Professional Documents
Culture Documents
Dr. T Kachwala
Brief Outline
2. Functions of Inventory
Analysis etc.
Independent Demand items relate to items that are ready to be sold for example computer.
Dependent demand items relate to components of finished products for example component
used to assemble computer. EOQ models etc. are applicable for independent demand items.
An inventory is a stock or store of goods. Firms stock hundreds of items ranging from small
items such as nuts & bolts to large items such as machines and trucks.
Inventory for a manufacturing plant means all the materials, parts, supplies, expense tools &
in-process or finished products recorded in the books of account of an organization and kept
aside in its stock either in the factory or at the warehouse for a defined period of time.
Service firms carry inventories of supplies & equipment:
Inventory for Department Stores includes clothing, furniture, stationery, appliances, toys, gifts, cards etc.
Inventory for Hospitals includes drugs, surgical supplies, life monitoring equipment, sheets & pillow
cases etc.
Inventory for Supermarkets includes fresh foods, canned foods, frozen foods, household supplies, baked
goods, dairy products, groceries etc.
Meaning of the term Inventory
One widely used measure of Managerial performance relates to ROI which is PAT
divided by Total assets. Reduction of Inventories reduces total assets & therefore
indirectly increases ROI.
Inadequate control of inventories can result in both under & overstocking of items.
Under-stocking results in missed deliveries, lost sales, dissatisfied customers and
production bottlenecks. Over-stocking unnecessarily ties up funds that might be
productive else where.
Meaning of the term Inventory
Inventory management has two main concerns: level of customer service (right
goods, in the right quantity, in the right place, at the right time) & cost of
management.
2. Inventory turnover; which is the ratio of annual cost of goods sold to average
inventory investment. The turnover ratio indicates how many times a year the
inventory is sold.
3. Days of inventory on hand; a number that indicates the expected number of days of
1.Under a periodic system, (‘P’ system) a physical count of items in inventory is made at
periodic intervals (e.g. weekly, monthly) in order to decide how much to order of each item.
2.A perpetual inventory system (also known as a continual system) keeps track of removals
from inventory on a continuous basis, so the system can provide information on the current
level of inventory for each item. When the amount on hand reaches a predetermined
A-B-C Approach is a classification of inventory into three classes: A, B and C, based on their
value. This analysis is based on the popular Pareto Principle, which states that 80% of the
value of the material or items is on account of 20% of the items.
The analysis is done by rearranging the item in the order of value and identifying the three
2. E – Essential items are those items the absence of which results in partial
stoppage of the production line. Moderate control is required for these items.
3. D – Desirable items are those items the absence of which does not affect the
production line. Loose control is adequate for these items.
Classification of Inventory - HML Analysis
HML analysis is a classification of inventory into three classes: High value
items, Medium value items, and Low value items based on their value
(similar to ABC Analysis). The analysis is done by rearranging the items in
the order of value and identifying the three categories as explained in the
example of Inventory classification of Purchase Order (contractual
document and hence very critical for an organization) below:
The purchase orders can be classified according to their value, so that
only the high value purchase order are monitored by the manager. The
other smaller value purchase orders can be delegated to the lower
authorities.
Classification of Inventory - SDE Analysis
SDE analysis is a classification of inventory into three classes: Scarce, Difficult & Easy based
on the lead time of procurement. The analysis is done by rearranging the items in the order of
the lead time of procurement and identifying the three categories as explained in the example
1.S – Scarce items, which are the items that are in short (limited) supply & very difficult to
procure. e.g. Imported items, where the lead time is very high. Rigid control is required.
2.D – Difficult items, which are available but difficult to procure because there are limited
3.E – Easy items, which are items that are easily available. E.g. standard items available off
the shelf. There is no lead time of procurement for these items. Loose control is adequate
Classification of Inventory - FSN Analysis
FSN analysis is a classification of inventory into three classes: Fast moving, Slow moving &
Non moving based on the frequency of issue of items from Stores. The analysis is done by
rearranging the items in the order of the frequency of issue of items and identifying the three
1.F – Fast moving items, which are the items that are required frequently; for example all
2.S – Slow moving items are issued limited number of times in a given period; for example
3.N – Non moving items are not issued for the period of time under consideration. These
The XYZ category is a general category of classification for the three classes:
1. ‘X’ items are those items that are heavy & bulky.
