Embed Size (px)
DESCRIPTION
Citation preview
Inventory Control
Inv.Control - ObjectivesInv.Control - Objectives
IntroductionIntroduction
Purpose of InventoriesPurpose of Inventories
Inventory Cost StructuresInventory Cost Structures
Independent versus Dependent DemandIndependent versus Dependent Demand
Economic Order QuantityEconomic Order Quantity
Continuous Review SystemContinuous Review System
Periodic Review SystemPeriodic Review System
Using P and Q System in PracticeUsing P and Q System in Practice
Selective Inventory Control SystemsSelective Inventory Control Systems
IntroductionIntroduction
Inventory: a stock of materials used to Inventory: a stock of materials used to facilitate production or to satisfy customer facilitate production or to satisfy customer demand.demand.
Types of inventoryTypes of inventory– Raw materials (RM)Raw materials (RM)– Work in process (WIP)Work in process (WIP)– Finished goods (FG)Finished goods (FG)– Maintenance, repair & operating supplies (MRO)Maintenance, repair & operating supplies (MRO)
A Material-Flow ProcessA Material-Flow Process
Work inprocess
Work inprocess
Work inprocess
Finishedgoods
RawMaterials
Vendors Customer
Productive Process
A Water Tank Analogy for InventoryA Water Tank Analogy for Inventory
Supply RateInventory Level
Demand Rate
Inventory Level
Purpose of Inventories Purpose of Inventories
To protect against To protect against uncertaintiesuncertainties – in demand (finished goods, MRO)in demand (finished goods, MRO)– supply (RM, MRO)supply (RM, MRO)– lead times (RM/PP or WIP)lead times (RM/PP or WIP)– schedule changes (WIP)schedule changes (WIP)
To allow economic production and To allow economic production and purchase (as in discounts for buying RM/PP purchase (as in discounts for buying RM/PP in bulk)in bulk)
Purpose of Inventories (Contd.)Purpose of Inventories (Contd.)
To cover anticipated changes in demand (as To cover anticipated changes in demand (as in a level strategy) or supplyin a level strategy) or supply– finished goodsfinished goods– RM/PPRM/PP
To provide for transit (pipeline inventories)To provide for transit (pipeline inventories)– RM/PPRM/PP– finished goodsfinished goods– WIP (independence of operations)WIP (independence of operations)
Inventory Cost StructuresInventory Cost Structures
Ordering (or setup) costOrdering (or setup) cost– Paperwork, worker time (ordering)Paperwork, worker time (ordering)– worker time, downtime (setup)worker time, downtime (setup)– Typically expressed as a fixed cost per order or Typically expressed as a fixed cost per order or
setup. setup.
Inventory Cost Structures(contd.) Inventory Cost Structures(contd.) Carrying (or holding) cost:Carrying (or holding) cost:– Cost of capital (market rate or internal rate of return)Cost of capital (market rate or internal rate of return)– Cost of storage (building, utilities, insurance, handling)Cost of storage (building, utilities, insurance, handling)– Cost of obsolescence, deterioration, and loss Cost of obsolescence, deterioration, and loss
(shrinkage)(shrinkage)– Management cost (record keeping, counting)Management cost (record keeping, counting)
Typically expressed as a percentage of SKU cost. Typically expressed as a percentage of SKU cost. Average in INDIA is estimated to be Average in INDIA is estimated to be 25 percent25 percent per year.per year.Businesses often use only cost of capital Businesses often use only cost of capital (understatement).(understatement).
Inventory Cost Structures(contd.) Inventory Cost Structures(contd.) How the 25 percent carrying cost is distributedHow the 25 percent carrying cost is distributed
Cost of Capital—15 percentCost of Capital—15 percent
Obsolescence—2 percentObsolescence—2 percent
Storage—5 percentStorage—5 percent
Materials Handling—2 percentMaterials Handling—2 percent
Shrinkage/pilferage—1 percentShrinkage/pilferage—1 percent
Insurance—1 percentInsurance—1 percent
Inventory Cost Structures(contd.) Inventory Cost Structures(contd.)
