INVENTORY An inventory is a stock of goods that is held for the purpose of future production sales.

Raw materials, work in process, and finished goods is classified as inventory items, and the decisions about them are similar obviously, such decision often have a critical on the health of the firm. REASON FOR CARRYING INVENTORY 1. Smooth Production Often, the demand for an item fluctuates widely due to a number of factors such has seasonality of production schedules. 2. Product Availability Most retail goods and many industrial goods are carried in inventory to ensure prompt delivery to customers. Not only for does a good inventory provide a competitive edge. It often means the difference between success and failure. If a firm gains a reputation for constantly being out of stock, it may lose a significant number of the customers. 3. Advantages of Producing or Buying in Large Quantities Most production runs involve machine set up time and production time. If set up time significant, real savings can be achieved by producing in large lots. In addition many firms offer quantity discounts many offer quantity discounts for buying large quantities. 4. Hedge against Long or Uncertain Lead Times The time between ordering and receiving goods is known as lead time. Firms do not want to stop manufacturing or selling goods during lead time: so it is necessary to carry inventory. IMPORTANCE OF EFFECTIVE INVENTORY MANAGEMENT In manufacturing environment poor inventory control can result in production stoppages thus wasting expensive labor and capital equipment resources. In retail environment the availability of stock can make the difference success and failure. Too much inventory could be an impossible financial burden and not enough inventories could result in losing the customer goodwill necessary to succeed. In a service industry such has as the transportation industry, lack of critical spare parts can cause cancelled service or delayed departures. INVENTORY DECISION 1. When to order 2. Where to order from 3. How much to order

What are the proper logistic? INVENTORY MANAGEMENT SYSTEM Physical Inventory System It is a system in which management periodically reviews inventory levels of the various items to make inventory decision? Continuous Inventory System These are typically more sophisticated than periodic ordering system.4. . Real time system keep the inventory master file continuously up to date. Demand Forecasting. When a unit is drawn out of or added to inventory the event is recorded immediately and the master file reflects the change immediately typically real time system are significantly more costly than batch system. DECISION SUPPORT SYSTEM FOR INVENTORY MANAGEMENT ABC Analysis The logic of this classification scheme ABC classification is to spend money and time closely controlling only important inventory system. Inventory Reporting – a good inventory system will produced standard reports for use by inventory analysts and summary reports that will tell senior Figure 1. 2.to make intelligent replenishment and allocation decision the system must forecast demand for each item. 3. Batch processing inventory system is a system in which inventory transactions additions to withdrawals from inventory are collected periodically. 4. Computerized inventory system can be classified as batch processing system and real time systems. This requires a data base and transaction processing software. Inventory Accounting – keeping track of quantities on hand on order for each inventory item is a major function of any inventory management system. a. 1. Inventory Decision Making – in system where the demand for an item is one place. It can range from extremely simple manual system to very sophisticated computer based system. decision making function is focused on how much to order or when. batched together and processed to update the current inventory master file. 2. BASIC FUNCTIONS OF A DECISION SUPPORT SYSTEM FOR INVENTORY MANAGEMENT 1. b.

These items and their annual dollar volume are shown in Table 1.Example: Let us assume that a firm has only 12 individual inventory items.647. the following assumptions must ne satisfied: a.000 | |1. 22432. As shown it Table 2. | |22213 |22157 |22545 |22432 |22511 |22457 |22111 |22331 |22471 |22512 |225531 |22122 | |Annual demand |100 |2. Deterministic Demand.8 | |18.725 |7 | |$2.000 | |625 | |600 | |500 | |$2. Table 1 – Annual dollar volume usage: |Item no. 75.500 |500 |700 |100 |50 |100 |100 |25 |20 |10 |Total annual value |$1.0 | FIGURE 2 – STEPS IN DEVELOPING INVENTORY SYSTEM DECISION MODULE ANALYTICAL MODELS FOR REPLENISHMENT DECISIONS 1. Table 2 also shows that if items 22213 and 22517 were controlled.5 percent of the annual inventory volume will also be controlled.000 |500 |1.000 | |200. There is nothing sacred about these percentages.6% and 4 would be 33. and 50% in category C. The ABC classification typically seeks to put approximately 15% of the items in category A.647. but these are often used.000.000 | |105.5 | |629. 2 would make up 16. and 22545.000 | |1. BASIC ECONOMIC ORDER QUANTITY MODEL (EOQ) In order to apply the Basic EOQ model. and 22457 were in category B.000 | |24. .725 |100. 35% in category B.000 |23.000 | |1.000 |75.000 | |300.000 | |15. items 22213 and 22517 were classified under category A.000.it must possible to predict demand with a high degree of confidence. Since in the example there are 12 items.000 |200 |400 |150 |240 |300 |10 |10 |25 |30 |50 | | |Per-unit cost |$10.3%.000. 22511. with the remaining items in category C.725 | Table 2 – ABC Analysis |Category |A |B |C | |Total annual value |Percent of Total | |$2.

