11

Inventory Control Inventory Control ModelsModels

22

Chapter Learning ObjectivesChapter Learning Objectives

Students will be able to:Students will be able to:– Use the economic order quantity (EOQ) to Use the economic order quantity (EOQ) to

determine how much to order.determine how much to order.

– Compute the reorder point (ROP) in Compute the reorder point (ROP) in

determining when to order more inventory.determining when to order more inventory.

– Understand the importance of inventory Understand the importance of inventory

control.control.

– Perform sensitivity analysis on basic Perform sensitivity analysis on basic

inventory quantities.inventory quantities.

33

Chapter Learning Objectives Chapter Learning Objectives continuedcontinued

Students will be able to:Students will be able to:

– Understand the use of safety stock with Understand the use of safety stock with

known and unknown stockout costs.known and unknown stockout costs.

– Perform ABC analysis.Perform ABC analysis.

44

Inventory as an Important AssetInventory as an Important Asset

Inventory can be the most expensive and Inventory can be the most expensive and the most important asset for an the most important asset for an organizationorganization

Other Assets 60%

Inventory 40%

Inventory as a percentage of total assets

55

The Inventory ProcessThe Inventory Process

Suppliers Customers

Finished Goods

Raw Materials

Work in Process

Fabrication and

Assembly

Inventory Storage

Inventory Processing

66

Importance of Inventory ControlImportance of Inventory Control

Five Functions of InventoryFive Functions of Inventory

DecouplingDecoupling

Storing resourcesStoring resources

Adapting to irregular supply and demandAdapting to irregular supply and demand

Enabling the company to take advantage Enabling the company to take advantage

of quantity discountsof quantity discounts

Avoiding stockouts and shortagesAvoiding stockouts and shortages

77

Inventory DecisionsInventory Decisions

How much to orderHow much to order

When to orderWhen to order

wish to minimize total inventory costwish to minimize total inventory cost

88

Inventory CostsInventory Costs

Cost of the itemsCost of the items

Cost of orderingCost of ordering

Cost of carrying, or holding inventoryCost of carrying, or holding inventory

Cost of safety stockCost of safety stock

Cost of stockoutsCost of stockouts

99

Ordering CostsOrdering CostsDeveloping and sending purchase ordersDeveloping and sending purchase orders

Processing and inspecting incoming inventoryProcessing and inspecting incoming inventory

Bill payingBill paying

Inventory inquiriesInventory inquiries

Utilities, phone bills, etc., - purchasing department.Utilities, phone bills, etc., - purchasing department.

Salaries/wages - purchasing department employeesSalaries/wages - purchasing department employees

Supplies (e.g., forms and paper) - purchasing Supplies (e.g., forms and paper) - purchasing

departmentdepartment

1010

Carrying CostsCarrying CostsCost of capitalCost of capital

TaxesTaxes

InsuranceInsurance

SpoilageSpoilage

TheftTheft

ObsolescenceObsolescence

Salaries/wages - warehouse employeesSalaries/wages - warehouse employees

Utilities/building costs - warehouseUtilities/building costs - warehouse

Supplies (e.g., forms, paper) - warehouseSupplies (e.g., forms, paper) - warehouse

1111

Inventory Usage Over Time Inventory Usage Over Time

1212

Costs as Functions of Order Costs as Functions of Order QuantityQuantity

AnnualCost

Order QuantityQ*

Total Cost Curve

Carrying (holding)Cost Curve

Ordering (set-up)

Cost Curve

MinimumCost

1313

Steps in Finding the Optimum Steps in Finding the Optimum InventoryInventory

Develop an expression for the ordering Develop an expression for the ordering cost.cost.

Develop and expression for the Develop and expression for the carrying cost.carrying cost.

Set the ordering cost equal to the Set the ordering cost equal to the carrying cost.carrying cost.

Solve this equation for the optimum Solve this equation for the optimum desired.desired.

1414

EOQ : Basic AssumptionsEOQ : Basic Assumptions

Demand is known and constantDemand is known and constant

Lead time is known and constantLead time is known and constant

Receipt of inventory is instantaneousReceipt of inventory is instantaneous

Quantity discounts are not possibleQuantity discounts are not possible

The only variable costs are the cost of setting up or The only variable costs are the cost of setting up or

placing an order, and the cost of holding or storing placing an order, and the cost of holding or storing

inventory over timeinventory over time

Stockouts can be completely avoided if orders are Stockouts can be completely avoided if orders are

placed at the appropriate timeplaced at the appropriate time

15

• Annual ordering cost:

• Annual holding or carrying cost:

• Total inventory cost:

Developing the EOQ

oCQ

D

orderper units ofNumber

demand Annual

hC2

Q

YearPer Cost Carrying*Inventory Average

hot C2

QC

Q

D C

1616

EOQEOQ

hC2DC*Q

Per Unit Carrying Cost:

Percentage Carrying Cost:

IP

DCQ *

0

1717

Inputs and Outputs of the EOQ Inputs and Outputs of the EOQ ModelModel

EOQModels

Input Values Output Values

Annual Demand(D)

Ordering Cost (Co)

Carrying Cost(Ch)

Lead Time (L)

Demand Per Day (d)

EconomicOrder

Quantity(EOQ)

ReorderPoint(ROP)

1818

The Reorder Point (ROP) CurveThe Reorder Point (ROP) Curve

ROP = (Demand per day) x (Lead time for a new order, in days) = d x L

Inve

ntor

y L

evel

(U

nits

) Q*

ROP(Units)

Slope = Units/Day = d

Lead Time (Days) L

1919

The Use of Safety StockThe Use of Safety StockIn

vent

ory

on

Han

dIn

vent

ory

on

Han

d

StockoutTime

Stockout is avoidedTime

Safety Stock

2020

The Use of Safety StockThe Use of Safety Stock

Known stockout costs:Known stockout costs:

– Given probability of demand, find total Given probability of demand, find total

cost for each safety stock alternativecost for each safety stock alternative

Unknown stockout costs:Unknown stockout costs:

– Set service level; use normal distributionSet service level; use normal distribution

2121

Service Level versus Carrying CostsService Level versus Carrying Costs

2222

Summary of ABC Analysis Summary of ABC Analysis

Group A Items - CriticalGroup A Items - Critical

Group B Items - ImportantGroup B Items - Important

Group C Items - Not That ImportantGroup C Items - Not That ImportantInventory

GroupDollar

Usage (%)InventoryItems (%)

Are ComplexQuantitative

ControlTechniques Used?

ABC

702010

102070

YesIn some casesNo

2323

ABC Inventory AnalysisABC Inventory Analysis

1009080706050403020100 Percent of Inventory Items

Per

cent

of

Ann

ual

Dol

lar

Usa

ge

1 2 3 4 5 6 7 8 9 10

AItems

B Items C

Items

2424

ABC Inventory PoliciesABC Inventory PoliciesGreater expenditure on supplier Greater expenditure on supplier

development for A items than for B development for A items than for B

items or C itemsitems or C items

Tighter physical control on A items Tighter physical control on A items

than on B items or on C itemsthan on B items or on C items

Greater expenditure on forecasting A Greater expenditure on forecasting A

items than on B items or on C itemsitems than on B items or on C items