Inventory Control M0729,M0733,M0739

Inventory ManagementInventory Management

byby neha gupta neha gupta

hemant sachanhemant sachan & &

jyotsana mishrajyotsana mishra

DEFINITION OF INVENTORYDEFINITION OF INVENTORY

Inventory Inventory is the stock of any item or is the stock of any item or resource used in an organisation.resource used in an organisation.

Inventory systemInventory system is the set of is the set of policies and controls that monitor policies and controls that monitor levels of inventory and determine levels of inventory and determine what level should be maintained, what level should be maintained, when stock should be replenished, when stock should be replenished, and how large orders should be.and how large orders should be.

PURPOSES OF INVENTORYPURPOSES OF INVENTORY To maintain independence of To maintain independence of

operationsoperations. A supply of materials at . A supply of materials at a work center allows that center a work center allows that center flexibility in operations.flexibility in operations.

To meet variation in product To meet variation in product demanddemand. If the demand for the . If the demand for the product is known precisely, it may be product is known precisely, it may be possible to produce the product to possible to produce the product to exactly meet the demand.exactly meet the demand.

To allow flexibility in production To allow flexibility in production scheduling. scheduling.

To provide a safe guard for variation To provide a safe guard for variation in raw material delivery time.in raw material delivery time.

To take advantage of economic To take advantage of economic purchase order size.purchase order size.

Types of InventoryTypes of Inventory

Raw materialRaw material Work-in-progressWork-in-progress Maintenance/repair/operating supplyMaintenance/repair/operating supply Finished goodsFinished goods

The Functions of InventoryThe Functions of Inventory

To “decouple” or separate various parts of the To “decouple” or separate various parts of the production processproduction process

To provide a stock of goods that will provide a To provide a stock of goods that will provide a “selection” for customers“selection” for customers

To balance the seasonal fluctuations in demandTo balance the seasonal fluctuations in demand To take advantage of quantity discountsTo take advantage of quantity discounts To meet the fluctuation losses during machinery To meet the fluctuation losses during machinery

breakdown, shut down arising out of non-breakdown, shut down arising out of non-availability vital inputs availability vital inputs

To hedge against inflation and upward price To hedge against inflation and upward price changeschanges

To protect against stock-outs.To protect against stock-outs.

Higher costsHigher costs Item cost (if purchased)Item cost (if purchased) Ordering (or setup) costOrdering (or setup) cost

• Costs of forms, clerks’ wages etc.Costs of forms, clerks’ wages etc. Holding (or carrying) costHolding (or carrying) cost

• Building lease, insurance, taxes etcBuilding lease, insurance, taxes etc..

Difficult to controlDifficult to control Hides production problemsHides production problems

Disadvantages of InventoryDisadvantages of Inventory

INVENTORY MODELSINVENTORY MODELS Independent versus Dependent Independent versus Dependent

DemandDemand Holding, Ordering, shortage costs and Holding, Ordering, shortage costs and

Setup CostsSetup Costs

INVENTORY MODELS FOR INDEPENDENT INVENTORY MODELS FOR INDEPENDENT DEMANDDEMAND

1.Basic Economic Order Quantity (EOQ) 1.Basic Economic Order Quantity (EOQ) ModelModel

Minimizing CostsMinimizing Costs

Reorder PointsReorder Points

2.Production Order Quantity Model2.Production Order Quantity Model

3.Quantity Discount Models3.Quantity Discount Models

Independent versus Independent versus Dependent DemandDependent Demand

Independent demandIndependent demand - The - The demand for various items are demand for various items are unrelated to each other.unrelated to each other.

Dependent demandDependent demand - demand for - demand for item is dependent upon the demand item is dependent upon the demand for some other itemfor some other item

INVENTORY COSTSINVENTORY COSTS

Holding or carrying costsHolding or carrying costs Ordering costsOrdering costs Shortage costsShortage costs Setup or production change costs.Setup or production change costs.

Holding (Carrying) CostsHolding (Carrying) Costs ObsolescenceObsolescence InsuranceInsurance Extra staffingExtra staffing InterestInterest DamageDamage WarehousingWarehousing Etc.Etc.

Ordering CostsOrdering Costs

SuppliesSupplies FormsForms Order processingOrder processing Clerical supportClerical support Etc.Etc.

SHORTAGE COSTSSHORTAGE COSTS

When the stock of an item is depleted, an When the stock of an item is depleted, an order for that item must either wait until order for that item must either wait until the stock is replenished or be cancelled. the stock is replenished or be cancelled. There is a trade off between carrying stock There is a trade off between carrying stock to satisfy demand and the costs resulting to satisfy demand and the costs resulting from stock out. This balance is sometime from stock out. This balance is sometime difficult to obtain, because it may not be difficult to obtain, because it may not be possible to estimate lost profits, the effect possible to estimate lost profits, the effect of lost customers, or lateness penalties. of lost customers, or lateness penalties.

