Chapter 3

Inventory Control
Inventory Control:
Inventory is essential to provide flexibility in operating a system.

Inventory can be classified as

i) Raw materials inventory Removes dependency between suppliers
and plants
ii) In process inventory Removes dependency between machines of a
product line
iii) Finished goods inventory removes dependency between plant and it
customer / market.

Main functions of inventory are

Smoothing out the irregularities in supply
Minimizing the production cost
Allowing organizations to cope with perishable materials
Inventory Control:
Inventory decisions:
Two basic inventory decisions are generally taken by managers
i) When to replenish the inventory of that item.
ii) How much of an item to order when inventory of that item is to be
replenished.

Components of Total inventory cost:

Cost of items
Cost of ordering
Cost of carrying or holding inventory

Costs Trade-off:
i) If the order quantity is less, the cost of order will be more but the
inventory carrying / holding cost will be less.
ii) If the order quantity is more, the cost of order will be less but the
inventory carrying / holding cost will be more.
Inventory Control:

In the above figure, the total cost represents the sum of ordering cost and
carrying cost / holding cost for each order size.

The order size at which the total cost is minimum is called Economic Order
Quantity (EOQ) or Q* (Optimal order size)
Inventory Control:
Models for Inventory:

There are different models of inventory. The various inventory models

commonly used

i) Purchase model with Instantaneous replacement and without shortages.

ii) Manufacturing model without shortages.

iii) Purchase model with Instantaneous replacement and with shortages.

iv) Manufacturing model with shortages.

Inventory Control:
Purchase model with Instantaneous replenishment and without shortages:

In this model of inventory, orders of equal size are placed at periodic

intervals. The items against an order are replenished instantaneously and
the items are consumed at a constant rate. The purchase price per unit is
the same irrespective of the order size.

The model could be represented as:

Inventory Control:
Purchase model with Instantaneous replenishment and without shortages:

Now, if D annual demand in units

Co ordering cost / order
Cc holding cost / unit / year
P Purchase price / unit
Q order size

Then, the economic order quantity is given as

2Co D
Q*
Cc

No of orders in a year = (D / Q*)

Time between orders = (Q* / D)

Inventory Control:
Alpha industry estimates that it will sell 12,000 units of its product for the
forthcoming year. The ordering cost is Rs 100 per order and the carrying
cost per unit per year is 20% of the purchase price per unit. The purchase
price per unit is Rs 50. Find
(i) EOQ; (ii) No. of orders per year; (iii) Time between successive orders
using Purchase model without shortages

Solution:
D = 12,000 units / year; Co = Rs 100 / order
Cc = Rs 50 * 0.02 = Rs 10 /unit / year

2Co D
EOQ = 490 units (approx)
Cc

No. of Orders = (D / EOQ) = 24.49 ~ 25

Time between successive orders = (EOQ / D) = 0.04 year ~ 15 days

Inventory Control:
Manufacturing model without shortages:

If a company manufactures its component which is required for its main

product, then the corresponding model of inventory is called Manufacturing
model.

The rate of consumption of items is uniform throughout the year. The cost of
production per unit is same irrespective of production lot size.

Let D annual demand in units

k production rate of the input component
r consumption rate of the input component
Co cost per set up
Cc holding cost / unit / period
P Production cost / unit
Q Batch size per production
Inventory Control:
Manufacturing model without shortages:
The model could be represented as:

2Co D 2Co r
Then, the economic batch quantity is given as Q*
Cc (1 r / k ) Cc (1 r / k )

Inventory build up time t1* = (Q* / k)

Q * (1 r / k )
Inventory consumption time t2* =
r
Time between successive inventory build ups = t1* + t2*
Inventory Control:
If a product is to be manufactured within the company and the details are as
follows:
r = 24,000 units / year; k = 48,000 units / year; Co = Rs 200 / set-up
Cc = Rs 20 / unit / year
Find the (i) EBQ; (ii) cycle time using Manufacturing model without
shortages
Solution:
2Co r
Q* EBQ = 980 units (approx)
Cc (1 r / k )

Inventory build up time (t1*) = Q* / k = 0.02 year

Q * (1 r / k )
Inventory consumption time (t2*) = = 0.02 year
r

Total cycle time (t*) = t1* + t2* = 0.04 year ~ 15 days

Inventory Control:
Purchase model with Instantaneous replenishment and with shortages:

In this model of inventory, the items of an order will be received

instantaneously and they are consumed at a constant rate. The purchase
price per unit remains the same irrespective of order size. If there is no stock
at the time of receiving a request for the items, it is assumed that it will be
satisfied at a later date with penalty. This is called backordering.

