Industrial Management

and
Engineering Economy
Chapter -4

INVENTORY MANAGEMENT

1/1/2021 8:34 AM 1
 INVENTORY MANAGEMENT

 Types of Inventory
 Importance of Inventory
 Inventory management
 ABC Inventory
 Independent Inventory Management (EOQ)
 Dependent Inventory Management (MRP)
 JIT Inventory

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 Inventory
Refers to stock of any item, valuable assets
Refers to items that contribute to a finished product, or become a
part of the product output
Types of inventory:-
Raw materials (RM): chemicals, rubber, paper pulp
Work In Process (WIP): sub assemblies,
Maintenance, Replacement, Operating parts (MRO): lighting bulbs,
filters, machine parts,gears
Finished Goods (FG): end products

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 Functions of Inventory
 As buffer stock to meet anticipated demand by customer
 To protect operations against shortage and uncertainty
 To permit operations to continue smoothly
 To take advantage ofquantity discount, economic of scales
 To hedge against inflation
 To buy/stock up in view of price increase
 To decouple production fromdistribution

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 Inventory Management
Set of policies and control to manage and monitor inventory:
What levels should be maintained, and holdingcosts
When and how often to order
How much to order, and orderingcosts
What is the total inventorycosts
Monitor and inventory control

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 Inventory Management Models

1. ABC Inventory Management

 Store management technique
2. Dependent Inventory Management Model
 Economic Order Quantity technique (EOQ).
3. Independent Inventory Management Model
 Materials Requirement Planning technique (MRP).
4. Just in Time Model
 JIT and lean production technique

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 1. ABC Inventory Management

 Classification of items, stocks by costs and quantity

 Class A items
 costly, expensive items: keep only 15-20% of total quantity; this contributes to average 75-80% of annual
inventory. Examples: car engines, gold wires, metal parts
 Class B items
 medium cost items, keep about 0-40% of total quantity ; this contributes to average 15 %dollar value.
Examples: wire assemblies, electrical components, display parts
 Class Citems
 cheap, small items: keep 40-50% of items, because its cost is only 10-15% of dollar value. Examples: screws,
bolts, plastic bags or parts, packingcartons

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 ABC Inventory Technique

• Bin card control

– Records for receiving in / issuing out parts
– Description of parts/ partcodes
– Samples / standard lot packing quantity
• Cycle count / stock count / stock take
– To track physical quantity and to identify losses, thefts, quantity variance
– To seizeoperations
– Counting of physical parts/items and compare to system quantity
– For fiscal closing and accountingpurposes

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 Independent Inventory Management Model

- This model is for independent demand system for finished goods which is
determined by market and customer requirements.
- Relates to EOQ model based on these assumptions:
- demand is known, constant and independent
- lead time is known and constant
- delivery of order is instantaneous
- inventory quantity resumes back to original quantity
- no stock out occurs
- ordering time is when Inventory is Q/2
- when total inventory costs is minimum: total ordering costs equals to total holding costs
- Ordering costs or set up costs:
- costs incurred when placing an order, phone/fax charges, clerical salary, setting up the
machine, delivery cost, invoicingfees.
- Holding costs or carrying costs:
- Costs incurred to store the stocks: rental costs, security costs, insurance costs, store
-
- staff, forklift drivers
• Stock out costs, Opportunity costs , Cost of goods 9
 Inventory Order Cycle
Order quantity, Q
Demand
Inventory Level rate

Reorder point, R

0 Lead Lead time Time

time Order Order
Order Order placed receipt
placed receipt

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 2. Management Model
(EOQ CostModel)

Co - cost of placing order D - annual demand

Cc - annual per-unit carrying cost Q - order quantity

Co D
Annual ordering cost =
Q

C cQ
Annual carrying cost =
2
CoD C cQ
Total cost = +
Q 2

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 EOQCostModel (cont.)

