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Presentation on theme: "21-1 HANSEN & MOWEN Cost Management ACCOUNTING AND CONTROL."— Presentation transcript:


2 21-2 Inventory Management: Economic Order Quantity, JIT, and the Theory of Constraints 21

3 21-3 Three types of inventory costs can be readily identified with inventory: (1)The cost of acquiring inventory. (2)The cost of holding inventory. (3)The cost of not having inventory on hand when needed. Just-in-Case Inventory Management 1

4 21-4 1.Ordering Costs: The costs of placing and receiving an order. Examples:Clerical costs, documents, insurance for shipment, and unloading. 2. Setup Costs: The costs of preparing equipment and facilities so they can be used to produce a particular product or component. Examples: Setup labor, lost income (from idled facilities), and test runs. Just-in-Case Inventory Management 1

5 21-5 3.Stock-Out Costs: The costs of not having sufficient inventory. Examples:Lost sales, costs of expediting (extra setup, transportation, etc.) and the costs of interrupted production. 4.Carrying Costs: The costs of carrying inventory. Examples:Insurance, inventory taxes, obsolescence, opportunity cost of capital tied up in inventory, and storage. Just-in-Case Inventory Management 1

6 21-6 Just-in-Case Inventory Management 1 Traditional Reasons for Carrying Inventory

7 21-7 Economic Order Quantity TC = PD/Q + CQ/2 The total ordering (or setup) and carrying cost The cost of placing and receiving an order (or the cost of setting up a production run) The known annual demand The number of units ordered each time an order is placed (or the lot size for production) The cost of carrying one unit of stock for one year Just-in-Case Inventory Management 1

8 21-8 An EOQ Illustration EOQ =  2PD/C D = 25,000 units Q = 500 units P = $40 per order C = $2 per unit EOQ =  (2 x 25,000 x $40) / $2 EOQ =  1,000,000 EOQ = 1,000 units Just-in-Case Inventory Management 1

9 21-9 Reorder point = Rate of usage x Lead time Example: Assume that the average rate of usage is 100 parts per day. Assume also that the lead time is 4 days. What is the reorder point? Reorder point = 4 x 100 = 400 units Thus, an order should be placed when inventory drops to 400 units. When to Order or Produce Just-in-Case Inventory Management 1

10 21-10 Just-in-Case Inventory Management 1 The Reorder Point

11 21-11 Demand Uncertainty and Reordering To avoid running out of parts, organizations often choose to carry safety stock. Safety stock is extra inventory carried to serve as insurance against fluctuations in demand. Example: If the maximum usage of the VCR part is 120 units per day, the average usage is 100 units per day, and the lead time is four days, the safety stock is 80. Maximum usage120 Average usage-100 Difference20 Lead time x 4 Safety stock80 Just-in-Case Inventory Management 1

12 21-12 Just-in-Case Inventory Management 1 EOQ and Reorder Point Illustrated

13 21-13 JIT reduces the costs of acquiring inventory to insignificant levels by: 1. Drastically reducing setup time 2. Using long-term contracts for outside purchases Carrying costs are reduced to insignificant levels by reducing inventories to insignificant levels. Setup and Carrying Costs: The JIT Approach JIT Inventory Management 2

14 21-14 Due-Date Performance: The JIT Solution Lead times are reduced so that the company can meet requested delivery dates and to respond quickly to customer demand. Lead times are reduced by: reducing setup times improving quality using cellular manufacturing JIT Inventory Management 2

15 21-15 Avoidance of Shutdown: The JIT Approach  Total preventive maintenance to reduce machine failures  Total quality control to reduce defective parts  The use of the Kanban system is also essential JIT Inventory Management 2

16 21-16 What is the Kanban System? A card system is used to monitor work in process  A withdrawal Kanban  A production Kanban  A vendor Kanban The Kanban system is responsible for ensuring that the necessary products are produced in the necessary quantities at the necessary time. JIT Inventory Management 2

17 21-17 Withdrawal Kanban JIT Inventory Management 2 Production Kanban

18 21-18 Vendor Kanban JIT Inventory Management 2

19 21-19 The Kanban Process JIT Inventory Management 2

20 21-20 Discounts and Price Increases: JIT Purchasing versus Holding Inventories  Careful vendor selection  Long-term contracts with vendors  Prices are stipulated (usually producing a significant savings)  Quality is stipulated  The number of orders placed are reduced JIT Inventory Management 2

21 21-21 JIT Limitations Patience in implications is needed. Time is required. JIT may cause lost sales and stressed workers. Production may be interrupted due to an absence of inventory. JIT Inventory Management 2

22 21-22 Basic Concepts of Constrained Optimization 3 Every firm faces limited resources and limited demand for each product.  External constraints, such as market demand  Internal constraints, such as machine or labor time availability Constrained optimization is choosing the optimal mix given the constraints faced by the firm.

23 21-23 Linear Programming The unit contribution margins are $300 and $600 for X and Y, respectively. Z = $300X + $600 Y Total contribution margin This equation is called the objective function, the function to be optimized. Basic Concepts of Constrained Optimization 3

24 21-24 Internal constraints: X + Y  80 X + 3Y  120 2X + Y  90 External constraints: X  60 Y  100 Basic Concepts of Constrained Optimization 3 Linear Programming

25 21-25 X + Y  80 X + 3Y  120 2X + Y  90 X  60 Y  100 X  0 Y  0 Linear Programming Basic Concepts of Constrained Optimization 3

26 21-26 160 140 120 100 80 60 40 20 20 40 60 80 100 120 140 Y  100 X  60 X + Y  80 X + 3Y  120 2X + Y  90 Basic Concepts of Constrained Optimization 3 D C B A Graphical Solution

27 21-27 Linear Programming Corner Point X-Value Y-Value Z = $300X + $600Y A00$ 0 B04024,000 C303027,000 D45013,500 C is the optimal solution! Basic Concepts of Constrained Optimization 3

28 21-28 Throughput Inventory Operating expenses Three Measures of Systems Performance: (Sales revenue – Unit-level variable expenses)/Time Theory of Constraints 4

29 21-29 1. Identify an organization’s constraints. 2. Exploit the binding constraints. 3. Subordinate everything else to the decisions made in Step 2. 4. Elevate the organization’s binding constraints. 5. Repeat the process as a new constraint emerges to limit output. Five-Step Method for Improving Performance Theory of Constraints 4

30 21-30 Drum-Buffer-Rope System: General Description Theory of Constraints 4 Continued Continued from left

31 21-31 Drum-Buffer-Rope System: Schaller Company Theory of Constraints 4

32 21-32 New Constraint Set: Schaller Company Theory of Constraints 4

33 21-33 End of Chapter 21

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