INVENTORY MANAGEMENT

Shiela Fatallo Rustelle Joy Hernandez Denice Cansicio Leona Lopez Sheila Mae Osanastre Venice dela Vega

What is inventory?
is an expensive and important asset of the company, representing

as much as fifty percent of the total invested capital

It is any stored resources used to satisfy a current or future need Examples: raw materials, work in process, finished goods

Functions
To decouple or separate various parts of the production process To provide a stock of goods that will provide a selection for customers To take advantage of quantity discounts To hedge against inflation and upward price changes

The Material Flow Cycle

Types of Inventory
Raw Material - Items that are used in a manufacturers process of conversion to produce a finished product. Work-in-progress - Materials, part or components which are being processed or waiting to be processed. Maintenance/repair/operating supply Finished goods - Completed and ready for a customer order

Independent versus Independent Demand

Independent Demand - Demand for item is independent of demand for any other item Dependent Demand - Demand for item is dependent upon the demand for some other item

Cost associated to inventory

Holding Costs Ordering Costs Purchase Cost Setup Costs

Holding Costs
Associated with holding or carrying inventory over time It includes: - Obsolescence - Pilferage - Insurance - Damage - Extra Staffing - Warehouse - Interest

Ordering Costs
Associated with costs of placing order and receiving costs It includes: Supplies Order processing Forms Clerical support

Purchase Cost
Amount the buyer pays in purchasing the inventory items
In case of available quantity discounts, it is quoted price of inventory minus any discounts allowed plus shipping charges

Setup Costs
Cost to prepare a machine or process for manufacturing an order It includes: Clean-up costs Re-tooling costs Adjustment costs

Calculating Inventory Costs

Terms:
D = Annual Demand Q = Order Quantity C = Purchase Cost per unit K = Cost of Placing an Order H = Cost of Holding one unit in inventory for a year TPC = Total Annual Purchase Cost THC = Total Annual Holding Cost TOC = Total Annual Ordering Cost

Purchase Cost = (annual demand)(purchase cost / unit) TPC = ( D ) ( C )

Total Ordering Cost = number of orders per year = D / Q (orders per year)(placing cost) TOC = ( D / Q ) K

Total Holding Cost = (average inventory)(cost of holding one unit) THC = ( Q / 2 ) H Average inventory = maximum inventory / 2 =Q/2

Example 1:
Visual Graphics produces a variety of produce in a production facility in Southern Luzon. One particular chemical LX95, is used extensively and is supplied by a small firm in Manila. A view of the records from the last two years indicates the usage of this product is relatively constant throughout the year, and Visual Graphics uses 2,000 cases per year. Every time an order is placed, the time placing the order, checking the order when it arrives, placing the cases in the storage room and paying the bills costs the company P20 of personnel time.

Cont. Example 1:
The company also had found the cost of the capital for the company as well as insurance, spoilage, and other factors costs the company 10% of the value or cost of the inventory. Each case of LX95 costs P80, and there are no discounts available for ordering large quantities. In the past, Visual has placed orders for 40 cases every week; the company is open five days per week and 50 weeks per year. Now it is considering reducing the number of order per year by ordering more cases each time an order is placed.

Cont. Example 1:
Given: D = 2,000 units Q = 40 units C = P80 per case K = P20 per order H = 10% of P80 = P8

Cont. Example 1:
Computations: TPC = 2,000 (80) = 160,000 THC = ( 40 / 2) 8 = P160 per year TOC = (2,000 / 40) 20 = P1,000 per year

Cont. Example 1:
Past record of Q: Annual = 2,000 units per year Quarterly = 2,000 / 4 = 500 units per quarter
Monthly = 2,000 / 12 = 166.67 or 167 per year month

Inventory Models
Economic Order Quantity (EOQ)

The economic order quantity (EOQ) model is

one of the oldest and most commonly known inventory control techniques

Help answer the inventory planning questions!

An inventory related equation that determines

the optimum order quantity that a company should hold in its inventory given a set cost

of production, demand rate and other

variables. This is done to minimize variable inventory costs.

Economic Order Quantity (EOQ)

The economic order quantity (EOQ) model is one of the oldest and most commonly known inventory control techniques

An inventory related equation that determines the optimum order quantity that a company should hold in its inventory given a set cost of production, demand rate and other variables. This is done to minimize variable inventory costs.

The EOQ model is based on some specific assumptions about the inventory system:
Known and constant demand Known and constant lead time Instantaneous receipt of material No quantity discounts Only order setup cost and holding cost No stockout

Deriving an EOQ
Develop an expression for setup or ordering costs Develop an expression for holding cost Set setup cost equal to holding cost Solve the resulting equation for the best order quantity

Inventory Usage Over Time

EOQ Model
How Much to Order Decision
This decision can be based of applying the EOQ formula. This is the quantity that will minimize the total cost of inventory for each piece of each product with recurring usage that you buy.

EOQ Model

The EOQ Formula

TC = TO + TH ( DK / Q) + (HQ / 2)
The Q Formula: Q = 2DK/H Where: D = annual demand K = ordering cost H = holding cost Q = quantity ordered

Example 2:
How many orders will be placed during the year assuming that the demand for coke for 52 weeks (one year) is 2000 cases per week making it 104,000 in a year. The computed annual holding cost is P2 and the annual ordering cost is P32.

Cont. Example 2:
Computation: Q Formula: Q = 2 DK / H TC = [ ( 104,000(32) / Q)] + [ (Q / 2) 2] = 2 (104,000)(32) TC = Q + (3,328,000 / Q) = 1, 824 cases

Example 3
-How much should a company order if the demand for one year for cooking oil is 2000 given them ordering cost of 20 and the holding cost of 8?

