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MANAGEMENT
CHAPTER 3
INVENTORY CONTROL
MANAGEMENT
Inventory
Management Finance :
Cash flow and
Cost of money
Information Systems :
Inventory control
Judicial Aspects :
systems
Ownership and
responsibility
OBJECTIVE OF INVENTORY
MANAGEMENT
Independent Demand
Chocolate
Finished Goods
Cake
Dependent Demand
Raw
TYPES OF INVENTORY (CONT.)
Raw material purchased items received which have
not entered the production process.
Works-In-Process raw materials that have entered
the manufacturing process and are being worked on
or waiting to be worked on.
Finished Goods ready to be sold as completed
items.
Distribution inventories finished goods located in
distribution system.
Maintenance, repair & operating (MRO)
item used in production that do not become part
of the product.
include hand tools, spare parts, lubricants and
cleaning supplies.
INVENTORY CLASSIFICATIONS
Inventory
Available Inventory:
Available Inventory = Projected on hand
Safety stock
Inventory allocated to
other items
DIFFERENTIATE
Holding (carrying) costs: cost to carry an item in
inventory for a length of time, usually a year
Annual cost of 20%-40% of value (unit price) of
an item
Ordering costs: costs of ordering and receiving
inventory
fixed dollar amount per order, regardless of
order size
Shortage costs: costs when demand exceeds
supply
difficult to calculate often assumed
INVENTORY MODELS
Economic
Order Quantity
(EOQ) model
Economic
Production Quantity
(EPQ) model
Quantity Discount (QD) model
ECONOMIC ORDER QUANTITY
(EOQ) MODEL
The order size that minimizes total annual
cost.
Assumptions :
Only one product is involved.
Annual demand requirements are known.
Demand is even throughout the year.
Lead time does not vary.
Each order is received in a single delivery.
There are no quantity discounts.
EOQ (INVENTORY CYCLE)
Profile of Inventory Level Over Time
Q Usage
Quantity rate
on hand
Reorder
point
Time
Receive Place Receive Place Receive
order order order order order
Lead time
EOQ (ANNUAL CARRYING COST)
Annual carrying cost is computed by
multiplying the average amount of
inventory on hand by the cost to carry one
unit for one year, even though any given
unit would not necessarily be held for a
year.
Q
Total annual carrying cost H
2
where Q = Order quantity in units
H = Holding (carrying) cost per unit
EOQ (ANNUAL ORDERING COST)
Q D
TC = H + S
2 Q
EOQ (OPTIMAL ORDER QUANTITY)
2 DS
Q0
H
Q
Length of order cycle
D
Number of order per year, N
Demand D
N=
Order Quantity Q
EOQ (COST MINIMIZATION GOAL)
The Total-Cost Curve is U-Shaped
Q D
TC H S
2 Q
Annual Cost
Ordering Costs
Order Quantity
QO (optimal order quantity) (Q)
EXAMPLE 1 (EOQ)
Omega is a company which manufactures
megaphones. The company buys its
speakers at a cost of RM20 each. With each
order, Omega must spend RM50
(preparation of the purchase order, delivery,
receiving). The annual demand for speakers
is 10,000 units and the annual carrying cost
is 20 % of the unit cost.
Which quantity, Q would minimize the
annual total cost?
SOLUTION : EXAMPLE 1 (EOQ)
D = 10,000 units
H = 20% of the unit cost RM20
S = RM50
2DS
Qo =
H
2 x 10000 x RM50
=
20% x RM20
= 500 units
EXAMPLE 2 (EOQ)
A local distributor for a national tire company
expects to sell approximately 9,600 steel-belted
radial tires of a certain size and tread design next
year. Annual carrying cost RM16 per tire, and
ordering cost is RM75. The distributor operates
288 days per year.
a. What is the EOQ?
b. How many times 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
quantity is ordered?
SOLUTION : EXAMPLE 2 (EOQ)
D = 9,600 tires per year
H = RM16 unit per year
S = RM75
a. Q = 2DS 2(9600)(75)
o = 300tires
H 16
Q D
d. TC = H S
2 Q
300 9600
= 16 75
2 300
RM 2,400 RM 2,400
RM 4,800
ECONOMIC PRODUCTION
QUANTITY (EPQ) MODEL
Production is done in batches or
lots.
Capacity to produce a part exceeds
the parts usage or demand rate.
Assumptions of EPQ are similar to
EOQ except orders are received
incrementally during production.
