1. Inventory Management
A Presentation by R.K.Agarwal, Manager (Finance), PFC

2. Inventory Control Inventory System Defined Inventory Costs
Independent vs. Dependent Demand
Basic Fixed-Order Quantity Models
Quantity Discounts-also known as price break models. 2

3. Inventory System Defined
raw materials, finished products, component parts, supplies, and work-in-process.
An inventory system is the set of policies and controls that monitor levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be. 3

4. Purposes of Inventory 1. To maintain independence of operations.
2. To meet variation in product demand.
3. To allow flexibility in production scheduling.
4. To provide a safeguard for variation in raw material delivery time.
5. To take advantage of economic purchase-order size. 4

5. Inventory Costs Holding (or carrying) costs.
Costs for storage, handling, insurance, etc.
Setup (or production change) costs.
Costs for arranging specific equipment setups, etc.
Ordering costs.
Costs of someone placing an order, etc.
Shortage costs.
Costs of canceling an order, etc. 5

6. Independent vs. Dependent Demand
Independent Demand (Demand not related to other items or the final end-product)
Video:
Dependent Demand
(Derived demand items for component parts,
subassemblies,
raw materials, etc.)
Managing
Inventory 6

7. Independent Demand

8. Dependent Demand

9. Classifying Inventory Models
Fixed-Order Quantity Models
Event triggered (Example: running out of stock)
The sale of an item reduces the inventory position to the re order point.
Fixed-Time Period Models
Time triggered (Example: Monthly sales call by sales representative) 7

10. Fixed-Order Quantity Models: Model Assumptions (Part 1)
Demand for the product is constant and uniform throughout the period.
Lead time (time from ordering to receipt) is constant.
Price per unit of product is constant. 8

11. Fixed-Order Quantity Models: Model Assumptions (Part 2)
Inventory holding cost is based on average inventory.
Ordering or setup costs are constant.
All demands for the product will be satisfied. (No back orders are allowed.) 9

12. Basic Fixed-Order Quantity Model and Reorder Point Behavior
R = Reorder point
Q = Economic order quantity
L = Lead time L Q R
Time
Number
of units
on hand 10

13. Cost Minimization Goal
Total Cost C O S T
Holding
Costs
Annual Cost of
Items (DC)
Ordering Costs
QOPT
Order Quantity (Q) 11

14. Basic Fixed-Order Quantity (EOQ) Model Formula
Total Annual Cost =
Annual
Purchase
Cost
Ordering
Holding +
TC = Total annual cost
D = Demand
C = Cost per unit
Q = Order quantity
S = Cost of placing an order
or setup cost
R = Reorder point
L = Lead time
H = Annual holding and storage cost per unit of inventory 12

15. Deriving the EOQ 13

16. EOQ Example Problem Data
Given the information below, what are the EOQ and reorder point?
Annual Demand = 1,000 units
Days per year considered in average daily demand = 365
Cost to place an order = Rs10
Holding cost per unit per year = Rs2.50
Lead time = 7 days
Cost per unit = Rs15 14

17. EOQ Example Solution
with no safety stock 15

18. Safety Stock Quantity Maximum probable demand Expected demandLT
Time
Expected demand
during lead time
Maximum probable demand
ROP
Quantity
Safety stock
Safety stock reduces risk of
stockout during lead time

19. Reorder Point The ROP based on a normal
Risk of
a stockout
Service level
Probability of
no stockout
Expected
demand
Safety
stock z
Quantity
z-scale
The ROP based on a normal
Distribution of lead time demand

20. Special Purpose Model: Price-Break Model Formula
Based on the same assumptions as the EOQ model, the price-break model has a similar Qopt formula:
i = annual percentage of unit cost attributed to carrying inventory
C = cost per unit 13

21. Price-Break Example Problem Data (Part 1)
Order Quantity(units) Price/unit(Rs.)
0 to 2,
2,500 to 3,
4,000 or more
Start at lowest price per unit. 14

22. Price-Break Example Solution (Part 2)
First, start with the lowest price per unit.
Annual Demand (D)= 10,000 units
Cost to place an order (S)= Rs.4
Carrying cost % of total cost (i)= 2%
Cost per unit (C) = Rs1.20, Rs.1.00, Rs.0.98
Next, determine if the computed Qopt values are feasible or not.
Interval from 4000 & more, the Qopt value is not feasible.
Interval from , the Qopt value is not feasible.
Interval from 0 to 2499, the Qopt value is feasible. 15

23. Price-Break Example Solution (Part 3)
Next, Compare total cost for the feasible root Q and price break Q values.
TC(1826)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20)
= Rs12,043.82
TC(2500) = Rs10,041
TC(4000) = Rs9,949.20 15

24. Because the total annual cost function is a “u” shaped function.
Price-Break Example
Since the feasible solution occurred in the first price-break, it means that all the other true Qopt values occur at the beginnings of each price-break interval. Why?
Because the total annual cost function is a “u” shaped function.
Total annual costs
Order Quantity
EOQ
Not EOQ
Not EOQ 15

25. ABC Classification System
Items kept in inventory are not of equal importance in terms of:
Amount invested
profit potential
sales or usage volume
stock-out penalties 60
% of
$ Value A 30 B C
% of
Use 30 60
So, identify inventory items based on percentage of total value , where “A” items are roughly top 15 %, “B” items as next 35 %, and the lower 65% are the “C” items. 26

26. THANKS Other Aspects Just In Time Inventory (Zero Inventory Model).
Defining Minimum Level, Max. Level, Re-order level, Safety Level, etc.
Identifying Slow Moving / Non Moving and obsolete items.
Scrap Disposal
THANKS 26