an order We also need a reorder point to tell us
when to place an order
13. EOQ Example (1) Problem Data Annual Demand = 1,000 units Days per year considered in
average daily demand = 365 Cost to place an order = $10 Holding cost per unit per year = $2.50
Lead time = 7 days Cost per unit = $15 Given the information below, what are the EOQ and
reorder point? Given the information below, what are the EOQ and reorder point?
14. EOQ Example (1) Solution Q = 2DS H = 2(1,000 )(10) 2.50 = 89.443 units orOPT 90 units d
= 1,000 units / year 365 days / year = 2.74 units / day Reorder point, R = d L = 2.74units / day
(7days) = 19.18 or _ 20 units In summary, you place an optimal order of 90 units. In the course
of using the units to meet demand, when you only have 20 units left, place the next order of 90
units. In summary, you place an optimal order of 90 units. In the course of using the units to
meet demand, when you only have 20 units left, place the next order of 90 units.
15. EOQ Example (2) Problem Data Annual Demand = 10,000 units Days per year considered in
average daily demand = 365 Cost to place an order = $10 Holding cost per unit per year = 10%
of cost per unit Lead time = 10 days Cost per unit = $15 Determine the economic order quantity
and the reorder point given the following… Determine the economic order quantity and the
reorder point given the following…
16. EOQ Example (2) Solution Q = 2DS H = 2(10,000 )(10) 1.50 = 365.148 units, orOPT 366
units d = 10,000 units / year 365 days / year = 27.397 units / day R = d L = 27.397 units / day (10
days) = 273.97 or _ 274 units Place an order for 366 units. When in the course of using the
inventory you are left with only 274 units, place the next order of 366 units. Place an order for
366 units. When in the course of using the inventory you are left with only 274 units, place the
next order of 366 units.
17. Economic Production Quantity (EPQ) Production done in batches or lots Capacity to
produce a part exceeds the part’s usage or demand rate Assumptions of EPQ are similar to
EOQ except orders are received incrementally during production
18. Assumptions: Only one item involved Annual demand is known The usage rate is
constant Usage occurs continually, but production occurs periodically The production rate is
constant Lead time does not vary There are no quantity discounts
19. Economic Production Quantity Model
20. Formulas: No. of runs per year = D/Q Annual setup cost = (D/Q)S TCmin = Carrying
Cost + Setup Cost = ( )H+(D/Qo)S Qo = ; where p = production or delivery rate u = usage rate
Cycle Time = Run Time = Imax = (p-u) and Iaverage =
21. Example 1 A toy manufacturer uses 48,000 rubber wheels per year for its popular dump truck
series. The firm makes its own wheels, which it can produce at a rate of 800 per day. The toy
trucks are assembled uniformly over the entire year. Carrying cost is $1 per wheel a year. Setup
cost for a production run of wheels is $45. The firm operates 240 days per year.
22. Determine the a.Optimal run size. b.Minimum total annual cost for carrying and setup.
c.Cycle time for the optimal run size. d.Run time.
23. Given: D = 48,000 wheels per year S = $45 H = $1 per wheel per year p = 800 wheels per
day u = 48,000 wheels per 240 days, or 200 wheels per day
24. a. Qo= Qo= = 2,400 wheels b. TCmin = ( )H+(D/Qo)S Thus, you must first compute Imax:
Imax = (p-u) = (800-200) = 1,800 wheels TC = ( )($1) + ( )($45) = $1,800 Solution:
25. c. Cycle Time = = = 12 days Thus, a run of wheels will be made every 12 days. d. Run Time
= = = 3 days Thus, each run will require 3 days to complete.
26. Example 2 The Dine Corporation is both a producer & a user of brass couplings. The firm
operates 220 days a year & uses the couplings at a steady rate of 50 per day. Couplings can be
produced at a rate of 200 per day. Annual storage cost is $2 per coupling, & machine setup cost
is $70 per run. a.Determine the economic run quantity. b.Approximately how many runs per year
will there be? c.Compute the maximum inventory level.