Constant Replenishment Size-denoted by q is the only decision when variable in the basis EOQ model. f. Zero Lead Time. Infinite Replenishment rate . D(q)=C3(r/q) Where: C3= cost processing one order r = total demand for a given period of time r/q= numbers of orders . A(q) = C1 (q/2) Where: C1 holding cost per unit of inventory q/2 represents the average number of units in inventory Ordering cost can be thought of as the cost of placing an order multiplied by the number of orders placed in a particular time of period. Consultant Inventory Cost .b. Constant Rate of Demand-not only is it necessary to know the total demand. This assumption implies that of the three costs involved in an inventory system. g.Both costs in the basic EOQ model are constant. d. An infinite replenishment rate implies that inventory replenishment occurs at on time. and D(q) for the basic EOQ model .inventory replenishment are made whenever the inventory level reaches zero shortages not allowed to occur. No shortages. B(q). Inventory models in which the decision variable is order quantity have objective function in equation: Minimize C(q) = A(q)+B(q)+D(q) where: C(q) A(q) B(q) D(q) = = = = total cost function function of q that defines the holding cost function of q that represents the shortage costs function of q that defines the ordering costs To determine the optimal value of q.it is assumed that no appreciable time elapses between placing an order and receiving that order. it is necessary to develop the functions A(q). c. e. The other decision variable when to reorder is a fixed because demand is at a constant rate and replenishment occurs when the inventory level reaches zero. Stock cost does not exist in the basic EOQ model.As then rate at which units are added to inventory.

000/2.000.000 / .125 √4.A(q) C1 (q/2) C1 ([pic]/2) [pic]/2 = = = = D(q) C3 (r/q) C3r C3r/ C1 [pic] = 2 C3r/ C1 q* = √2C3r/ C1 1.000 = 5 units / order Total ordering cost/year = carrying cost/year t* optional time between orders (optional reorder schedule) Planning period N* 365/5 = 73 days’ supply Sensitivity of the basic EOQ model Consequently C(q) is not very sensitive to small changes in q.000 valves. To illustrate this fact Let us assumed that the XYZ Company orders 1. [pic] = [pic] = 10..000 valves q* q* = = = = √2C3r/ C1 √2(25)10. The XYZ company uses 10. If the XYZ Company buys 2.000/2..5% of the value of inventory C1 = $ 125 per valve year [(.000 valves every time inventory reaches zero the total annual cost of this policy is. The materials department estimate that cost 25$ to order a shipment of valves and the accounting department estimate the holding cost is 12. Each valves cost 1$. .000 valves per year.. C([pic]) C([pic]) = = = 25(2.000 valves in each order instead of the optimal 2.000 valves per order 2.00)] C3 = $ 25 per order r = 10.000 2.000) 25+125 $ 250 order / year 3. Once q is calculated.125)($1.000/2) + 25(10. is a simple matter to calculate the optimal numbers of order per year and the time between each other..

