Inventory Management-I PPT 16-18

Managing Value Chain through Operations
Operations Management - II
You know following topics

from Operations Management - I
Forecasting
Process strategy
Capacity planning
Facility location
From Operations Research subject:

Linear programming Problem
Transportation Problem
Assignment Problem
Inventory Management
Inventory Models
Inventory Control
Sorry we are out of that item
How often have you heard that during

shopping trips?
Stock of goods is necessary for future use or sale.
In this chapter, I will highlight the kinds of scientific

techniques of which develops mathematical models of
inventory processes.
Learning Goals:
Identify the advantage, disadvantage and costs of holding

Inventory.
Calculate the economic order quantity and apply it to various

Situations.
Define the different types of inventory and the roles they play
in supply chains.
Use ABC analysis to determine the items deserving most

Attention.
Determine the order quantity and order point for a continuous

review inventory control system.
What is Inventory
Inventory is the stock of any item or resource that has a economic
value and is maintained to fulfill the present and future needs of the
organization.
Manufacturing inventory :Raw material, semi-finished good,
finished goods, spare parts, etc.
Service inventory : refers to the tangible goods to be sold and

supplied necessary to administer the service.
Hospital: No of beds, stock of drugs, specialized personnel etc.

Bank: Cash reserves, tellers etc.
Airline company: Seating capacity, spare part, specialized maintenance
crew etc.
Unsold goods for sales or raw materials awaiting for manufacture.

Investing large inventories affect an organization's cash
flow and working capital.
Example: Automobile assembly plants and component manufacturers

are knows to carry little inventory and provide good quality finished
goods at the right time.
This will ensure that total inventory cost is minimal.
The basic purpose of inventory analysis is to
When items should be ordered ?

How large the order should be ? and
How much safety stock should be kept?
Inventory Management
Inventory Management is the planning and controlling or
methods use to organize, store, replace inventory to meet
supply of goods with cost minimization.
Too much of inventory reduces the profitability

Too little of inventory creates a shortage in supply chain
and damage customer confidence.
So, Inventory management involves trade-off.
Objectives of Inventory management
Optimal size of inventory for smooth production and sales

Maximize profitability
Minimum investment in inventories
Purpose of Inventory:
To meet the product demand.
Meet unexpected demand
Smooth seasonal or cyclic demand
To allow flexibility in production scheduling
Giving Price discount or price increase
To take advantage of economic purchase order size
It helps in smooth and effective running of an enterprise.
Irregular supply and demand
Avoiding stockouts (shortages)

Causes of poor inventory control:
I. Overbuying without regard to the forecast or proper

estimate the demand
II. Overproduction
III. Overstocking
IV. Cancellation of orders
V. Customer shift to competitors loss of sales.

Inventory Costs:
1: Purchase cost: actual price paid for the procurement of items.
Purchase cost = ( price per unit ) x (demand per unit time)
2: Holding (or Carrying cost): Cost carrying (or holding) inventory, i.e
facilities, storage, handling, insurance, breakage, taxes, depreciation etc.
Carrying cost = (Cost of carrying one unit of an item in the inventory

for a given length of time) X (Average number of units
of an item carried in the inventory for given time)
3: Ordering (or set-up cost): cost associated with the cost of placing
orders for procurement items. i.e Quotation, requisition ,order placing,
stationary, mailing, telephone calls, receiving, inspecting and storing etc.
Ordering cost = ( cost per order ) x (number of orders or set-up in the

inventory planning period)
Shortage (or stock out) cost: The shortage of items occurs when
actual demand cannot be fulfilled.
1) The supply of items is awaited by the customers. i.e the items are
back ordered
2) Customer are not ready to wait and there is loss of sale.
Shortage cost = ( Cost of being short one unit in the inventory) x

(Average number of units short in the inventory)
Factor Affecting Inventory Control
Demand
Lead Time
Order cycle
Re-order level
Stock replenishment
Buffer stocks
An Inventory Control problem:
The steps to built up a suitable inventory problem:
Step 1: Collect the data regarding the pattern of demand, time horizon,
inventory cost etc.
Step 2: Built up an appropriate relationship so as to develop objective

function of minimizing the total inventory costs subjects to changes in
inventory reorder policy and limits resources (storage, capital etc.).
Problem may be unconstrained optimization problem or mathematical
programming problem depending the constraints.
Step 3: Drive optimal inventory police( Economic order quantity, EOQ) by

appropriate solution procedure so as to balance inventory costs.
Future demand know exactly: Inventory problem is said under certainty

