Inventory Planning, Control and Valuation By: Ibrahim Kuhail Ahmed Abu Lebda 11/13/2018

Introduction Inventory may account for 50% of the total invested capital of an organization and 70% of the cost of goods sold 11/13/2018

Introduction All organizations have some type of inventory control system Inventory planning helps determine what goods and/or services need to be produced Inventory planning helps determine whether the organization produces the goods or services or whether they are purchased from another organization 11/13/2018

Introduction Inventory planning and control Controlling Inventory Levels Forecasting Parts/Product Demand Planning on What Inventory to Stock and How to Acquire It Feedback Measurements to Revise Plans and Forecasts Figure 6.1 11/13/2018

What is Inventory ? ‘A list of goods'. A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. Any stored resource used to satisfy a current or future need. An idle resource which has an economic value. Inventory System: A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be 11/13/2018

Inventory Types Raw-materials. Work-in-progress or in-transit Finished-goods In the warehouse, awaiting shipment, in delivery vehicles, in tanks, on shelves, in the stores Strategic inventory Scrap & re-work 11/13/2018

Inventory Contents Raw Material Work in Process Finished Goods Supplies 11/13/2018

Reasons for Inventories Provide flexibility minimum delay in supplying customers a good range Protect against uncertainties Enable economic purchasing Anticipate changes in demand or supply Buffers to feed processes and enable efficient scheduling Strategic stock holdings Improve customer service Transportation savings 11/13/2018

Uses of Inventory The decoupling function Storing resources Irregular supply and demand Quantity discounts Avoiding stockouts and shortages 11/13/2018

Inventory Decisions There are only two fundamental decisions in controlling inventory How much to order When to order The major objective is to minimize total inventory costs 11/13/2018

Inventory costs Item cost Holding/Carrying costs Storage costs Taxes, Insurance, Capital costs Risk costs Obsolescence Damage Pilferage Deterioration 11/13/2018

Inventory costs Ordering costs Production control costs Setup and teardown costs Lost capacity costs Purchase order costs Stockout costs (Lost sales cost, Back-order cost) Capacity-associated costs 11/13/2018

Inventory costs Ordering costs are generally independent of order quantity Many involve personnel time The amount of work is the same no matter the size of the order Carrying costs generally varies with the amount of inventory, or the order size The labor, space, and other costs increase as the order size increases Of course, the actual cost of items purchased varies with the quantity purchased 11/13/2018

Material-Flows Process Production Processes Work in process To Customer Stores warehouse Finished goods WIP From Suppliers WIP Inventory in transit 11/13/2018 5

Stock : Input (Flow in), Storage (Holding) and Flow out (Usage) Inventory Level Supply Rate Stock Level Rate of Demand (Usage) 11/13/2018 7

Economic Order Quantity In trying to minimize inventory costs a company must find the order quantity which spreads the ordering or set-up costs over as many units as possible without incurring excess holding costs. The EOQ model attempts to determine the amount of units to purchase which will minimize the total costs associated with ordering and holding inventory 11/13/2018

Economic Order Quantity The economic order quantity (EOQ) model is one of the oldest and most commonly known inventory control techniques It dates from 1915 It is easy to use but has a number of important assumptions 11/13/2018

How to calculate EOQ ? Tabular Approach /Trial and Error. (waste time) Graphic Approach /By using charts. Formula Approach /Mathematically . 11/13/2018

Graphic Approach Cost Curve of Total Cost of Carrying and Ordering Order Quantity Curve of Total Cost of Carrying and Ordering Minimum Total Cost Carrying Cost Curve Ordering Cost Curve Optimal Order Quantity Figure 6.3 11/13/2018

Tabular Approach It determines the total inventory costs at the different sizes of the order, and then the economic order or the nearest approximation by repeating the calculation a sufficient number of times 11/13/2018

Tabular Approach Example Total demand for next year = 5000 units, Ordering cost = $ 10 per order Carrying Cost = $ 0.1 per unit and based on average annual inventory level 11/13/2018

Tabular Approach Example N Q O = N * 10 H= Q/2*0.1 Total Cost 1 5000 10 260 2 2500 20 145 3 1667 30 113 4 1250 40 103 *5 1000 50 100 6 833 60 102 7 714 70 106 8 625 80 111 9 556 90 118 500 125 11/13/2018

