“) Quantitative Models wW for materials Planning and Control PLANNING The planning and control of inventory from product design to final deliv- ery are of considerable strategic significance to management. Inventories serve as a cushion between the production and consumption of goods and exist in various forms: materials awaiting processing; partially completed products or components; and finished goods at the factory, in transit, at ware- house distribution points, and in retail outlets. At each of these stages, # sound economic justification for the inventory should exist, since each add tonal unit carried in inventory generates some additional costs. Inventory investment varies with the type of industry and the characteris: tics of a company. On the average, inventory accounts for about one third & total assets, and for many manufacturers the cos about one half of total product cost. Any inventory planning and conta method should have but one goal that might be expressed in two ways: (l)® minimize total cost or (2) to maxi € profit within specified time and © ree ee as uaa o-gexample tthe sical ocd ite seine cape aise sonia tee a Sas) inherent in large production Hes in, the eo nomic ordering, handling, and shi i for flexi? tomeet uncertain future demang. "fH. and in the need for Hes MATERIALS REQUIREMENTS , in 18 & product, Whether I Cy @ series of planning stages is N& 350 Materials planning begins with the design of regular product or a special contract,art 13 QUANTITATIVE MODELS FOR MATERIALS PLANNING AND CONTROL jo pet matenals ant production. Ey the prekiminary stages, the oy stuxhies the proposal, design, blueprints, and other ava pares a product require ny ering ble specifics al pve : fons an The tooling department cs the W sh rai product ina particular The manufacturing control division examines production in terms of visting and contemplated production schedules, The materials planning and eX entimatings departments study the cumulative information and submit a fos eatimate for the production proposal, ‘The long-range or economic plan- ing scetion SURRESES dL PF oduct price based on considerations of present prod- nes, economic conditions and expectations, company policies, and ex- pansion plans, Executive management must finally decide whether to proceed with, reject, or modify the proposal, To plan manufacturing requirements, every stock item or class of items. must be analyzed periodically to: divi Hent statement ork details necessary to manufacture the plant. vet It Forecast demand for the next month, quarter, or year Determine acquisition lead time Plan usage during the lead time 1 3, 4. Establish quantity on hand 5, 6. |. Place units on order. Determine reserve or fety stock requirements, These six steps are illustrated below in determining the quantity to order in Seplember for a November delivery. In this illustration, the lead time, the time between the order and delivery, is two months. The desired inventory cushion or sufery stock is approximately a two weeks’ supply. Planned or forecast usage from review date: UNITS September production . 5 ea October production Aes November production .. feet 2.500 Desired inventory, November 30.... 1,00 Total to be provided on 8.000 Quantity on hand, September 1. aio On order for September delivery... 3000 On order for October delivery. Quantity to order for November delivery sv--re-" iced item play a central tely planned, nven- wa Future requirements for each purchased or prod an requirements are not accura terials control. If usa : esult in the wrong level of in aay ‘mos elaborate control system will ng and at the end of a future period Aitetials pkanning deals with two fundamental factor Me 10 purchase. Determination of how much and w 5 — the quantity and hen to buy involves and the cost of Wo a a whe iadege kinds of cost — the cost of carrying inventory and NE Mi C cf yc is indica cane careying, ‘The nature of these conficting com> ‘8 Comparison, a1Inventory Carrying and Ordering Costs for Economic Order Quantity Calculations PLANNING ANO CONTROL OF MATERIALS AND LABOR PART ¢ F Canning est cost oF INVENTORY MATE INADEQUATE CARRYING Interest or investment Extra purchasing, handling, and ‘of working capital... 10.00% transportation costs Property tax and Higher price due to small order insurance. 1.25 quantities Warehousing or Frequent stockouts resulting in storage. 1.80 disruptions of production Handling...» 4.25 schedules, overtime, and extra Deterioration and setup time shrinkage of stocks. 2.60 Additional clerical costs due to Obsolescence of keeping customer back-order stocks 5.20 records Total... 251 Inflation-oriented increases in prices when inventory purchases are deferred Lost sales and loss of customer goodwill The economic order quantity (EOQ) is the amount of inventory to be or- dered at one time for purposes of minimizing annual inventory cost. If a com- pany buys in large quantities, the cost of carrying the inventory is high be- cause of the sizable investment. If purchases are made in small quantities, frequent orders with correspondingly high ordering costs will result. There- fore, the’ quantity to order at a given time must be determined by balancing two factors: (1) the cost of possessing (carrying) materials and (2) the cost of acquiring (ordering) materials. Buying in larger quantities may decrease the unit cost of acquisition, but this saving may be more than offset by the cost of carrying materials in stock for a longer period of time. The six cost factors of carrying an inventory, listed at the top of this page: are expressed as a percentage of the average inventory investment and can be estimated and measured. These cost factors should include only those cos that vary with the level of inventory. For example, in the case of warehousité or storage, only those costs that will vary with changes in the number of units ordered should be included. The cost of labor and equipment used in storeroom is normally a fixed cost and should not be considered a part of carrying charge. Similarly, the insurance cost is included only when the CH Pany has a monthly reporting type of policy with premiums charged 0"! fluctuating inventory value. A standard insurance policy for one year of ™ should be considered a fixed cost that is irrelevant to the decision. ye It is difficult to determine the costs of not carrying enough inventor they must be considered in deciding upon order quantities and order en Such costs include ordering costs, although the fixed cost of placing 4° 1s not relevant. Only the variable or out-of-pocket cost of