CHAPTER - 4

May, 2023
 What is Materials Management ?
 Material management is a scientific technique, concerned
with Planning, Organizing &Control of flow of materials,
from their initial purchase to destination.
 Aim of Material Management is to get:-
1. The Right quality

2. Right quantity of supplies

3. At the Right time

4. At the Right place

5. For the Right cost

Points to be noted before purchase of an equipment
• Latest technology
• Availability of maintenance & repair facility, with minimum down time

• Post warranty repair at reasonable cost

• Upgradeability

• Reputed manufacturer

• Availability of consumables

• Low operating costs

• Installation
• Proper installation as per guidelines
 Inventory

Inventory: is an idle stock of material in store used to

facilitate production or to satisfy customer needs and can
include: raw materials, finished products, component parts ,
and work-in process.

Inventory is a detailed list of movable goods.

Inventory is the quantity of goods, raw materials or other

resources that are idle but, usable at any given point of time.
 Cont…
 Inventory Management:- Scientific method of finding
out how much stock should be maintained in order to
meet the production demands and be able to provide
right type of material at right time, in right quantities
and at competitive prices.
 Inventory control:- is a planned approach of
determining what to order, when to order, how much
to order and how much to stock.
 Cont…

 Inventory control is concerned with achieving an optimum

balance between two competing objectives.
 Minimizing the investment in inventory (Inventory cost).
 Maximizing the service levels to customer’s and it’s
operating departments.
 Inventory control basically deals with two problems:

When should an order be placed? (Order level), and

How much should be ordered? (Order quantity).

 Types of Inventory
 Raw material:- Purchased but not processed
 Work-in-process:- Undergone some change but not completed
 Finished goods
 Completed product awaiting shipment
 Goods-in-transit to warehouses or customers
 Distribution inventories; finished goods that are located in the
distribution system.
 Maintenance/repair/operating (MRO)
 Replacement parts, tools, & supplies
 Necessary to keep machinery and processes productive
 Key Inventory Terms
 Lead time: time interval between ordering and receiving the
order
 Holding (carrying) costs: cost to carry an item in inventory for
a unit of time. It can be based on max inventory or average
inventory. For most of the items is based on average inventory.
 Ordering costs: costs of ordering and receiving inventory
 Shortage costs: costs when demand exceeds supply
 Inventory Classification
 Items are categorized in a groups depending upon the
selected criteria such as value, usage, frequency and
consumption. Such grouping helps the organization for
scientific inventory control.
 Various types of inventory classifications:
 ABC
 VED (Vital, Essential, desirable)
 HML (High, Medium, Low)
 ABC Items

 A Items – typically 10 - 20% of the items accounting for

70 - 80% of the inventory value (Vital few).
 B Items – typically an additional 30% of the items
accounting for 15% of the inventory value (moderate).
 C Items – Typically the remaining 50% - 60% of the
items accounting for only 5% - 15% of the inventory
value (Trivial many).
Importance measure= price*annual sales
 Cont…
High
A
Annual $
value of items B

C
Low
VED (Vital, Essential, desirable) Few Many
Number of Items
V (Vital) - very important

E (Essential) - mod. Important

D (Desirable) - least important

 Inventory Counting Systems
Two type of physical count of items in inventory
 Periodic/Cycle Counting System: Physical count of items made
at periodic intervals.
 Continuous Counting System: System that keeps track of
removals from inventory continuously, thus monitoring current
levels of each item.
 Cont…
 Two-Bin System - Two containers of inventory; reorder
when the first is empty
 Universal Bar Code - Bar code printed on a label that has
information about the item to which it is attached.

214800 232087768
 Independent and dependent demand

 Independent demand item: An item whose demand

does not depend on the demand of any other item.

 Dependent demand item: An item whose demand is

derived from the demand of other item is called
Dependent demand item.
 Cont…
Inventory: a stock or store of goods Independent Demand

A Dependent Demand

B(4) C(2)

D(2) E(1) D(3) F(2)

Independent demand is uncertain.

Dependent demand is certain.
 Inventory Costs

Holding (or carrying) costs:- Costs for storage, holding

cost, insurance, depreciation cost, capital interest.
o Higher stock levels usually increase the risk of deterioration ,
obsolescence, & pilferage.

Setup (or production change) costs:- Costs to prepare a

machine or process for manufacturing an order, e.g..
arranging specific equipment setups, etc.

.
 Cont..
Ordering costs:- (costs of replenishing inventory); Costs of
placing an order and receiving goods, quality inspection cost,
transportation cost.

Shortage costs:- It is an absence of inventory item and the cost

associated with not serving the customer. Costs incurred when
demand exceeds supply.

