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INVENTORY

MANAGEMENT
Lecture Note Six
Fahmy Radhi
What is Inventory?
Stock of materials
Stored capacity
1995
Corel Corp.

Examples

1984-1994 T/Maker Co. 1984-1994 T/Maker Co.


1995 Corel Corp.
Types of Inventory

Raw material
Work-in-progress
Maintenance/repair/operating
supply
Finished goods
Independent versus
Dependent Demand
Independent demand - demand
for item is independent of demand
for any other item, e.g. Finished
Goods
Dependent demand - demand for
item is dependent upon the
demand for some other item, e.g.
Raw Material, Components, Work-in-
Process
Inventory Costs
Holding costs - associated with
holding or carrying inventory
over time
Ordering costs - associated
with costs of placing order and
receiving goods
Setup costs - cost to prepare a
machine or process for
manufacturing an order
Inventory Models

Fixed order-quantity Help


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Economic order
quantity
Quantity discount
Just-In-Time
Material Requirement
1984-1994
Planning T/Maker Co.
Economic Order Quantity
(EOQ)
EOQ - the order quantity that will minimize
total inventory cost (TC) that is the sum of
carrying cost (CC) and ordering cost
Assumptions of the EQO Model:
There is only one product involved
Constant demand of materials
The lead time is known well
each order is received in a single delivery
constant price per unit and no quantity
discounts
CC and OC is variable cost
TC = CC + OC
Carrying Costs
Carrying Costs - some cost relate to
physically holding items in storage,
including:
cost of invested funds
cost of storage space
taxes and insurance
obsolescence costs
Ordering Costs
Ordering Costs - some cost are
incurred each time a company places
an order to supplier and receives the
resulting of materials, including:
setup cost - preparing cost
delivery cost
handling cost
EOQ Model Equations
Optimal Order Quantity 2 D OC
= Q* =
CC
D
Expected Number of Orders =N =
Q*
Expected Time Between Orders Working Days / Year
=T =
N
D D = Demand per year
d =
Working Days / Year S = Setup (order) cost per order
H = Holding (carrying) cost
ROP = d L d = Demand per day
TIC = CC + OD L = Lead time in days
TIC = (Q*/2) CC + (D/Q*)
OC
Finding Reorder Point (ROP)
ROP = (demand/day) x (lead time for
a

Inventory Level (Units)


new order in days)
ROP = d x L
Q* Slope = units /day = d

ROP
(units)

Time
(days)

Lead Time = L
EOQ Model
How Much to Order?
Annual Cost

t C u r ve
a l C os ve
To t u r
Minimum C o st C
l din g
total cost Ho

Order (Setup) Cost Curve

Optimal Order quantity


Order Quantity (Q*)
Inventory Usage Over
Time
Order quantity = Q Usage Rate
(maximum inventory Average
level) Inventory
(Q*/2)
Inventory Level

Minimum
inventory 0
Time
Computing Average
Inventory
Inventory Level
Day
Beginning Ending Average
1 (order received) 10 8 9
2 8 6 7
3 6 4 5
4 4 2 3
5 2 0 1

Demand: Constant, 2 units/day


Ending Inventory is assumed to be always zero
Maximum level = 10 units
Total of Daily average = 9 + 7 + 5 + 3 + 1 = 25
Number of days = 5
Average inventory level = 25/5 = 5 Q/2
Example Sharp Inc
Sharp, Inc. a company that market painless
hypodermic needless to hospital, would like reduce
its inventory cost by determining the optimal number
of hypodermic needless to obtain per order. The
annual demand is 1,000 unit; the ordering cost is $10
per order; and holding cost is $0.5 per unit per year.
Based on the date, determines as the following:
Optimal number of per order (EOQ)
The number of order per year (N)
Expected time (T) by assuming a 250-day working year
Total inventory cost (TIC)
Reorder Point (ROP) by assuming that lead time is 5 days
Answer Questions
EOQ = 200 units
N = 5 orders per year
T = 50 days between order
TIC = $ 50 + $ 50 = $ 100
d = 1000/250 = 4 unit per day
ROP = 5 days X 4 unit = 20 unit
Quantity Discount
Model
Answers how much to order &
when to order
Allows quantity discounts
Reduced price when item is
purchased in larger quantities
Other EOQ assumptions apply
Trade-offis between lower
price & increased holding cost
Optimal Order Quantity
for Production Run Model
Ordering Cost = Carrying Cost
(D/Q)Co = ChQ(1-d/p)
Optimal Order Quantity
2 DCo
Q 2

d
Ch 1 Optimal Production Quantity,
p
2 DCs
2 DCo Q*
Q* d
d Ch 1
Ch 1 p
p
Quantity Discount Model