Setup CostsSetup Costs

Clean-up costsClean-up costs Re-tooling costsRe-tooling costs Adjustment costsAdjustment costs Etc.Etc.

Stock of materialsStock of materials Stored capacityStored capacity ExamplesExamples

What is Inventory?What is Inventory?

AMAZON.comAMAZON.com Jeff Bezos, in 1995, started Jeff Bezos, in 1995, started

AMAZON.com as a “virtual” retailer – AMAZON.com as a “virtual” retailer – no inventory, no warehouses, no no inventory, no warehouses, no overhead; just a bunch of computers.overhead; just a bunch of computers.

Growth forced AMAZON.com to excel Growth forced AMAZON.com to excel in inventory management!in inventory management!

AMAZON is now a worldwide leader in AMAZON is now a worldwide leader in warehouse management and warehouse management and automation.automation.

Order Fulfillment at AMAZONOrder Fulfillment at AMAZON1.1. You order items;, computer assigns You order items;, computer assigns

your order to distribution center your order to distribution center [closest facility that has the product(s)][closest facility that has the product(s)]

2.2. Lights indicate products ordered to Lights indicate products ordered to workers who retrieve product and reset workers who retrieve product and reset light.light.

3.3. Items placed in crate with items from Items placed in crate with items from other orders, and crate is placed on other orders, and crate is placed on conveyor. Bar code on item is scanned conveyor. Bar code on item is scanned 15 times – virtually eliminating error.15 times – virtually eliminating error.

Order Fulfillment at Order Fulfillment at AMAZON- ContinuedAMAZON- Continued

4.4. Crates arrive at central point where Crates arrive at central point where items are boxed and labeled with new items are boxed and labeled with new bar code.bar code.

5.5. Gift wrapping done by hand (30 Gift wrapping done by hand (30 packages per hour)packages per hour)

6.6. Box is packed, taped, weighed and Box is packed, taped, weighed and labeled before leaving warehouse in a labeled before leaving warehouse in a truck.truck.

7.7. Order appears on your doorstep within Order appears on your doorstep within a weeka week

The Material Flow CycleThe Material Flow Cycle

Techniques for Controlling Techniques for Controlling Service Inventory Include:Service Inventory Include:

Good personnel selection, training, Good personnel selection, training, and disciplineand discipline

Tight control of incoming shipmentsTight control of incoming shipments Effective control of all goods leaving Effective control of all goods leaving

the facilitythe facility

Fixed order-quantity models Fixed order-quantity models (Q- model)(Q- model) Economic order quantityEconomic order quantity Production order quantityProduction order quantity Quantity discountQuantity discount

Probabilistic modelsProbabilistic models

Fixed order-period models (P-Fixed order-period models (P-model)model)

Help answer the inventory planning questions!

Help answer the inventory planning questions!

Inventory ModelsInventory Models

ASSUMPTIONS:ASSUMPTIONS: Known and constant Known and constant demanddemand Known and constant Known and constant lead timelead time Instantaneous receiptInstantaneous receipt of material of material NoNo quantity quantity discountsdiscounts Only order (setup) cost and holding Only order (setup) cost and holding

costcost No No stockoutsstockouts

EOQEOQ

Deriving an EOQDeriving an EOQ

1.1. Develop an expression for setup or Develop an expression for setup or ordering costsordering costs

2.2. Develop an expression for holding Develop an expression for holding costcost

3.3. Set setup cost equal to holding costSet setup cost equal to holding cost

4.4. Solve the resulting equation for the Solve the resulting equation for the best order quantitybest order quantity

EOQ ModelEOQ ModelWhen To OrderWhen To Order

Reorder Point

(ROP)

Time

Inventory LevelAverageInventory

(Q*/2)

Lead Time

Optimal Order

Quantity(Q*)

EOQ ModelEOQ ModelHow Much to Order?How Much to Order?

Order quantity

Annual Cost

Holding Cost CurveTotal Cost Curve

Order (Setup) Cost Curve

Optimal Order Quantity (Q*)

Minimum total cost

More units must be stored if more are orderedMore units must be stored if more are ordered

Purchase Order

Description Qty.Microwave 1

Order quantity

Purchase Order

Description Qty.