Stock out Cost (Back order or Lost sales or Stock out Cost (Back order or Lost sales or Understocking Cost)Understocking Cost)– record maintenancerecord maintenance– lost incomelost income– customer dissatisfactioncustomer dissatisfaction– Typically expressed as a fixed cost per backorder Typically expressed as a fixed cost per backorder
or as a function of aging of backorders.or as a function of aging of backorders.
Inventory Cost Structures(contd.) Inventory Cost Structures(contd.)
Overstocking Cost ( Opportunity Loss Cost) Overstocking Cost ( Opportunity Loss Cost) - Cost incurred due to carrying Inventories - Cost incurred due to carrying Inventories excess to set normsexcess to set norms
Forms of Demand Forms of Demand
Independent demandIndependent demand– finished goods, spare parts, MROfinished goods, spare parts, MRO– based on market demandbased on market demand– requires forecastingrequires forecasting– managed using ‘replenishment philosophy’, i.e. managed using ‘replenishment philosophy’, i.e.
reorder when you reach a pre-specified level. reorder when you reach a pre-specified level.
Forms of Demand(contd.) Forms of Demand(contd.)
Dependent demandDependent demand – parts that go into the finished products, RM/PPparts that go into the finished products, RM/PP
oror WIPWIP– dependent demand is a known function of dependent demand is a known function of
independent demandindependent demand– calculate instead of forecastcalculate instead of forecast– Managed using a ‘requirements philosophy’, Managed using a ‘requirements philosophy’,
i.e. only ordered as needed for higher level i.e. only ordered as needed for higher level components or products.components or products.
Economic Order Quantity (EOQ)
Developed in 1915 by F.W. HarrisDeveloped in 1915 by F.W. HarrisAnswers the question ‘How much do I order?’Answers the question ‘How much do I order?’Used for Used for independent demandindependent demand items. items.Objective is to find order quantity (Q) that minimizes Objective is to find order quantity (Q) that minimizes the total cost (TC) of managing inventory.the total cost (TC) of managing inventory.Must be calculated separately for each SKU.Must be calculated separately for each SKU.Widely used and very robust (i.e. works well in a lot Widely used and very robust (i.e. works well in a lot of situations, even when its assumptions don’t hold of situations, even when its assumptions don’t hold exactly). exactly).
Economic Order Quantity (EOQ)Economic Order Quantity (EOQ)Basic Model AssumptionsBasic Model Assumptions
Demand rate is constant, recurring, and known.Demand rate is constant, recurring, and known.Lead time is constant and known.Lead time is constant and known.No stockouts allowed.No stockouts allowed.Material is ordered or produced in a lot or batch Material is ordered or produced in a lot or batch and the lot is received all at onceand the lot is received all at onceCosts are constantCosts are constant– Unit cost is constant (no quantity discounts)Unit cost is constant (no quantity discounts)– Carrying cost is a constant per unit (SKU)Carrying cost is a constant per unit (SKU)– Ordering (setup) cost per order is fixedOrdering (setup) cost per order is fixed
The item is a single product or SKU.The item is a single product or SKU.
EOQ Lot Size ChoiceEOQ Lot Size Choice
There is a trade-off between frequency of There is a trade-off between frequency of ordering (or the size of the order) and the ordering (or the size of the order) and the inventory level.inventory level.– Frequent orders (small lot size) lead to a lower Frequent orders (small lot size) lead to a lower
average inventory size, average inventory size, i.e.i.e. higher ordering cost higher ordering cost and lower holding cost.and lower holding cost.
– Fewer orders (large lot size) lead to a larger Fewer orders (large lot size) lead to a larger average inventory size, average inventory size, i.e.i.e. lower ordering cost and lower ordering cost and higher holding cost.higher holding cost.
Notations and measurement Notations and measurement units in EOQunits in EOQ
DD = = Demand rate, units per yearDemand rate, units per year
SS = = Cost per order placed, or setup cost,Cost per order placed, or setup cost,Rupees per orderRupees per order
CC = = Unit cost, Rupees per unitUnit cost, Rupees per unit
ii = = Carrying rate, percent of value per yearCarrying rate, percent of value per year
QQ = = Lot size, unitsLot size, units
TCTC== total of ordering cost plus carrying costtotal of ordering cost plus carrying cost
Cost Equations in EOQCost Equations in EOQ
Ordering cost = (cost per order) x orders per year) = SD/Q
Carrying cost per year = (annual carrying rate) x (unit cost) x average inventory = iCQ/2
Total annual cost (TC) = ordering cost per year + carrying cost per year = SD/Q + iCQ/2
Total Cost of InventoryTotal Cost of Inventory
TC and EOQTC and EOQ
TC = ordering cost + holding cost TC = ordering cost + holding cost
= S*(D/Q) + iC*(Q/2) = S*(D/Q) + iC*(Q/2)
EOQ =EOQ =
note: Although we have used note: Although we have used annualannual costs, any time period is all costs, any time period is all right. Just be consistent! The same is true for currency right. Just be consistent! The same is true for currency designations.designations.
