CHT 6 Inventory

Chapter 6
Inventory Control Models
Types of Inventory
Uses of Inventory
As
a buffer to decouple
suppliers and users,

manufacturers and customers,
two workstations in a workshop.
Costs Related to Inventory

Carrying
(holding) cost
Ordering cost
Stockout cost
Purchase (material) cost
Carrying Cost
Includes:
Capital cost
Opportunity costs,
Storage space rental, and labor and
facilities for storage,
Cost of obsolescence and damage,
Insurance.
Varies
with the amount of inventory.

5
Ordering Cost
Includes:
Shipping and handling cost,

Cost of processing orders, such as forms,
papers, labor.
Typically, this cost varies with number of

orders, not with number of units in an order.
Stockout Cost
Includes:
Lost profit,
Expediting and back ordering expenses,
Cost of reputation and goodwill
Inventory Profile
Average Inventory
Inventory
level changes everyday.

Average inventory is often used to
measure inventory level
Average daily inventory level
number of units in an order Q
2
2
9
Some Basic Calculations (1 of 2)

D=annual demand in units
Co=ordering cost per order
Ch=carrying cost per unit per year
Q=order quantity = number of units in an order.
Number of orders required in a year

annual demand in units
D
number of units in an order Q

10
Some Basic Calculations (2 of 2)

Q
Total annual holding cost =
Ch
2
Total
Total
D
annual ordering cost Co
Q
annual inventory cost
Q
D
Ch Co
2
Q
11
Economic Order Quantity

(EOQ)
EOQ
is the order quantity at which the

total annual cost (annual holding cost +
annual ordering cost) is minimized.
12
EOQ Total Costs

Total annual costs
= annual ordering costs + annual holding costs
13
Formula for EOQ

Let Q* be Economical Order Quantity (EOQ):
2 DCo
Q*
Ch
14
Simco Pump Example (p.197)

Annual demand = 1,000 units
Ordering cost = $10 / order
Annual holding cost = $0.5 / unit
What is the best order quantity?
15

With order quantity Q*=200 units,
(a) How many orders would be made
annually?
(b) What is the total annual ordering cost?
(c) What is the average daily inventory?
(d) What is total annual holding cost?
(e) What is the total annual inventory cost?
16

We have found the EOQ is 200 units per
order, and the associated total annual
inventory cost is $100.
If the company orders 250 units each
time, what is total inventory cost then?
If the company orders 100 units each
time, what is total inventory cost then?
17
Purchase Cost, C
Purchase cost, C, of inventory items is not
in the EOQ formula, since the order
quantity Q does not affect the annual
purchase cost, DC. That is, C is not
relevant in determining the order quantity.
Sometime, unit carrying cost is a percent, I,
of the purchase cost of the item, i.e., Ch=IC.
18
Reorder Point
Reorder
point is in terms of number of

units on hand, at which an order should
be placed.
Reorder point must be at least the
demand during the lead time (delivery
time).
19
Safety Stock
Safety
stock is the extra stock to help

in avoiding stockout, when there exist
uncertainties in demand and lead time.
20
Safety Stock and Uncertainties
21
Formula for Reorder Point

Reorder
Point
= dL + SS
where
d = average daily demand in units
L = lead time in days
SS = safety stock in units
22
Example (p.201 extended)

Procomps annual
demand is 8,000
units. There are 200 work days per
year. So, daily demand is 40 units.
Lead time = 3 days
Safety stock = 20 units
What is the reorder point (ROP)?
23
How Does EOQ Work in

Inventory Control?
For
each item k, calculate its economic

order quantity Qk* and its reorder point
ROPk.
Keep
watching the inventory on hand.

If the stock of item k drops to ROPk,
order Qk* units of item k.
24
EOQ Assumptions (p.193)

Demand
rate is constant.
The ordered units are delivered in a
single shipment (instantaneous).
No quantity discount is available
All demand is satisfied (no shortages)
25
EOQ without Instantaneous

Receipt Assumption (p.201)
The ordered units arrive piece by piece.
Application example:
A company's finished good inventory that is

supplied by its production department.
It is called Production Run Model

The best order quantity is called Optimal
Production Quantity (OPQ).
26
OPQ Formula
d = daily demand in units,
p = daily production capacity in units,
Cs = setup cost (similar to Co)
D and Ch are defined same as before,
then *
2 DCs
d
Ch (1 )
p
27
Meaning of Q* in OPQ:
Q*
here is still the order quantity

(number of units in an order), but
the order is issued to the production
department of the same company.
Therefore, Q* can also be
understood as the production batch
size.
28
Formulas in Production Run Model
Maximum Inventory Level
d
Q (1 )
p
Average Inventory Level
Q
d
(1 )
2
p
29
Formulas in Production Run Model

D
Total annual ordering cost =
Cs
Q
(same as for EOQ)

Q
d
Total annual holding cost (1 ) C h
2
p
Total annual inventory cost
D
Q
d
Cs (1 ) C h
Q
2
p
30
Example of Brown Manuf. (p.203)

Annual demand = 10,000 units;
Setup (ordering) cost = $100/order
Carrying cost = $0.50/unit/year
Daily production rate = 80 units
Daily demand rate = 60 units.
Once a unit is finished, it is counted into the
inventory.
31
To Find EOQ under Quantity

Discount (p.206 209)
Trial-and-error
method in general
May develop a spreadsheet that
calculate the total cost for each
possible order quantity. Then, pick up
the order quantity with the lowest total
cost. (See class demonstration)
32
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Chapter 6

Inventory Control Models

suppliers and users,

Costs Related to Inventory

with the amount of inventory.

Shipping and handling cost,

Typically, this cost varies with number of

level changes everyday.

Some Basic Calculations (1 of 2)

Number of orders required in a year

number of units in an order Q

Some Basic Calculations (2 of 2)

annual inventory cost

Economic Order Quantity

is the order quantity at which the

EOQ Total Costs

Formula for EOQ

Simco Pump Example (p.197)

What is the best order quantity?

Simco Pump Example (p.197)

Simco Pump Example (p.197)

point is in terms of number of

stock is the extra stock to help

Safety Stock and Uncertainties

Formula for Reorder Point

Example (p.201 extended)

How Does EOQ Work in

each item k, calculate its economic

watching the inventory on hand.

EOQ Assumptions (p.193)

EOQ without Instantaneous

A company's finished good inventory that is

It is called Production Run Model

here is still the order quantity

Formulas in Production Run Model

Maximum Inventory Level

Average Inventory Level

Formulas in Production Run Model

(same as for EOQ)

Example of Brown Manuf. (p.203)

To Find EOQ under Quantity

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