Microwave 1000

Order quantity

Why Holding Costs IncreaseWhy Holding Costs Increase

Cost is spread over more unitsCost is spread over more units

Example: You need 1000 microwave ovens Example: You need 1000 microwave ovens

Purchase OrderDescription Qty.Microwave 1

Purchase OrderDescription Qty.Microwave 1

Purchase OrderDescription Qty.Microwave 1

Purchase Order

Description Qty.

Microwave 1

1 Order (Postage $ 0.33) 1000 Orders (Postage $330)

Order quantity

Purchase Order

Description Qty.

Microwave 1000

Why Order Costs DecreaseWhy Order Costs Decrease

Optimal Order Quantity

Expected Number of Orders

Expected Time Between Orders Working Days / Year

Working Days / Year

= =× ×

= =

= =

=

= ×

QD SH

NDQ

TN

dD

ROP d L

2

D = Demand per year

S = Setup (order) cost per order

H = Holding (carrying) cost

d = Demand per day

L = Lead time in days

EOQ Model EquationsEOQ Model Equations

EXAMPLEEXAMPLE A HOSPITAL PROCURES ITS SUPPLIES OF A A HOSPITAL PROCURES ITS SUPPLIES OF A

MATERIAL ONCE A YEAR. THE TOTAL NUMBER MATERIAL ONCE A YEAR. THE TOTAL NUMBER PROCURED IS 2400 PACKAGES (IN A YEAR). THIS PROCURED IS 2400 PACKAGES (IN A YEAR). THIS POLICY OF PROCURING MATERIAL ONCE A YEAR IS POLICY OF PROCURING MATERIAL ONCE A YEAR IS BEING QUESTIONED. THE ACCOUNTANTS BEING QUESTIONED. THE ACCOUNTANTS CALCULATE THE COSTS OF INVENTORY HOLDING CALCULATE THE COSTS OF INVENTORY HOLDING AT Rs. 36/ PACKAGE/ YEAR. IT IS ALSO FGURED AT Rs. 36/ PACKAGE/ YEAR. IT IS ALSO FGURED OUT THAT THE COST OF PROCUREMENT AD UPTO OUT THAT THE COST OF PROCUREMENT AD UPTO Rs. 1200 PER ORDER. Rs. 1200 PER ORDER.

WHAT INVENTORY POLICY WOULD YOU ADVISE TO WHAT INVENTORY POLICY WOULD YOU ADVISE TO THIS HOSPITAL? THIS HOSPITAL?

SOLUTIONSOLUTION::

EOQ = 2 x EOQ = 2 x D x SD x SH

= 2 x 1200 x 2400

36

= 400 units

Therefore, it is best to place 2400 = 6 order in a year

400

The Reorder Point (ROP) CurveThe Reorder Point (ROP) Curve

Q

ROP (Units)

Slope = units/day = d

Lead time = LTime (days)

Inve

ntor

y le

vel (

units

)

Answers how much to order and when to Answers how much to order and when to orderorder

Allows partial receipt of materialAllows partial receipt of material Other EOQ assumptions applyOther EOQ assumptions apply

Suited for production environmentSuited for production environment Material produced, used immediatelyMaterial produced, used immediately Provides production lot sizeProvides production lot size

Lower holding cost than EOQ modelLower holding cost than EOQ model

Production Order Quantity Production Order Quantity ModelModel

Reasons for Variability in Reasons for Variability in ProductionProduction

Most variability is caused by waste or by poor Most variability is caused by waste or by poor management. Specific causes include:management. Specific causes include:

employees, machines, and suppliers produce employees, machines, and suppliers produce units that do not conform to standards, are units that do not conform to standards, are late or are not the proper quantitylate or are not the proper quantity

inaccurate engineering drawings or inaccurate engineering drawings or specificationsspecifications

production personnel try to produce beforeproduction personnel try to produce beforedrawings or specifications are completedrawings or specifications are complete

customer demands are unknowncustomer demands are unknown

Answers how much to order & Answers how much to order & when to orderwhen to order

Allows quantity discountsAllows quantity discounts Reduced price when item is Reduced price when item is

purchased in larger quantitiespurchased in larger quantities Other EOQ assumptions applyOther EOQ assumptions apply

Trade-off is between lower price & Trade-off is between lower price & increased holding costincreased holding cost

Quantity Discount ModelQuantity Discount Model

Quantity Discount ScheduleQuantity Discount Schedule

DiscoDiscount unt

NumbNumberer

Discount Discount QuantityQuantity

Discount Discount (%)(%)

Discount Discount Price (P)Price (P)

11 0 to 9990 to 999 No No discountdiscount

$5.00$5.00

22 1,000 to 1,000 to 1,9991,999

44 $4.80$4.80

33 2,000 and 2,000 and overover

55 $4.75$4.75

Answer how much & when to order Answer how much & when to order Allow demand to varyAllow demand to vary

