Page |1 DEFINITION OF INVENTORY Inventory is the stock of any item or resource used in an organisation.

Inventory system is the set of policies and controls that monitor levels of inventory and determine what level should be maintained, when stock should be replenished, and how large orders should be. PURPOSES OF INVENTORY To maintain independence of operations. A supply of materials at a work center allows that center flexibility in operations. To meet variation in product demand. If the demand for the product is known precisely, it may be possible to produce the product to exactly meet the demand. To allow flexibility in production scheduling. To provide a safe guard for variation in raw material delivery time. To take advantage of economic purchase order size. Types of Inventory Raw material Work-in-progress Maintenance/repair/operating supply Finished goods

The Functions of Inventory To decouple or separate various parts of the production process To provide a stock of goods that will provide a selection for customers To balance the seasonal fluctuations in demand To take advantage of quantity discounts To meet the fluctuation losses during machinery breakdown, shut down arising out of non-availability vital inputs To hedge against inflation and upward price changes To protect against stock-outs. Disadvantages of Inventory Higher costs Item cost (if purchased) Ordering (or setup) cost Costs of forms, clerks wages etc. Holding (or carrying) cost Building lease, insurance, taxes etc. Difficult to control Hides production problems

Page |2 INVENTORY MODELS Independent versus Dependent Demand Holding, Ordering, shortage costs and Setup Costs INVENTORY MODELS FOR INDEPENDENT DEMAND 1.Basic Economic Order Quantity (EOQ) Model Minimizing Costs Reorder Points 2.Production Order Quantity Model 3.Quantity Discount Models Independent versus Dependent Demand Independent demand - The demand for various items are unrelated to each other. Dependent demand - demand for item is dependent upon the demand for some other item INVENTORY COSTS Holding or carrying costs Ordering costs Shortage costs Setup or production change costs.

Holding (Carrying) Costs Obsolescence Insurance Extra staffing Interest Damage Warehousing. Etc.

Ordering Costs Supplies Forms Order processing Clerical support Etc.

Page |3 SHORTAGE COSTS When the stock of an item is depleted, an order for that item must either wait until the stock is replenished or be cancelled. There is a trade off between carrying stock to satisfy demand and the costs resulting from stock out. This balance is sometime difficult to obtain, because it may not be possible to estimate lost profits, the effect of lost customers, or lateness penalties. Setup Costs Clean-up costs Re-tooling costs Adjustment costs Etc.

What is Inventory Stock of materials Stored capacity Examples The Material Flow Cycle

Techniques for Controlling Service Inventory Include Good personnel selection, training, and discipline Tight control of incoming shipments Effective control of all goods leaving the facility Inventory Models Fixed order-quantity models (Q- model) Economic order quantity Production order quantity Quantity discount

Page |4 Probabilistic models Fixed order-period models (P-model) Economic order quantity (EOQ) Economic order quantity (also known as the Wilson EOQ Model or simply the EOQ Model) is a model that defines the optimal quantity to order that minimizes total variable costs required to order and hold inventory. The model was originally developed by F. W. Harris in 1913, though R. H. Wilson is credited for his early in-depth analysis of the model. Underlying assumptions 1. 2. 3. 4. 5. the annual (or monthly) demand for the item is known, deterministic and constant the lead time is not taken into account the receipt of the order occurs in a single instant and immediately after ordering it quantity discounts are not calculated as part of the model the ordering cost is constant

Note that deterministic does not imply the constancy of the demand. For instance, the sine function is deterministic, but not constant. Deriving an EOQ 1. 2. 3. 4. Develop an expression for setup or ordering costs Develop an expression for holding cost Set setup cost equal to holding cost Solve the resulting equation for the best order quantity

EOQ Model When To Order

Page |5 EOQ Model How Much to Order?

Why Holding Costs Increase More units must be stored if more are ordered Why Order Costs Decrease Cost is spread over more units

Variables Q = order quantity Q * = optimal order quantity R = annual demand quantity of the product P = purchase cost per unit C = fixed cost per order (not per unit, in addition to unit cost) H = annual holding cost per unit (real estate for warehouse space, refrigeration, etc. usually not related to the unit cost) The Total Cost function The single item EOQ formula finds the minimum point of the following cost function:

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Total Cost = purchase cost + ordering cost + holding cost

- Purchase cost: This is the variable cost of goods: purchase unit price annual demand quantity. This is PR - Ordering cost: This is the cost of placing orders: each order has a fixed cost C, and we need to order R/Q times per year. This is C R/Q - Holding cost: the average quantity in stock (between fully replenished and empty) is Q/2, so this cost is H Q/2

In order to determine the minimum point of the total cost curve, set its derivative equal to zero:

The result of this differentiation is:

Solving for Q gives Q* (the optimal order quantity):

Therefore:

Page |7 EXAMPLE A hospital procures its supplies of a material once a year. The total number procured is 2400 packages (in a year). This policy of procuring material once a year is being questioned. The accountants calculate the costs of inventory holding at rs. 36/ package/ year. It is also fgured out that the cost of procurement ad upto rs. 1200 per order. What inventory policy would you advise to this hospital?

The Reorder Point (ROP) Curve

Page |8 Production Order Quantity Model Answers how much to order and when to order Allows partial receipt of material Other EOQ assumptions apply Suited for production environment Material produced, used immediately Provides production lot size Lower holding cost than EOQ model Reasons for Variability in Production Most variability is caused by waste or by poor management. Specific causes include: employees, machines, and suppliers produce units that do not conform to standards, are late or are not the proper quantity inaccurate engineering drawings or specifications production personnel try to produce before drawings or specifications are complete customer demands are unknown 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-off is between lower price & increased holding cost Quantity Discount Schedule Discount Discount Number Quantity 1 2 3 0 to 999 1,000 to 1,999 2,000 and over

Discount (%) No discount 4 5

Discount (P) Rs. 5.00 Rs. 4.80 Rs. 4.75

Price

Probabilistic Models Answer how much & when to order Allow demand to vary Follows normal distribution Other EOQ assumptions apply Consider service level & safety stock Service level = Probability of stockout Higher service level means more safety stock

Page |9 Fixed Period Model Answers how much to order Orders placed at fixed intervals Inventory brought up to target amount Amount ordered varies No continuous inventory count (counted at particular times such as every week or every month) Possibility of stockout between intervals Useful when vendors visit routinely Useful when buyers want to combine orders to save transportation costs. Fixed- time period models generate order quantities that vary from period to period, depending upon the usage rates. These generally require a higher level of safety stock than a fixed order quantity system. Fixed time period model with safety stockOrder quantity = average demand over the period + safety stock inventory currently on hand REVIEW PERIOD FOR P-MODEL The optimal review period is approximately given by; P = 1/ N (opt)