procuring an 7 the should be included. The costs of processing an order include prepat™?QUANTITATIVE MODELS wort FOR MATERIALS PLANNING AND CONTROL quon and the purchase order, h “ eceiving report, Communicating in case of quantity /quality ne ty receipt of Humetials, and accounting for the shipment and ae) Other costs of not carrying enough inventory relate to aT ve gs in eight and quantity discounts as well as tothe question of when seer, including an appropriate allowance for safety stock. : toc epending upon many factors, it may cost from $2 to $20 or more to ovess an order and from 10 to 35 percentyof the average inventory invest- pent 10 HOW materials. Techniques for analyzing cost behavior, described and justrated 0 Chapter 18, should facilitate the determination of realistic carry- ing andl ordering cost estimates. Mathematical and statistical techniques per- bit improved planning and control in an endeavor to maximize profits and ‘andling the incoming shipment rea! ring & and pre- errors or the pay- questions rrisimize costs. : A tabular arrangement of data relative to a materials item: allows the de- Tabular temination of an approximate economic order quantity, and thereby the Determina- number of orders that need to be placed annually. To illustrate, assume the tion of the folowing data: Economic Estimated requirements for next year 2,400 units Order Cost of the item per unit $ 1.50 Quantity Ordering cost (per order) $20.00 Inventory carrying cost (% of average inventory investment) 10% Based on these data, various possible order sizes can be evaluated: Quantitative DATA Order size in units 300 400-800 1,200 2,400 Number of orders . oaks 8 6 bs 2 1 Average inventory (order size + 2) 150 200 400 600 1,200 Cosi Data 7 Average inventory investment ...... $225.00 $300 © $600 Total carrying cost (10% of average inventory). . $30 $60 Total ordering cost 60 $120 Cost 10 order and carry .. rz Of the order sizes calculated, 800 is the most economical; thus, an order ould be’y laced every four months. However, the most economical order Se may not have been calculated; there may be some unit quantity between d carry that is 7 ic ang? 8hMh on page 354 shows the lowest point of the total-cost-to-order Graphic Rand Surve, about $120, and the most economic order quantity of about Deters any The ideal order size iy the point where the sum of the ordering and tion ote ic SS S0Mts is at g minimum, i.e.. where the total cost curve Is At its lowest. Graer 0 oud ‘ing, Serge uty where the annual carrying charges equal the ordering Quantity + Where these (wo cost lines intersectGrapare Determine. of the Fr nor ter Quan The Econantie Order Quant Formuia PLANNING AND CONTROL OF MATERIALS AND Lang, Phy CCST TO ORDER AND CARRY Annual Ordering Cos 200 400 600 800 1.000 1,200 1.400 1.600 1,800 2.000 220 2p ORDER QUANTITY determine the economic order quantity by a tabular or graphic methoi Scengthy and may not provide the most accurate answer. Companies using order-point calculations based upon economic order quantities usually pele © use a formula. With information such as quantity required, unit price, ir Y carrying cost, and cost per order, differential calculus makes it pos: hie 10 compute economic order quantity by formula. One formula variatoa Tollows: ‘Economic order quantity = Vv 2 x Annual required units x Cost per oi Cost per unit of material x Carrying cost perce — oR 50Q = 2xRUxCO @ cux ce ° i “ ile terms EOQ, RU, CO, CU, and CC as specified, the form bused on the following relationships, at = Number of orders Placed annually RU x CO EOQ—~ = Annual ordering cost Fog “J = Average number of units in inventory at any point in time CU x CC x E0Q > = Annual carrying costYAN TITATIVE MOD! c a a ELS FOR MATERIALS PLANNING AND CONTROL eco, CUX EEX FO _ Total annual . | CURE x BOQ | cost of ordering and carry- wre > ing inventory. designated as AC) 5 formula for the economic order quantity, or least-cost ord ne square root of a fraction wh " st-cost order quantity sa ynitSs # the sq! eae dts ose numerator is twice the product ne * ual unit demands and the Cost per order and whose denominator is a product of the unit price and the annual carrying rate. The formula as- Ks es 8 constant rate of materials usage. ges es formula, the EOQ for the data on rage 353 is: 96.000 Fe 7 640,000 = 800 units —— TX BAO x $30 an PEE See £0Q = V “$7.50 x 10% V It is also possible to express EOQQ in dollars rather than in units. Tne folowing formula is usually employed: [TxAB £00 = \ TF where A = Annual requirements in doliars B = Ordering cost (per order) 1} = Inventory carrying cost (% of average inventory investment) Using this formula and the following data from the previous illustration: [A = $3,600 (or 2,400 units @ $1.59) B = $20 1 = 10% per year 50Q = (ae = $1,200 total cost The EOQ can be converted to units by dividing the EOQ total cost by the cost perunit ($1,200 + $1.50 = 800 units). ‘This later equation is then solved utilizing differential calculus to determine minimum total annual cost of mentary, AC represented by tne EOQ formula: RU x co , CU CXEOD AC = FON z cu xcc x E08 1 4 GUXCEA ERS AC = RU x CO x LOO?" * F ac peg CURE GAC RU x CO x FOO z dac |_| -RU x CO cuxcc geo" BO" aac “au xo, Ux ~0 Let GEog "°' EOF z cuxce | RUxCO z “FOr EOg x CU x CC = 2 RU * CO 2x RUxCO Bog = cox cc TERUE BOQ = Vor CePLANNING AND CONTROL OF MATERIALS AND LABOR , to indicate th Its wh The following example is given to indicate the results hen new Con since any shift in cost data will affect the answe; enter the formula. plaka ; 7 that Vary directly with order or producticg only those cost compone dire should be used, 1.