This document discusses various inventory management techniques. It begins by defining inventory and the objective of inventory management. It then describes the different types of inventory including raw materials, work-in-process, maintenance/repair/operating supplies, and finished goods. Several inventory management techniques are covered, including ABC analysis for prioritizing inventory items, cycle counting to maintain accurate records, and controlling service inventories. Inventory models like economic order quantity, production order quantity, quantity discounts, and probabilistic models are also summarized.
2. 2
Introduction
Inventory is any stock or stored resources of any
item that are used by organization to satisfy
current or future needs. They maybe items that
are purchased from others, or those produced
internally.
The objective of inventory management is to
strike a balance between inventory investment
and customer service.
3. UiTMK/Chapter 10 3
The Functions of Inventory
• 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
– Supplies usually offer discount to encourage bulk
buying
• To hedge against inflation and upward price
changes
– Buy more and stock up more when price is low
4. UiTMK/Chapter 10 4
Types of Inventory
Raw material
Purchased but not processed
Work-in-process
Undergone some change but not completed
A function of cycle time for a product
Maintenance/repair/operating (MRO)
Necessary to keep machinery and processes
productive
Finished goods
Completed product awaiting shipment
5. UiTMK/Chapter 10 5
Techniques of inventory
1. ABC Analysis
2. Record accuracy
3. Cycle Counting
4. Control of Service Inventories
6. UiTMK/Chapter 10 6
1. ABC Analysis
Divides inventory into three classes
based on annual dollar volume
Class A - high annual dollar volume
Class B - medium annual dollar volume
Class C - low annual dollar volume
Used to establish policies that focus on
the few critical parts and not the many
trivial ones
7. UiTMK/Chapter 10 7
% of Inventory Items
Classifying Items as ABC
0
20
40
60
80
100
0 50 100
% Annual $ Usage
A
B
C
Class % $ Vol % Items
A 80 15
B 15 30
C 5 55
8. UiTMK/Chapter 10 8
ABC Analysis
Other criteria than annual dollar
volume may be used
Anticipated engineering changes
Delivery problems
Quality problems
High unit cost
9. UiTMK/Chapter 10 9
2. Record Accuracy
Accurate records are a critical ingredient in
production and inventory systems
Allows organization to focus on what is needed
Necessary to make precise decisions about
ordering, scheduling, and shipping
Incoming and outgoing record keeping must be
accurate
Stockrooms should be secure
10. UiTMK/Chapter 10 10
3. Cycle Counting
Items are counted and records updated on a
periodic basis
Often used with ABC analysis
to determine cycle
Has several advantages
1. Eliminates shutdowns and interruptions
2. Eliminates annual inventory adjustment
3. Trained personnel audit inventory accuracy
4. Allows causes of errors to be identified and
corrected
5. Maintains accurate inventory records
11. UiTMK/Chapter 10 11
4. Control of Service Inventories
Can be a critical component
of profitability
Losses may come from
shrinkage or pilferage
Applicable techniques include
1. Good personnel selection, training, and discipline
2. Tight control on incoming shipments
3. Effective control on all goods leaving facility
12. UiTMK/Chapter 10 12
Independent versus
Dependent 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
13. UiTMK/Chapter 10 13
Inventory Costs
• Holding costs - associated with holding
or “carrying” inventory over time
• Ordering costs - associated with costs
of placing order and receiving goods
• Setup costs - cost to prepare a
machine or process for manufacturing
an order
15. UiTMK/Chapter 10 15
• Fixed order-quantity models
– Economic order quantity
• is the quantity level that results in the least total
annual inventory cost.
– Production order quantity
– Quantity discount
Inventory Models
16. UiTMK/Chapter 10 16
Assumption of EOQ model
Demand is known, constant and independent
Lead time is known and constant
Receipt of inventory is instantaneous and
complete. Orders are delivered as whole units at
a single point in time.
