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    Carrying Cost: Inventory Costs

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    Vivek Kumar Gupta
    The document discusses inventory costs including carrying costs, ordering/setup costs, purchase costs, and shortage costs. It provides formulas for calculating total annual costs using economic order quantity (EOQ) and economic batch quantity (EBQ) models. It also covers topics like service level, safety stock, regression analysis, seasonal indices, exponential smoothing, and measuring forecast accuracy.

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    Carrying Cost: Inventory Costs

    Uploaded by

    Vivek Kumar Gupta
    86 views31 pages
    The document discusses inventory costs including carrying costs, ordering/setup costs, purchase costs, and shortage costs. It provides formulas for calculating total annual costs using economic order quantity (EOQ) and economic batch quantity (EBQ) models. It also covers topics like service level, safety stock, regression analysis, seasonal indices, exponential smoothing, and measuring forecast accuracy.

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    The document discusses inventory costs including carrying costs, ordering/setup costs, purchase costs, and shortage costs. It provides formulas for calculating total annual costs using economic order quantity (EOQ) and economic batch quantity (EBQ) models. It also covers topics like service level, safety stock, regression analysis, seasonal indices, exponential smoothing, and measuring forecast accuracy.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    86 views31 pages

    Carrying Cost: Inventory Costs

    Uploaded by

    Vivek Kumar Gupta
    The document discusses inventory costs including carrying costs, ordering/setup costs, purchase costs, and shortage costs. It provides formulas for calculating total annual costs using economic order quantity (EOQ) and economic batch quantity (EBQ) models. It also covers topics like service level, safety stock, regression analysis, seasonal indices, exponential smoothing, and measuring forecast accuracy.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 31

    Inventory Costs

    1. Carrying Cost CCC


    – opportunity cost of capital
    – insurance
    – breakage, spoilage, pilferage, deterioration,
    obsolescence
    – handling & storage
    – Storekeeping
    CC = Carrying cost per unit per annum
    f = Company-wide Carrying Cost rate in fraction
    Cu = Average Cost per unit of material stocked
    CC = f x Cu
    CCC = Q/2. CC
    Inventory Costs …contd.
    2. Ordering Or Set-up Cost CCO
    CO = Cost of ordering per order / set up
    no = Number of orders placed in a year
    =R÷Q
    Q = quantity ordered per order
    CCO = CO * no
    3. Purchase Cost CCu = R . Cu
    4. Shortage Cost CCs = QS . Cs / 2
    Basic Fixed-Order Quantity (EOQ) Model
    Formula
    Total Annual Annual Annual
    Annual = Purchase + Ordering + Holding
    Cost Cost Cost Cost

    R Q
    TC = RCu + Co + Cc
    Q 2

    E.O.Q.= Qo=√ 2R.Co/Cc


    TVC = √ 2 R. Co. Cc
    2. Economic Batch Quantity (EBQ)/
    Production Model
    Total Annual Annual Annual
    Annual = Production + Set up + Holding
    Cost Cost Cost Cost

    R Q
    TC = RCu + Co + (1 - r/p)Cc
    Q 2

    EBQ = QB = √2RCo/Cc(1 – r/ p)
    TVC = √ 2 R. Co. Cc.(1 – r/ p)
    EOQ Model with Inflation
    EOQ (with inflation)
    =√ 2R.Co. (1 + i/2)/[ (f – i).Cu]
    SERVICE LEVEL (contd.)
    • Service Level (Fx) can also be calculated by equating
    Carrying cost per unit per annum with shortage cost
    per unit per annum.
    i.e. Cc = Cs
    = Csus * Prob. Of shortage * Number of
    times shortage situations can occur
    in a year
    = Csus * (1 – Fx) * R/Q
    • (1 – Fx) = Cc * (Q÷R) * 1 / Csus
    Fx = 1 - Cc * (Q÷R) * 1 / Csus
    SERVICE LEVEL (contd.)
    Service Level (Fx) can also be calculated by
    using the following formula:
    Fx = Ku / (Ku + Ko)
    where Ku = Opportunity cost of under
    stocking an item
    Ko = Opportunity cost of over
    stocking an item
    SAFETY STOCK (constant lead time and normally distributed DDLT)