thus causing a suboptimal q to be calculated.000/2) + 25(10. This means that if total demand. This means that even if the initial condition (or starting point) is known. A stochastic process is one whose behavior is non-deterministic. STOCHASTIC DEMAND MODEL Stochastic (from the Greek στόχος for aim or guess) means random. in a stochastic or random process there is some indeterminacy in its future evolution described by probability distributions. Instead of dealing with only one possible reality of how the process might evolve under time (as is the case. a change of 50% in q resulted to only a 25% increase in the total inventory cost. is the counterpart to a deterministic process (or deterministic system). any kind of time development (be it deterministic or essentially probabilistic) which is analyzable in terms of probability deserves the name of stochastic process. Until now. All of their properties are the same except that shortages are allowed and back ordered and the scheduling period is prescribed. it is a linear demand function • The scheduling period is prescribed • The lead time is zero • The replenishment rate is infinite • Shortages are made up: that is.50 order / year Hence. However. The basic-order-level system has the following properties: • Demand is deterministic • The rate of the demand is constant: that is. S: That is the decision variable • Holding cost is constant and is expressed as dollars per unit per time period. there are no lost sales • The decision variable is the order level. a stochastic process. • Shortage cost is constant and expressed as dollars per unit per time period. but some paths may be more probable and others less so.000) C([pic]) = 125(1. for solutions of an ordinary differential equation). In probability theory.000/1. 2. according to M. or sometimes random process. Kac[1] and E. we have assumed that all demand parameters of an inventory system are known with certainty and we have assumed that lead time is not equal to zero. for example. If we only loosen this latter assumption. the consequences are not as critical as they would b if shape of the total cost curve were more peaked. r is incorrectly estimated. Basic-Order-Level System The basic-order-level system is very similar to the basic EOQ system. Nelson[2].000) = 62. in that a system's subsequent state is determined both by the process's predictable actions and by a random element.50 + 250 = $312. there are many possibilities the process might go to.C(1. we must order prior to running out of inventory to prevent .

The problem is still: How much to order? and When to order? If we assume that a reasonable estimate of the optimal order quantity can be calculated using the basic EOQ formula. Annual demand is for 1.Frequency distribution of five-day demand for Prostaff tennis rackets |Demand for five-day Cumulative relative |period | |10 |5 |Frequency of specified demand|Relative Frequency | | |Frequency | |. The Inventory costs affected by changes in the reorder point are the: carrying costs and stockout costs. Ordering Cost should not be affected by changes in the reorder point. Figure 4 – Stochastic Demand [pic] If an inventory system has all the properties of basic EOQ system except that lead time is not zero and demand is not deterministic and constant. It takes 5 days between the day the order is placed and’ the receipt of the shipment from Wilson. This information is summarized in Table 4. Therefore. [pic] For example. then the problem is: What is the reordering point? Since the order quantity is given. Figure 3 – Basic EOQ system with nonzero lead time.10 |. Table 4 . demand is 10 units per day and lead time is known to be 5 days: then the reorder point (s) is equal to 50 units.stockouts. Now. What point does the sporting goods store order Prostaff tennis rackets? In order to answer this question. then the problem when to order becomes more complicated. See Figure 3 for the illustration of the basic EOQ system with nonzero lead time. an order for q units should be processed. whenever inventory reaches 50 units. it is necessary to have some idea of the probability distribution of the number of rackets demanded in any 5-day period. let us consider the following problem: A sporting good store wants to determine the proper reorder point for a Prostaff Wilson tennis racket. As you can see in Figure 4 – Stochastic Demand. To illustrate how to determine the reorder point.000 rackets sold at a rate of approximately 4 per day. There is now the danger of stockouts.10 | | . if we loosen the assumption of known or certain demand.

the reorder point is still unknown.000 100 But.1 • 10) + (15 • .|15 |20 |25 |30 |35 | |15 |20 |5 |4 |1 |50 |.00 |. q = = q = √ [2(1.08 |.1 • 10) + (20 • . .4 • 10) + (15 • . The shortage cost associated with this policy can be calculated in the following way… n C2 = [∑xP(x) c2] (r/q) i=1 Where: C2 = shortage cost for year x = number short during lead time P(x) = probability of being short x units c2 = per unit shortage cost q = order quantity n = number of reorder point to be examined Given that the reorder points is 10: C2 = [(0 • . Let us assume that the stockout cost is $10 per racket.1 • 10) + (5 • . carrying cost is $5 per racket per year and ordering cost is $25 per order.000)(25)] / 5 √ 10.02 |1.10 |. it is necessary to ascertain a per unit stockout cost.3 • 10) + (5 • .08 • 10) + (25 • .40 |. then simply choose the reorder level with the smallest total cost.40 |.4 • 10) + (10 • .80 |.00 | | | | | | | To determine a good reorder point.00 If the reorder point is 15: C2 = [(0 • .90 |.02 • 10)] (1000 / 100) = (0+0+20+10+12+4)(10) C2 = $ 460. it is possible to look at six reorder points and calculate the expected cost of each.1 • 10) + (0 • .08 • 10) + (20 • .02 • 10)] (1000 / 100) = (0+15+40+15+16+5)(10) C2 = $ 910.00 The summary of stockout costs for the reorder points are shown in Table 5.3 • 10) + (10 • .30 |.98 |1. In order to determine this total cost.

