Dr.

Weria Khaksar
Email: weria@uniten.edu.my
Room No.: BN-03-08


10.1. Overview

An 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.




10.1. Overview

- 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.




10.1. Overview

- 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

1. To establish a system of keeping track of items in inventory.
2. To make decisions about how much and when to order.

1. A system to keep track of the inventory on hand and on order.
2. A reliable forecast of demand.
3. Knowledge of lead times and lead time variability.
4. Reasonable estimates of inventory holding costs, ordering costs
and shortage costs.
5. A classification system for inventory items.

10.2. Inventory Management System

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.
10.2. Inventory Management System

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.


10.2. Inventory Management System

4. Reasonable estimates of inventory holding costs, ordering costs
and shortage costs.

Inventory Costs

Holding or carrying costs
Ordering costs
Shortage costs

10.2. Inventory Management System

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.
10.2. Inventory Management System

The A-B-C Approach: Example

Item
Number
Annual
Demand


Unit
Cost

=
Annual
Dollar Value
1 2,500 $ 360 $ 900,000
2 1,000 70 70,000
3 2,400 500 1,200,000
4 1,500 100 150,000
5 700 70 49,000
6 1,000 1,000 1,000,000
7 200 210 42,000
8 1,000 4,000 4,000,000
9 8,000 10 80,000
10 500 200 100,000
7,591,000
10.2. Inventory Management System

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.
10.2. Inventory Management System

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:

1. Only one product is involved.
2. Annual demand requirements are known.
3. Demand is spread evenly throughout the year so that the
demand rate is reasonably constant.
4. Lead time does not vary.
5. Each order is received in a single delivery.
6. There are no quantity discount.
10.2. Inventory Management System
1. The basic Economic Order Quantity Model (EOQ):
The inventory cycle
10.2. Inventory Management System
1. The basic Economic Order Quantity Model (EOQ):
A balance between Holding (Carrying) costs and ordering costs

Annual Ordering cost =

,
where:
= Demand,
(usuallyin units per year)
= Ordering cost



Annual Holding cost =

2
,
where:
= Order quantity in units
= Holding carrying cost per unit

10.2. Inventory Management System
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:

, =

10.2. Inventory Management System
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.
Annual holding cost is $16 per tire and ordering cost is $75. the
distribution operates 288 days a year.

a. What is the EOQ?
b. How many tires 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?


a. Q
0
=
2 9,600 75
16

= 300 tires
b. Number of orders per year =
D
Q
=
9,600 tires
300 tires
=32
c. Length of order cycle=
Q
D
=
1
32
of a year which is
288
32
= 9 workdays
d. TC =
300
2
16 +
9,600
300
75 = $4,800

10.2. Inventory Management System

2. The Economic Production Quantity Model (EPQ).
In this model, the manufacturer periodically produces items in
batches or lots instead of producing continually.
Basic assumptions of EOQ 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.
10.2. Inventory Management System

2. The Economic Production Quantity Model (EPQ).
10.2. Inventory Management System

2. The Economic Production Quantity Model (EPQ).
The number of runs or batches per year =

The annual setup cost =

TC
min
= Holding cost + Setup cost =

2
+

, where

=Maximum inventory.
The economic run inventory is

=
2
( )

where, = Production or delivery rate and = Usage rate
Cycle time =
(

, Run time =
(

2
=

2






10.2. Inventory Management System
2. The 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

a. Optimal run size.
b. Minimum total annual cost for holding and setup.
c. Cycle time for the optimal run size.
d. Run time.


a. Q
p
=
2 800 48,000 45
1(800200)
= 2,400 wheels
b. I
max
=
2,400
800
800 200 = 1,800 wheels
TC
min
=
1,800
2
$1 +
48,000
2,400
$45 = $1,800
c. Cycle time=
2,400 wheels
200 wheels per day
= 12 days
d. Run time
2,400 wheels
800 wheels per day
= 3 days
10.2. Inventory Management System

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 buyers
goal with quantity discount is to select the order quantity that will
minimize total cost including holding cost, ordering cost and
purchasing cost.

TC = Holding cost +Ordering cost +Purchasing cost
TC =

2
H +

+
where is the unit price.
10.2. Inventory Management System

3. The Quantity Discount Model.
10.2. Inventory Management System

3. The Quantity Discount Model.
Example: The maintenance department of a large hospital uses 816
cases of liquid cleanser annually. Ordering costs are $12, holding costs
are $4 per case a year and new price schedule indicates that orders of
less than 50 cases will cost $20 per case, 50 to 79 cases will cost $18
per case, 80 to 99 cases will cost $17 per case and larger orders will
cost $16 per case. Determine the optimal order quantity and the total
cost.

= 816 cases per year
S = $12
H = $4 per case per year

Range Price
1 to 49 ..
50 to 79 ..
80 to 99 ..
100 or more
$20
18
17
16
1. Compute the common minimum =
2

=
2 816 12
4

= 69.67 70 .

2. The 70 cases can be bough at $18 per case. Hence, the total cost will be:
TC
70
=(70/2)4+(816/70)12+18(816)=$14,968

3. Because lower range exist, each must be checked against the minimum cost
resulting from 70 cases at $18 each.

In order to buy at $17 per case, at least 80 cases must be purchased. (WHY?)
TC
80
=(80/2)4+(816/80)12+17(816)=$14,154

In order to buy at $16 per case, at least 100 cases must be purchased.
TC
100
=(100/2)4+(816/100)12+16(816)=$13,354

Therefore, because 100 cases per order yields the lowest total cost, 100 cases is
the overall optimal order quantity.