Chapter 10 Chapter 10 Key Terms Order Quantities

Order Quantities

Stock-keeping unit (SKU),260 1) An inventory item. For example, a shirt in six colors and five sizes would represent 30 different SKUs. 2) In a distribution system, an item at a particular geographic location. For example, one product stocked at the plant and at six different distribution centers would represent seven SKUs. Lot-for-lot,261 A lot-sizing technique that generates planned orders in quantities equal to the net requirements in each period. Fixed-order quantity,261 A lot-sizing technique in MRP or inventory management that will always cause planned or actual orders to be generated for a predetermined fixed quantity, or multiples thereof, if net requirements for the period exceed the fixed order quantity. Min-max system,261 A type of order point replenishment system where the min(minimum) is the order point, and the max(maximum) is he order up to inventory level. The order quantity is variable and is the result of the max minus available and on-order inventory. An order is recommended when the sum of the available and on-order inventory is at or below the min. Time between orders,271 This is calculated by dividing the EOQ by the demand rate. Questions 1. What are the two basic questions in inventory management discussed in the text? The two basic questions are as follows: How much should be ordered at one time? When should an order be placed? 2. What are decision rules? What is their purpose? Management must establish decision rules to answer the upward questions so inventory management personnel know when to order and how much. 3. What is an SKU? 1) An inventory item. For example, a shirt in six colors and five sizes would represent 30 different SKUs. 2) In a distribution system, an item at a particular geographic location. For example, one product stocked at the plant and at six different distribution centers would represent seven SKUs. 4. What is the lot-for-lot decision rule? What is its advantage? Where would it be used? The lot-for-lot rule says to order exactly what is needed no more no less. The order quantity changes whenever requirements change. Since items are ordered only when needed, this system creates no unused lot-size inventory. It is the best method for planning A items and is also used in a just-in-time environment.
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Study Notes Prepared by Vancal

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5. What are the four assumptions on which economic-order quantities are based? For what kind of items are these assumptions valid? When are they not? The assumptions on which the EOQ is based are as follows: Demand is relatively constant and is known. The item is produced or purchased in lots or batches and not continuously. Order preparation costs and inventory-carrying costs are constant and known. Replacement occurs all at once. These assumptions are usually valid for finished goods whose demand is independent and fairly uniform. There is no reason to calculate the EOQ for made-to-order items, in which the customer specifies the order quantity. In material requirements planning, the lot-for-lot decision rule is often used. 6. Under the assumptions on which EOQs are based, what are the formulas for average lot size and the number of orders per year? Average lot size inventory = order quantity / 2 Number of orders per year = annual demand / order quantity 7. What are the relevant costs associated with the two formulas? As the order quantities increase, what happens to each cost? What is the objective in establishing a fixed-order quantity? The relevant costs are as follows: Annual cost of placing orders. Annual cost of carrying inventory. As the order quantity increases, the average inventory and the annual cost of carrying inventory increase, but the number of orders per year and the ordering cost decrease. 8. Define each of the following in your own words and as a formula: a. Annual ordering cost. b. Annual carrying cost. c. Total annual cost. Let: A = annual usage in units S = ordering cost in dollars per order i = annual carrying cost rate as a decimal of a percentage c = unit cost in dollars Q = order quantity in units Then: Annual ordering cost = number of orders costs per order = A/Q S Annual carrying cost = average inventory cost of carrying one unit for one year = average inventory unit cost carrying cost = Q/2 c i Total annual costs = annual ordering costs + annual carrying costs = A/Q S + Q/2 c i

9. What is the economic-order quantity (EOQ) formula? Define each term and give the unites used. How do the units change when monetary units are used?
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Chapter 10 Let:

Order Quantities

A = annual usage in units S = ordering cost in dollars per order i = annual carrying cost rate as a decimal of a percentage c = unit cost in dollars Then: EOQ = sqrt ( 2AS / ic ) Let: AD = annual usage in dollars S = ordering costs in dollars i = carrying cost rate as a decimal of a percent Then the EOQ in dollars is: EOQ = sqrt ( 2ADS / i ) 10. What are the relevant costs to be considered when deciding whether to take a quantity discount? On what basis should the decision be made? The EOQ formula depends upon the cost of ordering and the cost of carrying inventory. When the total costs have been reduced, the decision should be made. 11. What is the period-order quantity? How is it established? When can it be used? A lot-sizing technique under which the lot size is equal to the net requirements for a given number of periods, e.g., weeks into the future. The number of periods to order is variable, each order size equalizing the holding costs and the ordering costs for the interval. Period-order quantity = EOQ / average weekly usage 12. How do each of the following influence inventory decisions? a. Lumpy demand. The EOQ assumes that demand is uniform and replenishment occurs all at once. When this is not true, the EOQ will not produce the best results. It is better to use period-order quantity. b. Minimum orders. Some suppliers require a minimum order. This minimum may be based on the total order rather than on individual items. Often these are C items where the rule is to order plenty, not an EOQ. c. Transportation costs. d. Multiples. Sometimes, order size is constrained by package size.