Probability of distribution of future demand ( from the past record) is
know: Inventory problem under risk
Future demand is are unknown : Inventory under uncertainty.
Planning for dependent demand item is done to meet manufacturer
requirements, In case of independent demand items, it is done to
meet customer requirements.
Attributes of Independent demand item:

They are continuous demand
Example: Demand of Sony 32 LCD colour television panels in a
particular city is continuous.
When demand is continues for an item:
i)Constant availability
ii)Periodic replenishment of stock
iii)Improve Planning process
Otherwise lost of sales, poor customer goodwill, additional cost.
Uncertainty of Demand:
Independent demand items are uncertainty. So in inventory planning
independent demand items are addressed.
Inventory models for independent demand:
Basic economic order quantity (EOQ) model
The basic economic order quantity model:
Model (I): The Economic Lot size model with constant demand
The economic order quantity (EOQ) is commonly known inventory

control techniques.
Assumptions:
Demand is known ,continuous and constant over time.
Lead time, that is, the time between the placement of the
order and the receipt of the order, is known and fixed.
Receipt of inventory is instantaneous. In other words,

the inventory from an order arrives in one batch, at one time.
Quantity discounts are not possible
The only variable costs are an ordering (or setup cost)

and holding or carrying cost).
There are no stock overages or shortages.

The optimal order quantity occurred at the point where the
ordering cost curve and the carrying cost curve intersected.
with the EOQ model, the optimal order quantity will occur at a
point where the total setup cost is equal to the total holding cost.
Model formulation:
Q = Number of pieces per order

Q* = Optimum number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
Inventory Model with constant Demand and instantaneous Supply

Ordering cost = (Number of orders placed per year) x
(order cost per order)
= (Annual demand / Number of units in each order) x
order cost per order
= (D / Q) S
Holding cost = (Average inventory level) x

(holding cost per unit per year)
= ([L max + L min ]/2 ) x Holding cost per unit per year
= (Q / 2) H
Optimal order quantity is when ordering cost equals to

holding cost.
i.e
(D/Q) S = (Q/2) H
_______
Q* = (2DS)/H
The total annual inventory cost is the sum of the Ordering and
holding costs:
Total annual cost = Ordering cost + Holding cost
TC = (D/Q) S + (Q/2) H
Other Formulae:
1)Optimal length of inventory replenishment cycle time (t*)

i.e optimal interval between the successive order:
t* = Q*/D
2)Optimal number of order (N*) to be placed in a given time
period assume (One year)
N* = D / Q*
3) Optimal (minimum) total cost:
TC = (D/Q) S + (Q/2) H
_________
TC* = (2DSH)
Problem :
A manufacturing company purchases 9,000 parts of a

machine for its annual requirements, ordering one months
requirement at a time . Each part costs $ 20.The ordering
cost per order is $ 15 and the carrying changes are 15% of
the average inventory per year. You have been asked to
suggest a more economic purchasing police for the company.
What advice would you offer, and how much would it save the
company per year.
Problem(2):
A two-wheeler component manufacturing unit uses large

quantities of a component made of steel. Although these are
production items, the demand is continuous and inventory
planning could be done independent of the production plan.
The annual demand of the component is 2,500 boxes. The
company produces the item from a supplier at the rate of
Rs. 750 per box. The company estimates the cost of carrying
inventory to be 18 per cent per unit per annum and the cost
ordering as Rs 1,080 per order. The company works for 250
in a year. How should the company design an inventory control
system for this item? What is the overall cost of the plan?
Production Order Quantity model :
This model is applicable when inventory continuously flows or builds up

over a period of time after an order has been placed or when units are
produced and sold simultaneously. We take into account the daily
production (or inventory flow) rate and the daily demand rate.
We can determine the annual inventory holding cost for the production
run model:
Assumptions:1) Supply is continuous and constant
2) Production rate per unit time > demand rate
3) Production begins immediately after production set up
Q = Number of pieces per order

H = Holding cost per unit per year
p = Daily production rate
d = Daily demand rate
t = Length of the production run in days
1) Annual inventory holding cost = (Average inventory level) x
(Holding cost per unit per year)
= (Average inventory level) x H
a) Average inventory level = (Maximum inventory level) /2
b) Maximum inventory level = (Total produced during the

production run)
(Total consumed during the production run)
= pt dt
But Q = total produced = pt,
So, t = Q/p.
Therefore,
Maximum inventory level = p(Q/p) d(Q/p)