iC
SDQ
2
Continuous Review SystemContinuous Review System
Relax assumption of constant demand. Relax assumption of constant demand. Demand is assumed to be random.Demand is assumed to be random.Check inventory position each time there is a Check inventory position each time there is a demand (i.e continuously).demand (i.e continuously).If inventory position drops below the reorder If inventory position drops below the reorder point, place an order for the EOQ.point, place an order for the EOQ.Also called fixed-order-quantity or Q system Also called fixed-order-quantity or Q system (the fixed order size is EOQ).(the fixed order size is EOQ).
A Continuous Review (Q) SystemA Continuous Review (Q) System
R = Reorder PointQ = Order QuantityL = Lead time
A Continuous Review (Q) SystemA Continuous Review (Q) SystemAmount to order = EOQ
Order when inventory position = reorder point.
Reorder point = lead time * demand/period
= R = lead time demand (when demand is constant)
Reorder point is independent of EOQ!
EOQ tells how much to order.Reorder point tells when to order.
Periodic Review System Periodic Review System
Instead of reviewing continuously, we review Instead of reviewing continuously, we review the inventory position at the inventory position at fixed intervalsfixed intervals. For . For example, the bread truck visits the grocery example, the bread truck visits the grocery store on the same days every week.store on the same days every week.
Also known as “P system”, “Fixed-order-Also known as “P system”, “Fixed-order-interval system” or “Fixed-order-period interval system” or “Fixed-order-period system”system”
Periodic Review System Periodic Review System (contd.)(contd.)
Each time we review the inventory, we either Each time we review the inventory, we either order or don’t. The decision depends upon our order or don’t. The decision depends upon our reorder point.reorder point.
The amount we order is the amount needed to The amount we order is the amount needed to bring us up to a target (T).bring us up to a target (T).
A Periodic Review (P) SystemA Periodic Review (P) System
Using P and Q System in PracticeUsing P and Q System in Practice
Use P system when orders must be placed at Use P system when orders must be placed at specified intervals.specified intervals.
Use P systems when multiple items are Use P systems when multiple items are ordered from the same supplier (joint-ordered from the same supplier (joint-replenishment).replenishment).
Use P system for inexpensive items.Use P system for inexpensive items.
Using P and Q Systems in Using P and Q Systems in PracticePractice
P may be easier to use since levels are P may be easier to use since levels are reviewed less often.reviewed less often.
P requires more safety stock since may only P requires more safety stock since may only order at fixed points.order at fixed points.
P is more likely to run out since cannot P is more likely to run out since cannot respond to increases in demand immediatelyrespond to increases in demand immediately
Either may be more costly: P in safety Either may be more costly: P in safety stock, Q in monitoring cost.stock, Q in monitoring cost.
