Inventory Management

AT3D Quantec
Group 5 Written Report
Group Members:
Alcantara, Hannah Denisse C.
Cepillo, Christian Adrian D.
De La Vega, Nikko U.
Medalla, Jefferson G.
Pangilinan, John Paul G.
Ramos, Aldrin P.

Inventory

One of the most expensive assets of many companies representing as much as 50% of
total invested capital

Operations managers must balance inventory investment and customer service

Functions of Inventory

1. To decouple or separate various parts of the production process

2. To decouple the firm from fluctuations in demand and provide a stock of goods that will
provide a selection for customers

3. To take advantage of quantity discounts

4. To hedge against inflation

Types of Inventory

Raw material

Purchased but not processed

 Work-in-process

Undergone some change but not completed

A function of cycle time for a product

Maintenance/repair/operating (MRO)

Necessary to keep machinery and processes productive

Finished goods

Completed product awaiting shipment

Inventory Management

How inventory items can be classified

How accurate inventory records can be maintained

Control of Service Inventories

Can be a critical component of profitability

Losses may come from shrinkage or pilferage

Applicable techniques include

1. Good personnel selection, training, and discipline

2. Tight control on incoming shipments

3. Effective control on all goods leaving facility

Independent versus Dependent Demand

Independent demand

the demand for item is independent of the demand for any other item in
inventory

demand is beyond control of the organization

Dependent demand
 the demand for item is dependent upon the demand for some other item in the
inventory

demand is driven by demand of another item

Holding, Ordering, and Setup Costs

Holding costs - the costs of holding or carrying inventory over time

Ordering costs - the costs of placing an order and receiving goods

Setup costs - cost to prepare a machine or process for manufacturing an order

Inventory Models for Independent Demand

-Need to determine when and how much to order

Basic economic order quantity

Production order quantity

Quantity discount model

Tim
e
EOQ Model
Inventory Level

Usage rate
Order quantity = Q
(maximum inventory
level)
Average inventory
Q
=

ROP
(Reorder point)

T
i
m
e
 Total cost of holding and setup (ordering)

Lead time = L Time

Minimum total cost

Order quantity
Order Cycle Time
Annual cost

Holding cost

Setup (or ordering) cost curve

Optimal order quantity (Q*)

Objective is to minimize total costs

Basic EOQ Model

Economic Order Quantity (EOQ): minimizes total costs; point at which holding and
orders costs are equal

How much to order

Important assumptions

1. Demand is known, constant, and independent

2. Lead time is known and constant

3. Receipt of inventory is instantaneous and complete

4. Quantity discounts are not possible

5. Only variable costs are setup and holding

 6. Stockouts can be completely avoided

EOQ Model (Example 12.2)

Sharp, Inc., a company that markets painless needles to hospitals, would like to reduce its inventory cost by
determining the optimal number of hypodermic needles to obtain per order. The annual demand is 1000 units; the
ordering cost is $10 per order; the carrying cost per unit per year is $0.5; and the unit price of product is $10. The
number of working days per year is 250 days. In order to minimize the annual total cost,

(1) how many

D=hypodermic needles should be ordered each time?
1,000 units
S = $10 per order
H = $.50 per unit per year

(2) how many orders should be placed per year?

D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year

(3) what is the expected time between orders?

D = 1,000 units Q* = 200 units

S = $10 per order N = 5 orders per year
H = $.50 per unit per year
Number of working days per years = 250 days
(4) how much is the optimal annual total inventory cost?
D = 1,000 units Q* = 200 units

S = $10 per order

TotalHannual
= $.50 cost = Setup
per unit cost + Holding cost
per year

D Q* 1,000 200
TC = S + TCH= ($10) + ($.50
Q* 2 200 2

TC = (5)($10) + (100)($.50)
= $50 + $50

D = 1,000 units
= $100
(5) how much is the optimal annual total cost?
Q* = 200 units
S = $10 per order
H = $.50 per unit per year
P = $10 per unit per product