Deriving Qopt Proving equality of

costs at optimal point
CoD CQ
TC = + c
Q 2 Co D CQ
= c
TC CoD Cc Q 2
= +
Q Q2 2
2CoD
Q2 =
C0D Cc Cc
0= +
Q2 2
2CoD Qopt =
Qopt = 2CoD
Cc
Cc

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 EOQCost 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

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 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 = + 2
(0.75) 2,000

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

Orders per year = D/Qopt Order cycle time = 365 days/(D/Qopt)

= 10,000/2,000 = 365/5
= 5orders/year = 73 store days
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 Production Quantity Model

• An inventory system in which an order is received gradually,

as inventory is simultaneously being depleted
• AKA non-instantaneous receipt model
– assumption that Q is received all at once is relaxed
• p - daily rate at which an order is received overtime,
a.k.a. production rate
• d - daily rate at which inventory is demanded

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 Production Quantity Model (cont.)

p = production rate d = demand rate

Maximum inventory level = Q - Qp d

d
=Q1- p 2CoD
Qopt =
Q Cc 1 - d
Average inventory level = 1- d p
2 p

C o D C cQ d
TC = Q + 2 1 - p

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 Production Quantity Model: Example

Cc = $0.75 per yard Co = $150 D = 10,000 yards

d = 10,000/311 = 32.2 yards per day p = 150 yards per day

2CoD 2(150)(10,000)
Qopt = = = 2,256.8 yards
Cc 1 - d 0.75 1 - 32.2
p 150

C oD C c Q d
TC = Q + 1 - p = $1,329
2

Q 2,256.8
Production run = p = = 15.05 days per order
150
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Production Quantity Model: Example (cont.)

Number of production runs = D = 10,000 = 4.43 runs/year

Q 2,256.8

Maximum inventory level = Q 1 - d

p = 2,256.8 1 - 32.2
150

= 1,772 yards

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Quantity Discounts

Price per unit decreases as order

quantity increases

CoD CQ
TC = + c + PD
Q 2

where
P = per unit price of the item
D = annual demand

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 Quantity Discount Model (cont.)
ORDER SIZE PRICE
0 - 99 $10 TC = ($10 )
100 – 199 8 (d1)
200+ 6 (d2) TC (d1 = $8 )

TC (d2 = $6 )
Inventory cost ($)

Carrying cost

Ordering cost

Q(d1 ) = 100 Qopt Q(d2 ) = 200

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 Quantity Discount: Example
QUANTITY PRICE
Co = $2,500
1 - 49 $1,400 Cc = $190 per computer
50 - 89 1,100 D = 200
90+ 900

2CoD 2(2500)(200) = 72.5 PCs

Qopt = =
Cc 190

For Q = 72.5
CoD CcQopt
TC = + + PD = $233,784
Qopt 2

For Q = 90
CoD C cQ
TC = + + PD = $194,105
Q 2
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 Dependent Inventory Management Model

• This model is for dependent demand for parts, items which are
dependent on the quantity of finished goods.
• Also known asmaterials requirement plan (MRP)
• MRPor dependent inventory model requires:
– Master production schedule (MPS)
– Bill of materials(BOM)
– Inventory level
– Purchase order outstanding (PO)

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 MRP
Master production schedule (MPS)
-Time phase plan that specify forecast demand, production
quantity the firm plans to build specific final products
Bill of material (BOM)
- List of quantities and its description of components, parts,
ingredients and materials required to make aproduct
- A product structure that shows the interrelationship of parts
and its assemblies
Inventory level
- The amount of inventory level in hand for each item
Purchase orders outstanding
- Records for parts order, its delivery schedule, date
- Knowledge of outstanding orders: lead time,
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 MRP and JIT System

• MRP is just for planning parts quantity; it does not specify delivery manner:
quantity, batches, standardpacking

• Just in Time (JIT) technique specifies the delivery details and manner: the
actual quantity needed, the time required, the place where it is needed,
and the expected production schedule.

• MRPand JITcomplements each other towards lean production

• JIT delivers small batches of materials in exact quantity, exact time and
exact place when needed, thusreducing WIPand storage

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 JIT and Lean Production
 JIT is a system that drives out wastes, losses with continual improvement efforts
towards establishing alean production.
 JIT is the key component for alean production.
 Lean production refers to delivering to what the customer wants in terms of
quantity and time without incurring wastes such as delays, staging, transit and
storage.
 JIT deliver the parts in right amount at the right time and the right place straight into
the production process with minimal handling or staging.

 JIT and lean production practice the “pull” system: to “pull” or order, take the actual
quantity needed for the next process; thereby eliminates wastes and variability:
storage, delay, waiting in queue,defects.

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 Water Tank Analogy for Inventory

Inventory Level
Supply Rate

Buffers Demand Rate

Inventory Level from Supply Rate

Demand Rate
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