FORMULAE – FORMULAE – INVENTORY MANAGEMENTINVENTORY MANAGEMENT
E.O.Q. = E.O.Q. = 2 X Annual Demand X Ordering cost2 X Annual Demand X Ordering cost
Unit Price X Inv. Carr. Cost (%) Unit Price X Inv. Carr. Cost (%)
Fixed order Qty model ( “Q” System)Fixed order Qty model ( “Q” System)o Order Qty = E.O.Q.Order Qty = E.O.Q.o Reorder Point = Average Daily Demand X Lead-time in days Reorder Point = Average Daily Demand X Lead-time in days
Total Annual Cost = Annual + Annual + AnnualTotal Annual Cost = Annual + Annual + Annual
Purchase Ordering InventoryPurchase Ordering Inventory
Cost Cost Carr. CostCost Cost Carr. Cost
(i.e. Annual (i.e. Annual
Demand XDemand X
Unit Cost)Unit Cost)
o Safety Stock = Constant based X Std. deviationSafety Stock = Constant based X Std. deviation
on Service level in demandon Service level in demand
Fixed order Qty model with safety stockFixed order Qty model with safety stock
o Reorder Point = (Average daily demand + SafetyReorder Point = (Average daily demand + Safety
X Stock X Stock
lead-time in days) lead-time in days)
Fixed – Time Period Model with Safety Stock (“P” System)Fixed – Time Period Model with Safety Stock (“P” System)o Safety stock = Constant based X Std. deviationSafety stock = Constant based X Std. deviation
on Service level (during Reviewon Service level (during Review
period + leadtime ) period + leadtime )
Where = (R.P. + L.T.) X (Std. Dev.) Where = (R.P. + L.T.) X (Std. Dev.) 22
*
*
o Optimal Order Qty (Q) =Optimal Order Qty (Q) =
Average Daily Demand X (Review Period +Leadtime) + Average Daily Demand X (Review Period +Leadtime) + (Plus) (Plus)
Safety Stocks Safety Stocks
– – (minus)(minus)
Current Inventory Status Current Inventory Status
(Physical Stocks + Quantity on order)(Physical Stocks + Quantity on order)
Selective Inventory Control SystemSelective Inventory Control SystemMethods of classification:-Methods of classification:-
Title Basis Main Use
A-B-C Value of Consumption To control- raw material/ w.i.p/ components
H-M-L (High-Med-Low)
Unit price of the material Mainly to control purchase
X-Y-Z Value of items in storage To review the inventories & their uses at scheduled intervals
V-E-D (vital/essen/
desirable
Criticality of the component To determine stock levels of spare parts
F-S-N (fast/slow/non-moving)
Consumption pattern of the component
To control obsolescence
S-D-E (scarce/diff/easy)
Problems faced in procurement Lead-time analysis & purchasing strategy
G-O-L-F (govt/open/local/fore
ign)
Source of materials Procurement strategies
S-0-S (seasonal/ off seasonal)
Nature of supplies Procurement stocking strategies for seasonal items like agricultural
V-E-I-N (vital/ essen/ imp/normal)
Plant &machinery Production Machinery
& Services
A-B-C AnalysisA-B-C Analysis
Class ‘A’
Class ‘B’
Class ‘C’
0
65
90
100
15 40 100
Cumulative % of Total number of items
Cu
mu
lati
ve %
of
An
nu
al c
on
sum
pti
on
val
ue
ABC Inventory Management ABC Inventory Management
Based on “Pareto” concept (80/20 rule) and Based on “Pareto” concept (80/20 rule) and total usage in dollars of each item.total usage in dollars of each item.
Classification of items as A, B, or C based on Classification of items as A, B, or C based on usage.usage.
Purpose is to set priorities on effort used to Purpose is to set priorities on effort used to manage different SKUs, i.e. to allocate scarce manage different SKUs, i.e. to allocate scarce management resources.management resources.
ABC Inventory Management ABC Inventory Management (contd.)(contd.)
‘‘A’ items: 20% of SKUs, 80% of A’ items: 20% of SKUs, 80% of Ann.Con.ValueAnn.Con.Value
‘‘B’ items: 30 % of SKUs, 15% of B’ items: 30 % of SKUs, 15% of Ann.Con.ValueAnn.Con.Value
‘‘C’ items: 50 % of SKUs, 5% of A.C.ValueC’ items: 50 % of SKUs, 5% of A.C.Value
Three classes is arbitrary; could be any number.Three classes is arbitrary; could be any number.
Percents are approximate.Percents are approximate.
Danger: Consumption Value may not reflect Danger: Consumption Value may not reflect importance of any given SKU!importance of any given SKU!
