Inventory

Planning &
Control
 Amazon.com
 Amazon.com started as a “virtual”
retailer – no inventory, no
warehouses, no overhead; just
computers taking orders to be filled
by others
 Growth has forced Amazon.com to
become a world leader in
warehousing and inventory
management

© 2011 Pearson Education, Inc.

 Inventory………
………
• Inventory is an idle stock of physical goods
that contain economic value, and are held in
various forms by an organization in its
custody awaiting packing, processing,
transformation, use or sale in a future point of
time.
 Inventory
Planning
• The process of determining the optimal quantity
and
timing of Inventory for the purpose of aligning it
with sales and production capacity .

•Inventory planning has direct impact a company's

cash flow and profit margins especially for
smaller businesses that rely upon a quick turnover
of goods or materials.
Objectives of Inventory
Planning
Inventory Planning for
Independent Demand
• Independent Demand: Finished goods &
Spare Parts
• To meet customer requirement.
• Continuous Demand
• Uncertainty in the demand

• Dependent Demand: to meet

manufacturing requirements
 Examples for Independent Versus
Dependent Demand
Independent demand – finished goods, items that
are ready to be sold such as computers, cars.
Forecasts are used to develop production and
purchase schedules for finished goods.
Dependent demand – components of finished
products (computers, cars) such as chips, tires and
engine
Dependent demand inventory control
techniques utilize material requirements
planning (MRP) logic to develop production and
purchase schedules
 Independent Demand

A Dependent Demand

B(4) C(2)

D(2) E(1) D(3) F(2)

Independent demand is uncertain. That is why it is forecasted.

Dependent demand is certain and it is calculated.
Regardless of the nature of demand
(independent, dependent) two fundamental
issues underlie all inventory planning:

How Much to Order?

When to order?

11
 Types of Inventory
INPUT PROCESS OUTPUT
Raw Materials Work In Process Finished Goods
Consumables required Semi Finished Finished Goods at
for processing. Eg : Production in various Distribution Centers
Fuel, Stationary, Bolts stages, lying with through out Supply
& Nuts etc. required in various departments Chain
manufacturing like Production, WIP
Stores, QC, Final
Assembly, Paint Shop,
Packing, Outbound
Store etc.
Maintenance Production Waste Finished Goods in
Items/Consumables and Scrap transit
 INPUT PROCESS OUTPUT
Raw Materials Work In Process Finished Goods
Packing Materials Rejections and Finished Goods with
Defectives Stockiest and Dealers
Sales Promotion &
Sample Stocks
Local purchased Spare Parts Stocks &
Items required for Bought Out items
production
Defectives, Rejects
and Sales Returns
Repaired Stock and
Parts
Sales Promotion &
Sample Stocks
Advantages of inventory planning
You know your stock levels
You can conduct stock rotation
You can optimize and reduce stock of items
that don’t move that quickly
You can move you quick moving items to
the front thereby speeding up picking
You can quick identify items that are not
moving that you can remove from your
inventory
Disadvantages of inventory planning
It doesn’t stop staff stealing stock
It can waste a lot of effort if not
implemented and maintained correctly
It doesn’t replace incompetent
management
It can be very expensive and the return on
investment can take a long time
It requires a lot of staff training and you
may loose some staff on the way
Inventory System
A set of policies and controls that monitors levels of
inventory and determines what levels should be
maintained, when stock should be replenished, and
how large orders should be
Single Period Inventory
•A business scenario faced by companies that order
seasonal or one time items.
•There is only one chance to get the quantity right
when ordering , as the product has no value after the
time it is needed
•The amount of the single order is based on balancing
the cost of over- and under-estimating demand. This is
a very common problem in areas such as:

For example:
•Newspaper
•Christmas trees
•t-shirts for a sporting event
Multi period inventory system
• 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