€., the variable costs au 2400) units of materials used per year (200 units per noth) CO ~ $100 tne ing cost per 0 CU + S180 cost per unit « UC = WF carrying cost os EOQ The economic ord h per year, Other order quantities resulting ; year are not so economical. as proven by the following table. wh quantity for the stock item is 400 Units, oF six ergo, in more or ss than six orders y ch is bases fon $3,600 annual usage of materials. unt ws Fe Vater ORDERING CARRYING Toy rin YEAR eek ORDIR py ORDER Cost Cos Gs ; 2.400 sien so S360 = > 1.20 aw 20 10 a *O 1,200 3 120 4 0 wO 30 a < 380 720 so 2 6 0 600 60 oO x 300 a5) xo 45 Quantity By purchasing in quantities larger than the minimum. quantity price & Price counts and/or freight savings may be realized. resulting in a lower cos * Discounts unit and alter z the economic order quantity. However, buying in § quantities involves a larger investment in inventories. Therefore. | uties should be purchased only if an added return on the average a vestment is adequate? The table on page 387 considers the effect of quantity price using a cost-comparison approach. £00 the FOQ formula is equally appropriate in computing the optimus © Foi nula # production run. in which case CO. represents an estimate of the se aoe a nd CU ay the variable manufacturing cost per unit. To illustrate. # - . Rome tom Mock Hem ANG iy manutactured rather than purchased: the setUP SM x 1 Yl e such as the cost of labor to rearrange and adjust machines. #§ SOF Sariable manufacturing cost (CU) is $2 per unit Laas somputed ay follows The opti fuer due meron is NV 5} ' ‘ } 3 i-# “ | ' ; + ! oes Ihe BOQ formula answers . . re question of when However, 1 controlled by three factors guage, and (3) safety stock. Un pant has no generally applica ander point would be relatively placing an order and having me tion — and the usage pattern for # ost stock items there is a variation in either or both almost always causes one of three result expectation during an order period, the new taisting stock is consumed, thereby adding to the cost af Susy as Ss Q) if lead time or usage is grestter than expected. & oes the resultant incurrence of costs associated te OL CATT VINE © wih tery; 3) if average lead time is used to an onier OY Stee auld be expected on every other onder Forecasting materials usage requires the eypenssses af tone aon a oer management, forecasts sre an expense ay Welle yh Baaeer cost to acquire and the cont by carry dents ys Subeg PNTST LSS farely possible, an inventory usta ah Sahel AEN Ks els ~ masta stavkout The Ras greater han mostel ne ws ant eolly device for protecting the ee) Stock quantity, [the safety sto ; 2g cot il et hs 09 ah tse SES Tum safety cea tlre. aan sal ws wea TS Sckouts ant oy ‘ that quantity which resuliy ay anes! ‘ Same manner ety stock careyany Tiny canny Tot nner as in calculating UM erator aii Jevorannmnent rig Cast ty The annual cost ecanenn.G@ AND CONTROL OF MATERIALS AND LABOR ss PLANNIN! Paar cost of stockouts depends upon their probability and the actual cos of eg stockout. To illustrate, assume that a ¢ orders per year, the cost of a stoc unit. The following probabilities © levels of safety stock ompany uses an item for Which it play, out is $30, and the cart ying cost is § f a stockout have been est'mated for Pad iu Safety Stock Level Probabilit 0% 0 units 50 20 10 100 200 5 carrying cost and stockout cost at each level of safety stocy is The total determined as foows: EXPECTED ANNUAL Srockours LPROBABILEEY X Tota ToTAaL Tora. NUMBER oF Srockout CARRYING STOCKOUT ano OnDeKS) Cost Cost CARRYING Cost 4.0 $120 -0- $120 2.0 60. $ 25 35 10 30 50 8 cs) 15 100 4s In this illustration, the optimum level of safety stock is 100 units, sinc the total stockout and safety stock carrying cost is minimized at this leve. Such an analysis of important stock items leads to smooth operations an! effective materials management. ; Order Point Order points are based on usage during the time necessary to reqistit Formula order, and receive materials, plus an allowance for protection agains s out. The order point is reached when inventory on hand and quantities duet are eyuc: to the lead time usage quantity plus the safety stock quant s equation form, the order point may be expressed as: 1+ QD = LTQ + SSQ, when: Inventory balance on hand Quantities due in from orders previously placed, materials transi and returns to stock 1 1 QD = oe LTQ = Lead time quantity equals average lead time in months, Wet days multiplied by average month's, week's, or day's Use SSQ = Safety stock quantity i | we The following approaches are illustrated, both of which are solved Le ly and graphically: i 1. Usage and lead ti 7 time ai i ity; therefor" stocks provided.’ STOWn With certain: "QUANTITATIVE MODELS FOR MATERIAI LS PLANNING Al ND CONTROL ne 13 he same figures, a safety stock is inj S38 pased ont ck is injected 2. ee into the calcula- at ustrated — NO Safety Stock. Assume the weekl: i y us ae Fit Un guns each Monday through Friday, 025 aetna 9 and that a ead ine of four weeks establishes an order point Soa eertsurits * 4 Necks). Assuming that the unit cost is §.50, the eanyiny url= 20%, the order cost is $24, and annual usage is 9,100 units (175 pate Lette the EQ is computed as follows: ms I5x 9,100 x $24 _ [TRIO S26 £00= V $50 x 20% 100 = 2,090 units ach order provides a 12 weeks’ supply (2,090 + 175). Figure } shows the contro} pattern of this item if usage and lead time are definitely ix itis apparent that (1) if lead time is more than four weeks, a stockout “?: Pi ifusage exceeds 700 units in any four-week period foliow oe pont, a stockout is inevitable. Since perfect prediction of usage and jsusually unrealistic, a safety stock allowance is needed. 2,500, Maximum Inventory ! 104 g Figure 1 — z Rate of Usage Lead Time co 1,045 Average Inventory aeerth f Certainty 700 Order Point 500. 0 9 0 11 WEEKS: Order poy Per west strated = Safety Stock. Assumin sy ac jon” im Figure 1, with @ lead tim pe uri long as nine weeks, the order point Beg rg" Mormal lead time (175 units * * WOE ‘Units x § weeks), Assuming 4 beginning #1 g the same usage of fe of normally co : Id be 1,575 units: ; eeeks) plus 875 units safety ventory OF **360 PLANNING AND CONTROL OF MATERIALS AND LaBoR | AR 4 and no orders outstanding, the usage, order schedule, and inventory , would be: levels 2,800 units in beginning inventory usage to order point (1,255 + 17$ weekly usage = 7 weeks) order point usage during normal lead time (700 = 175 weekly usage = 4 weeks) maximum inventory or safety stock at date of delivery :assuming mal lead time and usage or. EOQ units received maximum inventory, assuming normal lead time and usage The average inventory, assuming normal iead time and usage, is 1,520 uj (12,090 EOQ = 2) + 875 units safety stock]. Figure 2 depicts materials > ning under the above assumptions and shovvs that a stockout would not see, unless lead time exceeds nine weeks, assuming normal usage. 3.000. 2,800 Beginning Inventory 2,500.4 Figure 2 — 2.0004 Rate of Usage Known with 1,920 Average Inventory 1,575 Order Point UNITS 1.500] a Certainty and | Lead Time Known but +.000.| ar Variable ———— 5004 10 18 16 20 oo WEEKS In most businesses, a constant normal usage is not likely to occur bect#® usage depends upon production schedules, and production depends ¥N* sales. For instance, if the usage rate is as high as 210 units per weeks ¥ lead time normally four weeks or possibly as long as nine weeks, the s#® stock would have to be 1,190 units and the order point 1.890 units, calcul as follows: Normal usage for normal lead time of four weeks (175 units x 4 weeks)... fety stock: Normal usage for five weexs’ delay (175 units A$ WEEKS) oof ce ccreen eseesneeae . 