Systems cost:- Refers to costs which depend on the quantity &

quality of effort expended in controlling inventories.
 Inventory Models
 Inventory models deals with determining optimum inventory
level that should be kept to keep the inventory cost to the
minimum and customer satisfaction or service level to the
maximum.

 When to order?

 How much to order?

 How much and when to produce?

 Level of inventory
 Inventory Models

 Economic Order Quantity (EOQ)

 Economic Production Quantity (EPQ)

 Quantity discount model

 1. Economic Order Quantity Model (EOQ)

 Economic Order Quantity Model (EOQ) which is a Fixed

Order Quantity Models.
 Developed by F. Harris in 1913
 One of the oldest and most well known inventory
control techniques.
 Easy to use
 Based on a number of assumptions
 EOQ Assumptions

Known and constant demand throughout the period.

Known and constant lead time (time from ordering to receipt)

No quantity discounts (Price per unit of product is constant).

Only order (setup) and holding cost

No stock outs (shortages) are allowed.

Only one product is involved

All demands for the product will be satisfied. (No back orders
are allowed.)
 Developing the EOQ Model
 The optimal or minimum cost occurs at the intersection point
of holding cost and ordering cost. So using calculus the Q
value at this point can be computed.

 Reorder point: level of inventory at which a new order is

placed (when to order). R = d*L
Where
d = demand rate per period
L = lead time
 High TC
Carrying
cost
= HQ
2
Inventory Cost

EOC

Purchase
Cost = CD

Low Ordering
cost
Low EOQ Quantity high = SD
Q
 Cont..

 The EOQ is the optimum quantity that gives a minimum

inventory cost. It is the intersection point at which the ordering
cost is equal to carrying cost.

EOQ = ( Carrying cost = Ordering cost)

 Given a lot size of Q, we have an average inventory of Q/2.

Annual Carrying cost = H *Q/2

Annual Ordering cost = (S*D/Q)

Total Inventory Cost = Ordering Cost + Carrying Cost + Purchase Cost

 The EOQ Model

EOQ = Q = Optimal number of Order Quantity

D = Annual demand in units for the inventory item

S = Setup or ordering cost for each order

H = Holding or carrying cost per unit per year

 The Total cost function
 Total Annual Costs = Annual Ordering Costs + Annual Holding
Costs + Annual purchase Costs
 Two methods of carrying cost

 Carrying cost (H) can be expressed either:

1. As a fixed cost, such as

H = $0.50 per unit per year

2. As a percentage of the item’s purchase cost (P)

H=hxc

h = a percentage of the purchase cost

 Cont…
Expected Number of Orders = N= D/Q

Expected Time Between Orders = T= working days per year = Q/d

N

Demand rate per period (d) = Demand (D)

working days per year
 Cycle Interval (T): The total time between one order receipt
period and next order receipt.
 Order frequency (N): Total number of orders per year (per full
inventory cycle).
 Cycle Inventory (Q/2): Average inventory kept per cycle
interval.
 Calculating the Economic Order Quantity
Example1: A computer company has annual demand of 10,000.
They want to determine EOQ for circuit boards which have an
annual holding cost (H) of $6 per unit, and an ordering cost (S)
$75. they want to calculate TC and the reorder point (R) if the
purchasing lead time is 5 days and working days if not given
(250).

Solution: = 500 units

Demand rate per period (d)=D/working days=10,000/250 = 40unit/day

 Cont…
R = d*L = 40x5 = 200 units

TC = Holding cost + Ordering cost + purchasing cost

TC = HQ/2+SD/Q+CD = 1500+1500+0 = $3000

Number of orders (N) = D/Q = 10,000/500 = 20 orders

Time Between Orders (T) = Q/d = 500/40 = 12.5 days,

Or

= working days/N = 250/20 = 12.5 days

Cycle inventory = Q/2 = 500/2 = 250 units

 Quantity discount models

 Allows quantity discounts.

• Price per unit decreases as order quantity
increases.
• Other EOQ assumptions apply.

A. Optimal Policy for “All –Units” Discount

B. . Incremental Quantity Discount

 A. Optimal Policy For “All –Units” Discount
Price Break (Quantity Discount) Models
Example1: A company purchases voltmeters for aircraft
navigation. Annual demand for the voltmeter is 10,000 units and
its ordering cost $ 20.00 per order. Carrying cost is estimated at
20% of the unit price of the voltmeter.
The supplier offers the following discount break. Which discount
break should the company take?
Order Quantity Unit price ($)
A. 0-499 5.00
B. 500.-999 4.50
C. 1000 and above 3.90
Optimal Policy For “All –Units” Discount Schedule

 The discount schedule is all- units because the

discount is applied to all of the units in an order.
 The order cost function is C(Q) is defined as follows;