Computation:
Q = 2DK/H = 2 (2000) 20 / 8 = 100 units

Re-order Point (ROP)

The When-to-Order Decision - To avoid running out of stocks. - To come up with this decision, the concept of inventory position is introduced. Inventory Position - A quantity used to measure the current inventory level.

The When-to-Order Decision

Re Order Point (ROP)

The inventory position at which a new order should be placed.

Based on the inventory position of a firm, the lead time, and the demand rate.

Re Order Point (ROP)

Re-order Point Formula

ROP = d x L Where: ROP = reorder point d = demand per day L = lead time for a new order in day

Example 1:
The manufacturer of a Coca Cola softdrink guarantees a two day delivery on any order placed by C & C Beverage. Assuming a constant demand rate of 2000 per cases per week or 400 cases per day.

Given :
Computation: d = 400 ROP = d x L L=2 = 400 (2) = 800 cases Therefore, when the inventory level reaches 800 cases, it is time to make order.

Example 2:
Assume that C & C Beverage is open 326 days per year. If the annual demand is 6,300 and the lead time is 30 days, determine the re-order point for beverages. Given: Annual demand = 6,300 Period = 326 Lead time = 30 days beverage Computation: ROP = d x L (6,300 / 326) (30) =579.75 or 580

Therefore, when the inventory level reaches 580 beverages, it is time to make an order.

Example 5:
Mrs. Gonzaga, the manager of Gonzagas Boutique knows that suppliers of brass candlesticks will deliver 30 days after, Gonzagas places an order and knows that his average sale is 2. Determine the reorder point for candlesticks. Given : Daily demand = 2 Lead Time = 30 days Computation: ROP = d x L = 2 (30) = 60 candlesticks Therefore, when the inventory level reaches 60 candlesticks, it is time to make order.

Quantity Discount Model

Answers how much to order and when to order Allows quantity discounts
Reduced price when item is purchased in larger quantities Other EOQ assumptions apply

Trade-off is between lower price and increased holding cost

Quantity Discount Models

Because unit cost is now variable Quantity discounts are commonly Holding cost Ch IC available I holding cost as a percentage of the unit cost (C)

The basic EOQ model is adjusted by adding the purchase materials cost Total cost in Material cost + or Ordering cost + Holding
D Q Total cost DC C o C h Q 2 where D annual demand in units Cs ordering cost of each order C cost per unit Ch holding or carrying cost

Quantity Discount Schedule

Discount Number 1 Discount Quantity 0 to 999 Discount (%) No Discount Price (P) $5.00

discount 2 1,000 to
1,999 3 2,000 and over 5 $4.75

$4.80

Buying at the lowest unit cost

is not always the best choice

Quantity Discount How Much To Order

 Brass Department Store stocks toy race cars Their supplier has given them the quantity discount schedule shown in Table 6.3
Annual demand is 5,000 cars, ordering cost is $49, and holding cost is 20% of the cost of the car

Brass Department Store Example

The first step is to compute EOQ values for each discount (2)(5,000 )( 49 ) EOQ 1 700 cars per order (0.2)(5.00 ) (2)(5,000 )( 49 ) EOQ 2 714 cars per order (0.2)( 4.80 ) (2)(5,000 )( 49 ) EOQ 3 718 cars per order (0.2)( 4.75 )

Brass Department Store Example

The second step is adjust quantities below the allowable discount range The EOQ for discount 1 is allowable The EOQs for discounts 2 and 3 are outside the allowable range and have to be adjusted to the smallest quantity possible to purchase and receive the discount Q1 700 Q2 1,000 Q3 2,000

Brass Department Store Example

The third step is to compute the total cost for each ANNUAL ANNUAL ANNUAL quantity
DISCOUNT NUMBER UNIT PRICE (C) ORDER QUANTITY (Q) MATERIAL COST ($) = DC ORDERING COST ($) = (D/Q)Co CARRYING COST ($) = (Q/2)Ch TOTAL ($)

1 2 3

$5.00 4.80 4.75

700 1,000 2,000

25,000 24,000 23,750

350.00 245.00 122.50

350.00 480.00 950.00

25,700.00 24,725.00 24,822.50

The fourth step is to choose the

alternative with the lowest total cost

Probabilistic Models
Answer how much and when to order Allow demand and vary
Follows normal distribution Other EOQ assumptions apply

Consider service level and safety stock

Service level= 1 probability of stockout Higher service level means more safety stock More safety stock means higher ROP

When To Order

Safety Stocks
Safety stock can be implemented by adjusting the ROP Safety stock can prevent stockouts when demand is unusually high To prevent stockouts, it is necessary to carry extra inventory called safety stock Extra inventory held as a hedge, or protection, against the possibility of a stock out.

Two effects on the firms cost:

Decrease the cost of stockouts Increase carrying cost

Stock out
Condition that exist when inventory on hand is not sufficientto cover needs. Two kinds of stockouts: 1. demand (usage) was normal but delivery was later than expected 2. delivery was on schedule but usage was greater than expected

Formula of Safety Stocks

Safety Stock = Maximum Daily Usage Average Daily Usage (Lead Time) A safety stock variable is added to the equation to accommodate uncertain demand during lead time

Example 6:
ABC Ltd. Is engage in production of tires. It purchases rims from JAM Ltd. an external supplier. JAM Ltd. takes 10 days in manufacturing and delivering an order. ABCs requires 10,000 units of rims. Its ordering cost is P1,000 per order and its carrying costs are P3 per unit per year. The maximum usage per day could be P50 per day. Calculate the safety stock? Solution: Safety Stock = (50 27.4) x 10 = 226 units