= Q (d / p) Q
= Q (1 d / p)
Annual inventory holding cost (or simply holding cost) =
(Maximum inventory level / 2) H = (Q / 2) ( 1 (d / p) ) H
= (1/2) HQ (1 (d / p) )
Setup cost = (D / Q) S
Set ordering cost equal to holding cost to obtain EOQ Model (Q*p)
(D / Q) S = (1/2) HQ(1 (d / p))
Q2 = 2DS / (H (1 (d / p))
________________
Q*p = 2DS / H (1 (d / p))
Q*p Economic Production Lot Size when inventory is
consumed as it is produced.
Other Formulae:
1)The total Minimum inventory cost:
TC* = (D / Q*) S + (1/2) HQ* (1 (d / p) )
On substituting the value of Q* we get

_______________
Optimal cost = 2DSH (1 (d / p)
2) Optimal length of each lot size production run:
t*p = Q*/ p
_________________
= 1/p ( 2DS / (H (1 (d / p))
3) Optimal production cycle time: t* = Q* /D
_________________
= 1/D ( 2DS / (H (1 (d / p))
_______________
= ( 2 S /DH (1 (d / p)
4) Optimal number of production runs per year: N* = D/ Q*

_________________
= D/ ( 2DS / (H (1 (d / p))
_______________
=( DH (1 (d / p)/2S
Problem:
A product is sold at the rate of 50 pieces per day and is manufacturing

at a rate of 250 pieces per day. The set up costs of the machines are $
5000 and the storage costs are found to be $ 0.15 per pieces per day,
with labor charges of $ 20 per pieces , material cost $ 15 and overhead
$ 50 per piece, find the minimum cost batch size if the interest charges
are 8 percent. Compute the optimal number of cycles required in a year
for manufacturing of this product. (Assume 300 working days in a
year.)
Home Assignment :
The economical lot size model with different rates of

demand in different cycle.

Inventory Management-I PPT 16-18

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Managing Value Chain through Operations

You know following topics

From Operations Research subject:

How often have you heard that during

Stock of goods is necessary for future use or sale.

In this chapter, I will highlight the kinds of scientific

Identify the advantage, disadvantage and costs of holding

Calculate the economic order quantity and apply it to various

Use ABC analysis to determine the items deserving most

Determine the order quantity and order point for a continuous

Service inventory : refers to the tangible goods to be sold and

Hospital: No of beds, stock of drugs, specialized personnel etc.

Unsold goods for sales or raw materials awaiting for manufacture.

Example: Automobile assembly plants and component manufacturers

This will ensure that total inventory cost is minimal.

The basic purpose of inventory analysis is to

When items should be ordered ?

Too much of inventory reduces the profitability

So, Inventory management involves trade-off.

Objectives of Inventory management

Optimal size of inventory for smooth production and sales

To allow flexibility in production scheduling

Giving Price discount or price increase

To take advantage of economic purchase order size

It helps in smooth and effective running of an enterprise.

Irregular supply and demand

Avoiding stockouts (shortages)

I. Overbuying without regard to the forecast or proper

IV. Cancellation of orders

V. Customer shift to competitors loss of sales.

Carrying cost = (Cost of carrying one unit of an item in the inventory

Ordering cost = ( cost per order ) x (number of orders or set-up in the

2) Customer are not ready to wait and there is loss of sale.

Shortage cost = ( Cost of being short one unit in the inventory) x

Step 2: Built up an appropriate relationship so as to develop objective

Step 3: Drive optimal inventory police( Economic order quantity, EOQ) by

Future demand know exactly: Inventory problem is said under certainty

Attributes of Independent demand item:

Basic economic order quantity (EOQ) model

The basic economic order quantity model:

The economic order quantity (EOQ) is commonly known inventory

Receipt of inventory is instantaneous. In other words,

Quantity discounts are not possible

The only variable costs are an ordering (or setup cost)

There are no stock overages or shortages.

Q = Number of pieces per order

Inventory Model with constant Demand and instantaneous Supply

Holding cost = (Average inventory level) x

Optimal order quantity is when ordering cost equals to

1)Optimal length of inventory replenishment cycle time (t*)

A manufacturing company purchases 9,000 parts of a

A two-wheeler component manufacturing unit uses large

This model is applicable when inventory continuously flows or builds up

Q = Number of pieces per order

= (Average inventory level) x H

a) Average inventory level = (Maximum inventory level) /2

b) Maximum inventory level = (Total produced during the

Maximum inventory level = p(Q/p) d(Q/p)

Annual inventory holding cost (or simply holding cost) =

TC* = (D / Q) S + (1/2) HQ (1 (d / p) )