27. Solution a. Qp = = ≈ 1,013 units
28. b. No. of runs = D = 11,000 = 10.86 ≈ 11 per year Q0 1,013 c. Imax = Qp (p - u) = 1,013 (200
- 50) p Imax = 759.75 or 760 units
29. Quantity Discounts • Quantity Discounts, also called Price-Break Models, are price
reductions for large orders offered to costumers to induce them to buy in large quantities. • The
buyer must weigh the potential benefits of reduced purchase price and fewer orders that will
result from buying in large quantities against the increase in carry costs caused by higher
average inventories.
30. Quantity Discounts • The buyer’s goal with quantity discounts is to select the order quantity
that will minimize total cost. • Total cost is the sum of carrying cost, ordering cost and purchasing
cost.
31. Price-Break Model Formula CostHoldingAnnual Cost)SetuporderDemand)(Or2(Annual = iC
2DS =QOPT Based on the same assumptions as the EOQ model, the price-break model has a
similar Qopt formula: i = percentage of unit cost attributed to carrying inventory C = cost per unit
Since “C” changes for each price-break, the formula above will have to be used with each price-
break cost value
32. Total Cost = Carrying Cost + Ordering Cost + Purchasing Cost TC = (Q/2)H + (D/Q)S + PD
Where: Q = Quantity P = Unit Price D = Demand S = Ordering Cost
33. Example1 A company has a chance to reduce their inventory ordering costs by placing larger
quantity orders using the price-break order quantity schedule below. What should their optimal
order quantity be if this company purchases this single inventory item with an e-mail ordering
cost of $4, a carrying cost rate of 2% of the inventory cost of the item, and an annual demand of
10,000 units? A company has a chance to reduce their inventory ordering costs by placing larger
quantity orders using the price-break order quantity schedule below. What should their optimal
order quantity be if this company purchases this single inventory item with an e-mail ordering
cost of $4, a carrying cost rate of 2% of the inventory cost of the item, and an annual demand of
10,000 units? Order Quantity(units) Price/unit($) 0 to 2,499 $1.20 2,500 to 3,999 1.00 4,000 or
more .98
34. Solution units1,826= 0.02(1.20) 4)2(10,000)( = iC 2DS =QOPT Annual Demand (D)= 10,000
units Cost to place an order (S)= $4 First, plug data into formula for each price-break value of
“C” units2,000= 0.02(1.00) 4)2(10,000)( = iC 2DS =QOPT units2,020= 0.02(0.98) 4)2(10,000)( =
iC 2DS =QOPT Carrying cost % of total cost (i)= 2% Cost per unit (C) = $1.20, $1.00, $0.98
Interval from 0 to 2499, the Qopt value is feasible Interval from 2500-3999, the Qopt value is not
feasible Interval from 4000 & more, the Qopt value is not feasible Next, determine if the
computed Qopt values are feasible or not
35. Solution Since the feasible solution occurred in the first price- break, it means that all the
other true Qopt values occur at the beginnings of each price-break interval. Why? Since the
feasible solution occurred in the first price- break, it means that all the other true Qopt values
occur at the beginnings of each price-break interval. Why? 0 1826 2500 4000 Order Quantity
Total annual costs So the candidates for the price- breaks are 1826, 2500, and 4000 units So the
candidates for the price- breaks are 1826, 2500, and 4000 units Because the total annual cost
function is a “u” shaped function Because the total annual cost function is a “u” shaped function
36. Solution iC 2 Q +S Q D +DC=TC Next, we plug the true Qopt values into the total cost
annual cost function to determine the total cost under each price-break Next, we plug the true
Qopt values into the total cost annual cost function to determine the total cost under each price-
break TC(0-2499)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20) = $12,043.82 TC(2500-
3999)= $10,041 TC(4000&more)= $9,949.20 TC(0-2499)=(10000*1.20)+(10000/1826)*4+
(1826/2)(0.02*1.20) = $12,043.82 TC(2500-3999)= $10,041 TC(4000&more)= $9,949.20 Finally,
we select the least costly Qopt, which is this problem occurs in the 4000 & more interval. In
summary, our optimal order quantity is 4000 units Finally, we select the least costly Qopt, which
is this problem occurs in the 4000 & more interval. In summary, our optimal order quantity is
4000 units
37. Example2 Consider the following case, where D = 10,000 units (annual demand) i = 20% of
cost (annual carrying cost, storage, interest, obsolescence, etc.) S = $20 to place an order C =
Cost per unit (according to order size; 0-499 units, $5 per unit; 500-999, $4.5 per unit; 1,000 and
up, $3.9 per unit) Consider the following case, where D = 10,000 units (annual demand) i = 20%
of cost (annual carrying cost, storage, interest, obsolescence, etc.) S = $20 to place an order C =
Cost per unit (according to order size; 0-499 units, $5 per unit; 500-999, $4.5 per unit; 1,000 and
up, $3.9 per unit) What quantity should be ordered?What quantity should be ordered?