7 - 875 Usage variation [(210 ~ 175) » 9 weeks} BIS 110 — mee ys 700 vaiswo 3 : man tad time and usage QUANTITATIVE MODELS FOR MATERIALS py LANNING AND CONTROL ‘qa beginning inventory of 2.800 units with i myer schedule, and inventory levels would 6 orde’ beginning inventory a point (910 = NO orders outs Ye: 210 maximum weekly usage = 4.3 week. 3 weeks) ¢ for normal lead time (700 = 175 norinal weekly usage = 4 inventory or safety stock imum i at date of delivery, assuming nor. ‘OQ units received nding, fh 361 0) E xg) maximum inventory, assuming normal lead time and usage ke . average inventory, assuming normal lead time and usage, is 2.235 units me70Q = 2) + 1.190 units safety stock]. Figure 3 shows materials plan- ig urbe the assumptions that the rate of usage and lead time are known but ai z atl 3500 3000 2000 2,235 Average Inventory 1,890 Order Point aalee | 1,190 Safety Stock 25 30 5 10 15 WEEKS Figure 3 — Rate of Usage and Lead Time Known but Variableia : 362 satety Stock Calculations by Statistical Methods PLANNING ANG CONTROL OF MATERIALS AND LaBgR = . ions tend to provide a safety stock for ‘ The preceding ad lead time variability. In other sittations weet oar tock is often calculated by traditional rules of thumb, such 9 of safety stor ‘These approaches have given way to statistica} tech,” rece minimize the combined eosts of stockouts and carrying inventory Sears complexity of calculations, computer application ig inevitayj ary ne tabulation of an eight months’ actual consumption of ie : Mat al ty together with the forecast monthly usage, forms the basis for the fotovig statistical approach: qa) Q) Q) 4 Forecast Units Minus Couns Forecast Consume UNtTs CONSUMED Squash 260 250 10 100 Febuary 218 225 <7 ae 275 15 2s 230 240 ~10 100 275 280 5 25 270 260 10 10 245 240 5 25 270 280 10 100 x22 ns | In Column 3, the differences between forecast re are derived and totaled. In Column 4, these di taled. The Column 3 total is squared and di periods (8 months) and the quotient is subtrac quirements and actual usage ifferences are squared and to vided by the number of tine ted from the Column 4 total: -2 724 - 23 ca = 724 - * = 724 ~ 60.5 = 663.5 The result is divided by the number of root is computed, giving the Standard 6 The average difference betwee! computed next by dividing the time periods minus one, and the squat deviation: = V94.786 = 9.74 nl forecast requirements and actual usegt i Column 3 total by the number of time pero (months): — Sri 2.75 Based on a normal minus the average difference. 22 units). : se Of —2.75 increases the safety stoc mitt B€, greater than the forecast usage: A P Here the average difference the actual usage is, on the avera;difference would indicate that, on the average, the actu wee forecast, thus reducing the safety stock figure, tat ree times the standard deviation minus the ely 32 units (3(9.74) — (—2.75)]} of safety stoc! nt protection against stockouts due to va veience of eight months. Pin January, with a usage forecast of 260 units, a lead time of one month a safety stock of 22 units, the order point is 282 units for Material 1-2. Of forts, an additional safety stock allowance may be needed if lead time varies, again giving consideration to the degree of protection desired by man. iment, When the stock reaches the order point level, it should trigger an order for the most economical order quantity. Lead time units must be the same time period units of measure as those used in computing the standard deviation, e.g., days, weeks, or months. This iustration uses months as time period units and assumes a lead time of one nonth. When the lead time is not one time period, proper computation of the safety stock requires the multiplication of the desired number of standard de- vations, the standard deviation, and the square root of the number of time period units. From this product, the average difference multiplied by the number of time period units is subtracted. Assuming the same standard devia- tion and average difference as computed on page 362 (two standard deviations ind a lead time of four months), the safety stock would be computed as fol- lows: ‘al usage is less average difference, approxi- k, would result in about 99,5 riation in‘usage based upon Safety stock = (2 x 9.74 x V4) ~ (-2.75 x 4) = (19.48 x 2) + 11 = 38.96 + 11 = 49.96 = approximately 50 units for safety stock The number of units needed during the lead time and the lead time itself Xe the two variables which influence the when-to-order decision. It is usually Possible to estimate fairly accurately the time required to receive materials. It seldom possible to forecast exactly the materials needed even for a short ture period; and when thousands of items are involved, the task becomes Potigious even with the aid of a computer. Some forecasting techniques are i¢fy mentioned in order to indicate the scope and complexity of the task: 1 Factor listing or barometric methods. Statistical methods. * Forecasting surveys. di “fog Alor listing involves enumerating the favorable and ee aa ar’ likely to influence sales of the various divisions or products : "s ji Juate the degree of the fr veal relies upon the forecaster’s judgment stematized factor listing. ‘actor. Barometric methods result in sys! ST pats i istorical patterns -cal methods describe historical pattern : ls may be simplg or complex, but the purpose is to reveal pattems tha — 363 Forecasting Usage364 General Observations ¢ AND CONTROL OF MATERIALS AND LABOR PLANNIN «PART g nd project them into the future. The usual p, ¢ series data (such as total sales, sales of Specig, lines or products, inventory units or dollars, labor hours, or machine hours ona graph, thus revealing a trend or a seasonal or cyclical pattern. A movin average may be used to smooth a series and remove irregular fluctuations, but the intent is to describe mathematically the growth or decline over a pericg o time. Regression analysis usually employs the least-squares method (see Chapter 18) to determine economic relationships between a dependent var, able and one or more independent variables, such as sales territory, family comes, advertising expenditures. and price of the product. Forecasting surveys are used to avoid complete dependence on historical data. They are commonly made in order to determine consumer buying inten. tions, opinions, or feelings about the business outlook, and capital