EOQ Assumptions Demand is known and constant Lead time is known and constant Receipt of inventory is instantaneous Purchase cost per unit is constant throughout the year The only variable costs are the placing an order, ordering cost, and holding or storing inventory over time, holding or carrying cost, and these are constant throughout the year Orders are placed so that stockouts or shortages are avoided completely 11/13/2018

Inventory Usage Over Time Inventory Level Order Quantity = Q = Maximum Inventory Level Minimum Inventory Figure 6.2 11/13/2018

EOQ Formula Q = number of pieces to order EOQ= Q* = optimal number of pieces to order D = annual demand in units Co = ordering cost per order Annual Ordering Cost= Number of orders placed per year x Ordering cost per order = D/Q * Co Ch = Holding or carrying cost per unit per year Annual Holding Cost = Average inventory x Carrying cost per unit per year = Q/2 * Ch 11/13/2018

Ordering cost = Holding cost EOQ Formula Ordering cost = Holding cost (D/Q*) x Co = (Q*/2) x Ch  11/13/2018

EOQ Example Annual demand = 12,000 units Days/year in average daily demand = 365 Cost to place an order = $500 Holding cost /unit = $12 ( 20% Cost per unit) 11/13/2018

Sumco Pump Company Example Company sells pump housings to other companies Would like to reduce inventory costs by finding optimal order quantity Annual demand = 1,000 units Ordering cost = $10 per order Average carrying cost per unit per year = $0.50 11/13/2018

Sumco Pump Company Example Total annual cost = Order cost + Holding cost 11/13/2018

Sensitivity Analysis with the EOQ Model The EOQ model assumes all values are know and fixed over time Generally, however, the values are estimated or may change Determining the effects of these changes is called sensitivity analysis Because of the square root in the formula, changes in the inputs result in relatively small changes in the order quantity 11/13/2018

Sensitivity Analysis with the EOQ Model In the Sumco example If the ordering cost were increased four times from $10 to $40, the order quantity would only double In general, the EOQ changes by the square root of a change to any of the inputs 11/13/2018

Restrictions on EOQ Restrictions on order size Specified quantities of products or supplies Restrictions on Storage Limited storage available and can not accommodate EOQ, more storage space needed and thus more cost. Quantity discount Discount provided by the supplier  increase the needed quantity). 11/13/2018

Economic Order Quantity with Order Size Restrictions Many companies put restrictions on the order size of the order because of the requirements of the assembly or packaging of products. If the EOQ is not equal to one order quantities allowed, it is necessary to calculate the total inventory costs of the minimum and the maximum order size of EOQ and then compare the total cost of the minimum size and maximum allowable. 11/13/2018

Economic Order Quantity with Order Size Restrictions Example Annual demand = 5,000 units Cost to place an order = $10 Holding cost /unit = $0.1 The company accepts a batch of 400 units, i.e. the company can request 400 units or 800 units or 1200 units. Required: Calculating the best alternative for EOQ 11/13/2018

Economic Order Quantity with Order Size Restrictions Example So, the company can request either 800 units or 1200 units. So the 2nd alternative is better First Alternative ( 800 units) Second Alternative ( 1200 units) 11/13/2018

Economic Order Quantity with Storage Limitation Example: Annual demand = 7500 units Ordering cost = $75 Holding cost /unit = $0.5 Required: Calculating EOQ Total inventory cost Assuming that the company has a storage capacity of 1000 units , and there is another storage that can be rented for 500 units with annual rent cost of $200. Will you advise the company to rent the storage ? If there is another near storage with rental cost of $ 50? will you advise the company to ren? 11/13/2018

Economic Order Quantity with Storage Limitation 1. 2. 11/13/2018

4. If the total rental cost is $50  3. Since the storage capacity is 1000 units, the company is advised to request 1000 units each time with total inventory cost : So, if the company request EOQ =1500 units, it will save $ 62.5, but it will pay $200 for renting $750 + $200 ( the other storage rental cost) =$950 4. If the total rental cost is $50  Total inventory cost = $750 + 50 ( rental) = 800 < 812.5  Save $12.5 11/13/2018

Economic Order Quantity with Quantity Discount Quantity discounts are commonly available The basic EOQ model is adjusted by adding in the purchase or materials cost Total cost  Material cost + Ordering cost + Holding cost 11/13/2018