Inventory holding cost is based on average

inventory

Ordering or setup costs are constant

All demands for the product will be satisfied (No

back orders are allowed)
 Fixed- order

multi quantity
models/
EOQ(Economi

period c Order
Quantity)

inventory Fixed- time

periods
models/p-
system model
Multi-Period Inventory Models

Fixed-Order Quantity Models: Each time a fixed

amount of order is placed.
Economic Order Quantity (EOQ) Model
Production Order Quantity (POQ) Model
Quantity Discount Models

Fixed-Time Period Models : Orders are placed at

specific time intervals .
Key Inventory Terms
Holding (carrying) costs: cost to carry an item in
inventory for a length of time, usually a year (heat, light,
rent, security, deterioration, spoilage, breakage,
depreciation, opportunity cost,…, etc.,)

Ordering costs: costs of ordering and receiving inventory

(shipping cost, preparing invoices, cost of inspecting
goods upon arrival for quality and quantity, moving the
goods to temporary storage)

Set-up Cost: cost to prepare a machine or process for

manufacturing an order

Shortage costs: costs when demand exceeds supply, the

opportunity cost of not making a sale
Different Types of Inventory Costs
1.Holding\Carrying cost
2.Ordering costs:
3.Storage costs:
4.Setup/production change
costs :
 Holding\Carrying cost
They are expenses such as storage, handling, insurance,
taxes, obsolescence, and interest on funds financing the
goods.
 These charges increase as inventory levels rise. To
minimize carrying costs, management makes frequent
orders of small quantities.
Holding costs are commonly assessed as a percentage of unit
value, rather than attempting to derive monetary value for each
of these costs individually.
This practice is a reflection of the difficulty inherent in
deriving a specific per unit cost, for example, obsolescence or
theft.
Ordering costs:
Ordering costs are those fees associated with placing
an order, including expenses related to personnel in
purchasing department, communications, and the
handling of related paper work.

Lowering these costs would be accomplished by

placing small number of orders, each for a large
quantity.

Unlike carrying costs, ordering expenses are generally

expressed as a monetary value per order.
Storage costs:
When the stock of the item is depleted, an order for
that item must wait until the stock is replenished or be
cancelled

There is a trade off between carrying stock to

satisfy demand and the cost resulting from
stock out
Setup/production change costs
To make each different product involves
obtaining the necessary material,
arranging specific equipment setup, filling
out the required papers, appropriately
charging time and materials, and moving out
the previous stock of material
If there were no cost or loss of time in
changing from one product to another,
many small lots would be produced.
These would reduce inventory levels, with a
resulting saving in cost.
Economic Order Quantity
Economic Order Quantity (EOQ or Q
System)
An optimizing method used for determining order quantity and
reorder points
Part of continuous review system which tracks on-hand
inventory each time a withdrawal is made.

Total Inventory Cost = (D/Q) *Co + (Q/2) *Ch + D*P

Where D= Annual demand, Co = Ordering cost/year,
Ch = Holding cost/year, P = Purchase price/unit,
Q = Order size

Co = (D x O) / Q : Order Cost = annual Demand times cost

per Order,
divided by the order Quantity (number
of units)

Ch = (H x Q) / 2: Holding Cost = annual unit Holding cost

 Economic Order Quantity
EOQ Assumptions:
• Demand is known & constant
- no safety stock is required
• Lead time is known &
constant
• No quantity discounts are
available
• Ordering (or setup) costs are
constant
• All demand is satisfied (no
shortages)
The order quantity arrives in
a single shipment
EOQ Total Costs

Total annual costs = annual ordering costs + annual holding

costs
The EOQ Formula

Minimize the TC by ordering the EOQ:

2 DCO
EOQ 
Ch

Where Co = Ordering cost/year

Ch = Holding/Carrying cost
D = Annual Demand
Number of Orders per year

=Annual Requirement/EOQ
When to Order:
The Reorder Point
Without safety stock:

R dL
With safety stock: where R  reorder point in units
d daily/weekly demand in units
L lead time in days/weeks

R dL  SS
where SS safety stock in units
Example 1.
Demand for the Child Cycle at Best Buy is 500 units per month. Best Buy
incurs a fixed order placement, transportation, and receiving cost of Rs.
4,000 each time an order is placed. Each cycle costs Rs. 500 and the
retailer has a holding cost of 20 percent. Evaluate the number of cycle that
the store manager should order in each replenishment lot?

