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1 Inventory Control Models. 2 Chapter Learning Objectives Students will be able to: –Use the economic order quantity (EOQ) to determine how much to order.

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Presentation on theme: "1 Inventory Control Models. 2 Chapter Learning Objectives Students will be able to: –Use the economic order quantity (EOQ) to determine how much to order."— Presentation transcript:

1 1 Inventory Control Models

2 2 Chapter Learning Objectives Students will be able to: –Use the economic order quantity (EOQ) to determine how much to order. –Compute the reorder point (ROP) in determining when to order more inventory. –Understand the importance of inventory control. –Perform sensitivity analysis on basic inventory quantities.

3 3 Chapter Learning Objectives continued Students will be able to: –Understand the use of safety stock with known and unknown stockout costs. –Perform ABC analysis.

4 4 Inventory as an Important Asset Inventory can be the most expensive and the most important asset for an organization Other Assets 60% Inventory 40% Inventory as a percentage of total assets

5 5 The Inventory Process SuppliersCustomers Finished Goods Raw Materials Work in Process Fabrication and Assembly Inventory Storage Inventory Processing

6 6 Importance of Inventory Control Five Functions of Inventory Decoupling Storing resources Adapting to irregular supply and demand Enabling the company to take advantage of quantity discounts Avoiding stockouts and shortages

7 7 Inventory Decisions How much to order When to order wish to minimize total inventory cost

8 8 Inventory Costs Cost of the items Cost of ordering Cost of carrying, or holding inventory Cost of safety stock Cost of stockouts

9 9 Ordering Costs Developing and sending purchase orders Processing and inspecting incoming inventory Bill paying Inventory inquiries Utilities, phone bills, etc., - purchasing department. Salaries/wages - purchasing department employees Supplies (e.g., forms and paper) - purchasing department

10 10 Carrying Costs Cost of capital TaxesInsuranceSpoilageTheftObsolescence Salaries/wages - warehouse employees Utilities/building costs - warehouse Supplies (e.g., forms, paper) - warehouse

11 11 Inventory Usage Over Time

12 12 Costs as Functions of Order Quantity Annual Cost Order QuantityQ*Q* Total Cost Curve Carrying (holding) Cost Curve Ordering (set- up) Cost Curve Minimum Cost

13 13 Steps in Finding the Optimum Inventory Develop an expression for the ordering cost. Develop and expression for the carrying cost. Set the ordering cost equal to the carrying cost. Solve this equation for the optimum desired.

14 14 EOQ : Basic Assumptions Demand is known and constant Lead time is known and constant Receipt of inventory is instantaneous Quantity discounts are not possible The only variable costs are the cost of setting up or placing an order, and the cost of holding or storing inventory over time Stockouts can be completely avoided if orders are placed at the appropriate time

15 15 Annual ordering cost: Annual holding or carrying cost: Total inventory cost: Developing the EOQ

16 16 EOQ h C 2DC * Q Per Unit Carrying Cost: Percentage Carrying Cost: IP DC Q * 0

17 17 Inputs and Outputs of the EOQ Model EOQ Models Input ValuesOutput Values Annual Demand (D) Ordering Cost (C o ) Carrying Cost (C h ) Lead Time (L) Demand Per Day (d) Economic Order Quantity (EOQ) Reorder Point (ROP)

18 18 The Reorder Point (ROP) Curve ROP = (Demand per day) x (Lead time for a new order, in days) = d x L Inventory Level (Units) Q*Q* ROP (Units) Slope = Units/Day = d Lead Time (Days) L

19 19 The Use of Safety Stock Inventory on Hand Inventory on Hand Stockout Time Stockout is avoided Time Safety Stock

20 20 The Use of Safety Stock Known stockout costs: –Given probability of demand, find total cost for each safety stock alternative Unknown stockout costs: –Set service level; use normal distribution

21 21 Service Level versus Carrying Costs

22 22 Summary of ABC Analysis Group A Items - Critical Group B Items - Important Group C Items - Not That Important Inventory Group Dollar Usage (%) Inventory Items (%) Are Complex Quantitative Control Techniques Used? ABCABC Yes In some cases No

23 23 ABC Inventory Analysis Percent of Inventory Items Percent of Annual Dollar Usage A Items B Items C Items

24 24 ABC Inventory Policies Greater expenditure on supplier development for A items than for B items or C items Tighter physical control on A items than on B items or on C items Greater expenditure on forecasting A items than on B items or on C items


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