50 | |25 | 32.50 | |30 | 55.50 | |20 | 12.4 •5) + (0•.Table 5 – Stockout costs |Reorder Point |10 |15 |20 |25 |30 |35 |Stockout Costs |$ 910 |460 |160 |60 |10 |0 | | | | | | | After computing all of those.02•5) ∆C1 = $0 If the reorder point is 25: ∆C1 = (15•.1• 5) + (0•.1• 5) + (0•.1•5) + (0•.4•5) + (0 •.08•5) + (0•.08•5) + (0•.02•5) ∆C1 = $ 32.3•5) + (5•.1•5) + (10•.50 Table 6 reflects the total incremental cost per year based on reorder point. Table 6 – Expected Incremental Cost |Reorder Point |Incremental Carrying Cost |10 |$ 0. let us now determine the incremental carrying cost for the various reorder points under consideration represented by: n ∆C1 = [∑yP(y) c1] i=1 Where: ∆C1 = incremental carrying cost y = number of units in inventory at the time of replenishment P(y) = probability of y units in inventory at the time of replenishment c1 = per unit carrying cost n = number of demand levels Given that the reorder points is 10: ∆C1 = (0•.00 | |15 | 2.00 | |35 |79.3•5) + (0•.50 | | Table 7 reflects the summary of the total costs at given reorder points: Table 7 – Cost of Reorder Point Policies .

50 |25 |60. end products and items stocked to meet customer demand are subject to independent demand. Development of MRP MRP was developed to better cope with lumpy demand patterns of dependent demand items. It is concerned with an all important problem: getting the right materials to the right place at the right time MRP has experienced a very rapid growth and level of acceptance since 1970 which is partly attributed to the MRP crusade carried out by the APICS (American Production and Inventory Control Society. For example.50 |65.00 | 32.) The APICS effort to promote the utility of MRP was spearheaded by such professionals as Joseph Orlicky of IBM. Material Requirements PlanningA Method for Dependent – demand items All the inventory methods that we’ve discussed are useful in inventory or items subject to independent demand. Thus. It is an independent demand when inventory demand is unrelated to demand for other items.00 |$ 0. component parts.50 | 92.00 |12. Demand that is lumpy occurs in discrete batches at different points in time. An item has a dependent demand whenever its demand depends on the demand for another item or product. the optimal inventory policy for the sporting goods company is to order 100 tennis rackets 10 times a year whenever the inventory level reaches 30 rackets. It has grown out of a certain disenchantment of practitioners with classical inventory methods for dependent-demand items.50 | | | | | | | |Total Since the total cost of the various reorder point policies is minimized when the reorder point is 30.50 |20 |160. and statistical order-point or EOQ methods are appropriate. The MRP Approach is particularly appropriate for manufacturing operations in which the demand for subassemblies. .|Reorder Point |Expected Stockout Costs Cost | | | |Carrying Cost |10 |$ 910.00 | 55. and raw materials is dependent upon end product. These dependent-demand items have a demand pattern that is not smooth overtime.50 |30 |10. it must be forecasted.00 |462. Since independent demand is not known exactly.50 |Expected Incremental |C2 + ∆C1 |$ 910.00 |79. automobiles.00 | 2. but lumpy.00 |25 |460.00 | 79. the demand for automobile engines depends directly on the demand for the final product.00 |35 |0. It is a methodology that has been developed “on the firing line” in industry rather than developed by academician and theoreticians.50 |172.