    • For the desired service level, find the value of


    Z from the table “Area under Normal Curve”
    • Let µL be Mean demand during lead time
    (DDLT) and σL be standard deviation of
    demand during lead time. Also let x be stock
    at which order is placed i.e. ROP
    • (X - µL)/σL = Z
    • Safety stock is = Z x σL
    • Take value of Z = 2.6 (2.33 for 95% service level)
    Regression and Seasonal Index
    Year Q1 Q2 Q3 Q4
    1 520 730 820 530
    2 590 810 900 600
    3 650 900 1000 650

    1200
    1000
    800
    Sales

    600
    400
    200
    0
    0 1 2 3 4 5 6 7 8 9 10 11 12 13
    Period
    Regression and Seasonal Index

    Year Q1 Q2 Q3 Q4
    1 520 730 820 530
    2 590 810 900 600
    3 650 900 1000 650
    Sum 1760 2440 2720 1780
    Regression and Seasonal Index

    Year Q1 Q2 Q3 Q4 Annual total


    1 520 730 820 530 2600
    2 590 810 900 600 2900
    3 650 900 1000 650 3200
    Sum 1760 2440 2720 1780 8700
    Avg 586.7 813.3 906.7 593.3 725.0
    Regression and Seasonal Index

    Year Q1 Q2 Q3 Q4 Annual total


    1 520 730 820 530 2600
    2 590 810 900 600 2900
    3 650 900 1000 650 3200
    Sum 1760 2440 2720 1780 8700
    Avg 586.7 813.3 906.7 593.3 725.0
    SI 0.809 1.122 1.251 0.818
    Regression and Seasonal Index
    De-seasonalized data

    For year 1 and Q1, 520 / 0.809 = 642.6

    Year Q1 Q2 Q3 Q4
    1 642.6 650.7 655.7 647.6
    2 729.1 722.0 719.7 733.1
    3 803.3 802.3 799.6 794.2
    Regression and Seasonal Index
    De-seasonalized data

    850.0
    800.0
    750.0
    700.0
    Sales

    650.0
    600.0
    550.0
    500.0
    0 1 2 3 4 5 6 7 8 9 10 11 12 13
    Period
    Exponential Smoothing

    • The weights used to compute the forecast (moving


    average) are exponentially distributed.

    • The forecast is the sum of the old forecast and a


    portion (a) of the forecast error (A t-1 - Ft-1).

    Ft = Ft-1 + a(A t-1 - Ft-1)


    Exponential Smoothing
    • The smoothing constant, , must be
    between 0.0 and 1.0.
    • If demand is stable, value of  may be taken
    between 0.1 to 0.3 to smoothen out sudden
    noise, if any, that might have occurred.
    • If demand is slightly unstable, value of 
    may be taken between 0.4 to 0.6
    • If demand is unstable (generally for new
    products), value of  may be taken between
    0.7 to 0.9
    Example: Central Call Center
    Moving Average

    CCC wishes to forecast the number of incoming calls it


    receives in a day from the customers of one of its clients.
    CCC schedules the appropriate number of telephone
    operators based on projected call volumes.
    CCC believes that the most recent 12 days of call volumes
    (shown on the next slide) are representative of the near
    future call volumes.
    Example: Central Call Center

    Moving Average
    Representative Historical Data

    Day Calls Day Calls


    1 159 7 203
    2 217 8 195
    3 186 9 188
    4 161 10 168
    5 173 11 198
    6 157 12 159
    Example: Central Call Center

    Moving Average

    Use the moving average method with an AP = 3


    days to develop a forecast of the call volume in
    Day 13.

    F13 = (168 + 198 + 159)/3 = 175.0 calls


    Example: Central Call Center
    Weighted Moving Average
    Use the weighted moving average method with an AP
    = 3 days and weights of 0.1 (for oldest datum), 0.3, and
    0.6 to develop a forecast of the call volume in Day 13.