The model could be represented as:

Inventory Control:
Purchase model with Instantaneous replenishment and with shortages:
In the above model
Q represents Economic Order Quantity
Q1 represents Maximum inventory
Q2 represents Maximum stock out

2Co D Cs Cc
Then, the economic order quantity is given as Q*
Cc Cs
2Co D Cs
Optimal Value of maximum inventory Q1*
Cc Cs Cc

Optimal Value of maximum shortage Q2* = Q* -Q1*

Time between orders (t*) = (Q* / D)

Optimal inventory period (t1*) = (Q1* / D)

Optimal shortage period (t2*) = (Q2* / D)

Inventory Control:
Annual demand for an automobile component is 24,000 units. The carrying
cost is Rs 0.4/unit/year, the ordering cost is Rs 20 per order and the
shortage cost is Rs 10 / unit / year. Find the optimal values of the following
using Purchase model with shortage:
(i) EOQ; (ii) Maximum inventory; (iii) Maximum shortage quantity;
(iv) Cycle time; (v) Inventory period (t1); (vi) Shortage period (t2)

Solution:
D = 24,000 units / year; Co = Rs 20 / order
Cc = Rs 10 /unit / year Cs = Rs 10 /unit / year
2Co D Cs Cc
Q* EOQ = 1580 units
Cc Cs
2Co D Cs
Maximum Inventory Q1* = 1520 units
Cc Cs Cc

Maximum shortage quantity (Q2*) = Q* Q1* = 60 units

Inventory Control:

Total cycle time (t*) = Q* / D ~ 24 days

Inventory period (t1*) = Q1* / D ~ 23 days

Shortage period (t2*) = (t* - t1*) = 01 day

Inventory Control:
Manufacturing model with shortages:
In this model of inventory, the items are produced and consumed
simultaneously for a portion of the cycle time. The rate of consumption is
uniform through out the year. The cost of production per unit is same
irrespective of production lot size.

In this model, shortage (Stock out) is permitted. It is assumed that the

shortage unit will be satisfied at a later date with penalty. This is called
backordering.

Let D annual demand in units

k production rate of the input component
r consumption rate of the input component
Co cost per set up
Cc holding cost / unit / period
Cc shortage cost / unit / period
P Production cost / unit
Inventory Control:
Manufacturing model with shortages:

The model could be represented as:

In the above model

Q represents Economic Order Quantity
Q1 represents Maximum inventory
Q2 represents Maximum stock out
Inventory Control:
Manufacturing model with shortages:
2Co kr C Cc
Then, the economic order quantity is given as Q* s
Cc (k r ) Cs

2Co r (k r ) Cs
Optimal Value of maximum inventory Q1*
Cc k Cs Cc

2CoCc r (k r )
Optimal Value of maximum shortage Q2 *
Cs Cs Cc k

k r
Optimal Value of maximum inventory Q1*
Q * Q2 *
k

Time between orders (t*) = (Q* / D)

t1* = Q1* / (k r) t2* = Q1* / r

t3* = Q2* / r t4* = Q2* / (k r)
Inventory Control:
The demand of an item is 18,000 units per year. Its production rate is 3000
units per month. The carrying cost is Rs 0.15/unit/month and the set up cost
is Rs 500 per set-up. The shortage cost is Rs 20 per unit per year. Find the
parameters of the inventory system for manufacturing model with shortage.

Solution:
r = 18,000 units / year; k = 3000 * 12 = 36,000 units / year
Co = Rs 500 / setup; Cc = Rs 1.8 /unit / year; Cs = Rs 20 /unit / year

2Co kr C Cc
Q* EOQ s = 4669 units
Cc (k r ) Cs

2CoCc r (k r )
Maximum shortage quantity Q2 * = 193 units
Cs Cs Cc k

k r
Maximum inventory Q1* Q * Q2 * = 2142 units
k
Inventory Control:

Total cycle time (t*) = Q* / r ~ 95 days

Inventory period (t1*) = Q1* / (k r) ~ 43.5 days

Inventory consumption period (t2*) = Q1* / r ~ 43.5 days

Shortage period (t3*) = Q2* / r ~ 4 days

Shortage build up (t4*) = Q2* / (k r) ~ 4 days

Practice Problems:
1) An industry estimates that it will sell 24,000 units of its product for the
forthcoming year. The ordering cost is Rs 150 per order and the carrying
cost per unit per year is 25% of the purchase price per unit. The purchase
price per unit is Rs 50. Find
(i) EOQ; (ii) No. of orders per year; (iii) Time between successive orders
using Purchase model without shortages

2) If a product is to be manufactured within the company and the details are

as follows:
r = 14000 units / year; k = 35,000 units / year; Co = Rs 500 / set-up
Cc = Rs 15 / unit / year
Find the (i) EBQ; (ii) cycle time using Manufacturing model without
shortages
Practice Problems:
3) The annual demand for an chemical component is 7,200 kg. The carrying
cost is Rs 500/kg/year, the ordering cost is Rs 1500 per order and the
shortage cost is Rs 2000 / kg / year. Find the optimal values of the following:
(i) EOQ; (ii) Maximum inventory; (iii) Maximum shortage quantity;
(iv) Cycle time; (v) Inventory period (t1); (vi) Shortage period (t2)
using Purchase model with shortage

4) The demand of an item is 6,000 units per year. Its production rate is 33
units per day. The carrying cost is Rs 50/unit/year and the set up cost is Rs
2000 per set-up. The shortage cost is Rs 100 per unit per year. Find the
parameters of the inventory system for manufacturing model with shortage.