MRP must be supplemented by a priority control system in the factory. The control system provides the means to enforce adherence to plans. An MRP system is an integral part of the priority planning system. Prerequisites and Assumptions of MRP MRP is primarily intended for manufacturing operations and has been used in such general applications as assembly operations. Thus. • Known lead time s on all inventory systems. Because of the large amounts of data that usually need to be manipulated. The following conditions are the primary prerequisites for using MRP: • The existence of a realistic master production schedule that can be stated in bill-ofmaterial terms • An accurate bill of material for each product that not only lists all components of the product but also reflects how the product is actually made in steps • Having each inventory item identified with a unique code or part number • Data file integrity pertaining to inventory status data and bill-of-material data (specifies a list of subassemblies and parts required to produce an end item). bills of materials. It can be applied to any operation provided that certain assumptions or pre requisites are satisfied. general machine shops. The MRP systems interact with production scheduling to time the release orders correctly for all required items. The system will not function properly without accurate input data. MRP system s are computerized : they are in a sense.Nature of MRP MRP is a technique for determining when to order dependent-demand items and how to replan and reschedule orders to adjust for changes in demand estimates from the master production schedule. The MRP is consists of inventory records. and fabrication assembly operations. and usually computer programs that translate the master production schedule into timephased net requirements for each component item needed. It helps to establish valid order priority by revising due dates that have been invalidated. A data processing approach to dependent demand inventory control. The purpose of an MRP system is more than to maintain inventory levels by ordering the right quantities of items at the right time. It provides valuable information for both purchasing and production operations. MRP avoids the averaging process of statistical inventory methods in managing inventory and calculates a specific quantity of what parts to order and when. Benefits and costs of MRP . The essential function of MRP is the calculation of exact inventory needs rather that statistical estimation. It Aids in priority and capacity planning.

The actual benefits depend upon how bad the performance of the current system really is. Even though demand for product A is uniform. Ability to modify the master schedule and respond to unanticipated changes in demand. 5. along with decreasing computation costs. Reduced subcontracting and purchasing costs. However successful adopters of MRP have noted the following potential benefits: 1. Lower Inventories – The ability to plan ahead and the flexibility to reschedule rather thane maintain large safety stocks allows significant reduction in inventory. Also.MRP’s benefits and costs will vary with individual companies. each B requires 3 Ds and each C requires. we can see that it takes 1 unit of component B and 2 units of component C to make 1 unit of A. 3. But once functioning smoothly. an MRP system is getting easier to justify. the MRP system offers really significant advantages to weigh against the costs. Illustration of Lumpy Demand Let us assume that we are about to produce a final product A whose demand is uniform at the rate of 4 units per week. The computing cost to support the function. and D have lead times of 2. Reduced Sales price and improved response to market demands. 2. However. From Figure 5 – Product Structure tree for A. and efficiency increases will depend on how well the company was doing with previous inventory system. 2. – It doesn’t only aids the expediting of jot orders but also helps in deexpediting orders that must be delayed. C. and 1 week respectively. 7. Improved customer service-The percentage of late orders and stockout is reduced. It will require personnel with MRP expertise and computer programmers to interact with the system although the actual MRP system software is usually purchased from major computer manufacturers 3. The Largest cost or disadvantage of MRP system are the following: 1. 4. with increasing inventory and production costs. 4. when should we release orders so that 20 units of A can be ready for the distribution at the end of week 6? Figure 5 – Product Structure tree for A [pic] . 6. the production of A occurs in lot sizes of 20 units in every 5 weeks as shown in Figure 6 – Master Production schedule for A. Given that 20 units of A take 1 week to produce and that parts B. Ability to aid in capacity and priority planning. Reduced overtime and idle time – the result of better and smoother planned production. Maintenance costs and the trials and tribulations of a system changeover.