investment plans. have occurred in the past a cedure results in plotting tim The primary key to good inventory planning is sufficient knowledge of the fundamental techniques to develop enough self-confidence to permit their practical adaptation to the specific needs of the company. Basically, economic order quantity and computed order points assume: Relatively uniform average demand. Uniform rate of inventory usage, Normal distribution of demand forecast errors. Constant purchase price per unit regardless of order size. Available funds when the order point is reached. Statistical independence of demand for all inventory items. ay repn Circular slide rules made expressly for computing EOQ are available, easy to use, and sufficiently accurate for all practical purposes. The formu can be translated into a logarithmic chart or nomograph, which makes its ¥& mechanical, requiring no mathematical knowledge. Aside from the technical and mathematical steps, it is important member that the following fundamentals largely determine the success of! inventory planning procedures: t to 1 1. The order point is a significant factor affecting inventory pletti since it establishes the inventory level. It determines the invest™" inventories and the ability to provide satisfactory customer isd The order point is primarly dependent on the accuracy of the usage forecast. , ance i ing ot? 2. Of equal importance is the establishment of unit costs. carry ordering costs, and the investment factor. They are invol¥! mining the economic order quantity. ott! 3. The inventory model should be sensitive and adaptive (© at ps usage variations and other nonstatic data influencing order PO! tity computations.MATERIALS eh functional organiz: ng woe vidence obt i cpopertions. These stakes Peyin with the approval of wales udeets and with the completion of Products which pment to warehouse Stocks oF to customers, Two levels of inventory control exist: unit control and doll chasing and production: managers are primarily inte wrk, order. and requisition in terms of units ins management is primarily interested in the financial control of inventories. Tiee executives think in terms of an adequate return on capital employed ie, daliys invested in inventory must be utilized efficiently ind effectively, Inventory control is operating successfully when inventory increases or de- creases follow a predetermined and predictable Pattern, related in amount and time to sales requirements and production schedules. The control of materials must meet two opposing needs: (1) maintenance ofan inventory of sufficient size and diversity for efficient operations und (2) nintenance of a financially favorable inventory. A basic objective of good materials control is the ability to place an order at the right time with the right source to acquire the right quantity at the right price and quality. Effective inventory control should: syaterals control is accomplished throu esponsibility, and documentary e ti . ent On, assign. timed at various stiyes and production are ready for sale and jar control. Pur. rested in unit control; they tead of dollars, Executive 1. Provide a supply of required materials and parts for efficient and unin- terrupted operations. 2. Provide ample stocks in periods of short supply (seasonal, cyclical, or strike), and anticipate price changes. 3. Store materials with a minimum of handling time and cost and protect them from loss by fire, theft, elements, and damage through handling. . 4. Keep inactive, surplus, and obsolete items to a minimum by systematic Teporting of product changes which affect mater tals and parts. 5. Assure adequate inventory for prompt delivery to customer 6. Maintain the amount of capital invested in} paler ay alevel c tent with operating requirements and management's plins ASE these fun- Inventory control systems and techniques should be based on damental principles: cy sand parts and (b) addi- into finished goods. | Inventory is created by purchasing (a) materials tional labor and overhead to process the materi : - Inventory is reduced through sales 2nd SPORE ig for eff » Accurate sales and production schedule ee inent Stent purchasing. handling. and materials VEN + Manazement policies. which attempt to balan’ Sy ventory for efficient operations and Cor! OV investment Lory. ure the greatest factor in determining IMYCMOD Ting production dering materials is a response (0 fOreculss Controls inventory. ¢ and diversity ¢ hat inven 365 CONTROL Control Principlesa3 QUANTITATIVE MODELS FOR MATERIAL: ware T S PLANNING Al ND CONTROL hed. A minimum level provides the m: + largil ockouts during a reorder cycle. The minimun putt) MEEESSAry to minimum level sets the order ng inventory to the maximum usage ‘i i orders the second bin contains the normal amount used from order date t fe to delivery date plus the safety Stock. When the first bin is empty and the second tin is tapped, 2 requisition for a new supply is prepared. The second bi reserve quantity is determined originally by estimating usage requireme a and adding a safety stock adequate to cover the time Tequired for replenishing the materials. For example, if monthly usage of an item is ten dozen, a oe month safety stock is desired; and if 30 days-are required to place an order and receive delivery, the second bin should contain 20 dozen units. A pur- chase order must be written when the reserve stock is tapped; otherwise, a stockout is likely to occur. The two-bin or “‘last bag” system requires little paper work, since reordering takes place when the “‘last bag’ is opened. The automatic order or order point system is automatic in the sense that ordering is triggered when a materials ledger card shows that the balance on hand has dropped to the order point. The system is especially advantageous in companies using electronic data processing equipment. The materials control department reviews materials items, forecasts usage and lead time, estab- lishes safety stock requirements, and determines economic order quantities. Thereafter, subject to quarterly or semiannual review, receipts and issues are Tachine-recorded on the materials cards. When the quantity on hand drops to the established order point, the materials cards are automatically machine- Sorted and are routed to order clerks who activate orders for the quantity ‘pecified. Companies with computers go even further in their use of the auto- atic order system. The computer reviews and updates order points, recal- Sates economic order quantities, and even w ‘tes purchase orders. Meaningful ratios require uniformity and