Quantity discounts are not possible
The only variable costs are setup cost and
holding cost
Shortages can be completely avoided if orders
are placed at the right time
17. 17
Economic Order Quantity
Number of Orders
Time Between Orders
(Reorder cycle)
Working Days Per Year
Working Days Per Year
= =
× ×
= =
= =
=
Q*
D S
H
N
D
Q*
T
N
d
D
2
D = Demand per year
S = Setup/Ordering Cost (RM per order)
H = Carrying/Holding cost (annual basis)
d = Demand per day
L = Lead time in days
ss = Safety Stock
EOQ Model Equations
UiTMK/Chapter 10
18. Reorder Point (without safety stock) = d x L
Reorder Point (with safety stock) = (d x L) + ss
Total ordering cost = (D/Q) x S
Total Carrying Cost = (Q/2) x H
Total annual cost = D x S + Q x H
(without ss) Q 2
Total annual cost = D x S + Q +ss x H
(with ss) Q 2 18
UiTMK/Chapter 10
19. UiTMK/Chapter 10 19
Cont…
• Lead time – the length of time between the time
order is placed and the time the inventory or
stock arrived or received
• Reorder point – the level that signals the need to
reorder inventory. It indicates the time for the
form to place new order.
• Safety stock – a buffer stock or additional stocks
maintain by the firm to meet the unexpected
increase in demand or uncertainties in delivery
time
20. UiTMK/Chapter 10 20
Production Order Quantity
Model
Used when inventory builds up over
a period of time after an order is
placed
Used when units are produced and
sold simultaneously
21. UiTMK/Chapter 10 21
Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days
= (Average inventory level) x
Annual inventory
holding cost
Holding cost
per unit per year
= (Maximum inventory level)/2
Annual inventory
level
= –
Maximum
inventory level
Total produced during
the production run
Total used during
the production run
= pt – dt
22. 22
Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days
= –
Maximum
inventory level
Total produced during
the production run
Total used during
the production run
= pt – dt
However, Q = total produced = pt ; thus t = Q/p
Maximum
inventory level = p – d = Q 1 –
Q
p
Q
p
d
p
Holding cost = (H) = 1 – H
d
p
Q
2
Maximum inventory level
2
UiTMK/Chapter 10
23. UiTMK/Chapter 10 23
Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
D = Annual demand
Q2 =
2DS
H[1 - (d/p)]
Q* =
2DS
H[1 - (d/p)]
p
Setup cost = (D/Q)S
Holding cost = HQ[1 - (d/p)]
1
2
(D/Q)S = HQ[1 - (d/p)]
1
2
24. UiTMK/Chapter 10 24
Reduced prices are often available when
larger quantities are purchased.
The concern – to determine the best order
size/to select the order quantity that would
minimized the total annual inventory costs
Answers how much to order &
when to order
Quantity Discount Model
25. UiTMK/Chapter 10 25
Total annual cost – without ss
= (D/Q x S) +(Q/2 x H) + (P x D)
Total annual cost – with ss
= (D/Q x S)+ (Q/2+ss) x H + (P x D)
Total Purchase Cost = P x D
P = cost of item/price
D = demand per year
26. UiTMK/Chapter 10 26
Steps involve for discount model
Compute EOQ for each price,until a
feasible EOQ is found
Compute TAIC for feasible EOQ
Then calculate the TAIC for the next lower
price breaks
Repeat procedure in step 3 until you found
the quantity that result in lowest TAIC
27. UiTMK/Chapter 10 27
Exercise 1:
• The owner of a bakery received a price list from a vendor
who supplies flour. The bakery uses approximately 5000
bags of flour every year. The annual holding cost for each
bag of flour is 30% of purchase cost and the ordering cost
is RM10 per order.
Determine an order quantity that will minimize the total cost
Quantity (bag) Purchase Cost per
bag(RM)
1 - 499 3.30
500 – 999 3.10
> 1000 2.90
28. UiTMK/Chapter 10 28
• Answer how much & when to order
• Allow demand to vary
– Follows normal distribution
– Other EOQ assumptions apply
• Consider service level & safety stock
– Service level = 1 - Probability of stockout
– Higher service level means more safety stock
• More safety stock means higher ROP
Probabilistic Models
29. UiTMK/Chapter 10 29
• Only one order is placed for a product
• Units have little or no value at the end of
the sales period
Fixed Period Model