This in turn will require 60 units of D to be ordered at beginning of week 3 and 40 units of D to be ordered at the beginning of week 1. Principles of MRP . we can see from the product structure in Figure 3 – Product Structure tree for A that we will need 20 units of B and 40 units of C at the beginning of week 4 and 40 units of C at the beginning of week 2. Table 8 – Lumpy Demand |ITEM B |Leadtime 2 weeks | |Gross requirement | |Planned order releases | |ITEM C |Leadtime 2 weeks | |Gross requirement | |Planned order releases | |ITEM D |Leadtime 2 weeks | |Gross requirement | |Planned order releases | |Week |1 | | |Week |1 | | |Week |1 | |40 | |40 |2 |40 | | | |2 | | |3 | |60 | |2 | | |3 | | |4 |60 | |3 | |20 |4 | | |5 | | | | |4 | | |5 |40 | | |6 |5 |20 | | |6 |6 Looking at the gross requirements for part D in Figure 6. the resulting dependent demand for part D is quite lumpy. to have 20 units of product A ready at the end of week 6. These order release dates are summarized in Table 8. In spite of the fact that the demand for the end product A is uniform at 4 per week.Figure 6 – Master Production schedule for A | |Week 1 |Week 2 Week 6 | |Demand for Product A | | |Production |4 |4 | |20 | | |Week 3 | |4 | |4 | | |4 |20 |Week 4 | |4 | |Week 5 | | | | Thus. we see that the requirements for part D in that figure. we see that the requirements follow a “lumpy pattern” of 0 40 0 60 0 0.

The MRP computer program must schedule not only orders for regular customer demand. These external orders can include service and repair parts. The MRP computer program has three major sources of input: master production schedule. the MRP system begins with the aggregate production plans which are refined into a master production schedule. and the bill-of-materials file lists all the MRP computer program then explodes the net requirements for the production of the end product and schedules order releases. interplant orders. the MRP computer program schedules order releases and production dates for the entire manufacturing operation. and items specially selected for experimentation or testing. The computer program is but one aspect of the overall MRP system. inventory records file. The master schedule specifies production quantities and due dates. The master schedule is broken down into firm and tentative plans. There are three important output reports here – Order Release Reports which are the principal output and they represent planned orders in the current period. Figure 6 – Structure of MRP System [pic] Chronologically. but also random orders or orders external to the planned master schedule.The example dealing with lumpy demand illustrates the basic process in MRP – working backward from the scheduled completion dates of end products. the inventory record file states then umber of units on hand and on order for each item. The calculation of dependent-demand quantities and order dates are performed by the MRP computer program. Forecasts of independent-demand items such as end products serve as input to aggregate plans and the master schedule. Tentative plans are sometimes revised according to market reactions. The Planned Order reports that tentatively schedule orders for release in future periods. Using these three inputs. taking into account and any lead times of items COMPUTER IMPLICATIONS The role of the computer in the effective management of inventories can be categorized into three areas: . Firm productions scheduled are needed for short-range time frames covering up to a month or two: tentative production plans may range from a month up to a year. The Order reschedule Reports that call for changes in due dates for open orders. whose structure Figure 6 depicts. and capacity output reports of the MRP computer program. These provide information in forecasting inventory and future work center loads. new forecasts. and the product structure or bill-of-material file.

Inventory Record keeping – With the increased availability of microcomputers and the proliferation of inventory software. Dasmariñas city Graduate School of Business & Management Master of Business Administration Written Report On: INVENTORY MODELS Submitted to: Engr. the majority of today’s automated inventory systems are still primarily record keeping systems with no replenishment-decision-making or decision-aiding capabilities. it is the rare company that does not or should not have their inventory record keeping automated. However. Without the computer and associated software an MRP approach to inventory management is simply not viable In short.1. Inventory decision making – Models like those described in this chapter have been integrated into many large-scale computer based inventory systems. 2. the effective management of an organization’s inventory requires the intelligent use of the computer. This means combining analytical models with today’s computer hardware and software to transform mere record-keeping inventory systems into intelligent systems that support cost-effective inventory decision making. MRP systems are the computer professional’s solution to dependent demand inventory problems. MRP systems – As was mentioned earlier. Mario Mecate Submitted by: Lovely Anne Digno Emelyn Encabo ----------------------Computer terminal Transaction Processing Module Demand forecasting module Decision making module Inventory Data base . Philippine Christian University Sampaloc 1. 3.

Report generator Standard detail reports Ad hoc reports Management reports Purchase shop orders Size Rate Demand Determined Inventory Properties Pattern Replenishment Size Cost properties Period Cons traits Pattern Formulate replenishment models Test Models Integrate chosen models into inventory management system .

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