consiste the cost of "to's underlying data. Inventory turnover is the ratio betwent Mt TT feds sold and the average inventory investment, and represth UV oy, ne Per accounting period that inventory iS physically ie roduct groups Fo, the focus must be on specific divisions and products of PUA ay Order to provide a viable materials control technique © Parison of planned ratios versus actual results. Jan, is an Segrepati F led the ABC plan, ‘sTegation of materials for selective control, ae ‘ABC plan measures the enc! approach based upon statistical aN oF high-value, items would st sien ‘als item. ience be under Stificance of each materials Wr’ asibility of the Mos experi r the tightest control and the 367 tency in computing the Inventory Turnover — A Basic Ratio Selective Control — The ABC Plan368 PLANNING AND CONTROL OF MATERIALS AND LAEOR vung items would be under simple physical controls such ay » personne). es, The plan provides an impressive 5, two-bin system with safety stoc! materials cost. The ABC plan concentrate: trol by importance and excep equal attention to all items in inven’ a2 s on important items and is also known Been, tion (CIE). Because it Is impractical to be tory, stock items are classified and rani. in descending order on the basis of the annual dollar value of each item, r., providing a proportional value analysis. In most situations, an arb number of items can be selected on @ percentage basis to approximate: 10% of the items to equal 70% of the dollar cost of materials used 30% of the items to equal 25% of the dollar cost of materials used 60% of the items to equal 5% of the dollar cost of materials used The following table suggests the handling of high-, middle-, and low-vzhe items to achieve effective control: HicH-VaLUE —-MIDDLE-VALUE — Low-Vatue Items Items Items (A) (B) (c) Quality of personnel .... Best : available Average Low Records needed .......... Complete Simple Not essential Order point and As guides, fre- Infrequent quantity used........... quent review review Strictly used Number of orders per YORE sssssscsesseee Generally high Two to six One of two Replacement time... AS short as possible Normal Can be long Amount of safety stock Low Moderate High Inventory turnover...... High Moderate Low _ The procedure for segregating materials for selective control consists £ six steps: 1. Determining future use in units over the review forecast period — month, quarter, or year. 2. Determining the price per unit for each item 3. Multiplying the projec it it Projected price per unit by the projected unit re@=™ 4 ren eocent the total cost of that item during the period. “4 . Arranging the items in t al ¢ i he highea Ieee lerms of total cost, listing first the item #1 5. Computing for each item i number of units of each ite: total cost — total cost of als. tS percentage of the total for (a) units = m divided by total units of all items. 2% each item divided ty total cost of all m™ 6. Plotting the percentages on a graph. sassift™ The table and graph on page 369 demonstrate ABC inventory 38 tion.units % OF ToTAL -U NIT Cost re 800 4} Tora i 12% $20.00 Cost 369 ae < 30.00 $16,000 2 OF Tora 1,600 16 12,000 a\ s } 1400 14}42% 4.50 a5 24. of 56% — » 200 12 5.00 200 Souk 4 7 14.4 a 000 14.0 6 2,000 20 4,800 96 38% — B 1 1,600 16} 46% a een ‘ ¢ 1,000 10) $9 a ‘9 200 Sf 6% y 15: g $ 8 56: 2 z z ° Distribution of < Inventory 5 Usage Values : (Cumulative 5 Percentages) 8 & E 2s. v2 25 50 54 15 \ . PERCENT OF TOTAL UNITS Physical ua Teceiving or inspection department forwards materials t Fate Pave Ponsible for sa som the materials. Materia © me the » in proper Reecneeaee ‘spaces until properly reais Storeroom ction, Admittance to the storeroom ares be restricted 10 em department. These employees often work pehind tacked d00"S: ler als through cage windows.ING AND CONTROL OF MATERIALS AND LABOR aru, PLANNI am ontrol responsibility is not ended when materia ntrollin: The materials cost ¢ se are finished, pa S ate ana requisitioned for production mi Coe potentials et ang wave oblems a . . This; Process shipped, inventory control pro are intimately relates his ess inventories WI articularly true of in-process inv ee and schedules, but often are not controlled. Genera entory levels based either on maximum pr to pr Hy, the duction processes duction objective is fo maintain inv or the lowest unit cost ee or wt mputation of turnover Tales aids in identifying inventory probe, Je computati¢ suuring the effectiveness of control procedures. A computation i, and measuring ach manufacturing department, Cost Center, or process by dividing the cost of units transferred to the next Scpameny ty) the ave ‘nventory cost of the transferring department. Turhover rates vary from on department to another; hence the focus is on turnover rate changes. Schedy. inu or production problems are often indicated by a declining turnover re Hor cost control purposes, the downtrend in turnover rates should suggey analysis and induce corrective action. usually made for e# Controlling An accurate sales forecast is the key to effectively managing finished Finished goods inventories and meeting delivery dates. This forecast must be commun. Goods icated to production control departments in order to develop production schedules for meeting sles commitments. To meet customer preferences and competition, many product lines fe ture a growing array of colors, sizes, and optional equipment. This results in added inventory items, more work in process inventory and finished suba- semblies, and the need for tighter control. Cnn Almost every organization is faced with the problem of surplus and Obsolete solete inventory at one time or other. Whatever the many possible reasons/it and Surplus such conditions may be, some action is required to reduce or eliminate thet Inventory items ‘om inventory and free the related capital. To accomplish a reducti®s management should first make certain that the buildup will not continue d 1© present ordering policies and, second, take steps to dispose of stock. Ac Tate perpetual inventory records showing acquisition and issue quantities dates, ay well as periodic review of the récords, are necessary to ietl ubsolete and surplus items. Obsolete inventory usually results from c= ‘design or dropping a product. Prompt sale of the inventory for t 'ovonable offer is usually the best policy, DISCUSSION QUESTIONS 1. What data are needed in order to exercise effective management of ™ cost and inventones? aequeens 4, 12, 13. 