1 inventory final

7/29/2019 1 Inventory Final

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Inventory Definition

A stock of items held to meet future demand Inventory-A physical resource that a firm holds in

stock with the intent of selling it or transforming itinto a more valuable state.

Inventory System- A set of policies and controlsthat monitors levels of inventory and determineswhat levels should be maintained, when stockshould be refilled, and how large orders should be

given to the purchased department.

Question: Goods vs Services?


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Def. - A physical resource that a firm holds in stock

with the intent of selling it or transforming it into a

more valuable state.Raw Materials

Works-in-Process

Finished Goods

Maintenance, Repair and Operating


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Opposing Views of InventoryWhy We Want to Hold Inventories

Why We Not Want to Hold Inventories


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Why We Want to Hold Inventories Improve customer service

Reduce certain costs such as

ordering costs stock out costs

acquisition costs

start-up quality costs

Contribute to the efficient and effective operation ofthe production system


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Why We Want to Hold Inventories

Finished Goods Essential in produce-to-stock positioning strategies Necessary in level aggregate capacity plans Products can be displayed to customers

Work-in-Process Necessary in process-focused production May reduce material-handling & production costs

Raw Material Suppliers may produce/ship materials in batches Quantity discounts and freight/handling $$ savings


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Why We Do Not Want to Hold

Inventories Certain costs increase such as

carrying costs

cost of customer responsiveness

cost of coordinating production

cost of diluted return on investment

reduced-capacity costs

large-lot quality cost

cost of production problems


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Types of Inventory

Inputs Raw Materials

Purchased parts

Maintenance and RepairMaterials

Outputs Finished Goods

Scrap and Waste

Process

In Process Partially CompletedProducts and

Subassemblies

(in warehouses, or in

transit)

(often on the factory

floor)


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Types of Inventory

Work in

process

Work in

process

Work in

process

Finished

goods

Raw

Materials

Vendors Customer


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Water Tank Analogy for Inventory

Supply Rate

Inventory Level

Demand Rate

Inventory Level

Buffers Demand Rate

from Supply Rate


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Independent and Dependent Demand

Inventory

Independent demand items demanded by external customers (Kitchen Tables)

Dependent demand

items used to produce final products (table top, legs,hardware, paint, etc.)

Demand determined once we know the type and numberof final products


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Independent and Dependent Demand

Inventory Management

Independent demand Uncertain / forecasted

Continuous Review / Periodic Review

Dependent demand Requirements / planned

Materials Requirements Planning / Just in Time


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Reasons To Hold Inventory

Meet variations in customer demand:Meet unexpected demandSmooth seasonal or cyclical demand

Pricing related:Temporary price discounts

Hedge against price increasesTake advantage of quantity discounts

Process & supply surprisesInternal upsets in parts of or our own processesExternal delays in incoming goods

Transit


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Reasons To NOT Hold Inventory Carrying cost

Financially calculable

Takes up valuable factory space

Especially for in-process inventory

Inventory covers up problems That are best exposed and solved

Driver for increasing inventory turns (finished goods) and leanproduction/Just in time for work in process


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Inventory Hides Problems

Poor

Quality

Unreliable

Supplier

Machine

BreakdownInefficient

Layout

Bad

Design

Lengthy

Setups


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To Expose Problems:

Reduce Inventory Levels

PoorQuality

Unreliable

Supplier

Machine


Layout

Bad

Design

LengthySetups


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Remove Sources of Problems and

Repeat the Process

PoorQuality

Unreliable

Supplier

Machine


Layout

Bad

Design

Lengthy

Setups


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Inventory Cost Structures

Ordering (or setup) cost Carrying (or holding) cost:

Cost of capital

Cost of storage

Cost of obsolescence, deterioration, and loss

Stock out cost

Item costs, shipping costs and other cost subject tovolume discounts


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Typical Inventory Carrying Costs

Housing cost:Building rent or depreciationBuilding operating costTaxes on buildingInsurance

Material handling costs:

Equipment, lease, or depreciationPowerEquipment operating cost

Manpower cost from extra handling and supervision

Investment costs:Borrowing costsTaxes on inventoryInsurance on inventory

Pilferage, scrap, and obsolescence

Overall carrying cost

6%

(3% - 10%)

3%(1% - 4%)

3%(3% - 5%)

10%(6% - 24%)

5%(2% - 10%)

(15% - 50%)

Costs as % ofInventory Value


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Inventory Management Systems

Functions of Inventory Management

Track inventory

How much to order

When to order Prioritization

Inventory Management Approach

EOQ

Continuous / Periodic


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ABC Prioritization Based on Pareto concept (80/20 rule) and

total usage in dollars of each item.