Problem No.2
The john equipment company estimates its carrying cost at 15% and its
ordering cost at $9 per order. The estimated annual requirement is 48,000
units at a price of $4 per unit.
Required:
(i). What is the most economical no. of units to order?
(ii). No. of orders to be placed in a year.
Example 2:
ABC Ltd. uses EOQ logic to determine the order quantity for its various
components and is planning its orders. The Annual consumption is
80,000 units, Cost to place one order is Rs. 1,200, Cost per unit is Rs. 50
and carrying cost is 6% of Unit cost. Find EOQ, No. of order per year,
Ordering Cost and Carrying Cost and Total Cost of Inventory.
Demand for the Child Cycle at Best Buy is 500 units per month. Best Buy incurs
a fixed order placement, transportation, and receiving cost of Rs. 4,000 each
time an order is placed. Each cycle costs Rs. 500 and the retailer has a holding
cost of 20 percent. Evaluate the number of cycle that the store manager should
order in each replenishment lot?

Soln : We know that EOQ = [2DCo/Ch]^ ½

Given : D = 500x12= 6000 cycles, Co= 4000, Ch= 500x 0.20 = 100

EOQ = [ 2x 6000x 4000 / 100]^1/2 = 693 Cycles

 Problem No.2
The john equipment company estimates its carrying cost at 15% and its ordering
cost at $9 per order. The estimated annual requirement is 48,000 units at a price
of $4 per unit.
Required:
(i). What is the most economical no. of units to order?
(ii). No. of orders to be placed in a year.

Total Inventory Cost = (D/Q) *Co + (Q/2) *Ch + D*P

= (80000/8000) .1200+ (8000/2)* 3+80000x50
= Rs.
EOQ Example
Find EOQ, Reorder point ?

RL = dxL

Weekly demand = 240 units

No. of weeks per year = 52
Ordering cost = $50
Unit cost = $15
Annual carrying charge = 20%
Lead time = 2 weeks
EOQ Example Solution

D 52 240 12,480 units / year

H 0.2 15 $3 per unit per year
2 DS 2 12,480 50
Q  644.98 645 units
H 3
 D   Q   12,480   645 
TC  S    H   50    3 
 Q   2   645   2 
967.44  967.5 $1,934.94

R dL 240 2 480 units

Quantity (Price) Discount Model

40
Quantity (Price) Discount Model
Quantity discount model is used when the vendor (supplier) offers
a discount for buying in large quantities.

For example, the supplier may quote a price of $ 10.00 per unit for
order size 1 to 999 and $ 9.50 for order size of 1,000 or more.

This scenario is also called a “price break” at quantity 1,000.

There could be several price breaks.

41
Example: Quantity (Price)
Discounts
The annual demand (D) for an item is 240,000 units. The ordering cost per order (S) is $
30.00. The inventory carrying cost per unit per year (H) is 30% of the cost (price) of the
item, that is, H = 30% of C.

The vendor has quoted the following costs (prices).

Price 1: $ 2.80 for order quantity less than or equal to 29,999.

Price 2: $ 2.77 for order quantity 30,000 and above.

Find the Economic Order quantity.

42
Example: Quantity (Price) Discounts
(continued)

To solve this problem we will compare the total costs for both
prices. As in the EOQ model, the economic order quantity is
given by the following equation,

QO =

and, the total cost (TC) is given by the following equation:

TC = (D/Q)*S + (Q/2)*H + D*C

43
Example: Quantity (Price) Discounts
(continued)

Start calculations by finding EOQ at the lower price ($ 2.77).

The inventory carrying cost for this price is $0.83 (= 30% of $ 2.77) per unit
per year and the economic order quantity for this price is 4,163.

However, we cannot buy 4,163 units at the price of $ 2.77 because the
minimum quantity specified by the vendor at this price is 30,000.