Follows normal distributionFollows normal distribution Other EOQ assumptions applyOther EOQ assumptions apply

Consider service level & safety stockConsider service level & safety stock Service level = Service level = Probability of stockout Probability of stockout Higher service level means more safety Higher service level means more safety

stockstock

Probabilistic ModelsProbabilistic Models

Answers how much to orderAnswers how much to order Orders placed at fixed intervalsOrders placed at fixed intervals

Inventory brought up to target amountInventory brought up to target amount Amount ordered variesAmount ordered varies

No continuous inventory count No continuous inventory count (counted at particular times such as every (counted at particular times such as every

week or every month) week or every month) Possibility of stockout between intervalsPossibility of stockout between intervals

Useful when vendors visit routinelyUseful when vendors visit routinely Useful when buyers want to combine Useful when buyers want to combine

orders to save transportation costs.orders to save transportation costs.

Fixed Period ModelFixed Period Model

FIXED PERIOD MODEL FIXED PERIOD MODEL CONTD.CONTD.

Fixed- time period models generate order Fixed- time period models generate order quantities that vary from period to period, quantities that vary from period to period, depending upon the usage rates. These depending upon the usage rates. These generally require a higher level of safety generally require a higher level of safety stock than a fixed order quantity system. stock than a fixed order quantity system.

Fixed time period model with safety stock-Fixed time period model with safety stock-

Order quantity = average demand over the Order quantity = average demand over the period + safety stock – inventory currently period + safety stock – inventory currently on hand on hand

REVIEW PERIOD FOR P-REVIEW PERIOD FOR P-MODELMODEL

The optimal review period is approximately The optimal review period is approximately given by;given by;

P = 1P = 1

N (opt)N (opt)

DIFFERENCE BETWEEN DIFFERENCE BETWEEN Q-MODEL AND P-MODELQ-MODEL AND P-MODEL

Features Q-model P-modelFeatures Q-model P-model

Order Quantity

Q- constant (Same amt. Ordered each time)

Q- variable (varies each time order is placed)

When to place order

when inventory position drops to the reorder level

When the review period arrives

Record keeping

Each time a withdrawal or addition is made

Counted only at review period

Size of inventory

Less than fixed time period model

Larger than fixed order quantity model

ABC classification scheme divides inventory items into three ABC classification scheme divides inventory items into three grouping:grouping:

high rupee volume (A)high rupee volume (A) moderate rupee volume (B)moderate rupee volume (B) low rupee volume (C)low rupee volume (C) Rupee volume is a measure of importance; an item low in cost but Rupee volume is a measure of importance; an item low in cost but

high in volume can be more important than a high cost item with high in volume can be more important than a high cost item with low volume.low volume.

Basis is usually annual volumeBasis is usually annual volume volume = Annual demand x Unit costvolume = Annual demand x Unit cost

Policies based on ABC analysisPolicies based on ABC analysis Develop class A suppliers moreDevelop class A suppliers more Give tighter physical control of A itemsGive tighter physical control of A items Forecast A items more carefullyForecast A items more carefully

ABC AnalysisABC Analysis

% of Inventory Items

Classifying Items as ABCClassifying Items as ABC

0

20

40

60

80

100

0 50 100

% Annual Usage

AABB

CC

Class % Vol % ItemsA 80 15B 15 30C 5 55

CYCLE COUNTINGCYCLE COUNTING

Cycle counting is a physical inventory Cycle counting is a physical inventory taking technique in which inventory is taking technique in which inventory is counted frequently rather than once or counted frequently rather than once or twice a year.twice a year.

The key to effective cycle counting is in The key to effective cycle counting is in deciding;deciding;

which items are to be counted,which items are to be counted,

when to be counted,when to be counted,

by whom to be counted.by whom to be counted.

CYCLE COUNTING CONTD.CYCLE COUNTING CONTD. The easiest time for stock to be counted is when The easiest time for stock to be counted is when

there is no activity in the stock room or on the there is no activity in the stock room or on the production floor. This means on the production floor. This means on the week-ends or week-ends or during the second or third shiftduring the second or third shift, when the facility is , when the facility is less busy. less busy.

The level of accuracy between physical inventory The level of accuracy between physical inventory and records has been much debated. The and records has been much debated. The recommended accuracy level by experts is:recommended accuracy level by experts is:

• + 0.2 % for A items,+ 0.2 % for A items,• + 1 % for B items,+ 1 % for B items,• + 5% for C items.+ 5% for C items.