Total annual cost = Setup cost + Holding cost + Product cost

D Q*
TC = S + H + PD
Q* 2
1,000 200
= ($10) + ($.50) +(1000)($10)
200 2

TC = (5)($10) + (100)($.50) + (1000)($10)

= $50 + $50 + $10,000
= $10,100
 Robust Model

The EOQ model is robust

It works even if all parameters and assumptions are not met

The total cost curve is relatively flat in the area of the EOQ

Reorder Points

EOQ answers the how much question

The reorder point (ROP) tells when to order

An apple distributor has a demand for 8,000 iPods per year. The firm operates a 250-day working year. On average, delivery of an
order takes 3 working days. What is the reorder points (ROP)?

Demand = 8,000 iPods per year

250 working day year

d = for orders Demand

Lead time per
is 3 working year
days
Number of working days in a year

= 8,000/250 = 32 units

ROP = d x L

= 32 units per day x 3 days = 96 units

 Probabilistic Models and Safety Stock

Used when demand is not constant or certain

Use safety stock to achieve a desired service level and avoid stockouts

Minimum demand during lead time

Inventory level

Maximum demand during lead time

Expected demand during lead time
0 ROP = 350 + safety stock of 16.5 = 366.5
Time
ROP

Safety stock 16.5 units

Lead time
Place order Receive order
 Example 12.5: A computer components manufacturer uses approximately 10,000 blank CDs annually. The CDs are used at a
safety rate during the 250 workdays that the plant operates. The price of each blank CD is $7.00 and the annual carrying cost is
$0.5 per unit per year. The ordering cost is $50. The lead time for ordering these CDs is ten days. In addition, due to poor
supplier delivery, the company has decided to maintain a safety stock of 1000 units.

(1) The optimal order size each time the inventory needs to be replenished.

D = 10,000 per year

2 DS
P = $7.00
Q*
H
H = $0.5 per unit per year 2 10,000 50

0.5
S = $50 per order
1415
L = 10 days

Safety stock = 1000 units

(2) Numberworking
Available of workdays
daysbetween
= 250each
dayspurchase order placed (order cycle time).
available workdays
D
Q*
250 (3) Average inventory level of CDs

10000
1415
Q*
35.4 days SS
2
1415
1000
Since the safety stock is used, the average inventory level 2
increases by the amount of safety stock 1708 units

(4) Maximum inventory level of CDs (5) Reorder point in units

The maximum Q * SS ROP d * L SS
inventory level
1415 1000
increases by the
10000
amount of
safety stock 2415 units 10 1000
250
1400 units
 (6) Annual setup/Ordering cost D 10000
*
S 50 $353
Setup/Ordering cost does
not change
Q 1415

(7) Annual carrying (holding) cost

Q* 1415
Carrying cost SS H 1000 0.5 $854
increases 2 2
(8) Total inventory cost
TAC $353 $854 $1207

When safety stock is used,

optimal holding cost optimal setup/carrying cost

Formulas
EOQ Model
Q = Order quantity
D = Annual Demand
S = Ordering/setup cost
H = Holding/carrying cost
P = Unit cost of product
Q
Average Inventory
2

2 DS
Q*
H
EOQ =
 D
Annual ordering cost S
Q

Q
Annual carrying cost H
2

D Q
Total inventory cost(TIC) ordering cost carrying cost S H
Q 2

D Q
Total Cost (TC) ordering cost carrying cost Product cost S H PD
Q 2

Q = Order quantity
D = Annual Demand
Demand D
Expected number of orders N
Order quantity Q

Order Cycle Time (i.e., the time between th e recepit of orders)

Number of working days per year

N
Number of working days per year

D
Q

Reorder Points

ROP = (Demand per day) (Lead time for a new order in days)

=dxL

Where d = Demand per year/Number of working days in a year

Safety Stock
ROP = d x L + ss
Q
Average Inventory SS
2

Max Inventory Q SS

Q
Annual carrying cost SS H
2
 D Q
TAC ordering cost carrying cost S SS H
Q 2