Application of Inventory Model in Industry - Foong Weng Kang - TS160.F66 2008

8/12/2019 Application of Inventory Model in Industry - Foong Weng Kang - TS160.F66 2008

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ABSTRACT

This study discusses the inventory models used at Ngee Ming Shoe Manufacturer

Sdn. Bhd, Selangor. The objective of the study is to identify and analyze the most

appropriate inventory models to be used in the company in term to decide the

ordering quantity and ordering time interval. The data gathered from interviews,

observations, journals, books, internet and company inventory record. The result was

analyzed, there are three inventory models used to determine the ordering quantity

and ordering interval time; Economic Order Quantity (EOQ), Economic Production

Quantity (EPQ) and Quantity Discount (QD). Each model has different

characteristic, where EOQ is focus on inventory cost, EPQ is focus on the production


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ABSTRAK

Kajian ini membincangkan tentang penggunaan model inventori di Syarikat Ngee

Ming Sdn. Bhd, Selangor. Objektif utama kajian ini adalah untuk menentukan dan

menganalisis model inventori yang paling sesuai dilaksanakan dalam syarikat

tersebut untuk menentukan kuantiti dan kekerapan pesanan. Data diperolehi daripada

temuduga, permerhatian, buku, jurnal, laman web dan data inventori syarikat.

Selepas data dianalisis, tiga model inventori digunakan bagi menentukan kuantiti dan

kekerapan pesanan iaitu kuantiti pesanan ekonomi, pengeluaran kuantiti ekonomi

dan kuantiti diskaun. Setiap model inventori mempunyai kriteria yang berbeza,

dimana kuantiti pesanan ekonomi menfokus kepada kos-kos penyimpanan,


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CHAPTER 1

INTRODUCTION

1.1 Company Background

Ngee Ming Shoe Manufacturers Sdn. Bhd. has successfully developed a complete

range of industrial safety shoe suitable for various working conditions. The company

has been specialized in providing steel toe, safety footwear for thousands of

hardworking people throughout Malaysia. They produce a wide range of products

named Oscar Safety Shoes and they manufactured by ISO 9001:2000 accredited

facilities and adhere to international quality standards.


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1.3 Objectives

There are several study objectives;

a) To identify the most appropriate inventory model to apply into the

company.

b) To protect against uncertainties such as supply, demand and lead time, so

safety stocks are required.

c) To allow economic production and purchase, it is more economic to

produce materials in a lot size because it can reduce the ordering costs,

quantity costs and transportation costs.

d) To ensure the company has gain customers satisfactory and competitive

advantages.

e) To ensure the products have delivered before due date and avoid loss

sales due to stock out.

1.4 Scope


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1.5 Important of The Project

The project is to determine the ordering quantity and timing in a minimum cost. This

project is important because with a suitable inventory model applied can succeed the

business operation and supply chain. A good inventory model can also reduce the

capital cost where the company can manage the buying amount without the problem

of exceed inventory. The capital can be invested in other investment to gain higher

turnover. Therefore, the turnover ratio is increased. Besides that, it can give more

empty spaces in the warehouse for other purposes. The capital can be invested in

other investment where have higher turnover.

The appropriate ordering time and quantity is important to ensure the company have

sufficient shoes supply to the customer during the production lead time. This is to

avoid the problems of delaying in products delivery time to customer where it may

caused the customer to switch to another supplier. Therefore, the company has loss in

sales and customer satisfactory. The company reputation will also drop and it is hard


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CHAPTER 2

LITERATURE REVIEW

2.1 Definition of Inventory

Inventory is stock or store of goods (Stevenson, 2007). In manufacturing, inventory

consists of raw materials, work-in-process, and finished goods. In wholesaling and

retailing, inventory is the stock of merchandise on hand. In direct marketing,

inventory may refer to direct-mail package components that are available for mailing

when needed. In the broadcast and print media industry, inventory is the time or

space available for sale to advertisers. In magazine publishing, inventory is the


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A firm can typically stock many of items in inventory. Thus, manufacturing firm

carry supplies of raw materials, purchased parts, partially finished item and finished

goods. Inventories may represent a significant portion of total assets, a reduction of

inventories can result in a significant increase in return on investment (ROI).

However, many of items have a limited life time, so carrying large quantities would

mean having to dispose of unused, costly supplies.

