PRODUCTION

PLANNING AND
CONTROL
(MEFB 433)
Ts. Zubaidi Faiesal
Email: [email protected]
Room No.: BN-1-010
10- INVENTORY
MANAGEMENT
10.1. OVERVIEW
10- Inventory Management
10.1. Overview
An Inventory is a stock or store of goods.
Manufacturing firms carries supplies of raw material, purchased
parts, partially finished items and finished goods as well as
spare parts for machines, tools and other supplies.
A typical firm probably has about 30% of its current assets and
perhaps as much as 90% of its working capital invested in
inventory.
As the amount of inventory reduces, the return on investment rate
(ROI) increases.
In U.S, one economical measures for a firm is the ratio of
investments to sales.
10- Inventory Management
10.1. Overview
Functions of inventory:

- To meet anticipated customer demand.

- To smooth production requirements.
- To decouple operations.
- To protect against stockouts.
- To take advantage of order cycles.
- To hedge against price increases.
- To permit operations.
10- Inventory Management
10.1. Overview
Different kinds of inventories include the following:

- Raw materials and purchased parts.

- Partially completed goods, called work-in-process (WIP).
- Finished-goods inventories.
- Tools and supplies.
- Maintenance and repair (MRO) inventory.
- Goods-in-transit to warehouses, distributions or customers.
10.2. INVENTORY MANAGEMENT
SYSTEM
10- Inventory Management
10.2. Inventory Management System
Two basic functions of inventory management:
1. To establish a system of keeping track of items in inventory.
2. To make decisions about how much and when to order.

Requirements for effective inventory management:

3. A system to keep track of the inventory on hand and on order.
4. A reliable forecast of demand.
5. Knowledge of lead times and lead time variability.
6. Reasonable estimates of inventory holding costs, ordering
costs and shortage costs.
7. A classification system for inventory items.
10- Inventory Management
10.2. Inventory Management System
Requirements for effective inventory management:
1. A system to keep track of the inventory on hand and on order.

Inventory Counting Systems

Periodic system: A physical count of items in inventory is made at

periodic intervals (Weekly or monthly).

Perpetual (continual) system: Keeps track of removals from

inventory on a continuous basis.
10- Inventory Management
10.2. Inventory Management System
Requirements for effective inventory management:
2. A reliable forecast of demand.
3. Knowledge of lead times and lead time variability.

Demand forecasts and lead-time information

It is essential to have reliable estimates on the amount and timing

of demand.

Lead-Time: The time interval between submitting an order and

receiving it.
10- Inventory Management
10.2. Inventory Management System
Requirements for effective inventory management:
4. Reasonable estimates of inventory holding costs, ordering
costs and shortage costs.

Inventory Costs

 Holding or carrying costs

 Ordering costs
 Shortage costs
10- Inventory Management
10.2. Inventory Management System
Requirements for effective inventory management:
5. A classification system for inventory items.
Classification system
Items held in inventory are not of equal importance in terms of dollars
invested, profit potential, sales or usage volume, or stockout penalties.
The A-B-C Approach: classifies inventory items according to some
measures of importance, usually annual dollar value.
A (very important): 10%-20% of number of items, but 60%-70% of the
annual dollar value.
C (least important): 50%-60% of number of items, but 10%-15% of the
annual dollar value.
B (moderately important): The rest of the items.
10- Inventory Management
10.2. Inventory Management System
Requirements for effective inventory management:
The A-B-C Approach: Example
Item Item AnnualAnnual Unit AnnualPercentage of
Classification Percentage
Number Number
Dollar Value Demand Cost of items
Dollar Value
Annual Dollar
1 2,500 $ 360 $ 900,000 Value
8 $2 4,000,0001,000 A 70 10 70,000 52.7
2 1,000 70 70,000
3 33 1,200,000
2,400 B 500 1,200,000
2,400 500 1,200,000
6 44 1,000,000
1,500 B 100 150,000
1,500 100 150,000
1 5 900,000
700 B 70 30 49,000 40.8
5 700 70 49,000
4 6 150,0001,000 C 1,000 1,000,000
10 6 100,0001,000 C 1,000 1,000,000
7 200 210 42,000
9 7 200 210 42,000
8 80,000 1,000 C 4,000 4,000,000
2 8 70,000 1,000 C 4,000 4,000,000
9 8,000 10 80,000
5 9 8,000 10 80,000
10 49,000500 C 200 100,000
7 10 42,000500 C 200 100,000
60 7,591,000 6.5
100 7,591,000 100
10- Inventory Management
10.2. Inventory Management System
How much to order: Economic Order Quantity Model (EOQ)

This model identifies the optimal order quantity by minimizing

the sum of certain annual costs that vary with order size.