5Q 0<Q<500

C(Q) = 4.5Q For 500<Q<1000

3.9Q 1000<Q
 A. EOQ (1- 499)

Q= 2SD/H

Q= (2 X 20 X 10,000) / (0.2 x 5)

= 633
Not feasible (Out of the range)

Total Cost 500 units = SD/Q + HQ/2 + CD Where H = h*c

= 20X(10,000/500)+(0.2 X5 X 500/2)+(5 X 10,000)

= 400+250+50000
=50,650
 B. EOQ (500- 999)

Q= 2SD/H

Q= (2 X 20 X 10,000) / (0.2 x 4.5)

= 666
Feasible (with in the range); but, not optimal

Total Inventory Cost = SD/Q + HQ/2 + CD

=20X(10000/666)+(0.2X4.5X666/2)+ (4.50X10000)
300.3+ 299.7+45000 = $ 45,599.70
 C. EOQ (1000 and above)

Q = 2SD/H

Q= (2 X 20 X 10,000) / (0.2 x 3.9)

= 716
Not Feasible (Bellow the range)

= SD/Q + HQ/2 + CD
Total Cost 1000
units = 20X(10,000/1000)+(0.2X3.9X1000/2)+(3.9X 10,000)
= 200 + 390 + 39000 = $ 39,590

Choose the price and quantity that gives the lowest total cost: Order
1000 at price of $ 3.90 a unit
 Problem

The weighty trash bag Co. has the following price schedule,

Order price/unit

Less than 500 bags $0.3

500 less than 1000 $0.29

1000+ $0.28
 The discount schedule is all- units because the discount is
applied to all of the units in an order.
 Cont…
 The order cost function is C(Q) is defined as follows;

0.3Q 0<Q<500

C(Q) = 0.29Q For 500<Q<1000

0.28Q 1000<Q
 The weighty trash Bag Co. uses trash bags at a fairly
constant rate of 600 per year. The accounting department
estimates the fixed cost of placing an order is $8, and the
holding cost are based on a 20 percent annual interest rate.
Optimal Policy For “All –Units” Discount Schedule

Average annual cost function

TC(Q) = D*c + S(D/Q) + (Q/2)(h*c)

Q0 = 2DS/hc0

Q1 = 2DS/hc1

Q2 = 2DS/hc2

The largest realizable (feasible) EOQ or one of the break points

that exceed it.
 Solution weighty Trash Bag company
For c0 Q0 = (2)(8)(600) = 400 feasible; but not optimal
(0.2)(0.3)

For c1 Q1= (2)(8)(600) = 406 not feasible

(0.2)(0.29)

For c2 Q2 = (2)(8)(600) = 414 not feasible

(0.2)(0.28)
 Cont…
 Evaluate ፡ TC(Q) = D*c + S(D/Q) + (Q/2)(h*c)
TC(400)=(600)(0.3)+(600)(8)/400+(0.2)(0.3)(400)/2

= $204.00

TC(500)=(600)(0.29)+(600)(8)/500+(0.2)(0.29)(500)/2

= $198.10 which is feasible and optimal (the mini one)

TC(1000)=(600)(0.28)+(600)(8)/1000+(0.2)(0.28)(1000)/2

= $200.80
 Summary for
“All-units Discount”

1. Determine the largest realizable EOQ value. The most efficient

way to do this is to compute the EOQ for the lowest price first,
and continue with the next higher price. Stop when the first
EOQ value is realizable (i.e. with in the correct interval).

2. Compare the value of the average annual cost at the largest

realizable EOQ and at all the price breakpoints that are greater
than the largest realizable EOQ. The optimal Q is the point at
which the average annual cost is a minimum.
Consider the same example but assume incremental
discounts.

For quantities 500 or less ---------bags cost $0.3 each

Between 500-1000 --------the first 500 bags cost $0.3

each and the remaining bags cost $0.29 each.

For quantities 1000 or more ---------the first 500 bags

cost $0.3 each the second 500 cost $0.29 each and the
remaining bags cost $0.28 each.
 Solution

The cost function

0.3 0.3 0<Q<500
150+0.29(Q-500) = 5+0.29Q For 500<Q<1000
295+0.28(Q-1000) = 15+0.28Q 1000<Q

The average annual cost = (TC(Q)) = (Q/2)h*c +S(D/Q)+DC,

D(0.3)+S(D/Q)+(Q/2)h(0.3) 0<Q<500
TC(Q)= D(0.29+5/Q)+S(D/Q)+(Q/2)h(0.29+5/Q) 500<Q<1000
D(0.28+15/Q)+S(D/Q)+(Q/2)h(0.28+15/Q) 1000<Q
 Cont…

