Basic Inventory Systems

8/12/2019 Basic Inventory Systems

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Basic inventory systems


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Investment in inventory is currently over 1.25 Trillion(U.S. Department of Commerce)


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Inventoriesare assets:

held for sale in the ordinary course of business; or

in the process of production for such sale; or

in the form of materials or supplies to be consumed in the

production process or in the rendering of services


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Inventory ?

Inventoryis the term used to indicate the stock of any item or resource used inan organization It can include: raw materials, finished products, component parts, supplies,and work-in-process.


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Inventories include:

goods: commodities purchased and held for resale supplies: raw materials

products: intermediate products, finished goods

Raw Materials Work in Progress Finished Goods


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Inventory system

An Inventory systemis the set of policies that controls and monitorlevels of inventory and determines what levels should bemaintained, when stock should be replenished, and how largeorders should be.


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Why inventory ?

The fundamental reason for carrying inventories is that it is physicallyimpossible and economically impractical for each stock item to arrive

exactly where it is needed and exactly when it is needed.

1. To maintain independence of operations

2. To meet variation in product demand

3. To allow flexibility in production scheduling

4. To provide a safeguard for variation in raw material delivery time.


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Stock Keeping unit : Each distinct item in the inventory at a location is termed as

SKU

TYPES OF INVENTORY: Basically classified in to 2 types

1. Transaction stocks: Those necessary to support the transformation,

movement and sales operations of the firm

2. Organization stocks : represent investment opportunities to achieveoperating efficiencies


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1. Transaction stocks: Those necessary to support the

transformation, movement and sales operations of the firm.

(a) Work in process stocks: materials currently being worked on or

moving between work centers .

(b) Transportation or Pipeline inventories : When transportationrequires a long time, the items in transportation represent

inventory


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Organization stocks : represent investment opportunities to achieveoperating efficiencies.

(a) Fluctuation or safety stock

(b) Anticipation inventory or leveling inventory(c) Lot size or cycle inventories


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Inventory costs

1. Ordering costs: involves clerical cost for Purchasing,

Inspection, Accounting and Transportation

2. Holding or Carrying costs: Storage, handling, Insurance , record

keeping, product deterioration and loss due to perishable nature

3. Stockout costs

4. Miscellaneous such as Setup costs, purchase or production cost.


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ABC Inventory Classification

ABC classificationis a method for determining level of control and

frequency of review of inventory items

A Pareto analysis can be done to segment items into value categoriesdepending on annual dollar volume

A Items

typically 20% of the items accounting for 80% of the inventoryvalue-use Q system

B Itemstypically an additional 30% of the items accounting for 15% ofthe inventory value-use Q or P

C ItemsTypically the remaining 50% of the items accounting for only 5%of the inventory value-use P


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ABC Analysis: The information that is required to do the analysis is:

Unit item Value, and Annual Unit Usage. The analysis requires a calculation

of Annual Usage and sorting that column from highest to lowest value,

calculating the cumulative annual volume, and grouping into typical ABC

classifications.


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ABC example

S.No Unit value(Rs.)

Annual usage(Qty)

1 100 165

2 125 100

3 450 10

4 16 200

5 225 10

6 5 400

7 6 200

8 100 10

9 10 96

10 60 10


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Item

Annual

Usage

value

% of Total

value

Cumulative %

of Total value

Item

Classifn

1 16,500 34.4 34.4 A2 12,500 26.1 60.5 A

3 4500 9.4 69.9 B

4 3200 6.7 76.6 B

5 2250 4.7 81.3 B

6 2000 4.2 85.5 B

7 1200 2.5 88 C

8 1000 2.1 90.1 C

9 960 2 92.1 C

10 875 1.8 93.9 C11 750 1.6 95.5 C

12 600 1.3 96.8 C

13 600 1.3 98.1 C

14 500 1 99.1 C

15 500 1 100.1 C


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Fundamental decision of Inv. Mgm

The Fundamental decisions of Inv. Mgm are:

1. What to order : Depends on MRP

2. When to order : Depends on MRP

3. How much to order : Depends on the order system followed


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Master Production Schedule (MPS):

Example

Production of 1000 no. 12468 staplers is planned for weeks 1, 2, and 3,followed by no more stapler production until week 6 in which 1500 staplerswill be produced.

Product: personal stapler no. 12468

1 2 3 4 5 6

Planned order releases 1000 1000 1000 0 0 1500

Week


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ORDER QUANTITY STRATEGIES

Lot-for-lot Order exactly what is needed for the next period

Fixed-orderquantity

Order a predetermined amount each time an order isplaced

Min-max system When on-hand inventory falls below a predeterminedminimum level, order enough to refill up to maximumlevel

Order n periods Order enough to satisfy demand for the next nperiods


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Mathematical Models for Determining Order Quantity

Economic Order Quantity (EOQ or Q System)

An optimizing method used for determining order quantity andreorder points

Part of continuous review systemwhich tracks on-hand inventoryeach time a withdrawal is made

Economic Production Quantity (EPQ)

A model that allows for incremental product delivery

Quantity Discount Model

Modifies the EOQ process to consider cases where quantitydiscounts are available


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Economic Order Quantity

Assumptions:

Demand is known & constant - nosafety stock is required

Lead time is known & constant

No quantity discounts are available Ordering (or setup) costs are

constant

All demand is satisfied (noshortages)