Three order size models:

1. The basic Economic Order Quantity Model (EOQ).

2. The Economic Production Quantity Model (EPQ).
3. The Quantity Discount Model.
10- Inventory Management
10.2. Inventory Management System
How much to order: Economic Order Quantity Model (EOQ)
1. The basic Economic Order Quantity Model (EOQ).
This model is used to identify a fixed order size that will
minimize the sum of the annual costs of holding inventory and
ordering inventory.
Basic assumptions of EOQ model:
2. Only one product is involved.
3. Annual demand requirements are known.
4. Demand is spread evenly throughout the year so that the
demand rate is reasonably constant.
5. Lead time does not vary.
6. Each order is received in a single delivery.
7. There are no quantity discount.
10- Inventory Management
10.2. Inventory Management System
How much to order: Economic Order Quantity Model (EOQ)
1. The basic Economic Order Quantity Model (EOQ):
The inventory cycle
10- Inventory Management
•   Inventory Management System
10.2.
How much to order: Economic Order Quantity Model (EOQ)
1. The basic Economic Order Quantity Model (EOQ):
A balance between Holding (Carrying) costs and ordering costs
10- Inventory Management
•10.2.
  Inventory Management System
How much to order: Economic Order Quantity Model (EOQ)
1. The basic Economic Order Quantity Model (EOQ):
A balance between Holding (Carrying) costs and ordering costs

The minimum of TC happens when holding and ordering costs are equal:
10- Inventory Management
10.2. Inventory Management System
How much to order: Economic Order Quantity Model (EOQ)
1. The basic Economic Order Quantity Model (EOQ):
 
Example: A local distribution for a national tire company expects
to sell approximately 9,600 tires of a certain size next year.
a. =32
Annual holding cost is $16 per tire and ordering cost is $75. the
distribution
b. Length ofoperates 288 days a year.
order cycle=
a. What is the EOQ?
b. How many times per year does the store reorder?
c. What is the length of an order cycle?
d. What is the total annual cost if the EOQ is ordered?
10- Inventory Management
10.2. Inventory Management System
How much to Produce:
Economic Production Quantity Model (EPQ)
In this model, the manufacturer periodically produces items in
batches or lots instead of producing continually.
Basic assumptions of EPQ model:
1. Only one item is involved.
2. Annual demand is known.
3. The usage rate is constant.
4. Usage occurs continually, but production occurs periodically.
5. The production rate is constant
6. Lead time does not vary.
7. There are no quantity discount.
10- Inventory Management
10.2. Inventory Management System
How much to Produce:
Economic Production Quantity Model (EPQ)
10- Inventory Management
•10.2.
  Inventory Management System
How much to Produce:
Economic Production Quantity Model (EPQ)

where =Maximum inventory.

The economic run inventory is

where,
10- Inventory Management
10.2. Inventory Management System
How much to Produce:
Economic Production Quantity Model (EPQ)
Example: A toy manufacturer uses 48,000 rubber wheels per year
 for its popular dump truck series. The firm makes its own wheels,
which it can produce at a rate of 800 per day. Toy trucks are
assembled uniformly over the entire year. Holding cost is $1 per
wheel a year. Setup cost for a production run of wheels is $45. the
firm operates 240 days per year. Determine the
c. Cycle time=
a. Optimal run size.
b. Minimum total annual cost for holding and setup.
c. Cycle time for the optimal run size.
d. Run time.
10- Inventory Management
•10.2.
  Inventory Management System

How much to order: Economic Order Quantity Model (EOQ)

3. The Quantity Discount Model.
In this model, price is reduced for large orders to induce the
customers to buy in large quantities.
The buyer must weigh the potential benefits of reduced purchase
price and fewer orders against the increase in holding. The
buyer’s goal with quantity discount is to select the order quantity
that will minimize total cost including holding cost, ordering cost
and purchasing cost.

.
10- Inventory Management
10.2. Inventory Management System
How much to order: Economic Order Quantity Model (EOQ)
3. The Quantity Discount Model.
 10- Inventory Management
•10.2.
  Inventory Management System

How much to order: Economic Order Quantity Model (EOQ)

3. The Quantity Discount Model.
 1.Example: The
Compute the maintenance
common minimumdepartment
. of a large hospital uses 816
2.cases
The 70ofcases
liquidcancleanser
be boughannually.
at $18 per Ordering
case. Hence,costs arecost
the total $12,willholding
be: costs
=(70/2)4+(816/70)12+18(816)=$14,968
are $4 per case a year and new price schedule indicates that orders of
3.less than lower
Because 50 cases
rangewill
exist,cost
each$20
mustper case, 50
be checked to 79thecases
against will cost
minimum cost $18
resulting
per case, 80from
to 70
99cases
casesat will
$18 each.
cost $17 per case and larger orders will cost
$16 per case.
In order to buyDetermine the optimal
at $17 per case, order
at least 80 casesquantity and the total
must be purchased. cost.
(WHY?)
=(80/2)4+(816/80)12+17(816)=$14,154
Range
In order to buy at $16 per case, at least 100 cases must be purchased. Price
=(100/2)4+(816/100)12+16(816)=$13,354 1 to 49 …..……………… $20
Therefore, because 100 cases per order yields 50the
to 79 …………………..
lowest total cost, 100 cases18
is
the overall optimal order quantity. 80 to 99 ………………….. 17
100 or more ……………… 16