EPQ
ASSUMPTIONS :
Only one item is involved
Annual demand is known
Usage rate is constant
Usage occurs continually
Production rate is constant
Lead time does not vary
No quantity discounts
EPQ (INVENTORY CYCLE)
Quantity
Production
Production
& Usage
& Usage
Usage
Usage
Time
ECONOMIC RUN SIZE
Solving a similar equation as for EOQ, we
get the following equation for the optimal
run size for EPQ.
The economic run quantity is
2 DS p
QP
H p u
p = production or delivery rate
u = usage rate
ECONOMIC RUN SIZE (CONT.)
The cycle time (the time between orders or
between the beginnings of runs) is a function of
the run size and usage (demand) rate :
QP
Cycle time
u
The run time (the production phase of the
cycle) is a function of the run (lot) size and the
production rate :
QP
Run time
P
ECONOMIC RUN SIZE (CONT.)
I max Qp
I average or ( p u)
2 2p
ECONOMIC RUN SIZE (CONT.)
The annual setup cost is equal to the number
of runs per year times the setup cost,
D
S, per run S
Q
a. 2 DS p
QP
H p u
2(48000)45 800
2 800 200
2,400wheels
SOLUTION EXAMPLE (EPQ)
b. TCmin = Carrying cost + Setup cost
I max D
TCmin H S
2 Q
Qp H D
TCmin p u S
p 2 Qp
2400 RM 1 48000
800 200 RM 45
800 2 2,400
RM 900 RM 900
RM 1,800
SOLUTION EXAMPLE (EPQ)
QP 2400
c. Cycle time
u 200
12days
A run of wheels will be made every 12 days.
QP2400
d. Run time
p 800
3days
Each run will require three days to
complete.
QUANTITY DISCOUNTS (QD) MODEL
Quantity discount are price reductions for large
orders offered to customers to induce them to
buy in large quantities.
The price per units decreases as order quantity
increase.
For example :
Volume (Per Unit) Discounts
1 to 49 = RM10/unit
50 to 100 = RM9/unit
100 and up = RM8/unit
Case Discounts
Single units = RM10/unit
Case of 10 = RM90 = RM9/unit
QD (TOTAL COST WITH PURCHASING
COST)
Quantity discounts are price reductions offered to
customers to induce them to buy in large
quantities.
TC = Annual carrying + Ordering + Purchasing
cost cost cost
Q D
TC H
S PD
2 Q
where P = Unit price
The buyers goal is to select the order quantity that
will minimize total cost.
TAKING THE DRIVATIVE WITH RESPECT TO
Q DOSENT CHANGE THE EOQ FORMULA
Cost
TC without PD
PD
0 EOQ Quantity
TOTAL COST WITH CONSTANT
CARRYING COSTS
TCa
Total Cost
TCb
Decreasing
TCc Price
CC a,b,c
OC
EOQ Quantity
EXAMPLE (QD)
The maintenance department of a large
hospital uses about 816 cases of liquid
cleanser annually. Ordering costs are RM12,
carrying costs are RM4 per case a year, and
the new price schedule indicates that orders
of less than 50 cases will cost RM20 per
case; 50 to 79 cases will cost RM18 per case;
80 to 99 cases will cost RM17 per case; and
larger orders will cost RM16 per case.
Determine the optimal order quantity and
the total cost.
SOLUTION EXAMPLE (QD)
Company Economic
Policies Considerations
Placed Orders
Master Production
Forecasted Demand Schedule:
Planning Time
Horizon unit
Capacity
Planning
MPS EXAMPLE : COMPANY OPERATIONS
Grain cracking
Mashing Boiling
(1 milling
(1 mashing tun) (1 brew kettle)
machine)
Fermentation Bottling
Filtering
(3 40-barrel (1 bottling
(1 filter tank)
ferm. tanks) station)
Fermentation Times:
Brew Ferm. Time
Bali Ale 2 weeks
Semangka 3 weeks
Winter Ale 2 weeks
Summer Brew 2 weeks
MASTER SCHEDULING PROCESS
Inputs Outputs
Changes
Order releases
Master
schedule Planned-order
schedules
Primary
reports
Exception reports
Bill of Planning reports
materials MRP computer Secondary
programs reports Performance-
control
reports
Inventory
Records/ Inventory
file transaction
MRP INPUTS
Level
1
Level
2
Level
3
PRODUCT STRUCTURE TREE
From example 2 :
The finished product is shown at the top, at level 0.
The components assembled to produce the finished
product is shown at level 1 or below. The sub-
components used to produce the components at
level 1 is shown at level 2 or below, and so on. The
number in the parentheses shows the requirement of
the item. For example, G(4) implies that 4 units of
G is required to produce 1 unit of B.