38. Solution units632.46= 0.2(5) 20)2(10,000)( = iC 2DS =QOPT Annual Demand (D)= 10,000
units Cost to place an order (S)= $20 First, plug data into formula for each price-break value of
“C” units666.67= 0.2(4.50) 20)2(10,000)( = iC 2DS =QOPT units716.11= 0.2(3.90) 20)2(10,000)(
= iC 2DS =QOPT Carrying cost % of total cost (i)= 20% Cost per unit (C) = $5, $4.5, $3.9
Interval from 0 to 499, the Qopt value is feasible Interval from 500-999, the Qopt value is not
feasible Interval from 1000 & more, the Qopt value is not feasible Next, determine if the
computed Qopt values are feasible or not
39. Solution iC 2 Q +S Q D +DC=TC Next, we plug the true Qopt values into the total cost
annual cost function to determine the total cost under each price-break Next, we plug the true
Qopt values into the total cost annual cost function to determine the total cost under each price-
break TC(0-499)=(10000*5)+(10000/634)*20+(634/2)(0.2*5) = $50,632.46 TC(500-999)=
$45,600 TC(1000&more)= $39,558.57 TC(0-499)=(10000*5)+(10000/634)*20+(634/2)(0.2*5) =
$50,632.46 TC(500-999)= $45,600 TC(1000&more)= $39,558.57 Finally, we select the least
costly Qopt, which in this problem occurs in the 1000 & more interval. In summary, our optimal
order quantity is 1000 units Finally, we select the least costly Qopt, which in this problem occurs
in the 1000 & more interval. In summary, our optimal order quantity is 1000 units
40. A-B-C Classification Classifies Inventory items according to some measure of importance,
Usually annual dollar value, and then allocates control efforts accordingly
41. Three Classes of Items A (Very Important Items) Account for 10%-20% of the number of
items in inventory 60%-70% of the dollar inventory of an inventory B (Moderately Important)
Account for 20%-30% of the number of items in inventory 20%-50% of the dollar inventory of
an inventory C (Least Important) Account for 50%-60% of the number of items in inventory
10%-15% of the dollar inventory of an inventory
42. A typical A-B-C breakdown in relative annual dollar value of items and number of items by
category.
43. Example The annual dollar value of 12 items has been calculated according to annual
demand and unit cost. The annual dollar values were then arrayed from highest to lowest to
simplify classification of items.
44. Item Number Annual Demand Unit Cost Annual Dollar Value Classification 8 $1,000 $4,000
$4,000,000 A 5 $3,900 $700 $2,730,000 A 3 $1,900 $500 $950,000 B 6 $1,000 $915 $915,000 B
1 $2,500 $330 $825,000 B 4 $1,500 $100 $150,000 C 12 $400 $300 $120,000 C 11 $500 $200
$100,000 C 9 $8,000 $10 $80,000 C 2 $1,000 $70 $70,000 C 7 $200 $210 $42,000 C 10 $9,000
$2 $18,000 C

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