TC0(Q) = 0.3D+SD/Q+0.3hQ/2

TC1(Q) = 0.29D+5D/Q+SD/Q+0.29h(Q/2)+2.5h

= (0.29D+2.5h)+(5+S)D/Q+0.29h(Q/2)

TC2(Q) = 0.28D+15D/Q+S(D/Q)+0.28h(Q/2)+7.5h

= (0.28D+7.5h)+(15+S)D/Q+0.28h(Q/2)
 Cont…
Suppose the demand D = 600/year
Cost per order S = $8/order
Holding cost h = 20%

Q0 = 2DS = 2(600)(8) = 400 feasible

hc0 (0.2)(0.3)

Tc0(400) = 600(0.3)+8(600/400)+(400/2)(0.2)(0.3) = $204

Q1 = 2(5+S)D = 2(13)(600) = 519 feasible

0.29h (0.29)(0.2)

Tc1(519) = 600(0.29+5/519)+8(600/519)+(519/2)(0.2)(0.29+5/519)=
$204.58
Solution

Q2 = 2(15+S)D = 2(23)(600) = 702 not feasible

0.28h (0.28)(0.2)

Tc0(400) < G1(519) therefore, order 400 which has minimum

cost TC = $204

N.B: We did not includes the break points in incremental quantity

discount models i.e. 500 and 1000 quantities.

Production Order Quantity (POQ/EPQ)
(Model II)

finite input rate, no backlogging

 The difference being that the EPQ model assumes orders are
received incrementally during the production process.
 An optimizing method used for determining production
quantity and reorder points.
 Production done in batches or lots.
 Used when demand is not constant or certain
 Cont…
 Assumptions
 Annual demand is known & usage rate “d” constant
 Production rate is larger than demand rate
 Usage occurs continually and Production rate p is constant
 There is only one product to be scheduled
 The rest of the EOQ assumptions stay in place
 Only one item is involved & Lead time does not vary
 Calculating the Economic Production Quantity (EPQ)

EPQ is the optimum quantity that gives a minimum inventory cost.

developing EPQ a model from the following information:
D: The annual demand of the materials
S: Ordering cost per order (Setup Cost)
H: Carrying cost of one unit/year. It is calculated on the basis
of average inventory in stock. H( 1-d/p)
Q: the order quantity per order (lot)
Q/2: average inventory
C: Purchase cost per unit
Total Inventory Cost = Ordering Cost + Carrying Cost + Purchase Cost
 Developing the EPQ Model

 EPQ =(Ordering cost = Carrying cost)

2SD
EPQ = H (1-d/p)
Average inventory = Q/2(1-d/p)

Max. Inventory = EPQ (1-d/p)

 The total cost at economic production is the sum of holding
and setup costs. At the optimal point holding cost and set up
costs are equal. Hence we can derive EPQ formula as follows:
TCEPQ = (S*D/Q) + H(1-d/p) (Q/2)
Example1: A small company manufactures an electric device
used for an aircraft navigation system. Annual demand for the
device is 6400 units. Production rate is 128 units per day, setup
cost for each production run is $24.00 and inventory holding cost
is $3.00 per unit per year. If there are 250 working days per year,
what is:
a) The optimal size production quantity?
b) Inventory cost?
c) Production (replenishment) time?
d) Usage time?
e) Idle time?
f) Maximum inventory?
g) Number of runs?
 2SD
a) EPQ =
H (1-d/p)

2x 24x 6400
3(1- 6400/32,000) = 357.77 Units

b) Total = (SX D/Q) + H(1-d/p) (Q/2)

Inventory
Cost = (24 X 6400/357.77) + 3 (1-6400/32000) (357.77/2)
429.32 + 429.32
=
= $858.64
 C) Replenishment
(Production time)
= EPQ/ Production Rate
= 357.77/128 =2. 795 days
d) Usage Time
= EPQ/ Usage Rate
= 357.77/ (6400/250) days
=13.975 days
g) Number of production runs
= Annual demand/EPQ
= 6400/357.77 = 17.99 times
e) Idle Time
= Usage time- Replenishment time
= 13.975 – 2.795 days
= 11.18 days
f) Maximum Inventory
= EPQ (1-d/p)
= 357.77 (1-6400/32000)
= 208.6 units
h) Production rate & demand rate
d = D/working days = 25.6units/day
p = annual production/working days =
128 units/day
Exercise 1 POQ for brown manufacturing
 Produces mini refrigerator
Demand rate d = 70 units/day
Setup cost S = $200/setup
Holding cost 20% of the purchased cost
And an item cost of $300
Annual Production P = 50,000 units/year
Then, determine
a). Optimum lot size quantity
b). Total Annual inventory cost
c). Average and maximum inventory cost
d). Frequency of production time