McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 12 Inventory Management

12-2 Learning Objectives  Define the term inventory and list the major reasons for holding inventories; and list the main requirements for effective inventory management.  Discuss the nature and importance of service inventories  Discuss periodic and perpetual review systems.  Discuss the objectives of inventory management.  Describe the A-B-C approach and explain how it is useful.

12-3 Learning Objectives  Describe the basic EOQ model and its assumptions and solve typical problems.  Describe the economic production quantity model and solve typical problems.  Describe the quantity discount model and solve typical problems.  Describe reorder point models and solve typical problems.  Describe situations in which the single- period model would be appropriate, and solve typical problems.

12-4 Independent Demand A B(4) C(2) D(2)E(1) D(3) F(2) Dependent Demand Independent demand is uncertain. Dependent demand is certain. Inventory: a stock or store of goods Inventory

12-5 Inventory Models  Independent demand – finished goods, items that are ready to be sold  E.g. a computer  Dependent demand – components of finished products  E.g. parts that make up the computer

12-6 Types of Inventories  Raw materials & purchased parts  Partially completed goods called work in progress  Finished-goods inventories  (manufacturing firms) or merchandise (retail stores)

12-7 Types of Inventories (Cont’d)  Replacement parts, tools, & supplies  Goods-in-transit to warehouses or customers

12-8 Functions of Inventory  To meet anticipated demand  To smooth production requirements (to build inventories during preseason period)  To decouple operations (in terms of operational difficulties)  To protect against stock-outs

12-9 Functions of Inventory (Cont’d)  To take advantage of order cycles (to produce in economic lot size)  To help hedge against price increases  To permit operations (work in progress inventory)  To take advantage of quantity discounts

12-10 Objective of Inventory Control  To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds  Level of customer service  Costs of ordering and carrying inventory Inventory turnover is the ratio of average cost of goods sold to average inventory investment.

12-11  A system to keep track of inventory  A reliable forecast of demand  Knowledge of lead times  Reasonable estimates of  Holding costs  Ordering costs  Shortage costs  A classification system Effective Inventory Management

12-12 Inventory Counting Systems  Periodic System Physical count of items made at periodic intervals ( Manager periodically check the shelves)  Perpetual Inventory System (Continuous) System that keeps track of removals from inventory continuously, thus monitoring current levels of each item

12-13 Inventory Counting Systems (Cont’d)  Two-Bin System - Two containers of inventory; reorder when the first is empty  Universal Bar Code - Bar code printed on a label that has information about the item to which it is attached

12-14  Lead time: time interval between ordering and receiving the order  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  Shortage costs: costs when demand exceeds supply Key Inventory Terms

12-15 ABC Classification System Classifying inventory according to some measure of importance and allocating control efforts accordingly. A A - very important B B - mod. important C C - least important Figure 12.1 Annual $ value of items A B C High Low High Percentage of Items

12-16  Economic order quantity (EOQ) model  The order size that minimizes total annual cost  Economic production model Economic Order Quantity Models

12-17  Only one product is involved  Annual demand requirements 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 Assumptions of EOQ Model

12-18 The Inventory Cycle Figure 12.2 Profile of Inventory Level Over Time Quantity on hand Q Receive order Place order Receive order Place order Receive order Lead time Reorder point Usage rate Time

12-19 Total Cost Annual carrying cost Annual ordering cost Total cost =+ TC = Q 2 H D Q S +

12-20 Cost Minimization Goal Order Quantity (Q) The Total-Cost Curve is U-Shaped Ordering Costs QOQO Annual Cost ( optimal order quantity) Figure 12.4C

12-21 Minimum Total Cost The total cost curve reaches its minimum where the carrying and ordering costs are equal. Q 2 H D Q S =

12-22 Deriving the EOQ Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q.

12-23Example A local distributor for a national tire company expects to sell approximately 9,600 steel belted radial tires of a certain cize and tread design next year. Annual carrying cost is $16 per tire and ordering cost is $75. The distributor operates 288 days a year. a)What is the Economic Order Quantity? b)How many times per year does the store Re-order? c)What is the length of an order cycle? d)What is the total annual cost if the EOQ quantity is ordered?

12-24  Production done in batches or lots  Capacity to produce a part exceeds the part’s usage or demand rate  Assumptions of EPQ are similar to EOQ except orders are received incrementally during production Economic Production Quantity (EPQ)

12-25  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 Economic Production Quantity Assumptions

12-26 Economic Run Size

12-27 A toy Manufacturing uses 48,000 rubber weels per year for its popular dump truck series. The firm makes its own wheels, which it can produce at a rate of 800 per day. The toy trucks are assembled uniformly over the entire year. Carrying cost is $1 per wheel a year. Setup cost for a production run of a wheels is $45. The firm operates 240 days per year. Determine the :- a) Optimal run size (optimal quantity produced) b) Minimum total annual cost for carrying cost and setup. c) Cycle time for the optimal run size? d) Run time

12-28 Safety Stock LT Time Expected demand during lead time Maximum probable demand during lead time ROP Quantity Safety stock Figure Safety stock reduces risk of stockout during lead time

12-29 THANKS