The levels are important. The net requirements of the
components are computed from the low levels to
high. First, the net requirements of the components at
level 1 is computed, then level 2, and so on.
EXAMPLE 3
The following product structure tree indicates the
components needed to assemble one unit of product W.
Determine the quantities of each component needed to
assemble 100 units of W.
W Level 0
Level 0
D Level 3
SOLUTION : EXAMPLE 3
W 100
A B(2) C(4)
1 x 100 2 x 100 4 x 100
= 100 = 200 = 400
D
1 x 800
= 800
SOLUTION : EXAMPLE 3
Summary :
Level Item Quantity
0 .. W 100
1 .. A 100
B 200
C 400
2 .. E 500 (100 + 400)
F 200
G 800
3 .. D 2,200 (200 + 1,200 + 800)
ii) BILL OF MATERIALS FORM
Bill of Materials: For each item, the name, number, source,
and lead time of every component required is shown on
the bill of materials in a tabular form.
BILL OF MATERIALS
Product Description: Ladder-back chair
Item: A
Component Quantity Source
Item Description Required
B Ladder-back 1 Manufacturing
C Front legs 2 Purchase
D Leg supports 4 Purchase
E Seat 1 Manufacturing
BILL OF MATERIALS
Product Description: Seat
Item: E
Component Quantity Source
Item Description Required
H Seat frame 1 Manufacturing
I Seat cushion 1 Purchase
MRP INPUTS : 3. INVENTORY
RECORDS
Inventory file : For each item, the number of units
on hand is obtained from the inventory file.
Includes information on the status of each item by
time period.
On-Hand Quantities
On-Order Quantities
Lot Sizes
Safety Stock
Lead Time
Past-Usage Figures
LOT SIZES
Lot-for-lot ordering (L4L)
Order quantity equals the net requirement,
Sometimes, lot-for-lot policy cannot be
used. There may be restrictions on
minimum order quantity or order quantity
may be required to multiples of 50, 100 etc.
Economic order quantity
Fixed-period ordering
Part-period model
ON HAND INVENTORY AND LEAD TIME
Seat
Subassembly 25 2
Seat frame 50 3
Seat frame
boards 75 1
MRP PROCESSING
Gross requirements
Total expected demand.
Scheduled receipts
Open orders scheduled to arrive,
Items ordered prior to the current
planning period and/or,
Items returned from the customer.
Planned on hand
Expected inventory on hand at the
beginning of each time period.
MRP PROCESSING (CONT.)
Net requirements
Actual amount needed in each time period.
Planned-order receipts
Quantity expected to received at the
beginning of the period,
Offset by lead time.
Planned-order releases
Planned amount to order in each time
period.
MRP OUTPUT
Every required item is either produced or
purchased. So, the report is sent to production or
purchasing.
Planned orders - schedule indicating the amount
and timing of future orders.
Order releases - Authorization for the
execution of planned orders.
Changes - revisions of due dates or order
quantities, or cancellations of orders.
Performance-control reports
Planning reports
Exception reports
SUMMARY : MRP INPUT AND OUTPUT
Master
Orders Production Forecasts
Schedule
Bill of MRP
computer Inventory
Materials
file
file program
E Level 0
Assemble M
Procure R Procure R
1 2 3 4 5
The table entries are arrived at as follows :
Master Schedule : 120 units of E to be available at
the start of week 5.
SOLUTION : EXAMPLE (MRP)
Item E : Gross requirements = 120 units (equal the quantity
specified in the master production schedule). There is no
on-hand inventory, net requirements = 120 units (start of
week 5). An order will need to be released at the beginning
of week 4 (one week lead time for assembly of E at level 0).
Item M : Gross requirements = 3 x net requirements for E
(start of week 4). Net requirements = 300 units (60 units
less due to the 60 units expected to be on hand / schedule
receipt). An order release at start of week 3 (one week lead
time for level 1).
Item R : Gross requirements = 2 x 300 units of M. Only 500
units need to be ordered (100 units will be on hand). Must
be ordered at the start of week 1 (two weeks lead time for
level 2).
SOLUTION : EXAMPLE (MRP)
The master schedule for E and requirements plans for E, M and R
follow :
REFER THE FORMAT OF MRP PROCESSING
Item = Beg.
1 2 3 4 5 6 7 8 9 10
LT = Inv.
Gross Requirements
Scheduled receipts
Projected on hand
Net requirements
Planned-order receipt
Planned-order release
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