14, 371 sOME OL the Conte of HI8 Of NOt carrying eNOUgH inventory? IH inventory? How can these Doeting and discuss the econ econome order quantit HMPUONS And accounting dat 7 ¥ (COQ) tochnique, inciuding an (AICPA adapted Inv nto \ ally are an important asset for both manutacturs ner aaa eee tt A Proper balance of mvantory quantities we ynd M8 mer ch a balan 18 dey of factors, including ordering at the Proper time and in the caarael fora Sorious penalties . fi Sarg renee may Feo rom Bay overstocking and stockout situations. basie, Explain cael ee atery ordering and control, certain terms are in og lowing (1) economic order quantity, (2) order port, (3) lead timo, and (4) satety stock. (b) (1) What are the costs of carrying inventories? Explain, (2) How does overstocking add to the cost of carrying inventories? (c) (1) What are the consequences of maintaining minimal or inadequate in- ventory levels? (2) What are the difficulties of measuring precisely the costs associated with understocking? (4) Discuss the propriety of including carrying costs (of normal inventory, overstocking, and undorstocking) in the inventory cost (1) for external reporting and (2) tor internal decision making (AICPA adapted) When should inventory be ordered? It is generally true that production and inventory management can be no bet- ter than the sales forecast, Name some techniques used to forecast sales. An inventory planning and control system is designed to minimize the total cost of ordering and carrying inventory. Therefore, inventory control is good as long as the investment in inventory is declining. Discuss Is general management concerned primarily with unit control or financial control of inventory? The control of material: What are the principal dil The principle of “excepti control. Explain. In what situation are selective control, aut materials effective? What ig the key to contr company? Select the answer which best complet (a) Expected annual usage of material 5 must meet two opposing needs. What are they? {ferences in commonly used control plans? on" should be utilized fully for effective materials jomatic control, and bin contro! of olling finished goods inventory in 8 manufacturing the statement: ng ig 2,000,000 units, and the geonomic , ’ nit is . tity is 10,000 units. The invoice cost of each u! order quanti r e cost to place one purch! der is $80. The average inventory is: (1) $80. verag cone purcl eae ' is: (1) 1,000,000 units: (2) 6,000 Uns! I astimated annual order O° the information in 000. Cn ° $16.000, (2) $100,000; (3) $32,000: (4) $5 of a perist les ties for daily sal i develope (c) A sales office has able product as shown on PA! J the probabill ge 372(f) (9) (h) TWA OF WATERSS pes aw Pecesmnes , z z sogwed at tre s'2t cf ezc" tay itm e > ¢ ganstying cevand re ireg ts y Of SAD STY TG SEES COTES, 1 in tg gl tty ete (9) 250, (2) 760. S) E20: (4) 159, ay ny hes Cee ced 2m IMvEntoTy mote toe nor minmging Te total B7Ua! evento gee by tory cost ave the COSIS Cf ROTING, Orcering ang ayy "Pate outs. The sciuten for minimizing inventory 9 °S Be € and Row Mary UNdS to receng = At at what inventory | mary unds te reorder: Bi now oe but not at what inventory fevei to er, (4) at what invens, Tess not how many units te reorder. A company s treasurer complains about an excessive invesimew pa tories. At the same time, the purchasing agent States that lace me balances are necessa’y 0 take advantage of supplier scama mn production manager complains that production oten is ceiavec 5) net tory shortages. The quantitative technique mest retevant to Ms sune is: (1) economic order qu oceis; (2) linear programmns 3 sn back analysis; (4) probability analysis. A company places orders for a certain item for which the oce sa: determined in advance, using the EOQ formula. Al ordes a8 tesa size. When the policy is implemented, demand per period is omy ow st of the expected cemand when order size was computed. Corsexen the actual total inventory cost will be: (1) larger than if the excece: = mand per period had occurred, and larger than if the actual cemat period had been used to caicuiate order size; (2) larger than # me pected demand per period had occurred, and smalier than if tek demand per period had been used to caiculate order size, @) swat if the expected demand per period had occurred, and larger Pa! * actual Cemand per period had been used to calculate orcer Ley smalier than if the expected demand per period had occur. smalier than if the actual demand per period had been used t order size an Ignoring safety stocks, a valid computation of the order pomt $+ economic order quantity; (2) the economic order quannty the anticipated demand during the lead time; (3) the anticics uring the lead time; (4) the square root of the anticipated the lead time. For its economic order quantity model, a company has placing an order and an annual cost of $2 for carrying 0 of oS the cost of placing an order increases by 20%, the annual COS”, yet one unit in stock increases by 25%, and all other consi nae en constant, the economic order quantity will: (1) remain UNCT Ag of crease; (3) increase; (4) either increase or decrease 4 order point. x ie? oe a cost fF ne unit insimize the rate of inventory rying cost, whichever is higher; Next period's demand econom cost and carrying cost. In computing economic o have the following result quantity in times of rising pi times of rising prices: (4) rising prices. (k) A company has correstly computed its economic order ar -* units, However. management feels it would rather order in qu: 600 units. The company’s tota! annual .. ~ rying cost tor a Over; (2) to minimize ordering cost or car- (8) to order sufficient quantity te meet the cally; (4) to minimize the total ordering (i) der quantity, a lifo or fifo inventory method will (1) no effect; (2) lito will increase the order rices: (3) lifo will reduce the order quantity in fifo will ‘increase the order quantity in times of as 500 ities of cost and total annual car- F ef quantity of 600 units compared to the respective $s for an order quantity of 500 units would be: (1) a higher ordering 2 « ". and a higher carrying cost; (2: a lower ordering cost and a lower “ying cost; (3) a higher ordering cost and a lower carrying cost; (4) a 2wer ordering cost and a higher carrying cost. “su ‘ollowing data refer to various annual costs relating to the inventory fu gle-product company Annual interest that could have been earned on alternate investment of funds «..... - $800 Units required during the year 10,000 Variqere Cos Pea UNT Transportation in on purchases $.20 SLOrAGE ee 5 12 Insurance. 