Note 8:

Inventory Management: EOQ, JIT,

and the Theory of Constraints
JUST-IN-TIME

An excellent option for many businesses and circumstances in need of improved inventory
control is just-in-time (JIT) inventory management. It is a contemporary inventory model in
which purchases and production of materials, parts and subcomponents are scheduled so that
items are available just when needed for production, not earlier and not later. There are zero
inventories. While Just-in-case inventory management provides the necessary background for
grasping the advantages of inventory management methods that are used in the contemporary
manufacturing environment. Without monitoring, companies waste money on unneeded
inventory storage facilities and enormous warehouses, as well as on materials and items that are
never utilized or sold.

Setup Costs Stock-out Costs Economic Order Quantity

- These are the costs of
preparing equipment and
facilities so they can be used
to produce a particular
product or component.
- Are the costs of not - It is a mathematical approach
to compute order size/number
having a product
of units to order to minimize the
available when demanded annual sum of the inventory
by a customer. carrying cost and ordering cost.

JIT INVENTORY SYSTEM ● The use of KANBAN incorporated in the design of a

computerized manufacturing system it states the quantity that a
succeeding process shall withdraw.
● Many non-JIT companies do not fully implement a JIT system
but they are maintaining an Optimum Level of Inventory to
manage their inventories.
JIC Inventory Management
3 types of inventory costs
the cost of acquiring inventory
the cost of holding inventory
the cost of not having inventory on hand when needed

Relevant Costs of Inventories

Cost of Ordering (These are the costs of placing and
receiving an order)
1. Preparing purchase or production orders
2. Receiving (unloading, unpacking, inspecting)
3. Processing all related documents
4. Extra costs of numerous small production
runs, setups and training
5. Quantity discounts lost (trade discounts on
volume purchases)
Cost of Carrying (These are the costs of holding
inventory)
1. Foregone return on capital invested in
inventory
2. Risk of obsolescence and deterioration
3. Storage-space costs
4. Personal property taxes on inventory
5. Insurance on inventory

INVENTORY CONTROL ADVANTAGES OF JIT

(TWO MAIN QUESTIONS)
1. How much to order?
best/optimum size = Economic Order Quantity (EOQ)
(the point where the total ordering costs is equal to
total carrying cost or total relevant inventory costs
(at the lowest) is equal to ordering costs plus the
carrying costs.)
2. When to order?
reorder point – inventory level where a purchase order
should be placed
INVENTORY MANAGEMENT
→ Reduced warehousing. Companies don’t need large
warehouses when they have less inventory to store,
which dramatically reduces warehousing budgets.
→ Improved efficiency. Less material overhead leads to
less waste, and less waste helps companies save money.
→ Easier rotating. JIT inventory makes it easier and
less costly for companies to pivot — to new lines,
upgraded products since there aren’t shelves of old
products that need to be cleared.
 Note 8:
Inventory Management: EOQ, JIT,
and the Theory of Constraints
ECONOMIC ORDER QUANTITY
Economic Order Quantity (EOQ) is a calculation used in inventory management to
determine the optimal order quantity that minimizes total inventory holding costs and
ordering costs.
Its goal is to find the balance between the costs associated with holding inventory and the
costs associated with ordering more inventory.
Formula:
Where:
AD= annual demand in units
AD (P)= annual demand in peso
CPO= cost of placing an order
CCR= carrying cost ratio
CCPU= annual cost of carrying one unit in
a stock per year
REORDER POINT (ROP)
- Inventory level signaling when to place a
purchase order.
- Calculated as Lead Time Quantity + Safety
Stock Quantity
LEAD TIME
- Calculated as normal usage x normal lead
time.
THEORY OF CONSTRAINTS
(TOC)
Objective: Make money now and in the future
through constraint management.
Constraint Definition: Limiting factor in
organizational performance; every system has at
least one.
Chain Analogy: Compares organizations to chains
with the weakest link (constraint).
TOC APPROACH:
» Focuses on system-level effects for continuous
improvement.
» Strengthening the weakest link improves overall
performance.
» Identifies constraints, exploits, subordinates,
elevates, and repeats the process.
Other Formulas:
CCPU= Total Carrying Cost/Average Inventory
CCPU= Unit cost x CCR
Average inventory= Order Size/2
CPO= Total ordering cost/ No.of Orders
Total ordering cost= CPO x No. of Orders
No.of Orders= AD/ Order Size
Order Size= Average Inventory x 2
SAFETY STOCK
- Reserved inventory to prevent
stockouts due to demand spikes or order
delays.
SAFETY STOCK
COMPONENTS
In Usage: (Max Usage – Normal Usage) ×
Normal Lead Time.
In Time: (Max Lead Time – Normal Lead
Time) × Normal Usage or Average Daily
Usage.
Maximum Inventory Level: Equals Safety
Stock Quantity plus Order Size.
FIVE-STEP METHOD FOR
IMPROVING PERFORMANCE:
Identify organization's constraints.
Exploit the binding constraints.
Subordinate everything else to decisions from
step 2.
Elevate the organization’s binding constraints.
Repeat the process as new constraints emerge,
limiting output.