Miscellaneous Systems:Bin SystemsTwo-Bin System
Full Empty
Order One Bin ofInventory
One-Bin System
Periodic Check
Order Enough toRefill Bin
The Two-Bin System
Second Bin
First Bin Re-order Level
Re-order point shifts with usage
Normal Lead-time
Usage
Time
Safety stock
Lead-time
Q
O
Inventory Accuracy and Cycle Counting
Inventory accuracy refers to how well the inventory records agree with physical count
Cycle Counting is a physical inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year
40
Question Bowl
The average cost of inventory in India is which of the following?
a. 10 to 15 percent of its costb. 15 to 20 percent of its costc. 20 to 25 percent of its costd. 25 to 30 percent of its coste. 30 to 35 percent of its cost
Answer: d. 25 to 30 percent of its cost
41
Question Bowl
Which of the following is a reason why firms
keep a supply of inventory?
a. To maintain independence of operations
b. To meet variation in product demand
c. To allow flexibility in production scheduling
d. To take advantage of economic purchase
order size
e. All of the above
Answer: e. All of the above (Also can include to provide a safeguard for variation in raw material delivery time.)
42
Question Bowl
An Inventory System should include policies
that are related to which of the following?
a. How large inventory purchase orders should
be
b. Monitoring levels of inventory
c. Stating when stock should be replenished
d. All of the above
e. None of the above
Answer: d. All of the above
43
Question Bowl
Which of the following is an Inventory Cost item
that is related to the managerial and clerical
costs to prepare a purchase or production order?
a. Holding costs
b. Setup costs
c. Carrying costs
d. Shortage costs
e. None of the above
Answer: e. None of the above (Correct answer is Ordering Costs.)
44
Question Bowl
Which of the following is considered a
Independent Demand inventory item?
a. Bolts to a automobile manufacturer
b. Timber to a home builder
c. Windows to a home builder
d. Containers of milk to a grocery store
e. None of the above
Answer: d. Containers of milk to a grocery store
45
Question Bowl
If you are marketing a more expensive
independent demand inventory item, which
inventory model should you use?
a. Fixed-time period model
b. Fixed-order quantity model
c. Periodic system
d. Periodic review system
e. P-model
Answer: b. Fixed-order quantity model
46
Question Bowl
If the annual demand for an inventory item is
5,000 units, the ordering costs are Rs100 per
order, and the cost of holding a unit is stock for a
year is Rs10, which of the following is
approximately the Qopt?
a. 5,000 units
b. Rs5,000
c. 500 units
d. 316 units
e. None of the above
Answer: d. 316 units (Sqrt[(2x5000x100)/10=316.2277)
47
Question Bowl
The basic logic behind the ABC Classification
system for inventory management is which of the
following?
a. Two-bin logic
b. One-bin logic
c. Pareto principle
d. All of the above
e. None of the above
Answer: c. Pareto principle
48
Question Bowl
A physical inventory-taking technique in
which inventory is counted frequently rather
than once or twice a year is which of the
following?
a. Cycle counting
b. Mathematical programming
c. Pareto principle
d. ABC classification
e. Stockkeeping unit (SKU)
Answer: a. Cycle counting
49
Solved Problems – OPERATIONS MANAGEMENT(Class of 2010)
Q1. A supplier is offering stainless steel bars at Rs 95 per kg for order of upto 100kg each, and at Rs 80 per kg for orders of 101kg and above. Your annual requirement is 1200kg. If your ordering cost is Rs 300 per order, and holding cost is 20%, what would be the most economical quantity to order?
(10 Marks)
Answer.
E.O.Q(1) = √2 × Annual Demand × Ordering Cost
√Unit Cost × Holding Cost
E.O.Q = √2 × 1200 × 300
√95 × 0.20
E.O.Q = 195 units
E.O.Q(2) = √2 × 1200 × 300
√80 × 0.20
= 212 units
50 Now, E.O.Q (1), i.e. 195 units does not fall in the category of upto 100kg
Therefore here consider it’s optimum E.O.Q as 100 units so that it falls under the category of Rs 95 per kg
Now, find the Total Cost
For 100 units
• Ordering Cost = 1200 × 300 = Rs 3600/-
100
• Purchase Cost = 1200 × 95 = Rs 1,14,000/-
• Holding Cost = 100 × 0.2 × 95 = Rs 950/-
Therefore Total Cost = Rs 1,18,550/-
For 212 units
• Ordering Cost = 1200 × 300 = Rs 1698/-
212
• Purchase Cost = 1200 × 80 = Rs 96,000/-
51
• Holding Cost = 212 × 0.2 × 80 = Rs 1696/-
2
Therefore Total Cost = Rs 99,394/-
Therefore most Economic Order Quantity to order is 212 kgs