Another consideration has been take is the space requirements of inventory. Space

limitation may pose restrictions on inventory storage capability, more space can

increase the storage capability thus more item can stored but also increase the

inventory holding costs. So it is depend on the functions of inventory. The most

important functions are to meet anticipated customer demand, to smooth production

requirement, to decouple operations, to protect against stock outs, to take advantage

of order cycles, to hedge against price increases, to permit operations and take

advantage of quantity discounts.


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In the software era Gordon Graham paved the road for today's inventory

management consultants. Gordon managed a consulting and training company for

over 25 years. Gordon spent many years consulting with distributors on how to

implement quality inventory management practices. Business practices that are easily

understood and which provide proven results on the distributors bottom line profits

(Gordon Graham, 1990).

Charles Bodenstab views order history as an inventory management database and

brings to it the power of statistical analysis. Charles Bodenstab's involvement during

the 1950's and 1960's with developing some of the earliest qualitative automated

approaches to inventory management. Charles has said

much of the statisticaltheory built into automated inventory control systems completely ignored the day-to-

day business realities of the typical distributor .


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2.2.2 Inventory Management Techniques

2.2.2.1 Demand Forecasting

Basically, inventory control needs to order the items some time before the customers

demand them, it is because the lead time between the ordering time and the delivery

time and also due to certain ordering costs it is often necessary to order in batches

instead of unit for unit. That s the forecasting need t o look ahead and forecast the

future demand. A demand forecast is estimated average of the demand size over

some future period. If the forecast is not certain, more safety stock is required.

Table 2.1: Forecasting techniques and formulation

Technique Formula Definitions

Moving average

forecast

Ft =( ! A t-i)/n A = Demand in period t-1

N = number of periods

Exponential smoothing Ft = F t-1 + (A t-1 F t-1) = smoothing factor


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Linear regression

forecast

yc = a + bc

b = (n( ! xy) (! x)( ! y)) /

(n(! x2) (! x)2)

a = ( ! y - b! x)/n

yc = computed value of

dependent variable

x = predictor

(independent) variable

b = slope of the line

a = value of y c when x=0

2.2.2.2 Material Requirement Planning

Material Requirement Planning (MRP) is a computer based information system that

translates master schedule requirements for end item into time-phased requirementsfor subassemblies, components, and raw material. The backward from the due date

using the lead time to determine the time and quantity of the order. An MRP system

is intended to simultaneously meet 3 objectives:

a) Ensure materials and products are available for production and delivery to


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expected to receive by the beginning and receipt offset by lead time. Basically, the

net requirement can determine by eliminate the gross requirement by available

inventory. From the MRP, the planned orders, a schedule indicating the amount and

timing of the future order can be decided.

2.3 Inventory Counting System

An inventory control system is an integrated package of software and hardware used

in warehouse operations, and elsewhere, to monitor the quantity, location and status

of inventory as well as the related shipping, receiving, picking and put away

processes.

2.3.1 Periodic system

Periodic inventory counting system is a physical count of items in inventory at

periodic interval in order to decide how much to order of each item, it can be once in


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Table 2.2: Comparison between periodic and perpetual inventory counting system

Inventory Counting

System

Periodic system Perpetual inventory

system

Advantages Orders for many items at

same time

Continuous monitoring of

inventory

Economies in processing Determine optimal

production order

2.4 Inventory Costs

There are three basic costs in maintaining the inventory; holding, transaction, and

shortage costs.

2.4.1 Holding costs

It is also call as carrying costs, cast is expense associated with maintaining inventory.


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2.4.1.2Taxes

Taxing authorities typically assess inventory held in warehouses. The tax rate and

means of assessment vary by location. The tax expense is usually a direct levy based

on inventory level on a specific day of the year or average level over a period of

time.

2.4.1.3 Insurance

Insurance cost is an expense based upon estimated risk or loss over time. The item

that are easily concealed like pocket cameras, transistor radios, calculator and fairly

expensive like cars, TV are prone to theft and pilferage, and some item that is easily

light fire like clothing, alcohol, these result in high insurance cost. Beside that, the

company facilities also influence the insurance cost such as security cameras and

sprinkler systems that might help to reduce risk.


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2.4.2 Ordering costs

It also calls as setup costs, the costs of ordering and receiving inventory. They are the

costs that vary with the actual placement of an order. Besides transportation cost,

shipping costs, preparing invoices, inspecting goods upon arrival for quality and

quantity, and moving the goods into temporary storage. For manufacturer which

produces its own inventory instead order from supplier, the ordering cost is cost of

machine setup, such as preparing equipment for job by adjusting the machine and

changing machine cutting tools are included into ordering costs.