1. ‘X’ items are those items that have very short shelf-life
If the order quantity is small (i.e. If the inventory is too little) then the
following cost are high:
1. Ordering Costs
3. Acquisition Costs
If the order quantity is large (i.e. If the Inventory is too much) then the
following cost are high:
1. Carrying Costs
4. Cost of Obsolescence
Concept of Economic Order Quantity (EOQ)
costs curve, an annual total stocking cost curve results. The order
quantity where total stocking cost is minimum is traditionally called
Economic Order Quantity (EOQ)
Determining Order Quantities (EOQ Models)
Q
2
Time
Q
Average inventory when the material is received all at once is
2
Slide 22
Model II-EOQ for Production Lots
Assumptions:
1. Annual demand, carrying cost, and ordering cost for a material can be estimated.
2. No safety stock is utilized, materials are supplied at a uniform rate (p) and used at a
uniform rate (d), and materials are entirely used up when the next order begins to
arrive.
3. Stock out, customer responsiveness, and other costs are inconsequential.
4. Quantity discounts do not exist.
5. Supply rate (p) is greater than usage rate (d)
Variable Definitions
1. All the definitions in Model I apply also to Model II. Additionally
2. d = rate at which units are used out of inventory (units per time period)
3. p = rate at which units are supplied to inventory (same units as d)
Slide 24
Replenishment Cycle
Material received uniformly at a constant rate
The rate at which the inventory is increasing is the difference between
production rate and demand rate (p-d)
The rate at which the inventory is decreasing is the
function of the demand rate (d)
The same cycle
Q repeats
Quantity
Q d
1-
2 p
Time
Q d
Annual carrying cost Average inventory level x Carrying cost C 1
2 p
D
Annual ordering cost Orders per year x Ordering cost S
Q
Q d D
Total annual stocking costTSC A
nnual carrying cost Annual ordering cost C 1 S
2 p Q
Equating annual carrying cost & annual ordering cost : EOQ C 1
2
SD
d
p
Model III – EOQ with Quantity Discounts
Assumptions:
1. Annual demand, carrying cost, and ordering cost for a material can be
estimated.
2. Average inventory levels can be estimated at either:
a. Q/2 – if the assumption of Model I prevail : no safety stock, orders are received
all at once, materials are used a uniform rate, and materials are entirely used up
when the next order arrives.
b. Q/2 [(p – d)/p] – if the assumption of Model II prevail : no safety stock, materials
are supplied at a uniform rate (p) and used at a uniform rate (d), and materials
are entirely used up when the next order arrives.
s
Profit Sale
os t
Sales / Cost
ta l C
To
bl e Co s t
Va r i a
Fixed Cost
Quantity
It can be observed in the above break-even chart, that as the output (quantity)
increases, the profit increases.
Model III-EOQ with Quantity Discounts
Variable Definitions :
Formulas
1. The EOQ and TSC formulae from either Model I or Model II are applied to Model III,
depending on which assumption best fit the inventory situation.
= TSC + (D) * ac
Slide 29
All at One Time
2
SD 2
SD
EOQ EOQ
C C 1 –pd
Q D Q d D
TMC C S D ac TMC C 1– S D
ac
2 Q 2 p Q
Procedures
1. Compute the EOQ using each of the sales prices.
2. Determine which EOQ from Step I above is feasible. In other words, is the computed EOQ
in the quantity range for its price ?
3The total annual material cost TMC is computed for the feasible EOQ and the quantity at any
price break with lower sales prices.
4. The order quantity with the lowest total annual material cost TMC is the economic order
quantity for the material.
When to Reorder
Reorder point
When the quantity on hand of an item drops to a predetermined amount, the item is reordered.
Determinants of the reorder point
Demand or lead time uncertainty creates the possibility that demand will be greater than available supply
To reduce the likelihood of a stock out, it becomes necessary to carry safety stock
Safety stock : Stock that is held in excess of expected demand due to variable demand and/or lead time
Expected demand
ROP Safety Stock
during lead time
Service level
As the amount of safety stock carried increases, the risk of stock out decreases. This improves customer service level
Service level (The probability that demand will not exceed supply during lead time)
Service level = 100% - Stock out risk
The amount of safety stock that is appropriate for a given situation depends upon:
1. The average demand rate and average lead time
2. Demand and lead time variability
3. The desired service level
Expected demand
ROP z dLT
during lead time
where
z Number of standard deviations
dLT The standard deviation of lead time demand
Reorder Point: Demand Uncertainty
ROP d LT z d LT
where
z Number of standard deviations
d Average demand per period (per day, per week)
d The stdev. of demand per period (same time units as d )
LT Lead time (same time units as d )
ROP d LT zd LT
where
z Number of standard deviations
d Demand per period (per day, per week)
LT The stddev. of lead time (same time units as d )
LT Average lead time (same time units as d )