Management & Production

Technology
Topic:
Materials Management/Inventory
Control (part-1)

© 2006 Prentice Hall, Inc. 12 – 1

 DEFINITION
“The overseeing and controlling of
the ordering, storage and use of
components that a company will
use in the production of the items it
will sell as well as the overseeing
and controlling of quantities of
finished products for sale”.

© 2006 Prentice Hall, Inc. 12 – 2

 Inventory

 One of the most expensive assets

of many companies representing as
much as 50% of total invested
capital
 Operations managers must balance
inventory investment and customer
service

© 2006 Prentice Hall, Inc. 12 – 3

 Inventory
• A business's inventory is one of its
major assets and represents an
investment that is tied up until the
item is sold or used in the production
of an item that is sold.
• It also costs money to store, track
and insure inventory.

© 2006 Prentice Hall, Inc. 12 – 4

 Inventory
• Inventories that are mismanaged can
create significant financial problems
for a business, whether the
mismanagement results in an
inventory excess or an inventory
shortage.
• Inventory is nothing but money
locked in terms of materials.

© 2006 Prentice Hall, Inc. 12 – 5

 Objectives of Inventory
Control-1
• Maximize the level of customer
service by avoiding under-stocking.
• Promote efficiency in production and
purchasing by minimizing the cost of
providing an adequate level of
customer service.
• To prevent stoppage of production
due to lack of materials.

© 2006 Prentice Hall, Inc. 12 – 6

 Objectives of Inventory
Control-2
• To keep minimum investment by
maintaining optimum inventory.
• To identify those items which are
obsolete.
• To reduce wastage of materials.
• Maximize customer service.

© 2006 Prentice Hall, Inc. 12 – 7

 Objectives of Inventory
Control-3
• To prevent theft of materials.
• To minimize carrying cost of inventory.
• To minimize inventory ordering costs.
• To maximize profitability by minimizing
investment in inventory.
• To make arrangement for sale of slow
moving items.

© 2006 Prentice Hall, Inc. 12 – 8

 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
© 2006 Prentice Hall, Inc. 12 – 9
 Holding, Ordering, and
Setup Costs
 Holding costs - the costs of holding
or “carrying” inventory over time.
 Ordering costs - the costs of
placing an order and receiving
goods.
 Setup costs - cost to prepare a
machine or process for
manufacturing an order.
© 2006 Prentice Hall, Inc. 12 – 10
 Holding Costs
•Housing costs (including rent or depreciation,
operating costs, taxes, insurance).

•Material handling costs (equipment lease or

depreciation, power, operating cost).

•Labor cost.

•Investment costs (borrowing costs, taxes, and

insurance on inventory).

•Pilferage, space, and obsolescence.

© 2006 Prentice Hall, Inc. 12 – 11
 Inventory Models for
Independent Demand
Need to determine when and how
much to order

 Basic economic order quantity

 Production order quantity
 Quantity discount model

© 2006 Prentice Hall, Inc. 12 – 12

 Basic EOQ Model
Important assumptions:
1. Demand is known, constant, and
independent.
2. Lead time is known and constant.
3. Receipt of inventory is instantaneous and
complete.
4. Quantity discounts are not possible.
5. Only variable costs are setup and holding.
6. Stockouts can be completely avoided.
© 2006 Prentice Hall, Inc. 12 – 13
 Inventory Usage Over Time

Usage rate Average

Order inventory
Inventory level

quantity = Q on hand
(maximum
Q
inventory
level) 2

Minimum
inventory

Time

© 2006 Prentice Hall, Inc. 12 – 14

 Minimizing Costs
Objective is to minimize total costs
Curve for total
cost of holding
and setup

Minimum
total cost
Annual cost

Holding cost
curve

Setup (or order)

cost curve
Optimal Order quantity
Table 11.5 order
© 2006 Prentice Hall, Inc.
quantity 12 – 15
 The EOQ Model
Annual setup cost =
D
Q
S

Q = Number of pieces per order

Q* = Optimal number of pieces per order (EOQ)
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

Annual setup cost = (Number of orders placed per year)

x (Setup or order cost per order)

Annual demand Setup or order

=
Number of units in each order cost per order

= D (S)
Q

© 2006 Prentice Hall, Inc. 12 – 16

 The EOQ Model
Annual setup cost =
D
Q
S
Q
Annual holding cost = H
Q = Number of pieces per order 2
Q* = Optimal number of pieces per order (EOQ)
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

Annual holding cost = (Average inventory level)

x (Holding cost per unit per year)

Order quantity
= (Holding cost per unit per year)
2

= Q (H)
2

© 2006 Prentice Hall, Inc. 12 – 17

 The EOQ Model
Annual setup cost =
D
Q
S
Q
Annual holding cost = H
Q = Number of pieces per order 2
Q* = Optimal number of pieces per order (EOQ)
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

Optimal order quantity is found when annual setup cost

equals annual holding cost

D Q
S = H
Q 2
Solving for Q*
2DS = Q2H
Q2 = 2DS/H
Q* = 2DS/H
© 2006 Prentice Hall, Inc. 12 – 18
 An EOQ Example
To Determine optimal number of needles to order.
D = 1,000 units
S = Rs10 per order
H = Rs.50 per unit per year

2DS
Q* =
H
2(1,000)(10)
Q* = = 40,000 = 200 units
0.50

© 2006 Prentice Hall, Inc. 12 – 19

 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = Rs10 per order
H = Rs.50 per unit per year

Expected Demand D
number of = N = =
orders Order quantity Q*
1,000
N= = 5 orders per year
200

© 2006 Prentice Hall, Inc. 12 – 20

 An EOQ Example
To Determine optimal number of needles to order.
D = 1,000 units Q* = 200 units
S = Rs10 per order N = 5 orders per year
H = Rs.50 per unit per year

Number of working
Expected days per year
time between = T =
orders N
250
T= = 50 days between orders
5

© 2006 Prentice Hall, Inc. 12 – 21

 EOQ Model

 The EOQ model is robust.

 It works even if all
parameters and assumptions
are not met.
 The total cost curve is
relatively flat in the area of
the EOQ.
© 2006 Prentice Hall, Inc. 12 – 22
 Reorder Points
 EOQ answers the “how much”
question.
 The reorder point (ROP) tells when to
order.
Demand Lead time for a
ROP = per day new order in days

=dxL
D
d = Number of working days in a year

© 2006 Prentice Hall, Inc. 12 – 23

 Reorder Point Curve
Q*
Inventory level (units)

Slope = units/day = d

ROP
(units)

Time (days)
Lead time = L
© 2006 Prentice Hall, Inc. 12 – 24
 Reorder Point Example
Demand = 8,000 DVDs per year
250 working day year
Lead time for orders is 3 working days
D
d=
Number of working days in a year

= 8,000/250 = 32 units

ROP = d x L
= 32 units per day x 3 days = 96 units

© 2006 Prentice Hall, Inc. 12 – 25

 Inventory management!
Wah,Very interesting.

© 2006 Prentice Hall, Inc. 12 – 26