Classification of items as A, B, or C oftenbased on $ volume.

Purpose: set priorities for managementattention.


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10 20 30 40 50 60 70 80 90 100

Percentage of items

P

ercentage

ofd

ollarvalue

100

90

80

70

60

50

40

30

20

10

0

+Class C

Class A

+Class B


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ABC Chart For Previous Slide

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

3 6 9 2 4 1 10 8 5 7

Item No.

Percen

tUsage

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

Cumulativ

e%Usage

Percentage of Total Dollar Usage Cumulative Percentage

A B C


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Inventory Management ApproachesA-items

Track carefully (e.g. continuous review)

Sophisticated forecasting to assure correct levels

C-items

Track less frequently (e.g.periodic review) Accept risks of too much or too little (depending

on the item)


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VED Classification: The VED analysis is done todetermine the critically of an item and its effect on

production and other services. It is specially used for

classification of spare parts. If it is essential, then itis given E classification and if it is not so essential,

the part is given D classification. For v items, a

large stock of inventory is generally maintained,

while forD items, minimum stock is enough.

The different techniques of inventory control are:ABC - Always better control analysis.HML - High, Medium & Low analysis.VED - Vital, Essential & desirable analysis.SDE - Scare, difficult & easy to obtain analysis.FSN - Fast moving, slow moving & non moving analysis.EOQ - Economic order quantity analysis.


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HML Classification: (High, Medium & Low analysis)

The high, medium & low analysis is based on the unit value

not on the consumption value. The inventory order should

be/will be listed in descending order of unit value & it is up

to the management to fix limits for three categories.

SDE Analysis:

This analysis is based upon the availability of items & this

is useful in the context of scarcity of supply. This analysis

refers on S forScarce items


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Economic Order Quantity (EOQ)

Model

Demand rate D is constant, recurring, and known

Amount in inventory is known at all times

Ordering (setup) cost S per order is fixed

Lead time L is constant and known.

Unit cost C is constant (no quantity discounts)

Annual carrying cost is i time the average $ value of theinventory

No stockouts allowed.

Material is ordered or produced in a lot or batch andthe lot is received all at once


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EOQ Lot Size Choice

There is a trade-off between lot size andinventory level.

Frequent orders (small lot size): higher ordering

cost and lower holding cost.Fewer orders (large lot size): lower ordering cost

and higher holding cost.


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EOQ Inventory Order CycleDemand

rate

0 TimeLead

time

Lead

timeOrder

Placed

Order

Placed

Order

Received

Order

Received

I

nventory

L

evel

Reorder point, R

Order qty, Q

As Q increases, average

inventory level increases, but

number of orders placed

decreases

ave = Q/2


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Total Cost of Inventory

EOQ Model

A t I t M t Q ti f


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Answer to Inventory Management Questions for

EOQ Model

Keeping track of inventoryImplied that we track continuously

How much to order?Solve for when the derivative of total cost with respect to Q

= SD/Q2 + iC/2 = 0Q = sqrt ( 2SD/iC)

When to order?Order when inventory falls to the Reorder Point-level R so

we will just sell the last item as the new order comes in:R = DL


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Re-order Point ExampleDemand = 10,000 quantity /year

Lead time = L = 10 days

When inventory falls to R, we order so as not to run outbefore the new order comes in.

R = ?


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Re-order Point ExampleDemand = 10,000 quantity /year

Daily demand = 10,000 / 365 = 27.4 quantity /day

Lead time = L = 10 days

R = D*L = (27.4)(10) = 274 quantity

(usually can neglect issues of working days vs

weekends, etc.)

Dont forget to convert to consistent time units!


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EOQ SummaryHow much to order?

Q = sqrt(2DS/iC)

When to order?R = DL


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EOQ Exercise Now you do it See Excel Spreadsheet: Excel_Inv_Examples.xls, EOQ

tab

Compute the values of R and Q and compare to thesimulation

Next see what happens when you have volumediscounts (EOQ w Discount Tab)


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EOQ ExampleUnit Cost C $0.45 /unitHolding cost factori 25% /year

Ordering cost S $15.00 /order

Demand rate D 10000 units/yearLead time L 0.0192 year

Solutions:

Re-order point R units (rounded)Q = sqrt(2SD/(iC)) units (rounded)

1 inventory final

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