2.4.3 Shortage costs

The costs result when demand exceeds the supply of inventory on hand. These costs

can include the opportunity cost of not making a sale, loss of customer goodwill, late

charges, and similar costs. Furthermore, if the shortage occurs in an item use at

internal, it can cause the cost of lost production.


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There are some assumptions of the basic EOQ model;

a) Only one product is involved

b) Annual demand requirement are known

c) Demand is spread evenly throughout the year so that the demand rate is

reasonably constant.

d) Lead time does not varye) Each order is received in a single delivery.

f) There are no quantity discount


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and the carrying costs also low, but its need more frequent orders, which increase the

annual ordering costs. Conversely, when the order size is larger, the average

inventory is high and therefore the carrying costs is increase, but the ordering costs is

decrease because the ordering infrequent interval.


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Annual ordering cost = $!%

Where; D = Demand, usually in units per year

S = Ordering cost

Because the number of orders per year, D/Q, decreases as Q increase, annual

ordering cost is inversely related to order size as figure above. The graph is showing

negative exponential. The total annual cost (TC) associated with carrying and

ordering inventory when Q units are ordered each time is

Total cost = Annual carrying cost + Annual ordering cost

&' ( )*#+,)% From this equation, the total cost reaches its minimum at the quantity where carrying

and ordering costs are equal. Thus;

-. ( / *012 The length of an order cycle is = Q/D


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The carrying cost for EPQ is almost same with the EOQ, the different is there are no

ordering costs, because the product is produce inside production section, and the

ordering quantity Q is replace by the inventory. The total cost for EPQ is

Total costs = carrying cost + setup cost

34567 ( 89:;< 2 +

=>?1

where,

I max = Maximum inventory

The economic run quantity is

-. ( / *012 /

@@AB

where,

p = production or delivery rate

u = usage rate

The cycle time for the economic run size models is a function of the run size and


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2.5.1.3 Quantity Discount

Quantity discount is a price reduction to the customer who order in a large

purchased. Generally there are two types:

a) Cumulative quantity discounts (also called accumulation discounts).

These are price reductions based on the quantity purchased over a set

period of time. The expectation is that they will impose an implied

switching cost and thereby bond the purchaser to the seller.

b) Non-cumulative quantity discounts. These are price reductions based on

the quantity of a single order. The expectation is that they will encourage

larger orders, thus reducing billing, order filling, shipping, and sales

personal expenses.

When the quantity discount is offered, some consideration have to take; the


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2.5.2 Ordering Time Interval

Reorder point (ROP) is when the quantity on hand of an item drops to this amount,

the item is reordered. This item amount is just sufficient to satisfy the expected

demand during the lead time. If the demand and lead time is constant, the reorder

point is simply

ROP = d X LT

Where;

d = demand rate (unit per day or week)

LT = Lead time in days or weeks (same unit as demand rate)


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Usually, the demand rate is not constant and variability, so it is necessary to carry

additional inventory call safety stock, to reduce the risk of running out of inventory

during lead time. The ROP then is increase by adding the safety stock.

ROP = expected demand during lead time + Safety stock

Safety stock is depending on the following factors;

a) The average demand rate and average lead time

b) Demand and lead time variability

c) The desired service level

The greater variability, the greater amount of safety stock are required to achieve the

service level, where the probability that demand will nor exceed supply during lead

time. So, the ROP is

ROP = Expected demand during lead time + z d LT

where,

z = number of standard deviations

d LT = the standard deviation of lead time demand


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The safety stock can be divided into three categories, the first is only demand is

variable, then

YZ[\ ( YZ] 3, and the reorder point isK_X ( ` a b^3 +cYZ] 3 Where;

a= average daily or weekly demand

d = standard deviation of demand per day or week

LT = lead time in days or weeks

Second is only lead time is variable, then d LT = d LT , and reorder point is

K_X ( ` a b^3 +cYZ[\ Whered = daily or weekly demand

^3 = average lead time in days or weeksLT = standard deviation of lead time in days or weeks


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CHAPTER 3

METHODOLOGY

3.1 Introduction

This chapter explained the research methodologies that were used in this study. The

methodology includes the planning of the study, survey instrument, and flow chart of

the research, data collection and analysis technique.

3.2 Planning of Study


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Figure 3.1: Flow chart for Planning of the Study

3.2.1 Flow Chart

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Application of Inventory Model in Industry - Foong Weng Kang - TS160.F66 2008