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Inventory Management A Presentation by R.K.Agarwal, Manager (Finance), PFC

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**Inventory Control Inventory System Defined Inventory Costs**

Independent vs. Dependent Demand Basic Fixed-Order Quantity Models Quantity Discounts-also known as price break models. 2

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**Inventory System Defined**

raw materials, finished products, component parts, supplies, and work-in-process. An inventory system is the set of policies and controls that monitor levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be. 3

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**Purposes of Inventory 1. To maintain independence of operations.**

2. To meet variation in product demand. 3. To allow flexibility in production scheduling. 4. To provide a safeguard for variation in raw material delivery time. 5. To take advantage of economic purchase-order size. 4

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**Inventory Costs Holding (or carrying) costs.**

Costs for storage, handling, insurance, etc. Setup (or production change) costs. Costs for arranging specific equipment setups, etc. Ordering costs. Costs of someone placing an order, etc. Shortage costs. Costs of canceling an order, etc. 5

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**Independent vs. Dependent Demand**

Independent Demand (Demand not related to other items or the final end-product) Video: Dependent Demand (Derived demand items for component parts, subassemblies, raw materials, etc.) Managing Inventory 6

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Independent Demand

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Dependent Demand

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**Classifying Inventory Models**

Fixed-Order Quantity Models Event triggered (Example: running out of stock) The sale of an item reduces the inventory position to the re order point. Fixed-Time Period Models Time triggered (Example: Monthly sales call by sales representative) 7

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**Fixed-Order Quantity Models: Model Assumptions (Part 1)**

Demand for the product is constant and uniform throughout the period. Lead time (time from ordering to receipt) is constant. Price per unit of product is constant. 8

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**Fixed-Order Quantity Models: Model Assumptions (Part 2)**

Inventory holding cost is based on average inventory. Ordering or setup costs are constant. All demands for the product will be satisfied. (No back orders are allowed.) 9

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**Basic Fixed-Order Quantity Model and Reorder Point Behavior**

R = Reorder point Q = Economic order quantity L = Lead time L Q R Time Number of units on hand 10

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**Cost Minimization Goal**

Total Cost C O S T Holding Costs Annual Cost of Items (DC) Ordering Costs QOPT Order Quantity (Q) 11

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**Basic Fixed-Order Quantity (EOQ) Model Formula**

Total Annual Cost = Annual Purchase Cost Ordering Holding + TC = Total annual cost D = Demand C = Cost per unit Q = Order quantity S = Cost of placing an order or setup cost R = Reorder point L = Lead time H = Annual holding and storage cost per unit of inventory 12

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Deriving the EOQ 13

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**EOQ Example Problem Data**

Given the information below, what are the EOQ and reorder point? Annual Demand = 1,000 units Days per year considered in average daily demand = 365 Cost to place an order = Rs10 Holding cost per unit per year = Rs2.50 Lead time = 7 days Cost per unit = Rs15 14

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EOQ Example Solution with no safety stock 15

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**Safety Stock Quantity Maximum probable demand Expected demand**

LT Time Expected demand during lead time Maximum probable demand ROP Quantity Safety stock Safety stock reduces risk of stockout during lead time

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**Reorder Point The ROP based on a normal**

Risk of a stockout Service level Probability of no stockout Expected demand Safety stock z Quantity z-scale The ROP based on a normal Distribution of lead time demand

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**Special Purpose Model: Price-Break Model Formula**

Based on the same assumptions as the EOQ model, the price-break model has a similar Qopt formula: i = annual percentage of unit cost attributed to carrying inventory C = cost per unit 13

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**Price-Break Example Problem Data (Part 1)**

Order Quantity(units) Price/unit(Rs.) 0 to 2, 2,500 to 3, 4,000 or more Start at lowest price per unit. 14

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**Price-Break Example Solution (Part 2)**

First, start with the lowest price per unit. Annual Demand (D)= 10,000 units Cost to place an order (S)= Rs.4 Carrying cost % of total cost (i)= 2% Cost per unit (C) = Rs1.20, Rs.1.00, Rs.0.98 Next, determine if the computed Qopt values are feasible or not. Interval from 4000 & more, the Qopt value is not feasible. Interval from , the Qopt value is not feasible. Interval from 0 to 2499, the Qopt value is feasible. 15

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**Price-Break Example Solution (Part 3)**

Next, Compare total cost for the feasible root Q and price break Q values. TC(1826)=(10000*1.20)+(10000/1826)*4+(1826/2)(0.02*1.20) = Rs12,043.82 TC(2500) = Rs10,041 TC(4000) = Rs9,949.20 15

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**Because the total annual cost function is a “u” shaped function.**

Price-Break Example Since the feasible solution occurred in the first price-break, it means that all the other true Qopt values occur at the beginnings of each price-break interval. Why? Because the total annual cost function is a “u” shaped function. Total annual costs Order Quantity EOQ Not EOQ Not EOQ 15

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**ABC Classification System**

Items kept in inventory are not of equal importance in terms of: Amount invested profit potential sales or usage volume stock-out penalties 60 % of $ Value A 30 B C % of Use 30 60 So, identify inventory items based on percentage of total value , where “A” items are roughly top 15 %, “B” items as next 35 %, and the lower 65% are the “C” items. 26

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**THANKS Other Aspects Just In Time Inventory (Zero Inventory Model).**

Defining Minimum Level, Max. Level, Re-order level, Safety Level, etc. Identifying Slow Moving / Non Moving and obsolete items. Scrap Disposal THANKS 26

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© The McGraw-Hill Companies, Inc., 2004 1. 2 Chapter 14 Inventory Control.

© The McGraw-Hill Companies, Inc., 2004 1. 2 Chapter 14 Inventory Control.

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