Operations management 12th stevenson ch13 inventory management

Chapter 13
Inventory Management

McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.


Chapter 13: Learning Objectives

 You should be able to:
1.

Define the term inventory, list the major reasons for holding inventories, and list the main requirements
for effective inventory management
2. Discuss the nature and importance of service inventories
3. Explain periodic and perpetual review systems
4. Explain the objectives of inventory management
5. Describe the A-B-C approach and explain how it is useful
6. Describe the basic EOQ model and its assumptions and solve typical problems
7. Describe the economic production quantity model and solve typical problems
8. Describe the quantity discount model and solve typical problems
9. Describe reorder point models and solve typical problems
10. Describe situations in which the single-period model would be appropriate, and solve typical problems

Instructor Slides

13-2


Inventory

Inventory
 A stock or store of goods

Independent demand items
 Items that are ready to be sold or used
Inventories are a vital part of business: (1) necessary for operations and (2)
contribute to customer satisfaction
A “typical” firm has roughly 30% of its current assets and as much as 90%
of its working capital invested in inventory

Instructor Slides

13-3


Types of Inventory

 Raw materials and purchased parts
 Work-in-process (WIP)
 Finished goods inventories or merchandise
 Tools and supplies
 Maintenance and repairs (MRO) inventory
 Goods-in-transit to warehouses or customers (pipeline inventory)

Instructor Slides

13-4

Inventory
Independent Demand

Inventory: a stock or store of goods

Dependent Demand

A

C(2)

B(4)

D(2)

E(1)

D(3)

F(2)

Independent demand is uncertain.
Dependent demand is certain.

12-5


Objectives of Inventory Control

Inventory management has two main concerns:

1. Level of customer service


Having the right goods available in the right quantity in the right place at the right time



The overall objective of inventory management is to achieve satisfactory levels of
customer service while keeping inventory costs within reasonable bounds

2. Costs of ordering and carrying inventories

1. Measures of performance
2. Customer satisfaction

 Number and quantity of backorders
 Customer complaints

3. Inventory turnover

Instructor Slides

13-6


Inventory Management

Management has two basic functions concerning inventory:
1.

Establish a system for tracking items in inventory

2.

Make decisions about

When to order
How much to order

Instructor Slides

13-7


Effective Inventory Management

 Requires:
1.

A system keep track of inventory

2.

A reliable forecast of demand

3.

Knowledge of lead time and lead time variability

4.

Reasonable estimates of



holding costs



ordering costs



shortage costs

5.

Instructor Slides

A classification system for inventory items

13-8


Inventory Counting Systems

Periodic System

Physical count of items in inventory made at periodic intervals

Perpetual Inventory System

 System that keeps track of removals from inventory continuously, thus
monitoring current levels of each item

An order is placed when inventory drops to a predetermined minimum level
 Two-bin system


Two containers of inventory; reorder

when the first is empty

Instructor Slides

13-9


Demand Forecasts and Lead Time

 Forecasts
 Inventories are necessary to satisfy customer demands, so it is important to have a reliable
estimates of the amount and timing of demand

 Point-of-sale (POS) systems
 A system that electronically records actual sales
 Such demand information is very useful for enhancing forecasting and inventory management

Lead time
 Time interval between ordering and receiving the order

Instructor Slides

13-10


Inventory Costs

Purchase cost

 The amount paid to buy the inventory

Holding (carrying) costs

 Cost to carry an item in inventory for a length of time, usually a year

Ordering costs

 Costs of ordering and receiving inventory

Setup costs

 The costs involved in preparing equipment for a job
 Analogous to ordering costs

Shortage costs

 Costs resulting when demand exceeds the supply of inventory; often unrealized
profit per unit

Instructor Slides

13-11


ABC Classification System
 A-B-C approach


Classifying inventory according to some measure of importance, and allocating control efforts accordingly



A items (very important)

 10 to 20 percent of the number of items in inventory and about 60 to 70 percent of the annual dollar
value



B items (moderately important)



C items (least important)

 50 to 60 percent of the number
of items in inventory but only
about 10 to 15 percent of the
annual dollar value

Instructor Slides

13-12


Cycle Counting

 Cycle counting
 A physical count of items

in inventory

 Cycle counting management
 How much accuracy is needed?
 A items: ± 0.2 percent
 B items: ± 1 percent
 C items: ± 5 percent
 When should cycle counting be performed?
 Who should do it?

Instructor Slides

13-13


ABC Classification Example
Item
1
2

3
4
5
6
7
8
9
10
11
12

Annual Unit Cost Annual $
Demand
($)
Value
Classification
1,000
4300 4,300,000
A
5,000
720 3,600,000
A
1,900
500
950,000
B
1,000
710
710,000
B

2,500
250
625,000
B
2,500
192
480,000
B
400
200
80,000
C
500
100
50,000
C
200
210
42,000
C
1,000
35
35,000
C
3,000
10
30,000
C
9,000
3

27,000
C
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How Much to Order: EOQ Models

Economic order quantity models identify the optimal order quantity by
minimizing the sum of annual costs that vary with order size and frequency

1.

The basic economic order quantity model

2.

The economic production quantity model

3.

The quantity discount model

Instructor Slides

13-15


Basic EOQ Model

 The basic EOQ model is used to find a fixed order quantity that will minimize

total annual inventory costs

 Assumptions:
1.

Only one product is involved

2.

Annual demand requirements are known

3.

Demand is even throughout the year

4.

Lead time does not vary

5.

Each order is received in a single delivery

6.

There are no quantity discounts

Instructor Slides

13-16

Assumptions of EOQ Model

H: Holding cost
S: Ordering cost
Q: Quantity
TC: Total Inventory Costs


= Ordering Costs + Holding Costs

12-17


The Inventory Cycle

Profile of Inventory Level Over Time

Q

Usage
rate

Quantity
on hand

Reorder
point

Time
Receive

Place

Receive

Place

Receive

order

order

order

order

order

Lead time

Instructor Slides

13-18


EOQ Example

12-19


Average Inventory

12-20


EOQ Total Costs Components

12-21


Total Annual Cost

Total Cost = Annual Holding Cost + Annual OrderingCost
=

Q
H
2

+

D
S
Q

where
Q = Order quantity in units

H = Holding (carrying)cost per unit, usually per year
D = Demand, usually in units per year
S = Orderingcost per order

Instructor Slides

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Goal: Total Cost Minimization

The Total-Cost Curve is U-Shaped
Annual Cost

Q
D
TC = H + S
2
Q
Holding Costs

Ordering Costs

Order Quantity (Q)
QO

Instructor Slides

(optimal order quantity)

13-23


Minimum Total Cost

The total cost curve reaches its minimum where the carrying and
ordering costs are equal.

Q

H

=

2

D

S

Q

TC = 2 (Q/2)H = 2 (D/Q)S

12-24


Deriving EOQ

 Using calculus, we take the derivative of the total cost function and set the derivative

(slope) equal to zero and solve for Q.

 The total cost curve reaches its minimum where the carrying and ordering costs are
equal.

2 DS
2(annual demand)(order cost)
QO =
=
H
annual per unit holding cost

Instructor Slides

13-25