Quantity Discount Schedule


Discount Discount Discount
Discount (%)
Number Quantity Cost ($)
5.00 (normal
1 0-999 0
cost)

2 1,000 1,999 4 4.80

3 2,000 over 5 4.75


Total Cost = material cost + ordering cost + carrying cost
= DC + (D/Q)Co + QCh
Total Cost Total Cost Curve
TC for Disc. 1

TC for Disc. 3

TC for Disc. 2

Q* for Disc. 2

Order Quantity

0 1,000 2,000
Use of Safety Stock
Safety stock: additional stock that is kept
on hand
It is used only when demand is uncertain
Main purpose: to avoid stockouts when the
demand is higher than expected
ROP = d x L (normal condition)
ROP = d x L + SS (demand is uncertain)
Because it is dealing with decision under
risk, knowing the probability of demand is
necessary.
Safety Stock with Known
Stockout Costs
Case of ABCO
ROP = 50 units (= d x L)
Ch = $5 (per unit per year)
Cso = $40/unit (stockout cost)
Optimal number of orders per year is 6
Objective: to find the reorder point,
including safety stock, that will minimize
total expected cost
Total expected cost is the sum of expected
stockout cost plus expected additional
carrying cost
MRP
MRP - a computer-based information
system designed to handle ordering
and scheduling of dependent-demand
inventories. It is designed to answer:
what, how much, and when is it
needed.
MRP Design
MRP Inputs
MRP Processing
MRP Outputs
MRP Design
MRP Inputs
Master Schedule - contains which end
items are to be produced and when these
are needed, and in what quantities.
Bill of Materials (BOM) - contains a
listing all of the assemblies, subassemblies,
part, and raw materials that are needed to
produced one unit of finished product.
Inventory Record File - contains
information on the status of each item by
time period
MRP Processing
MRP Processing involves taking the
end-item requirements specified by
the master schedule and exploding
them into time-phased requirement
of reassembles, parts, and raw
materials using the bill of material
offset by lead times.
MRP Processing
Some terms used in MRP processing :
Gross Requirement (GR) - Total expected demand
for an items of raw material during each time period
Schedule Receipts (SR) - open orders scheduled
to arrive from vendors or else where in the pipeline
Projected On Hand (BOP) - expected amount of
inventory that will be on hand at the beginning of
each time period. BOP = SR + Inv. Last Period
Net Requirement (NR) - The actual amount
needed in each time period
Planned-order receipts (POR ) - quantity
expected to be received by the beginning of the
period in which it is shown
Planned-order Releases (PORs ) - planned
amount order in each time period
MRP Processing
Lot-for-Lot Ordering (LFLO) - order
size equal to net requirement
Lot-Size Ordering (LSO) - order
unequal to net requirement
Safety Stock (SS) - stock that must be
available on hand during period time
Formulas:
BOP = SR + Inv. available from last period
NRt = GRt - BOPt + SS
MRP Outputs
Primary Reports concern production and
inventory planning and control:
planned orders - the amount and timing of future orders
orders release - the execution of planned order
changes - the revision of due dates or order quantities as
well as cancellations of orders
Secondary reports - concern such things as
performance control, planning, and exceptions:
performance control reports - evaluation of system
operation, including deviations from plans and cost
information
planning reports - data useful for assessing future
materials requirements
exception report - data on any major discrepancies
encountered
Product Structure Tree
MRP Problem
A firm that produced wood shutters and bookcases
has received two orders for shutters; one for 100
shutters and one for 150 shutters. The 100-unit
orders are due to at the start of week 4 of the
current schedule, and 150-unit order is due for
delivery at the start of week 8. Each shutter
consists of four slated wood section and two frames.
The wood section is made by firm, and fabrication
takes one week. The frames are ordered, and lead
time is two weeks. Assembly of the shutters
required one week. There is a scheduled receipt of
70 wood sections in week 1.
Determine the size and timing of planned-order
releases necessary to meet delivery requirement
under each of these conditions:
Lot-for-Lot Ordering
Lot-size Ordering with a lot size of 320 units for frames and
70 units for wood sections
Develop a Master Schedule

Week 1 2 3 4 5 6 7 8
Number

Quantit 10 10
y 0 0
A Product Structure Tree

Shutter

Frame (2) Sections (4)


An Assembly Time Chart

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