Quantity Discount Models Total cost curve for the quantity discount model Total Cost $ Order Quantity TC Curve for Discount 3 1,000 2,000 TC Curve for Discount 1 TC Curve for Discount 2 EOQ for Discount 2 11/13/2018 Figure 6.6

Quantity Discount Example Annual demand is 5,000 cars, ordering cost is $49, and holding cost is 20% of the cost of the car DISCOUNT NUMBER DISCOUNT QUANTITY DISCOUNT (%) DISCOUNT COST ($) 1 0 to 999 5.00 2 1,000 to 1,999 4 4.80 3 2,000 and over 5 4.75 11/13/2018

The second step is adjust quantities below the allowable discount range The EOQ for discount 1 is allowable The EOQs for discounts 2 and 3 are outside the allowable range and have to be adjusted to the smallest quantity possible to purchase and receive the discount Q1  700 Q2  1,000 Q3  2,000 11/13/2018

Quantity Discount Example DISCOUNT NUMBER UNIT PRICE (C) ORDER QUANTITY (Q) ANNUAL MATERIAL COST ($) = DC ANNUAL ORDERING COST ($) = (D/Q)Co ANNUAL CARRYING COST ($) = (Q/2)Ch TOTAL ($) 1 $5.00 700 25,000 350.00 25,700.00 2 4.80 1,000 24,000 245.00 480.00 24,725.00 3 4.75 2,000 23,750 122.50 950.00 24,822.50 11/13/2018

Reorder Point: Determining When To Order Once the order quantity is determined, the next decision is when to order The time between placing an order and its receipt is called the lead time (L) or delivery time When to order is generally expressed as a reorder point (ROP) Demand per day Lead time for a new order in days ROP    d  L 11/13/2018

Procomp’s Computer Chip Example Demand for the computer chip is 8,000 per year Daily demand is 40 units Delivery takes three working days ROP  d  L  40 units per day  3 days  120 units An order is placed when the inventory reaches 120 units The order arrives 3 days later just as the inventory is depleted 11/13/2018

EOQ and ROP example Annual Demand = 10,000 units Days per year considered in average daily demand =365 Cost to place an order = $10 Holding cost per unit per year = 10% of cost per unit Lead time = 10 days Cost per unit = $15 11/13/2018

EOQ and ROP example d = 10,000 units/year 365 days = 27.4 units/day Reorder point = 27.4 * 10 days = 274 units Place order for 365 units. When 274 left, place next order for 365. 11/13/2018

Order Quantities & Reorder Points Average stock Q/2 Q =365 Q No. of units on hand safety or buffer level 274 R L L Time R = Reorder point L = Lead time 11/13/2018

Order Quantities & Reorder Points 11/13/2018

Use of Safety Stock Safety stock (SS) is extra inventory held to help prevent stockouts If demand is unusually high during lead time, a stockout will occur if there is no safety stock If demand or the lead time are uncertain, the exact ROP will not be known with certainty Safety stock can be implemented by adjusting the ROP 11/13/2018

Use of Safety Stock 11/13/2018

Safety Stock and Re-order Levels A safety stock variable is added to the equation to accommodate uncertain demand during lead time ROP  d  L + SS where SS  safety stock SS  (max Demand – Expected Demand) * d 11/13/2018 22

SS example The EOQ for the Industry Co. is 600 units of and the demand is 150 units per week with lead time o two weeks, knowing that the maximum demand is 200 units. What is the ROP ? SS  (max Demand – Expected Demand) * d = ( 200 – 150 )* 2 = 100 units ROP  d  L + SS = 150*2 +100 = 400units 11/13/2018

SS example Units Safety Stock weeks 0 2 Actual lead Order Point 400 100 0 2 Dip into safety stock 4 11/13/2018

Just-in-Time Inventory Control To achieve greater efficiency in the production process, organizations have tried to have less in-process inventory on hand This is known as JIT inventory The inventory arrives just in time to be used during the manufacturing process One technique of implementing JIT is a manual procedure called kanban 11/13/2018

Just-in-Time Inventory Control Kanban in Japanese means “card” Kanban systems are quite simple, but they require considerable discipline As there is little inventory to cover variability, the schedule must be followed exactly 11/13/2018

The Kanban System P-kanban and Container C-kanban and Container Producer Area Storage Area User Area 4 1 3 2 Figure 6.17 11/13/2018

Thank You 11/13/2018