    F13 = 0.1(168) + 0.3(198) + 0.6(159) = 171.6 calls

    Note: The WMA forecast is lower than the MA


    forecast because Day 13’s relatively low call volume
    carries almost twice as much weight in the WMA
    (0.60) as it does in the MA (0.33).
    Example: Central Call Center

    Exponential Smoothing

    If a smoothing constant value of 0.25 is used and the


    exponential smoothing forecast for Day 11 was
    180.76 calls, what is the exponential smoothing
    forecast for Day 13?

    F12 = 180.76 + 0.25(198 – 180.76) = 185.07


    F13 = 185.07 + 0.25(159 – 185.07) = 178.55
    Measuring Accuracy

    • Accuracy of a forecasting approach needs to be measured


    to assess the confidence you can have in its forecasts and
    changes in the market may require re-evaluation of the
    approach

    • Accuracy can be measured in several ways


    – Standard Error of the forecast (covered earlier)
    – Mean Absolute Deviation (MAD)
    – Mean Squared Error (MSE)
    Measuring Accuracy

    Mean Absolute Deviation (MAD)


    Sum of absolute deviation for n periods
    MAD=
    n
    n

     Actual demand -Forecast demand


    i i
    MAD = i=1

    n
    Measuring Accuracy

    Mean Squared Error (MSE)

    MSE = (SE)2

    A small value for SE means data points are tightly grouped around
    the line and error range is small.
    When the forecast errors are normally distributed, the values of
    MAD and S.E are related:
    MSE = 1.25 (MAD)
    Example: Central Call Center
    AP = 3 a = .25
    Day Calls Forec. |Error| Forec. |Error|

    4 161 187.3 26.3 186.0 25.0


    5 173 188.0 15.0 179.8 6.8
    6 157 173.3 16.3 178.1 21.1
    7 203 163.7 39.3 172.8 30.2
    8 195 177.7 17.3 180.4 14.6
    9 188 185.0 3.0 184.0 4.0
    10 168 195.3 27.3 185.0 17.0
    11 198 183.7 14.3 180.8 17.2
    12 159 184.7 25.7 185.1 26.1

    MAD 20.5 18.0


    Example: College Enrollment
    • Simple Linear Regression

    At a small regional college enrollments have grown steadily over the past six
    years, as evidenced below. Use time series regression to forecast the student
    enrollments for the next three years.

    Students Students
    Year Enrolled (1000s) Year Enrolled (1000s)
    1 2.5 4 3.2
    2 2.8 5 3.3
    3 2.9 6 3.4
    Simple Linear Regression
    • Constants a and b

    The constants a and b are computed using the following


    equations:

    a=
      y- x xy
    x 2

    n  x 2 -(  x)2

    n xy-  x y
    b=
    n  x 2 -(  x)2
    Simple Linear Regression

    • Once the a and b values are computed, a future value of


    X can be entered into the regression equation and a
    corresponding value of Y (the forecast) can be
    calculated.
    Example: College Enrollment
    • Simple Linear Regression

    x y x2 xy
    1 2.5 1 2.5
    2 2.8 4 5.6
    3 2.9 9 8.7
    4 3.2 16 12.8
    5 3.3 25 16.5
    6 3.4 36 20.4
    Sx=21 Sy=18.1 Sx2=91 Sxy=66.5
    Example: College Enrollment
    • Simple Linear Regression
    91(18.1)  21(66.5)
    a  2.387
    6(91)  (21) 2

    6(66.5)  21(18.1)
    b  0.180
    105

    Y = 2.387 + 0.180X
    Example: College Enrollment

    Predicting the future

    Y7 = 2.387 + 0.180(7) = 3.65 or 3,650 students

    Y8 = 2.387 + 0.180(8) = 3.83 or 3,830 students

    Y9 = 2.387 + 0.180(9) = 4.01 or 4,010 students

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