Chapter 14

Inventory Control
Inventory

 Definition--The stock of any item or resource

used in an organization
 An inventory system is the set of policies and
controls that monitor levels of inventory and
determine what levels should be maintained,
when stock should be replenished, and how large
orders should be.
 Inventory

Manufacturing Inventory is typically classified into:

Raw materials Finished products
Component parts Supplies
Work in process
In service organization, inventory generally refers to
the tangible goods to be sold and the supplies
necessary to administer the service.
 Inventory

 Thebasic purpose of inventory analysis in

manufacturing and stockkeeping services is to
specify:

 1.When items should be ordered

 2.How large the order should be.

Purposes of Inventory

1. To maintain independence of operations

2. To meet variation in product demand
3. To allow flexibility in production scheduling
4. To provide a safeguard for variation in raw
material delivery time
5. To take advantage of economic purchase-order
size
Inventory Costs

 Holding (or carrying) costs

 Setup (or production change) costs

 Ordering costs

 Shortage costs
Classifying Inventory Models

 Fixed-Order Quantity Models

– Event triggered

 Fixed-Time Period Models

– Time triggered
Fixed-Order Quantity Models
Assumptions

 Demand for the product is constant and uniform

throughout the period

 Lead time (time from ordering to receipt) is

constant

 Price per unit of product is constant

Fixed-Order Quantity Models
Assumptions

 Inventory holding cost is based on average

inventory

 Ordering or setup costs are constant

 Alldemands for the product will be satisfied (No

back orders are allowed)
 EOQ Model--Basic Fixed-Order
Quantity Model

Number
of units
on hand Q Q Q

R
L L

Time
R = Reorder point
Q = Economic order quantity
L = Lead time
Cost Minimization Goal

C
O Total Cost
S
T Holding
Costs
Annual Cost of
Items (DC)

Ordering Costs

QOPT
Order Quantity (Q)
Basic Fixed-Order Quantity Model
Annual Annual Annual
Total Annual Cost = Purchase + Ordering + Holding
Cost Cost Cost
TC Total annual cost
D Demand
C Cost per unit
D Q Q Order quantity
TC = DC + S + H S Cost of placing an order
Q 2
or setup cost
R Reorder point
L Lead time
H Annual holding and storage cost
per unit of inventory
Deriving the EOQ

 Using calculus, we take the derivative of the total

cost function and set the derivative (slope) equal
to zero
2D S 2(A nnual D em and)(O rder or Setup C ost)
Q O PT = =
H A nnual H olding C ost

_
R eorder p oint, R = d L
_
d = average daily demand (constant)
L = Lead time (constant)
In-Class Exercise

Annual Demand = 10,000 units

Days per year considered in average daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = 10% of cost per unit
Lead time = 10 days
Cost per unit = $15

Determine the economic order quantity and the reorder point.

16
Solution

2D S 2(10,000 )(10)
Q O PT = = = 365.148 un its, or 366 u n its
H 1.50

10,000 units / year

d= = 27.397 units / day
365 days / year
_
R = d L = 27.397 units / day (10 days) = 273.97 or 274 units

When the inventory level reaches 274, order 366 units.

17
ABC Classification System
 Items
kept in inventory are not of equal
importance in terms of:
– dollars invested 60
% of
– profit potential $ Value 30 A
0 B
– sales or usage volume % of 30 C
Use 60
– stock-out penalties

26
PRICE – BREAK MODEL

This model deals with the fact that, the

selling price of an item varies with the order
size. This is a discrete or step change rather
than a per unit change.
The total cost for each feasible economic
order quantity and price-break order
quantity is tabulated, and the Q that leads to
the minimum cost is the optimum order
size.
PRICE – BREAK MODEL

Process of solving the price break problem:

1.Calculate the EOQ
2.Find whether feasible or not
3.Calculate total cost
4.Find the total minimum cost
5. Total minimum cost is the optimal solution
6. Order the quantity where the solution is optimal
EXAMPLE

D= 10,000 Units ( Annual Demand)

S= $ 20.00 to place each order
I = 20 per cent of cost
C = Cost per unit: (According to the order size)
Orders of 0 to 499 Units , Unit Price $5.00
Orders of 500 to 999 units, Unit Price $4.50
Orders of 1000 and above, Unit price $ 3.90

What Quantity should be ordered?

SOLUTIONS
 Theappropriate equations from the basic fixed-
quantity case are:

D Q
TC = DC + S + ic
Q 2

2DS
Q=
H
 SOLUTIONS

Q=633 Q=666 Q=716 Price Break

C=$5 C=$4.5 C=$3.9 1,000
Item cost 45,000 10000 *3.9
(DC) =39,000
Ordering Not (10000*20)/ Not (10000*20)/10
cost(D/Q*S feasible 666=$300 feasible 00 = $200
)
Holding 666/2*(.2*4. (1000/2)*(.2*3.
cost 5)= $299.7 9 =$390
(Q/2*ic)
Total Cost $45,599.7 $39,590
(TC)
 SOLUTIONS

 Solving for the economic order size, we obtain:

 C=$3.9, Q= 716 Not feasible
 C= $4.5, Q= 666 Feasible, TC= $45,599.7
 Price Break Q= 1,000, Cost = $39,590
 Place order for 1000 units which is the optimal
solution.