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Learning Objectives
After reading this lesson you would be able to understand
Importance of inventory management
Different types of inventory
Classifying different types of inventory
Optimal ordering quantity
Well dear students, all of us, I guess has a fair bit of an idea about
what inventory is all about. I don’t know about your answer, but as
far as I am concerned, this class has an abundant inventory of,
what you call the skill set and talent i.e. the human capital.
Please allow me to focus on the job at hand in a better and
organized manner.
Inventory management
Inventory management is an important concern for all managers.
Inventory is created when the receipt of materials, parts, or
finished goods exceeds their disbursement. It is depleted when
their disbursement exceeds their receipt. Inventory can serve
important functions that add flexibility to the operations of a firm.
Well, what about the uses of inventory?
Any answers around here?
Inventory-uses
Six uses of inventory are:
1. To provide a stock of goods to meet anticipated demand by
customers.
2. To decouple production from distribution. For example, if
product demand is high only during the summer, a firm may
build up stock during the winter and thus avoid the costs of
shortages and stockouts in the summer. Similarly, if a firm’s
supplies fluctuate, extra raw materials of inventory may be
needed to “decouple” production processes.
3. To take advantage of quantity discounts, since purchases in
larger quantities can substantially reduce the cost of goods.
4. To hedge against inflation and price changes.
5. To protect against shortages that can occur due to weather,
supplier shortages, quality problems, or improper deliveries.
“Safety stocks”, namely, extra goods on hand, can reduce the
risk of stockouts.
6. To permit operations to continue smoothly with the use of
“work-in-process” inventory. This is because it takes time to
make goods and because a pipeline of inventories are stocked
throughout the process.
Types of inventory
There are four types of inventories generally a firm maintains.
These are:-
(1) raw material inventory,
(2) work-in-process inventory,
(3) maintenance/repair/operating supply (MRO) inventory, and
(4) finished goods inventory.
Inventory management-
Operations managers establish systems for managing inventory.
First step is to classify inventory items.
Thousands of items are held in inventory by a typical organization,
but only a small percentage of need management’s closest
attention and tightest control. ABC analysis is the process of
dividing items into three classes according to their value (rupee
usage) so that managers can focus on items that have the highest
value. This method is the equivalent of creating a Pareto chart
except that it is applied to inventory rather than quality. The Pareto
principle states that there are a “critical few and trivial many”. The
idea is to focus resources on the few critical inventory parts and
not the many trivial ones. Figure 10.1 shows, class A items
typically represent only about 20 percent of the items but account
for 80 percent of the rupee usage. Class B items account for
another 30 percent of the items but only 15 percent of the rupee
usage. Finally, 50 percent of the items fall in class C, representing
a mere 5 percent of the rupee usage.
Example 10.1
The maintenance department for a small manufacturing firm has
responsibility for maintaining an inventory of spare parts for the
machinery it services. The parts inventory, unit cost, and annual
usage are as follows.
Part Unit Cost Annual
(Rs) Usage
1 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120
Ordering cost
Ordering cost includes costs of supplies, forms, order processing,
clerical support, and so forth. When orders are being
manufactured, ordering costs also exist, but they are known as
setup costs.
Setup cost is the cost to prepare a machine or process for
manufacturing an order. In many environments setup cost is highly
correlated with setup time. Setup usually requires a substantial
amount of work prior to an operation actually being accomplished
at the work center.
Inventory models for independent demand
Here we will introduce three inventory models that address two
important questions: when to order and
How much to order.
These independent demand models are:
1. Basic economic order quantity (EOQ) model
2. Production order quantity model
3. Quantity discount model
Figure 29.1 shows the inventory usage over time under these
assumptions. Q represents the amount that is ordered. If this
amount is 500 dresses, all 500 dresses arrive at one time (when an
order is received). Thus, the inventory level jumps from 0 to 500
dresses. In general, an inventory level increases from 0 to Q units
when an order arrives.
Q2 = (2DS/H)
Q* = √(2DS)/H
The total annual inventory cost is the sum of the setup and
holding costs:
Example 10.2
Electronic Village stocks and sells a particular brand of personal
computer. It costs the store Rs450 each time it places an order
with the manufacturer for the personal computers. The annual
cost of carrying the PCs in inventory is Rs170. The store
manager estimates that annual demand for the PCs will be 1200
units. Determine the optimal order quantity and the total
minimum inventory cost.
Solution:
D = 1200 personal computer
H = Rs170
S = Rs450
Q* = √(2DS)/H
= √(2 (450)(1200) / 170)
= 79.7 personal computers
TC = (D/Q) S + (Q/2) H
= 450 (1200/79.7) + 170 (79.7/2)
= Rs13,549.91
Reorder points
Once we have decided how much to order, now we will look at
the second inventory question, when to order. The time
between the placement and receipt of an order, called the lead
time or delivery time, can be as short as a few hours to as long
as months. Thus, when-to-order decision is usually expressed in
terms of a reorder point, the inventory level at which an order
should be placed.
The reorder point (ROP) is given as:
Example 10.3
The I-75 Discount Carpet Store is open 311 days per year. If
annual demand is 10,000 yards of Super Shag Carpet and the
lead time to receive an order is 10 days, determine the reorder
point for carpet.
Solution:
r = dL
= (10,000/ 311) 10
= 321.54
Thus, when the inventory level falls to approximately 321 yards
of carpet, a new order is placed. Notice that the reorder point is
not related to the optimal order quantity or any of the inventory
costs.
Friends, the next model lined up for today’s discussion is:-
Figure 29.2 Inventory levels over time for the production model
Setup cost = (D / Q) S
Holding cost = (1/2) HQ (1 – (d / p) )
Q2 = 2DS / (H (1 – (d / p))
Solution:
S = Rs150
H = Rs0.75
D = 10,000 meters
d = 10,000 / 311 = 32.2 meters per day
p = 150 meters per day
Points to ponder