The order quantity arrives in asingle shipment


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EOQ Total Costs

Total annual costs = annual ordering costs + annual holding costs


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EOQ: Total Cost Equation

costsetuporordering

costholdingannual

orderedbeoquantity t

demandannual

costannualtotal

2

S

H

Q

D

TC

Where

HQ

SQ

DTCEOQ


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The EOQ Formula

Minimize the TC by ordering the EOQ:

H

DSEOQ

2


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When to Order:

The Reorder Point

Without safety stock:

With safety stock:

days/weeksintimelead

unitsindemandlydaily/week

unitsinpointreorderwhere

L

d

R

dLR

unitsinstocksafetywhere

SS SSdLR


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EOQ Example

Weekly demand = 240 units No. of weeks per year = 52

Ordering cost = $50

Unit cost = $15

Annual carrying charge = 20% of unit cost

Lead time = 2 weeks


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Setup cost

Setup costs apply when the required items are produced in the organization & comprise the following factors

1. Cost of setting up the process i.e.,

(a) Setting up necessary equipment & making necessary tool changes

(b) Instructing the operator and follow up

(c) Building up the skill in operator

2. Cost of scrap

3.Cost of planning production & controlling

(a) Scheduling & following up of work

(b) Accounting for job costs

(c) Preparing necessary production control paper work


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EPQ (Economic Production Quantity) Assumptions

Same as the EOQ except: inventory arrives in increments & is

drawn down as it arrives


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EPQ Equations

Adjusted total cost:

Maximum inventory:

Adjusted order quantity:

H

IS

Q

DTC MAXEPQ

2

p

dQIMAX 1

p

dH

DSEPQ

1

2


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EPQ Example

Annual demand = 18,000 units

Production rate = 2500 units/month

Setup cost = $800

Annual holding cost = $18 per unit

Lead time = 5 days

No. of operating days per month = 20


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EPQ Example Solution

monthunitspmonthunitsd /2500;/150012

000,18

units

pdH

DSQ 2000

25001500118

800000,182

1

2

unitsp

dQIMAX 800

2500

1500120001

400,14200,7200,7

182

800800

2000

000,18

2

H

IS

Q

DTC MAX


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EPQ Example Solution (cont.)

The reorder point:

With safety stock of 200 units:

unitsSSdLR 575200520

1500

unitsdLR 375520

1500


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Quantity Discount Model Assumptions

Same as the EOQ, except:

Unit price depends upon the quantity ordered

Adjusted total cost equation:

PDH

Q

SQ

D

TCQD

2


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Quantity Discount Procedure

Calculate the EOQ at the lowest price

Determine whether the EOQ is feasible at thatprice Will the vendor sell that quantity at that price?

If yes, stopif no, continue Check the feasibility of EOQ at the next higher

price

Continue to the next slide ...


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QD Procedure (continued)

Continue until you identify a feasible EOQ

Calculate the total costs (including total itemcost) for the feasible EOQ model

Calculate the total costs of buying at the

minimum quantity required for each of thecheaper unit prices

Compare the total cost of each option &choose the lowest cost alternative

Any other issues to consider?


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QD Example

Annual Demand = 5000 units

Ordering cost = $49

Annual carrying charge = 20%

Unit price schedule:

Quantity Unit Price

0 to 999 $5.001000 to 1999 $4.80

2000 and over $4.75


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QD Example Solution

Step 1

feasiblenotQP 71875.42.0

49000,5275.4$

feasiblenotQP 71480.42.0

49000,5280.4$

feasibleQP 70000.52.0

49000,5200.5$


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QD Example Solution (Cont.)

Step 2

700,25$500000.500.52.02

700

49700

000,5700

QTC

725,24$500080.480.42.02

100049

1000

000,51000 QTC

50.822,24$500075.475.42.02

200049

2000

000,52000 QTC


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Safety Stock and Service Level

Order-cycle service level is the probability thatdemand during lead time wont exceed on-handinventory.

Risk of a stockout = 1(service level)

More safety stock means greater service level andsmaller risk of stockout


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Safety Stock and Reorder Point

Without safety stock:

With safety stock:

daysintimelead

unitsindemanddailyunitsinpointreorderwhere

L

dR

dLR

unitsinstocksafetywhere

SS

SSdLR


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Reorder Point Determination

R = reorder point

d = average daily demand

L = lead time in daysz = number of standard deviations associated with

desired service level

s= standard deviation of demand during lead time

dL

dL

zdLR

zSS

s

s

i.e.,


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Safety Stock Example

Daily demand = 20 units

Lead time = 10 days

S.D. of lead time demand = 50 units

Service level = 90%

Determine:1. Safety stock

2. Reorder point


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Safety Stock Solution

Step 1determine z

Step 2determine safety stock

Step 3determine reorder point

units264641020 SSdLR

28.1:BAppendixFrom z

units645028.1 SS


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Inventory Record Accuracy

Inaccurate inventory records can cause: Lost sales Disrupted operations

Poor customer service

Lower productivity Planning errors and expediting

Two methods are available for checking record accuracy Periodic counting-physical inventory

Cycle counting-daily counting of pre-specified items provides thefollowing advantages: Timely detection and correction of inaccurate records

Elimination of lost production time due to unexpected stock outs

Structured approach using employees trained in cycle counting

Documents

Basic Inventory Systems