Therefore, we have to buy at least 30,000 units to obtain this price discount.
We calculate the total cost TC (at 30,000). Using the TC equation,
TC (at 30,000) = (240,000/30,000)*30 + (30,000/2)*0.83 + 240,000*2.77 = $ 677,505.00

44
Example: Quantity (Price) Discounts
(continued)

Now calculate the EOQ for the higher price $ 2.80.

The value of H for this price is $ 0.84 (30% of $ 2.80).
The economic order quantity is 4,140.
This quantity is feasible because we can by up to 29,999 units at $ 2.80 per
unit.

The total cost, TC(at 4,140) will be:

TC (at 4,140) = = (240,000/4,140)*30 + (4,140/2)*0.84 + 240,000*2.80 = $ 675,477.93.

The order quantity for this example is 4,140

since TC (at 4,140) < TC (at 30,000).
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ABC analysis (Inventory)
ABC analysis is an inventory
categorization method which consists in
dividing items into three categories, A, B
and C: A being the most valuable items, C
being the least valuable ones. This method
aims to draw managers’ attention on the
critical
few (A-items) and not on the trivial many
(C-items).

Purpose: To develop policy guidelines for

selective cotrol
 ANALYSIS

CATEGORY PERCENTAGE OF PERCENTAGE OF

ITEMS MONETARY VALUE
A 5-10 (%) 75-85 (%)
B 10-15 (%) 10-15(%)
C 70-80 (%) 5-10(%)

CLASS ‘A’ ITEMS CLASS ‘B’ ITEMS CLASS ‘ C’ ITEMS

1. Close control 1.Moderate control 1. Loose control
required required required
2. Size of order is 2. Size of the order 2. Size of the order
based on calculated based on their based on their level of
requirement. consumption. inventory.
3. Procured from many 3. Procured from 2 or 3 3. Procured from 2
sources. sources. sources.
4. More effort is made 4. Moderate effort to 4. Minimum effort to
to reduce lead time. reduce lead time. reduce lead time.
 ABC analysis (Inventory)
The ABC approach states that, when reviewing inventory, a company
should rate items from A to C, basing its ratings on the following
rules:
A-items are goods which annual
consumption value is the highest. The top
70-80% of the annual consumption value of the
company typically accounts for only 10-20% of
total inventory items.
B-items are the interclass items, with a medium
consumption value. Those 15-25% of annual
consumption value typically accounts for 30% of
total inventory items.
C-items are, on the contrary, items with the
lowest consumption value. The lower 5% of
 ABC Classification System
Classifying inventory according to
some measure of importance and
allocating control efforts
accordingly.
A- very important
B- mod. important High
A
Annual
C- least important $ value B
of items

Low C
Low High
Percentage of Items
12-49
ABC Classification System
 Policies employed for A
items may include
More emphasis on
supplier development
Tighter physical
inventory control
More care in forecasting
 VED ANALYSIS
 VED ( VITAL-ESSENTIAL-DESIRABLE )
analysis represents classification of items
based on their criticality.
 VITAL- This category encompasses those
items for want of which production would
come to halt.
 ESSENTIAL- Items whose stockout cost is
very high.
 DESIRABLE –Items which do not cause
immediate halt in production or their
Typical categorization
plan
POINTS CLASSIFICATION
100 – 160 DESIRABLE

161 – 230 ESSENTIAL

231 - 300 VITAL

 F-S-N ANALYSIS

 F-S-N analysis is based on the consumption

figure of items. The items under this analysis
are classified into three groups :
 F ( fast moving ) ,S ( slow moving ) & N
( non moving )

To conduct this analysis the last date of

receipt or the last date of issue whichever is
later taken into account and the period,
usually in terms of no. of months, that has
Importance of F-S-N analysis

 It helps to identify :
 active items which require to review
regularly.

 surplus items whose stocks are higher than

their rate of consumption.

 non moving items which are not being

consumed. The last two categories are
viewed further to decide on disposal action
Than
k