10 The annual carrying cost per unit is: (1) $.22; (2) $.30; (3) $.42; (4) $.50. (m) A company has assembled the following data for a given year: Economic order quantity (standard order size) .. seennnsncsesnenne — §,000 Units Total cost t6 piace purchase orders for the y - x Cost to place o7e purchase order % Cost to carry one unit for one year. imated annual usat #000.000; (4) not determinable from the data given. '. Planning mai js requirements. {.the inventory of Material A is 2,000 units: 2.3 Riits tor February delivery. A minimum reserv ned throughout the remainder of the year. ‘A company's producti That A for erations, 2,100 units for February, 4! 00 unt for Mar oad ot Mater its are on order ge in units is: (1) 1,000,000; (2) 2,000,000; (3) {AICPA adapted) EXERCISES 2 its of a schedule calls for 2.300 uni ind 2,500 units for March. On Janus un of 72% of the January 1 | inventory is to be FrPLANNING AND CONTROL OF MATERIALS AND LABOR Pazy 374 ‘ ired: Fede y the number of units of Material A to order for M (2) The estimated quantity on hand on March 1 and on March 31 / September 1, a materials analyst is asked to q tor November delivery. The production sen arch delivery, aS of January 1 2. Usage forecast and inventory balances. 0" mine the number of units of Material X to oraer yee le calls for 3,500 units of this material for September operations ea Ha aon ane 209 uniis in November. On September 1, the inventory shows 4: Setivery. A 2.00G-unit 8 ON ode, | for September delivery, and 3,000 units on order for October y: f inimum serve inventory is maintained. eter, Required: 1) Quantity to order for November delivery. ; 2) The number of units on hand or a) November 1 and (o) Boers 30, if the usage occurs and outstanding orders are received on expecto y dates, ations of the EOQ formula. (Round off all answers to the nearey planneg 3. Computations and appl whole number.) (a) Shilders. inc., has an annual usage of 100 units of Item unit. The following data are applicable to Item M Ordering cost 5 $5 per order Carrying cost percentage 15% M with a purchase price of $55 pe Required: The economic order quantity. (b) Henry Company has developed the following information for one of its inventory items: b units required per year, 30,000; cost of placing an order, $400; unit carrying cost per yea $600. Required: The economic order quantity (c) Modern Equipment Company estimates a need for 9,000 Ajets next year at a cost of $3 pe unit. The estimated carrying cost is 20%, and the cost to place an order is $12. Required: The most economical number of units to order at one time. . (d) Trefoil, Inc., requires 27,000 containers next year at a list price of $12 per container. The estimated carrying cost is 25% of average inventory, and the cost to place an order is $20. Required: The most economical number of units to order at one time. (e) The Shubert Company estimates that it will need 12,500 cartons next year at a cost o$ Per carton. The estimated carrying cost is 25% of nt, and tt Cost te piace on ence carving of average inventory investme’ Required: (1) The most economical number Of units to order, (2) The frequency in days that orders should be Placed, based on a 365-day yea. (f) Bradiey Sporting Goods, Inc, buy will sell 36,000 dozen baseballs on its average inventory investmi dozen baseballs in the chase order e S10. ne VetA9E inventory is $.40. The cost invol Required: (1) The economic order quantity. (2) The total annual inventory expense to sell n jers ar? at 800 dozen evenly throughout the year. 36.000 dazeh besebalts Hor ot vi (g) Pierce Company annually manufactures 10,000 blades 1 ic lawn mower tins Blades are used evenly throughout the year. The setup cons ence tena production # made is $60, and the cost to carry a blade in inventory fs $ 40; Management's © to produce the blades at the lowest possible cost, rad son re? atQUANTITATIVE MODELS FOR MATERIALS PLA NNING AND ci ONTROL t economical number of annual production a5 duction runs it eac |. The mes! ne Tie ext 00m Hh run is Scheduied tor mer been ordering S000 specially designed metal coi pace curme,e pest year Th variable prodyction cost is SB per unit $6 feo ei iabor. and $2 for toe Y overhead It costs $1,500 to set Up tor one fonmatenas 29 0" te Ory Carrying cost 1s 20% Since this c stomer meg camfolumns per year. the Company would ike to avord matang te dito a ast % King five different production ag, The most economical production run uid Inc.. manufactures a !ine of 1 iy Nussbaum walnut office products Ma naseid for the double walnut letter tray at 6,000 units. The tray sells Tor S80. Thencees gemarg tothe letter tray are: manufacturing cost per tray, $50; cost to ita Sa reatespo, annual cost of carrying the tray in inventory. 20% of manulacturing cost In prot years, the production for the tray has been scheduled in two equal production runs "bees The expected annual cost savings the com uted pany could experience if t employed tite order quantity model to determine the number of production runs which Sno be fed curing the year. (CMA adapted: ata « cot esulting from inability to use EQ. The Electro Company manufactures some ofits pros wires rom raw materials, and for other products assembles purchased parts. For one product sia subassembled parts at $100 each are purchased annually. The per order and receiving cost gid, and the carrying cost is 25% Tne only one of many inventory items the firm must carry, and a capital rationing decision sasteen made to spend only $10,000 at a time on these subassemblies. Units must be ordered in rutigies of 100. feted it) Computation of the EOQ. 2) The opportunity loss expressed as tothe availability of capital carrying cost by changing the EOQ and inventory level $ Oner point, inventory levels, ordering cost. The Western-Colorado Company has developed telolowing data to assist in controlling one of its inventory items Economic order quantity. 1000 liters Average daily use . 100 liters Minimum daily use... 80 liters Maximum daily use «.-- 120 er Worki year ale 400 liters Safety stock in Cost of carrying inventory Metuited: Lead time Ba. 3 Order point 0) nerage inventory Aaatai Maximum inventory ved) 8) Cost ut maximum inventory (CGAA adapted! Be Placing one order. ined the nom Wom" Order quantity, order point, safety St $1.00 per liter per year 7 working days ck. The Bolger COMPANY has obt 9 00. ! sts and other data pertaining to one of its materials oso Working days per yea" 500 units : Normal use per day B00 units Maximum use per day - 400 units , Minimum use per day. saays , Lead time...» $36 one order n=" Ae Variable cost of placing Variable carrying cost per unit per year