Inventory Management 12 2014 Pearson Education Inc 2014 Pearson Education Inc 12 1 Learning Objectives When you complete this chapter you should be able to 1 Conduct an ABC analysis 2 Explain and use cycle counting 3 Explain and use the EOQ model for independent inventory demand 4 Compute a reorder point and safety stock 5 Apply the production order quantity model 6 Explain and use the quantity discount model 7 Understand periodic review systems vs continuous review 8 Apply the Newsboy Problem EXTRA 2014 Pearson Education Inc 12 2 Inventory Management The objective of inventory management is to strike a between inventory and 2014 Pearson Education Inc 12 3 Importance of Inventory One of the most expensive assets of many companies representing as much as 50 of total must balance inventory investment and customer service 2014 Pearson Education Inc 12 4 Functions of Inventory 1 To provide a selection of goods for anticipated demand and to separate the firm from fluctuations in demand 2 To decouple or separate various parts of the production process 3 To take advantage of quantity discounts 4 To hedge against inflation 2014 Pearson Education Inc 12 5 Types of Inventory Purchased but not processed Undergone some change but not completed A function of cycle time for a product Necessary to keep machinery and processes productive Completed product awaiting shipment 2014 Pearson Education Inc 12 6 Managing Inventory 1 How inventory items can be analysis 2 How inventory records can be maintained 2014 Pearson Education Inc 12 7 ABC Analysis Divides inventory into three based on annual dollar volume Class high annual dollar volume Class medium annual dollar volume Class low annual dollar volume Used to establish that focus on the few parts and not the many trivial ones 2014 Pearson Education Inc 12 8 ABC Analysis Other criteria than annual dollar volume may be used Anticipated changes Delivery problems problems High cost 2014 Pearson Education Inc 12 9 ABC Analysis Policies employed may include More on supplier development for A items Tighter physical inventory for A items More in forecasting A items 2014 Pearson Education Inc 12 10 Record Accuracy Accurate records are a ingredient in production and inventory systems Allows organization to on what is needed Necessary to make decisions about ordering scheduling and shipping Incoming and outgoing record keeping must be accurate Stockrooms should be 2014 Pearson Education Inc 12 11 Cycle Counting Items are counted and records updated on a basis Often used with ABC analysis to cycle Has several advantages 1 Eliminates shutdowns and interruptions 2 Eliminates annual inventory adjustment 3 Trained personnel audit inventory accuracy 4 Allows causes of errors to be identified and corrected 5 Maintains inventory records 2014 Pearson Education Inc 12 12 Control of Service Inventories Can be a critical component of profitability Losses may come from shrinkage or pilferage Applicable techniques include 1 Good personnel selection training and discipline 2 Tight control on incoming shipments 3 Effective control on all goods leaving facility 2014 Pearson Education Inc 12 13 Independent Versus Dependent Demand demand the demand for item is independent of the demand for any other item in inventory demand the demand for item is dependent upon the demand for some other item in the inventory 2014 Pearson Education Inc 12 14 Inventory Costs costs the costs of holding or carrying inventory over time costs the costs of placing an order and receiving goods costs cost to prepare a machine or process for manufacturing an order May be highly correlated with 2014 Pearson Education Inc 12 15 Inventory Models for Independent Demand Need to determine and to order 1 Basic EOQ economic order quantity 2 Production order quantity 3 Quantity discount model 2014 Pearson Education Inc 12 16 Basic EOQ Model Important assumptions 1 Demand is known constant and independent 2 Lead time is known and constant 3 Receipt of inventory is instantaneous and complete 4 Quantity discounts are not possible 5 Only variable costs are setup and holding 6 Stockouts can be completely avoided 2014 Pearson Education Inc 12 17 Minimizing Costs By minimizing the sum of setup or ordering and holding costs total costs are Optimal order size Q will minimize total cost total cost A reduction in either cost reduces the Optimal order quantity occurs when holding cost and setup cost are 2014 Pearson Education Inc 12 18 Minimizing Costs Q Number of pieces per order Q Optimal 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 Annual setup cost Number of orders placed per year x Setup or order cost per order Annual demand Number of units in each order Setup or order cost per order 2014 Pearson Education Inc 12 19 Minimizing Costs Q Number of pieces per order Q Optimal 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 Annual holding cost Average inventory level x Holding cost per unit per year Order quantity 2 Holding cost per unit per year 2014 Pearson Education Inc 12 20 Minimizing Costs Q Number of pieces per order Q Optimal 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 Optimal order quantity is found when annual setup cost equals annual holding cost Solving for Q 2014 Pearson Education Inc 12 21 An EOQ Example Determine optimal number of needles to order D 1 000 units S 10 per order H 50 per unit per year Q units 2014 Pearson Education Inc 12 22 An EOQ Example Determine expected number of orders D 1 000 units S 10 per order H 50 per unit per year Q 200 units Expected number of orders Demand N Order quantity N orders per year 2014 Pearson Education Inc 12 23 An EOQ Example Determine optimal time between orders D 1 000 units S 10 per order H 50 per unit per year Q 200 units N 5 orders year Expected time between orders T Number of working days per year Expected number of orders T days between orders 2014 Pearson Education Inc 12 24 An EOQ Example Determine the total annual cost D 1 000 units S 10 per order H 50 per unit per year Q 200 units N 5 orders year T 50 days Total annual cost Setup cost Holding cost 2014 Pearson Education Inc 12 25 The EOQ Model When including